At the same time, the Chancery Court signaled an openness to deferring to directors’ business judgment in deals that would ordinarily be subject to entire fairness review if “enhanced-independence” directors have approved the challenged transaction. The new approach, if established as Delaware law, would allow controlling stockholders and directors to qualify for the presumptions of the business judgment rule in self-dealing transactions even when the transaction is not conditioned on approval by a majority of the minority stockholders.
Background
The case arose from an acquisition engineered by the Batista family of Brazil, whose investment-holding company agreed in May 2017 to pay a fine of US$3.2 billion to the Brazilian government. To raise the necessary funds, JBS S.A., a large Brazilian meat-processing company controlled by the Batista holding company, was alleged to have caused its subsidiary Pilgrim’s Pride Corporation, a Nasdaq-quoted Delaware corporation that sells chicken in the United States, to acquire a separate, wholly owned subsidiary of JBS, Moy Park, Ltd., for a purchase price of US$1.3 billion.
At the time of the acquisition, JBS owned 78% of the common stock of Pilgrim’s Pride and controlled the company through its right to appoint six of the board’s nine members. The remaining three seats on the board were designated for the holders of the company’s remaining equity. A special committee of those three directors (whom the Court considered independent for pleading purposes) was formed to consider, negotiate and decide on the proposed acquisition of Moy Park. Over the course of several weeks, the special committee and JBS negotiated price and timing, eventually coming to terms on price and on an agreement for exclusivity while the deal documents were negotiated. Soon after, JBS breached the exclusivity agreement and discussed a competing bid for Moy Park with a third party, which JBS used to raise Pilgrim’s Pride’s offer. The special committee ultimately agreed to a higher price and approved the acquisition and deal documents.
In addition to the approval by the special committee, the full board of Pilgrim’s Pride approved the transaction to satisfy a covenant in the company’s bond indenture that required board approval for certain material transactions. On that same day, the full board also adopted a company bylaw designating the Delaware Court of Chancery as the sole and exclusive forum for disputes related to the company’s internal affairs.
The plaintiffs, minority stockholders of Pilgrim’s Pride, filed suit against JBS as controlling stockholder and five of the directors designated by JBS, alleging breach of their fiduciary duties for having caused Pilgrim’s Pride to consummate the acquisition at an inflated price. The plaintiff stockholders claimed that Pilgrim’s Pride did not engage in true arm’s-length bargaining with JBS, alleging in particular that Pilgrim’s Pride permitted its management team and its financial advisor to lead the negotiations despite their lack of independence from JBS and ultimately agreed to pay a purchase price that was higher than what internal analyses supported and other bidders were willing to pay.
The defendants did not dispute that the acquisition, as a transaction between a company and its controlling stockholder, would ordinarily be reviewable under the entire fairness standard of review. As the deal had not been conditioned on approval by a special committee of independent directors and a majority of the stockholders unaffiliated with JBS, the MFW framework for restoring the presumptions of the business judgment rule had not been met.2 However, JBS moved to dismiss the complaint for lack of personal jurisdiction, maintaining that the complaint did not establish any ties between JBS and the State of Delaware other than JBS’s status as controller of Pilgrim’s Pride. The defendant directors also moved to dismiss, arguing that the special committee had negotiated and approved the deal in its entirety while the defendant directors’ only involvement was approving the acquisition to avoid violating the indenture covenant.
Implied Consent to Personal Jurisdiction
The Chancery Court rejected JBS’s motion to dismiss for lack of personal jurisdiction, holding that because Pilgrim’s Pride was controlled by JBS, the Pilgrim’s Pride board’s adoption of a Delaware forum-selection bylaw with the involvement of JBS’s board representatives constituted implied consent by JBS to personal jurisdiction in Delaware. In support of its ruling, the Court cited decisions by the federal district court in Delaware and the Delaware Superior Court that held that when parties specify an exclusive forum for disputes, they implicitly agree to the existence of personal jurisdiction in that forum.3 The Court extended that principle to the controlling stockholder in the case at hand, in which the controlled board adopted the bylaw on the same day that it approved the acquisition. Given the reasonable inference that the board adopted the bylaw specifically to funnel any stockholder claims relating to the acquisition to the Delaware Court of Chancery, and that JBS was the obvious stockholder defendant in any action claiming a breach of fiduciary duties, JBS was held to have consented implicitly to personal jurisdiction in Delaware when its representatives on the Pilgrim’s Pride board voted to adopt the bylaw.4
Key Takeaways
The Chancery Court emphasized that its decision was limited to the facts of the case and that it was not making a blanket ruling that ownership of stock (even 100% ownership, let alone a mere controlling stake) in a Delaware corporation confers personal jurisdiction.5 Nevertheless, the facts of the case are common enough to serve as a warning to non-resident controlling stockholders who cause their subsidiaries to undertake an M&A transaction. Adopting a Delaware forum-selection bylaw has become common practice in M&A deals with Delaware governing law when the target company does not already have such a bylaw in place. In any situation in which a controlled subsidiary adopts a forum-selection bylaw, the controlling stockholder (assuming it at least controls a majority of the subsidiary board) should be on notice that it could be held to have submitted to personal jurisdiction in Delaware.
On the basis of the rationale described in Pilgrim’s Pride, personal jurisdiction could extend to non-resident controlling stockholders even in deals that are not self-dealing transactions. Rather, even in an arm’s-length transaction, if the target company board, a majority of whose members are appointed by the controlling stockholder, adopts a forum-selection bylaw on the same day that it approves the transaction, the non-resident controlling stockholder of the target company should similarly be on notice that it could be held to have consented to personal jurisdiction in Delaware.
