In Corwin v. KKR Financial Holdings LLC, No. 629, 2014 (Del. Oct. 2, 2015), the Delaware Supreme Court sitting en banc unanimously affirmed the Delaware Court of Chancery decision that the voluntary judgment of the fully informed, disinterested stockholders to approve a merger invoked the deferential business judgment rule standard of review in a post-closing damages action.
The plaintiffs in the Corwin case challenged a stock-for-stock merger between KKR & Co. L.P. (“KKR”) and KKR Financial Holdings LLC (“Holdings”) in which KKR acquired all of the issued and outstanding shares of Holdings at a 35% premium. The transaction was approved by an independent board and by a majority vote of the disinterested stockholders. The Chancery Court dismissed the complaint, and the plaintiffs appealed. The plaintiff’s main challenge was that the appropriate standard of review of the transaction should have been entire fairness, a higher standard of review which would require the defendants to show that the transaction was fair in price and process, rather than the business judgment rule, a more deferential standard of review that presumes that the board acted on an informed basis and in the honest belief that the action was taken in the best interest of the corporation.
In Corwin, the plaintiffs advanced two arguments in favor of the entire fairness standard of review. First, the plaintiffs argued that KKR was a controlling stockholder of Holdings because (i) Holdings’ primary business was financing KKR’s buyout activities and (ii) Holdings was managed by an affiliate of KKR under an agreement that could only be terminated by Holdings if it paid a termination fee. The defendants countered that KKR was not a controlling stockholder of Holdings because (i) KKR owned less than 1% of Holdings’ stock and (ii) KKR had no contractual right to appoint any directors of Holdings or to veto any Holdings’ board actions. The Chancery Court agreed with the defendants and further found that Holdings’ investors knew of the circumstances at issue at all relevant times.
The second argument advanced by the plaintiffs was that, even if KKR were not a controlling stockholder of Holdings, the Chancery Court should not have dismissed the complaint because the plaintiffs had a Revlon claim against the directors, i.e., another form of enhanced scrutiny in reviewing the transaction. The Supreme Court held that it did not matter whether Revlon applied to the transaction because the Chancery Court was correct in determining that the entire fairness standard did not apply to the transaction since the transaction was approved by an uncoerced and informed stockholder vote.
Although the plaintiffs argued that such a finding would impair Revlon and Unocal or expose stockholders to unfair action by directors, the Supreme Court stated that the plaintiffs ignored three factors. First, Unocal and Revlon are primarily designed to provide pre-closing injunctive relief for stockholders and not designed to address post-closing money damages. Second (and most important to the Court), the business judgment rule would not apply if material, troubling facts regarding director behavior existed and were not disclosed to stockholders prior to their vote. Third, in cases in which disinterested stockholders have had an informed opportunity to decide on the merits of a transaction, the costs to stockholders, in the form of litigation and inhibitions on risk-taking, of judicial second-guessing would outweigh the benefits to stockholders.
In arriving at its conclusion, the Delaware Supreme Court distinguished its prior decision in Gantler v. Stephens, 965 A.2d 695 (Del. 2009), which many practitioners had read to hold that informed stockholder approval only shifts the standard of review to business judgment rule where such approval is not required to effect the transaction. The Supreme Court indicated that Gantler should be interpreted as a narrow decision focused on defining the legal concept of “ratification.”
The Corwin decision emphasizes once again the importance of ensuring that the informed judgment of disinterested stockholders is applied in approving transactions. Practitioners can plan transactions, including those not involving a controlling stockholder, to obtain deferential business judgment rule review by the Delaware courts by obtaining an affirmative vote of a majority of fully informed, disinterested stockholders following the recommendation of a committee (or Board) comprised of independent directors.
