In a recent decision, the Delaware Court of Chancery granted a motion to dismiss a complaint asserting breach of fiduciary duty claims arising out of a stock issuance proposed by a controlling stockholder. IRA Trust f/b/o Bobbie Ahmed v. Crane, et al., C.A. No. 12742-CB (Del. Ch. Dec. 11, 2017). Addressing an issue of first impression, the Court held that the analytical framework articulated by the Delaware Supreme Court in Kahn v. M&F Worldwide, Corp., 88 A.3d 635 (Del. 2014) (“MFW”) applied to the conflicted stock issuance, and, in turn, dismissal was appropriate under the business judgment rule.
The case resulted from a reclassification of the shares of NRG Yield, Inc. (the “Company”) in order to preserve voting control of the Company’s controlling stockholder, NRG Energy, Inc. (“NRG”), which also managed the Company’s day-to-day affairs and was responsible for identifying and placing assets into the Company. The Company had two classes of stock, each of which was entitled to one vote per share. NRG owned all of the Company’s Class B shares, and public stockholders held the Class A shares. NRG held 65% of the voting power at the time of the Company’s 2013 IPO, but its voting power had declined to 55% due to the Company’s issuance of additional Class A shares to acquire assets.
NRG proposed a recapitalization to create a class of nonvoting shares that could be issued to acquire assets without reducing NRG’s control position. Following negotiations with the Company’s conflicts committee, comprised of independent directors, the transaction was revised to be a pro rata stock split where each Class A and B shareholder was issued Class C and D shares entitled to 1/100th of a vote. The proposal was conditioned at the outset on the approval of the majority of Class A shareholders not affiliated with NRG, as well as the approval of the Company’s conflicts committee. The committee recommended the transaction, and the transaction was approved by a majority of shareholders, including a majority of the shareholders not affiliated with NRG.
The plaintiff filed a class action challenging the stock issuance as a conflicted controller transaction, and naming NRG and the Company’s board of directors as defendants.
The Court's Analysis
First, the Court held that the stock issuance constituted a conflicted controller transaction subject to entire fairness review, even though it was a pro rata stock split. The Court reasoned that, consistent with prior precedent, it was appropriate to classify the stock issuance as a conflicted controller transaction because the complaint pleaded sufficient facts to establish that NRG received a “unique” or “non-ratable” benefit not shared with the Company’s other stockholders – specifically, the ability to maintain its control over the Company. Thus, the Court stated that the stock issuance “presumptively would be subject to entire fairness review.” Id. at 24.
Second, the Court concluded that it was appropriate to apply the MFW analytical framework to the stock issuance. In MFW, the Delaware Supreme Court held that the business judgment rule applied to a squeeze-out merger if certain protections were in place to protect minority stockholders – namely, “where the merger is conditioned ab initio upon both the approval of an independent, adequately-empowered Special Committee that fulfills its duty of care; and the uncoerced, informed vote of a majority of the minority stockholders.” Id. at 24-25 (quoting MFW, 88 A.3d at 644). The Court cited a number of Court of Chancery decisions endorsing the application of the MFW framework to circumstances other than squeeze-out mergers, and stated, “I can see no principled basis on which to conclude that the dual protections in the MFW framework should apply to squeeze-out mergers but not to other forms of controller transactions.” Id. at 29.
Lastly, having concluded that it was appropriate to apply the MFW framework, the Court assessed whether the MFW framework had been satisfied based on the face of the pleadings. Under the MFW framework, the business judgment rule applies if six elements are met: (1) the transaction is conditioned on the approval of both a Special Committee and a majority of the minority stockholders; (2) the Special Committee is independent; (3) the Special Committee is empowered to select advisors and to definitively reject the transaction; (4) the Special Committee meets its duty of care in price negotiations; (5) the minority vote is informed; and (6) the minority vote is not coerced. Id. at 32 (quoting MFW, 88 A.3d at 645). The Plaintiff’s “only serious challenge” to the application of the MFW framework was that the minority vote was not informed. Id. After extensive analysis of the alleged disclosure deficiencies, the Court concluded that the Plaintiff “failed to plead facts sufficient to call into question satisfaction of any of the six elements set forth in the MFW framework.” Id. at 53.
Accordingly, the Court concluded that the business judgment rule was the appropriate standard of review. Because the Plaintiff failed to plead facts sufficient to overcome the business judgment rule, the complaint was dismissed. Id.
The decision highlights that Delaware courts are likely to apply the MFW framework broadly to conflicted controller transactions regardless of their form. Moreover, the decision follows other recent Delaware decisions demonstrating that cases challenging conflicted controller transactions are susceptible to dismissal at the pleading stage – before discovery – where the elements of the MFW framework have been met.