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E-MailThis post is based on a Wachtell, Lipton, Rosen & Katz client memorandum by William 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.
The Delaware Court of Chancery has suggested certain rules of the road when a third party acquires a company with a controlling stockholder. In re John Q. Hammons Inc., S’holder Litig., C.A. No. 758-CC (Del. Ch. Oct. 2, 2009).
The case arose from the sale of John Q. Hammons Hotels, Inc., a publicly traded hotel chain controlled by John Hammons. In late 2004, a special committee of the company’s board explored potential third-party mergers. Hammons informed the committee that, in view of his particular tax and business interests, he would consider a transaction only if he retained an interest in the surviving entity and received a line of credit to continue developing new hotels. The committee ultimately recommended that the board approve a transaction in which public shareholders were cashed out at a substantial premium. Hammons separately bargained for a participating preferred interest in the surviving company and lines of credit totaling $300 million. The transaction was conditioned on the approval of a majority of the minority shares actually voting, and was approved and closed in 2005.
Certain shareholders challenged the transaction, alleging that Hammons dominated the negotiation process and received an undue proportion of the merger consideration. Ruling on crossmotions for summary judgment, the Court rejected the argument that the transaction was presumptively subject to the plaintiff-friendly “entire fairness” standard of review. Because Hammons was not himself cashing out the shareholders or otherwise “standing on both sides of the transaction,” but was instead dealing with a third party, the Chancellor concluded that all defendants would be protected by the business judgment rule “if the transaction were (1) recommended by a disinterested and independent special committee, and (2) approved by stockholders in a [fully informed and] non-waivable vote of the majority of all the minority stockholders.”
The Court went on to rule, however, that for business judgment to apply, “there [must] be robust procedural protections in place to ensure that the minority stockholders have sufficient bargaining power and the ability to make an informed choice of whether to accept the third party’s offer for their shares.” The protections here did not qualify, “both because the vote could have been waived by the special committee and because the vote only required approval of a majority of the minority stockholders voting on the matter, rather than a majority of all the minority stockholders.” The Court also declined to dismiss plaintiffs’ claim that the committee’s legal and financial advisors’ representation of parties involved in financing the buyer’s offer should have been disclosed, emphasizing that “the compensation and potential conflicts of interest of the special committee’s advisors are important facts that generally must be disclosed to stockholders before a vote.”
Hammons thus confirms that properly structured third-party transactions where a controlling stockholder receives different consideration from the public, or retains a stake in the post-transaction company while the public is cashed out, may still be protected by the business judgment rule. Even more powerfully, the decision reaffirms the need for a careful process at every stage in the life of a major transaction.
