Introducing the Debevoise & Plimpton Special Committee Report

Jeffrey J. Rosen, Gregory V. Gooding, and William D. Regner are partners at Debevoise & Plimpton LLP. This post is based on a Debevoise memorandum by Mr. Rosen, Mr. Gooding, Mr. Regner, Michael Diz, Jonathan E. Levitsky and Maeve O’Connor, and is part of the Delaware law series; links to other posts in the series are available here.

Special committees of boards of directors play an essential role in many corporate transactions. Nevertheless, they are often imperfectly understood. Special committees are both underutilized—not deployed in circumstances where their use could have protected conflicted parties from liability—and over-utilized—formed in circumstances where no obvious conflict exists or where their use provides no meaningful legal benefit. Moreover, the case law is replete with examples of special committees being formed in a manner that undermines their purpose, not being given the authority necessary to provide their intended benefit, or behaving in a manner that results in potential liability both to the members of the committee and to other affiliates of the company.

The Debevoise & Plimpton Special Committee Report is intended to assist controlled companies, corporate boards, financial advisors and other transaction participants to better understand how and when special committees are used and how to ensure that they function as intended. The Report will—on a periodic basis—catalog recent transactions involving special committees and summarize recent judicial decisions concerning special committees. We expect to identify trends involving the use of special committees and comment on issues relevant to the use (and misuse) of special committees.

Although future editions of this Report will cover special committee activity and cases in the prior period, this post covers the entirety of 2020.

In 2020, the Delaware courts continued to refine the boundaries of the applicability of the 2014 decision of the Delaware Supreme Court in Kahn v M&F Worldwide Corp. (upholding the 2013 decision of the Court of Chancery in In re MFW Shareholders Litigation). That case provided a path to the application of the business judgment rule—rather than the strict test of entire fairness—to transactions involving a controlling stockholder provided that the transaction was subject to the approval of both a special committee of independent directors and a majority of the shares held by unaffiliated stockholders and that those requirements were in place from the outset, before substantive negotiations.

In 2020, the Delaware Court of Chancery rejected the applicability of MFW, and thus of the business judgement rule, to transactions where the controller had undertaken negotiations with certain minority stockholders prior to committing to the MFW conditions and with the future financial advisor to the special committee prior to the formation of the committee, determining in each case that these discussions caused the transaction to fail the requirement that the MFW conditions be in place from the start. In other cases, the Court of Chancery held that coercive or domineering actions by the Controller precluded the application of the business judgment rule or rendered the special committee members not independent and thus subject to liability.

The Delaware courts also held in 2020 that a 35% stockholder with certain contractual rights pursuant to a stockholders agreement may be a de facto controller of the company and that even where a stockholder has de facto control of the company prior to a transaction, other stockholders can suffer damage as a result of an unfair transaction that does not otherwise affect them if it results in the controller acquiring actual (i.e., greater than 50% voting power) control.

These and other key judicial decisions in 2020 involving special committees are discussed further below.

Recent Special Committee Decisions

Notable rulings of Delaware courts in 2020 dealing with the use of special committees included the following:

1. Special Committee members are not independent where they are so dominated by the controlling stockholder that they labor under a “controlled mindset.”

Viacom and CBS combined in a stock-for-stock merger initiated by NAI, which controlled 80% of the voting power of both companies and which in turn was controlled by Shari Redstone.

Viacom had formed a special committee of independent directors to negotiate the transaction and recommend it to the Viacom stockholders. The transaction was not subject to the approval of stockholders who were unaffiliated with NAI. Following the consummation of the merger, former stockholders of Viacom brought fiduciary duty claims against, among others, the controlling entities and the members of the special committee. In denying a motion to dismiss, the Delaware Court of Chancery held that it was reasonably conceivable that the committee members breached their duty of loyalty in connection with the merger as a result of the combination of their personal relationships with Redstone, their fear of retribution by Redstone, and the fact that Redstone so dominated the committee that they operated under a “controlled mindset” that caused them to succumb to Redstone’s will. In re Viacom, Inc. Stockholders Litigation, C.A. No. 2019-0948 (Del. Ch. Dec. 29, 2020; rev. Dec. 30, 2020).

