Delaware Confirms Fairness of Third-Party Transaction with Controlled Company

William Savitt is a partner in the Litigation Department of Wachtell, Lipton, Rosen & Katz. This post is based on a Wachtell Lipton firm memorandum by Mr. Savitt and Ryan A. McLeod. This post is part of the Delaware law series, which is cosponsored by the Forum and Corporation Service Company; links to other posts in the series are available here.

In a recent post-trial decision, the Delaware Court of Chancery upheld as entirely fair the third-party acquisition of a controlled company in which the controlling shareholder received consideration that differed from that provided to the public minority. In re John Q. Hammons Hotels Inc. S’holder Litig., C.A. No. 758-CC (Del. Ch. Jan. 14, 2011).

The matter arose from the 2005 sale of John Q. Hammons Hotels, Inc., a publicly traded company controlled by John Hammons. In the transaction, the public shareholders were cashed out at a substantial premium while Hammons himself received an ongoing preferred equity interest and other contractual rights. In an important decision earlier in the case, the Chancellor ruled that with proper planning such a transaction may be reviewed under the deferential business judgment rule, but held that the Hammons transaction would nevertheless be subject to the plaintiff-friendly “entire fairness” test due to the lack of sufficient procedural safeguards.

Even under this searching standard of review, however, the plaintiffs were unable to show that the transaction was unfair. With respect to the board process, the Chancellor emphasized that the transaction was approved by an independent special committee of the board with “extensive experience,” and he found that the committee was “thorough, deliberate, and negotiated at arm’s length” with multiple bidders over a nine-month period. Rejecting plaintiffs’ contention that the committee was intimidated into approving a deal by Hammons’ effective veto right over any transaction, the Chancellor held that “the mere possibility that the situation would return to the status quo” did not constitute coercion “render[ing] the special committee ineffective.” And with respect to the price, the Court’s thoughtful decision resolved dueling expert testimony in favor of the defense and issued a sharp critique of the plaintiffs’ expert’s “litigation-driven projections.”

Finally, the Chancellor accorded substantial weight to the overwhelming approval of the transaction by the company’s unaffiliated stockholders. The plaintiffs sought to discredit the stockholder vote on the ground that the proxy solicitation materials failed to disclose potential conflicts of interest among the special committee’s advisors. But the Court ruled that the failure to disclose mere potential conflicts, or minor matters that the board of directors was not even aware of, could not change the conclusion that shareholder support was “an undisputed fact that further supports the fairness of the Merger.”

Considered along with the earlier Hammons decision, last week’s ruling provides important practical guidance for structuring third-party transactions involving controlled companies. With careful planning, transacting parties in this situation can preserve the full protection of the business judgment rule or, at a minimum, create a record of robust process that will withstand even the close scrutiny of a trial for entire fairness.

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