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In re IAC/InterActive Corp., C.A. No. 3486-VCL (Del. Ch. Mar. 28, 2008) (Lamb, V.C.)

March 28, 2008

In this Court of Chancery decision, Vice Chancellor Lamb resolved contract interpretation questions relating to the proposed spin-off (the “Spin-Off”) of four IAC subsidiaries as independent public companies (the “spincos”).  Importantly, the Court concluded that written consents delivered on behalf of IAC’s majority stockholder, Liberty Media Corporation (“Liberty”), and its affiliates purporting to remove members of the IAC board were invalid.

Together with its affiliates, Liberty owns approximately 30% of the outstanding equity of IAC, including high-vote Class B common stock, and 62% of IAC’s voting power.  Liberty’s voting rights are controlled by IAC chairman and CEO, Barry Diller (“Diller”), who holds an irrevocable proxy subject to Liberty’s limited consent rights.  In an effort to avoid certain regulatory restrictions, Liberty and Diller entered into a number of agreements in 1995 and formed the predecessor to BDTV, Inc. for the purpose of allowing Liberty to maintain a controlling stake in IAC.  The parties memorialized a 1995 term sheet in the 1997 Governance Agreement and 1997 Stockholders Agreement, which were subsequently amended in 2001 and 2005 (collectively, the “Governance Agreements”).  In January 2008, the IAC board preliminarily approved and publicly announced the general terms of the Spin-Off.  Although the board did not finalize the spinco voting structures, Diller suggested that he expected to recommend a single-tier spin-off, pursuant to which the resulting spincos would have a single class of voting common stock.  Under a single-tier voting structure, Liberty would hold approximately 30% of the spinco’s outstanding voting securities; under a two-tiered voting structure, Liberty would hold in excess of 60% of the spinco’s outstanding voting securities.  Liberty and its affiliates took the position that a single-tier spin-off that does not replicate the current two-tiered IAC voting structure violates Diller’s and IAC’s contractual and fiduciary duties.  Immediately after the board’s January meeting, IAC filed a compliant seeking a declaratory judgment regarding the legal effect of a single-tier structure.  Liberty countersued two days later, also seeking declaratory relief.  Operating under the theory that Diller repudiated his contractual duties, thereby terminating the irrevocable proxy, Liberty delivered to IAC written consents purporting to remove and replace members of the IAC board.  That same day, Liberty brought suit pursuant to Section 225 of the DGCL (the “Section 225 Action”). 

Preliminarily, the Court addressed the parties’ positions with respect to whether the fiduciary duty claims were ripe for adjudication, finding that such issues were unripe.  Vice Chancellor Lamb reasoned that the IAC board had not yet made a final decision regarding the spinco voting structures and noted that the fiduciary claims would depend on a factual record that had not yet developed.  The Court also suggested that Liberty’s reliance on Condec Corporation v. Lunkenheimer Company, 230 A.2d 769 (Del. Ch. 1967), and Canada Southern Oils Limited v. Manabi Exploration Company, 96 A.3d 810, 813-14 (Del. Ch. 1953), was misplaced because unlike those cases, “the fiduciary duty issues raised in these law suits lack the characteristic per se illegality of the claims in Condec and Canada Southern Oils.”  In further distinguishing Condec and Canada Southern Oils, the Vice Chancellor took note of the fact that Diller currently controls IAC’s majority voting power, and “Diller, not Liberty, will see his power diminished as a result of a single-tier spin-off.” 

The Section 225 Action, however, was found to be ripe for adjudication.  Notwithstanding Liberty’s arguments to the contrary, the Court also concluded that the contract interpretation issues related to the Governance Agreements and the IAC and BDTV constituent documents were fit for review because such issues were central to the claims raised in the Section 225 Action.  The Court first reviewed Section 2.03 of the 2005 Governance Agreement (“Section 2.03”), which granted Liberty a consent right with respect to certain enunciated “Contingent Matters.”  Section 2.03 divided the Contingent Matters into two categories: consent rights triggered in the event that IAC fell below a specified total debt ratio, and consent rights not subject to such debt ratio test.  Liberty argued that a single-tier spin-off would limit its “full rights of ownership” by “stripping out 70% of IAC’s assets” in the proposed Spin-Off in contravention of Section 2.03(a), which was not subject to the debt-ratio test.  IAC, on the other hand, argued that Section 2.03(a), which grants Liberty the right to consent to any “transaction not in the ordinary course of business, launching new or additional channels or engaging in any new field of business … that will impose material additional restrictions or limitations on such Person’s full rights of ownership (including, without limitation, voting) thereof or therein” (the “Third Clause”), relates exclusively to regulatory matters.  Using the ejusdem generic cannon of construction, the Court agreed with IAC, finding that “the clear regulatory scope of [the balance of Section 2.03(a)] requires the court to read the general language of the Third Clause as being related to the same subject matter.”  In so holding, the Court rejected Liberty’s broad interpretation of the Third Clause as being a “catch-all” provision.  In particular, the Court observed that Section 2.03(b)(i), which addressed transactions similar to the Spin-Off, conditioned Liberty’s consent right on IAC falling below the specified debt ratio.  Although some redundancy “is acceptable, excessive surplusage is not.”  In the Court’s view, it was “nearly inconceivable that the parties specifically contemplated IAC issuing stock, in a manner similar to the proposed spin-off, in Section 2.03(b)(i) and then broadly addressed the same scenario in general terms in Section 2.03(a) among several regulatory provisions.  This represents not a mere redundancy, but a glaring inconsistency…”  The Court also rejected Liberty’s parol evidence, finding that such evidence failed to support its claims that the parties intended Liberty to maintain a consent right with respect to transactions similar to the Spin-Off under all circumstances. 