Special Committee Spotlight

In August 2020, Liberty Broadband Corporation (NASDAQ: LBRDA, LBRDK, LBRDP) agreed to acquire GCI Liberty, Inc. (NASDAQ: GLIBA, GLIBP) in a stock-for-stock merger valuing GCI Liberty at approximately $8.7 billion. John C. Malone was chairman of the board of directors of each of GCI Liberty and Liberty Broadband and held approximately 27.5% and 48.5% of the respective aggregate voting power of the two companies, which also shared overlapping senior management teams. Liberty Broadband and GCI Liberty each formed a special committee to evaluate, negotiate and approve the terms of a potential combination. Although these protections were not initially proposed by Mr. Malone, the special committees obtained, prior to negotiations, Mr. Malone’s agreement that any combination would be conditioned upon the approval of the special committees of both companies and the approval of the holders of a majority of the voting power of the unaffiliated stockholders of both companies. The transaction was approved by the stockholders of the two companies on December 15, 2020, with approximately 78.8% of the vote held by the unaffiliated stockholders of Liberty Broadband voting in favor of the merger and approximately 79.6% of the vote held by the unaffiliated stockholders of GCI Liberty voting in favor of the merger. The transaction closed in December 2020 following receipt of required regulatory approvals. Debevoise represented the special committee of Liberty Broadband.

2. Special Committee members are entitled to privileged communications between management and company counsel.

In a dispute involving a special committee that negotiated a contract between WeWork and its controlling stockholder, which contract the special committee was seeking to enforce against the controller, the special committee sought discovery from the company. Management objected to the production of communications between management and counsel to the company on the basis of attorney-client privilege, asserting that the special committee had become adverse to the company. The court ordered production of the privileged materials, holding that whether the special committee was adverse to the company was a question for the board, not for management, that evidence indicated that the special committee was in fact adverse to the controlling stockholder rather than the company, and that the ability of management to assert attorney-client privilege against members of the board was contrary to the principle that directors—not management—are responsible for overseeing corporate affairs of the company. In re WeWork Litigation, C.A. No. 2020-0258 (Del. Ch. Aug. 21, 2020).

3. Non-tendering stockholders may be prejudiced as a result of a de facto controlling stockholder obtaining actual control by means of an unfair tender offer.

JAB, a family-controlled German conglomerate, held approximately 40% of the outstanding stock of Coty. Four of the nine Coty directors were affiliated with JAB, and one director was the CEO. JAB proposed a tender offer conditioned on the approval of a special committee consisting of the four remaining directors. The committee approved the tender offer terms, subject to JAB’s entering into a stockholders agreement that limited JAB’s rights to transfer Coty shares or acquire additional shares for three years and required that there be at least four (and in the future six) independent directors on the board. The tender offer closed, increasing JAB’s ownership of Coty to 60%. Plaintiff stockholders sued, alleging, among other things, that JAB was a de facto controller prior to the tender offer and therefore owed fiduciary duties to Coty that it breached. Defendants moved to dismiss the fiduciary duty claim of the non-tendering stockholders on the basis that they could not assert both that JAB controlled Coty before the tender offer and that they were harmed by the tender offer. The court denied the motion, holding that actual control was more valuable than de facto control and therefore, the move by one to the other by means of the tender offer conceivably harmed the non-tendering stockholders. In re Coty, Inc. Stockholder Litigation, C.A. No. 2019-0336 (Del. Ch. Aug. 17, 2020).

4. Price discussions with minority stockholders prior to committing to MFW conditions render MFW inapplicable.

Jefferies Financial Group, which owned 70% of the common shares of Homefed Corporation, acquired the remaining Homefed shares in a stock-for-stock transaction approved by a special committee of independent directors and a majority of the shares held by unaffiliated stockholders. Jefferies originally proposed the transaction in 2017 but then abandoned it. A year later, Jefferies discussed the potential transaction with two large minority stockholders of Homefed, gaining their support, before again presenting it to the special committee for approval. The transaction ultimately was on the terms discussed with the two stockholders. Plaintiff stockholders brought suit for breach of fiduciary duty. Defendants moved to dismiss, claiming that the transaction was subject to the business judgment rule under MFW. The court held that MFW was inapplicable as a result of the price discussions with the two large stockholders, which occurred prior to Jefferies proposing the transaction to the special committee and prior to its publicly committing to the MFW conditions. In re Homefed Corp. Stockholder Litigation, C.A. No. 2019-0592 (Del. Ch. July 13, 2020).