Personal Liability for Approval of a Transaction
The Chancery Court further rejected the director defendants’ motion to dismiss the suit on the grounds that they were uninvolved in the deal. The director defendants argued that the full board only approved the transaction for purposes of compliance with the company’s indenture while the special committee did all the relevant work, and that their involvement was not enough to support personal liability.
The Court agreed that under Delaware law, a director can avoid liability for an interested transaction by totally abstaining from any participation in the transaction.6 Here, however, two of the director defendants did more than simply vote on the resolution to approve the transaction, but actively participated in the negotiations.7 With respect to the other three directors, the Court acknowledged that approval of a board resolution is a “slim reed” on which to base personal liability.8 However, the Court noted that the directors could have used the threat of violating the indenture covenant to halt the transaction. Their failure to do so constituted sufficient involvement in the transaction at the pleading stage to deny the director defendants’ motion to dismiss.9
Key Takeaways
The Pilgrim’s Pride decision on personal liability for directors based on mere approval of the transaction is, at this point, relevant only for purposes of dismissing a claim at the pleading stage. The decision is also somewhat ambiguous as to whether it applies only in the context of a self-dealing transaction or any time the board takes action, and whether it applies any time the board approves a transaction or only if the approval represented some failure to exercise leverage, as was the case here. Therefore, it is too soon to conclude that mere approval of a transaction can expose directors to damages. Nevertheless, directors who have properly recused themselves from participating in a conflict transaction should be aware that the mere act of approving the transaction, even for contractual-compliance purposes, can provide a basis for litigation in Delaware, if not liability.
Standard of Review
Although both parties assumed that the operative standard of review would be entire fairness, Vice Chancellor Laster suggested of his own accord that there could be another way aside from the MFW framework in certain controller transactions to lower the standard of review to the business judgment rule. Citing to an article by Lucian Bebchuk and Assaf Hamdani,10 the Court proposed that if a transaction is approved by directors who are not only independent, but who are nominated and can be removed by the minority stockholders—whom the article describes as “enhanced-independence directors”—the transaction should qualify for the more lenient business judgment rule standard of review. The Court noted Bebchuk and Hamdani’s observation that while the MFW structure works well for major transactions like squeeze-out mergers, its significant requirements are harder to meet in other types of controller transactions such as the Moy Park acquisition, where a more flexible framework might be appropriate. The paper argues that approval by enhanced-independence directors should suffice because the concern of undue influence by the controller over the decision-making of otherwise independent directors is mitigated if the minority stockholders control the directors’ selection, election and removal.
Here, the three members of the special committee who negotiated and approved the transaction for Pilgrim’s Pride were appointed to the board in a stockholder vote in which JBS was required to vote its shares in the same proportion as the shares held by the minority stockholders were voted. The Court held that as a practical matter, this voting structure would qualify the special-committee members as enhanced-independence directors. Nevertheless, the Court agreed with the plaintiff stockholders that the proposed framework opened too many questions of first impression for the Court to resolve on the current record and did not consider the approach any further.
Key Takeaways
While the Chancery Court did not rule on the application of the enhanced-independence framework, its decision in Pilgrim’s Pride signals to the deal community the Court’s readiness to take up the issue.
The enhanced-independence framework would likely be embraced in the private equity realm, where portfolio companies are frequently owned by a sponsor that would qualify as a controller under Delaware law, yet the minority stockholders at times have contractual rights to appoint directors to the board. The framework would also apply in situations beyond the typical squeeze-out merger (where the aggrieved stockholders are the minority stockholders of the target company), such as in the transaction at issue in Pilgrim’s Pride, in which the plaintiff stockholders owned equity in the buyer entity.
Various questions concerning the application of the enhanced-independence framework would have to be resolved in a future decision on the subject, including whether:
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Approval by enhanced-independence directors warrants restoring the presumptions of the business judgment rule or simply relaxing the standard of review to the intermediate standard of enhanced scrutiny.11
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A special committee comprised only of enhanced-independence directors would have to be formed to negotiate and approve the transaction in order to lower the standard of review to business judgment, or whether ordinary independent directors could also participate in the process (and, if so, whether the enhanced-independence directors must at least comprise a majority of the special committee).
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The standard of review should be lowered if the transaction is approved by enhanced-independence directors even if the transaction was not initially conditioned by the controller on such enhanced-independence directors’ approval.
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The enhanced-independence framework should be available in squeeze-out mergers, where the MFW procedural protections are required to lower the standard of review to business judgment.
Footnotes
1) In re Pilgrim’s Pride Corp. Deriv. Litig., 2019 WL 1224556 (Del. Ch. Mar. 15, 2019).
2) See Kahn v. M & F Worldwide Corp., 88 A.3d 635, 644 (Del. 2014), affirming that the business judgment rule can be the operative standard of review for a transaction that would otherwise be reviewable under entire fairness if the controller conditions the transaction on the approval of both (i) a special committee of independent directors and (ii) a majority of the minority stockholders.
3) Id. at *12.
4) Id. at *13.
5) Id. at *15.
6) Weinberger v. UOP, Inc., 457 A.2d 701, 710–11 (Del. 1983).
7) Id. at *17.
8) Id at *2.
9) Id. at *18.
10) Independent Directors and Controlling Shareholders, 165 U. Pa. L. Rev. 1271 (2017). See Pilgrim’s Pride, 2019 WL 1224556, at *8.
11) See Pilgrim’s Pride, 2019 WL 1224556, at *9, n.4.