Liberty also argued that the implied duties of good faith and fair dealing precluded Diller from voting the proxy in favor of a single-tier spin-off.  The Court found that this argument lacked merit, concluding that the parties memorialized the exact scope of Diller’s voting authority via the proxy in the 2005 Governance Agreement.  Citing Dave Greytak Enter., Inc. v. Mazda Motors of America, Inc., 622 A.2d 14, 23 (Del. Ch. 1992), the Court stated that “‘where the subject at issue is expressly covered by the contract, or where the contract is intentionally silent as to that subject, the implied duty to perform in good faith does not come into play.’”  In the instant case, the parties expressly set forth the scope of Diller’s proxy in the Governance Agreements, and “those bargained-for provisions clearly negate the possibility that Diller’s exercise of his voting rights are subject to some broader undefined standard, such as a fiduciary duty” and the Court declined to “undermine the bargain reached by the parties.”

The Court also rejected Liberty’s claims based on the IAC and BDTV constituent documents, finding that such agreements failed to provide a separate contractual basis to prevent a single-tier spin-off.  One of Liberty’s claims was based on the 2005 Shareholders Agreement, which required the unanimous approval of BDTV stockholders in respect of any action taken by BDTV that “would have constituted a Fundamental Change under the 1997 Stockholders Agreement.”  The list of “Fundamental Changes” in the 1997 Stockholders Agreement was essentially the same as the list of Contingent Matters, as set forth in the 2005 Governance Agreement, without the total debt ratio test introduced by agreement of the parties in 2001.  Accordingly, to the extent that the 2005 Shareholders Agreement is read to restrict actions taken by the IAC board and stockholders, such provision would “circumvent and render nugatory the parties’ clear and manifest agreement in 2001 to subject the list of [Contingent Matters] to the 4:1 total debt ratio test.”  Moreover, the relevant provision of the 1997 Shareholders Agreement is expressly limited to actions taken by BDTV.  Here, the Spin-Off will be authorized by the IAC board and no corporate action by BDTV is required.  Similarly, the Court deemed the BDTV charter irrelevant to Liberty’s arguments, because Diller, in voting the proxy in favor of the Spin-Off, may do so without causing BDTV to take any action.

Finally, the Court addressed Liberty’s arguments that the single-tier spin-off would violate the IAC charter.  The relevant provision thereof prohibited stock dividends and stock splits unless all shares of common stock of IAC were treated equally and identically.  Liberty contended that the Spin-Off would constitute a “stock dividend” because a reasonable interpretation of such charter provision would consider a dividend of stock in a subsidiary a stock dividend.  In response, IAC relied on duPont v. duPont, 208 A.2d 509 (Del. 1965), and Fulweiler v. Spruance, 222 A.2d 555 (Del. 1966), arguing that “spun-off shares of stock in another corporation are not ‘stock dividends.’”  The Court began its analysis by acknowledging the distinctions between cash dividends, stock dividends, and stock splits.  In Lynam v. Gallagher, 526 A.2d 878, 882 (Del. 1987), the Delaware Supreme Court defined a stock dividend as “a dividend payable in stock instead of cash.”  The Supreme Court’s decision in Lynam, is “consistent with the widely understood notion in [the Court of Chancery], that a dividend is ‘a distribution by a corporation to its shareholders of a share of the earnings of the corporation.’ … The proposed spin-off is not a distribution out of the earnings of IAC and it is not a distribution of stock of IAC that would otherwise be paid as a cash dividend.”  Accordingly, the Court concluded that the charter provision relied upon by Liberty was not applicable.  Rather, the Spin-Off would be a distribution of shares of newly formed companies that are legally distinct from IAC. 

Based upon the foregoing, and in light of the Vice Chancellor’s determination that Liberty lacks the contractual authority to consent to the proposed Spin-Off, the Court entered judgment in favor of IAC.

The full opinion is available here