A recent Delaware Chancery Court decision, In re CNX Gas Corp. Shareholders Litigation, C.A. No. 5733-VCL (Del. Ch. May 25, 2010), changes the process and dynamics for controlling stockholder freeze-out transactions and improves the minority stockholders’ position.
In CNX Gas, the Delaware Chancery Court applied a unified standard for review of all controlling stockholder freeze-out transactions, regardless of whether structured as a straight merger or as a tender offer followed by a short-form merger. Under the CNX Gas unified standard, the business judgment rule presumptively applies when a freeze-out transaction is both negotiated and approved by a special committee of independent directors and conditioned on affirmative vote of a majority of the minority stockholders. If the transaction does not incorporate both protective devices, or if a plaintiff can plead particularized facts sufficient to raise a litigable question about the effectiveness of one of the devices, then the transaction is subject to the more strict entire fairness review.
Under prior Delaware cases, including Siliconix1 and Pure Resources,2 a controlling stockholder could structure a freeze-out transaction as a tender offer followed by a short-form merger and receive a less onerous standard of judicial review.3 Under the prior case law, a special committee of the target subsidiary board was required to review the controlling shareholders’ tender offer, but the committee was not required to take a position or make a recommendation to the minority stockholders.
Under the new CNX Gas standard, the special committee of the target subsidiary board must affirmatively support the proposed tender offer price, after determining it is the best deal reasonably available for the minority shareholders, in order to avoid the entire fairness standard of review in subsequent shareholder litigation. If the entire fairness standard is applicable, a shareholder lawsuit challenging the freeze-out will be more difficult for the controlling stockholder to win and, therefore, more expensive to settle.
Prior Delaware case law, including Kahn v. Lynch Communications,4 reviewed a controlling stockholder freeze-out structured as a straight merger under the entire fairness standard. This tension between the historically different standards of review for essentially the same result has been the subject of substantial debate.5 In light of CNX Gas, the Delaware Supreme Court will probably address the issue.
3 The ability of the Siliconix structure to avoid an entire fairness review because neither a tender offer nor short-form merger, viewed independently, is subject to entire fairness review. The Delaware Supreme Court has held that appraisal is a stockholder’s exclusive remedy following a short-form merger. Glassman v. Unocal Exploration Corp., 777 A.2d 242, 248 (Del. 2001).
5 See, e.g., Faith Stevelman, "Going Private at the Intersection of the Market and the Law," 62 Bus. Law. 775 (2007); Peter Letsou and Steven Hass, "The Dilemma That Should Never Have Been: Minority Freeze Outs in Delaware", 61 Bus. Law. 25 (2005); Bradley Aronstam et al., "Revisiting Delaware’s Going Private Dilemma Post-Pure Resources", 59 Bus. Law. 1459 (2004); Bradley Aronstam et al., "Delaware’s Going Private Dilemma: Fostering Protections for Minority Shareholders in the Wake of Siliconix and Unocal Exploration," 58 Bus. Law. 519 (2003).
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