S. Muoio & Co. LLC v. Hallmark Entertainment Investments Co., C.A. No. 4729-CC (Del. Ch. Mar. 9, 2011) (Chandler, C.)
In Muoio, the Court of Chancery held that the recapitalization of Crown Media Holdings, Inc. (“Crown”) was “entirely fair.” After years of Crown being unable to make its debt payments, Crown’s primary debt holder and controlling stockholder, Hallmark Cards, Inc. (“Hallmark”), proposed a recapitalization plan pursuant to which Hallmark would exchange its debt for an increased percentage of Crown’s Class A common stock, new preferred stock, and a new and far smaller amount of debt with longer maturities (the “Recapitalization”). The Recapitalization would permit Crown to avoid a debt default and bankruptcy. Immediately after Hallmark’s proposal of the Recapitalization, Crown created a special committee (the “Special Committee”) to consider the proposed Recapitalization, but before the Special Committee could consider the recapitalization, the plaintiff, a Crown stockholder, filed an action seeking to enjoin the proposed Recapitalization. The parties agreed to stay the litigation while the Special Committee considered the proposed Recapitalization. They also stipulated that Crown would provide the plaintiff with seven weeks’ notice of the terms of any transaction prior to the consummation thereof and, in the event the plaintiff sought a preliminary injunction, would establish a schedule for its resolution during that seven-week period. After Crown and Hallmark announced that they entered into an agreement relating to the Recapitalization and provided notice to the plaintiff, the plaintiff, rather than seeking a preliminary injunction, filed an amended and supplemental complaint seeking rescission of the transaction. The plaintiff alleged that the Recapitalization was the result of an unfair process, undervalued Crown, and resulted in a transfer of wealth and voting power from the minority stockholders to Hallmark. A few months after the filing of the amended and supplemental complaint, the Recapitalization closed, and the action proceeded to trial.
The plaintiff asserted (and the defendants conceded) that entire fairness was the appropriate standard of review. Evaluating the Recapitalization under entire fairness, the Court noted that in majority stockholder transactions, the party standing on both sides of the transaction has the initial burden of proof. If that party can show that the transaction was negotiated and approved by an independent committee of directors or approved by an informed majority of the minority stockholders, the burden shifts to the stockholder plaintiff to prove that the transaction was not entirely fair. The Court concluded that all members of the Special Committee were independent and approved the transaction after an arm’s length negotiation, and the plaintiff therefore bore the burden to show that the Recapitalization was not entirely fair. Notably, in dicta, the Court indicated that if the transaction is approved by both an independent committee and an informed majority of the minority stockholders, then the transaction could avoid entire fairness review. The Court concluded that the plaintiff had failed to show that the Recapitalization did not involve fair dealing on the part of the Special Committee, thereby disagreeing with the plaintiff’s allegations that the timing of the Recapitalization was unfair to the minority stockholders, that certain members and advisors of the Special Committee were not independent, and that its process was not the result of arm’s length negotiations. Moreover, the Court stressed the importance that the Special Committee’s mandate provided it with the “‘critical power’ to say ‘no’ to the transaction.” With respect to the fair price aspect of entire fairness review, the Court also concluded that the plaintiff failed to show that the Recapitalization did not fairly value Crown. Relying on other Delaware case law valuing companies on the brink of bankruptcy, the Court concluded that the Recapitalization was fair to the minority because Crown was “underwater,” and without the Recapitalization, bankruptcy seemed inevitable. The Recapitalization allowed the minority stockholders to realize some value that they would not realize if Crown were insolvent and the stockholders’ equity worthless. Moreover, the Court held that the valuation question “resulted in a battle of the experts,” which the “plaintiff’s expert lost,” as he was less credible and persuasive than the defendants’ expert. Ultimately, the Court held that the Recapitalization was entirely fair.