Court of Chancery Dismisses Challenge to Stock Reclassification

William Savitt and Ryan A. McLeod are partners at Wachtell, Lipton, Rosen & Katz. This post is based on a Wachtell Lipton publication by Mr. Savitt, Mr. McLeod, and Anitha Reddy. This post is part of the Delaware law series; links to other posts in the series are available here.

The Delaware Court of Chancery held this week that approval by a committee of independent directors and the informed vote of minority stockholders insulated from review a transaction that created and distributed new classes of low-vote stock designed to preserve the voting power of a controlling stockholder. IRA Trust FBO Bobbie Ahmed v. Crane, C.A. No. 12742-CB (Del. Ch. Dec. 11, 2017).

The case concerned the reclassification of the capital structure of NRG Yield, Inc. Since its formation, Yield has been controlled by NRG Energy, and Yield has consistently disclosed to its public investors that Energy would maintain this controlling interest. But Energy’s voting power declined as Yield issued new equity to make acquisitions and, by early 2015, Energy estimated that it could fall below a majority position in less than a year. Energy proposed that Yield create and issue pro rata new classes of stock with de minimis voting rights that could be used for future acquisitions without diluting Energy’s control position. The proposal was conditioned on approval by a special committee and a majority-of-the-minority vote, both of which were obtained.

Although every Yield stockholder received identical treatment in the reclassification, the Court of Chancery concluded it provided a “non-ratable benefit” to Energy because Energy “was on the cusp of losing its control position” and the reclassification “was done to perpetuate that control.” The Court nevertheless ruled that onerous “entire fairness” review would not apply, because the reclassification was subject to “the dual protections of special committee review and the approval of a majority of the minority stockholders.” In so holding, the Court extended the application of the “MFW framework” to govern another category of controlling-stockholder transaction.

The decision suggests that reclassifications with the potential to prolong a control structure may be subject to strict judicial scrutiny, absent both independent director and minority stockholder approval. Where available, those “dual protections” may insulate such transactions from judicial review. As to other situations, the vexing question of how to determine economic fairness for pro rata distributions that maintain a pre-existing control structure remains to be resolved.

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