5. Allegedly coercive actions by controller preclude application of the business judgment rule.

Dell Technologies proposed to redeem a class of tracking stock in a transaction conditioned on the approval of both a special committee of independent directors and a majority of the stockholder class. Following closing, stockholders sued for breach of fiduciary duty, alleging that the transaction was not entirely fair. Dell moved to dismiss on the basis that approval of the redemption by a special committee of independent directors and a majority of the stockholder class rendered the transaction subject to the business judgment rule under MFW. The Delaware Court of Chancery denied the motion to dismiss on the basis that it was reasonably conceivable that (a) alleged threats by Dell to redeem the stock pursuant to a contractual “forced conversion” right undermined the special committee’s power to “say no”; (b) Dell undermined the committee by negotiating directly with a group of large stockholders when it appeared that the stockholders would not vote in favor of the terms originally approved by the committee; (c) Dell’s threat of a “forced conversion” was coercive of the stockholder vote; (d) certain of the committee members lacked independence; and (e) the stockholder vote was not fully informed. The Court of Chancery held that “[i]n order to invoke MFW and receive the benefit of the business judgment rule, the controller must irrevocably and publicly disable itself from using its control to dictate the outcome of the negotiations and the shareholder vote, thereby allowing the conflicted transaction to acquire the shareholder-protective characteristics of third party, arm’s-length mergers.” In re Dell Technologies, Inc. Class V Stockholders Litigation, C.A. No. 2018-0816 (Del. Ch. June 11, 2020).

6. Commencement of negotiations with the financial advisor for a special committee prior to the formation of special committee defeats application of MFW.

Empire Resorts was taken private by its controlling stockholder in a transaction conditioned on the approval of a special committee of independent directors and a majority of the minority stockholder vote. Following closing, stockholders brought a books and records action to investigate wrongdoing by the controlling stockholder in connection with the acquisition. The company opposed on the basis that the transaction was subject to the business judgment rule under MFW. Plaintiffs presented evidence that the controller discussed the proposed transaction with the financial advisor chosen to represent the special committee prior to the formal engagement of the advisor by the committee and prior to the time that the formation of the committee became effective, which the Delaware Chancery Court held would defeat application of MFW. Chad Brown v. Empire Resorts, Inc., C.A. No. 2019-0908 (Del. Ch. Feb. 20, 2020).

7. MFW’s ab initio requirement applies to transactions not involving a controller.

Intersections, Inc. was acquired in a transaction in which certain Intersections directors rolled their shares into the combined company. Following closing, stockholders sued, alleging the transaction was subject to entire fairness as a result of director conflicts. Defendants moved to dismiss, arguing that the transaction was cleansed of fiduciary misconduct as a result of its approval by a majority of the shares held by unaffiliated stockholders under Corwin and as a result of the approval by an independent special committee under In re Trados. The Delaware Court of Chancery denied the motion to dismiss on the basis that the special committee was formed after substantive economic negotiations had taken place, holding that MFW’s ab initio requirement also applied to special committee approval in the absence of a controller. The court appeared to assume that Corwin could apply to a transaction otherwise subject to entire fairness as a result of a majority of directors having conflicts rather than as a result of a conflicted controller, but the court separately held that disclosure defects precluded the application of Corwin. Lance Salladay v. Bruce L. Lev, et al., C.A. No. 2019-0048 (Del. Ch. Feb. 27, 2020).

8. Pending derivative claims render special committee members potentially interested parties, precluding applicability of MFW.

AmTrust Financial Services was acquired by its controlling stockholders in a transaction conditioned on the approval of a special committee and a majority of shares held by unaffiliated stockholders. Following closing, stockholders brought suit, claiming that the transaction was not entirely fair. Defendants asserted applicability of the business judgment rule under MFW. The Delaware Court of Chancery denied the motion to dismiss on the basis that a majority of the members of the special committee members were conceivably conflicted because the transaction extinguished pending derivative claims against those directors relating to a prior transaction. In re AmTrust Financial Services, Inc. Stockholder Litigation, C.A. No. 2018-0396 (Del. Ch. Feb. 26, 2020).

9. 35% stockholder held to be a potential controller.

NCI Building Systems merged with a company controlled by NCI’s largest stockholder. Stockholders sued, alleging applicability of entire fairness. In denying a motion to dismiss, the Delaware Court of Chancery held that it was reasonably conceivable that NCI’s 34.8% stockholder exercised effective control of the company as a result of the combination of its stock ownership, its right to appoint a third of the members of the Company’s board and its possession of certain veto rights under a stockholders agreement. Gary D. Voigt v. James S. Metcalf, et al. and NCI Building Systems, Inc., C.A. No. 2018-0828 (Del Ch. February 10, 2020).

The complete publication, including appendix, is available here.

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