In re Crimson Exploration Inc. S'holder Litig., C.A. No. 8541-VCP (Del. Ch. Oct. 24, 2014) (Parsons, V.C.)
In this memorandum opinion, the Court of Chancery granted the defendants’ motion to dismiss plaintiffs’ claims which alleged that the defendants breached their fiduciary duties in connection with a stock-for-stock merger (the “Merger”) of Crimson Exploration, Inc. (“Crimson”) and Contango Oil & Gas Co. (“Contango”). The plaintiffs, stockholders’ of Crimson (“Plaintiffs”), claimed that (i) Oaktree Capital Management, L.P, along with certain of its affiliates (“Oaktree”), constituted a controlling stockholder of Crimson and breached its fiduciary duties by selling Crimson below market-value and receiving significant side benefits not shared with Crimson’s other stockholders, (ii) Crimson’s board of directors (the “Crimson Board”) breached its fiduciary duties by approving the Merger and (iii) Contango and the merger subsidiary, Contango Acquisition, Inc. (“Merger Sub”), aided and abetted the foregoing breaches of fiduciary duties. The Court granted defendants’ motion to dismiss, finding that Plaintiffs failed to state a claim upon which relief could be granted under Court of Chancery Rule 12(b)(6).
Crimson and Contango entered into merger negotiations in January 2013 and signed a merger agreement on April 29, 2013 (the “Merger Agreement”). Pursuant to the terms of the Merger Agreement, Contango acquired Crimson in a stock-for-stock exchange, the ratio of which constituted a 7.7% premium based on the trading price of Contango and Crimson common stock on April 29, 2013. At the time of the Merger, (i) Oaktree controlled 33.7% of Crimson’s stock, (ii) three of the seven directors on the Crimson Board also worked for Oaktree (the “Oaktree Directors”) and (iii) Crimson had a term loan of which an affiliate of Oaktree held a significant, but unspecified, portion (the “Term Loan”).
Prior to the execution of the Merger Agreement, Oaktree sought and obtained a registration rights agreement (the “RRA”) permitting it to sell its stock in Contango in a private placement. Contango, Crimson and Oaktree participated in the negotiation of the RRA from April 13, 2013 to April 25, 2013. After the execution of the Merger Agreement, Contango agreed to pay-off the entire Term Loan, including a 1% prepayment penalty (the “Prepayment”). The Crimson Board was not involved in negotiating or approving the Prepayment. Neither the RRA nor the Prepayment were included as terms in the Merger Agreement.
In analyzing Plaintiffs’ claims, the Court first addressed Plaintiffs’ allegation that Oaktree was a controlling stockholder that had breached its fiduciary duties by (i) selling Crimson below market-value and (ii) receiving significant side benefits, in the form of the RRA and the Prepayment, that were not shared with Crimson’s other stockholders. On this basis, Plaintiffs argued that the Court should review the Merger under the entire fairness standard.
The Court began its analysis by restating the established Delaware principle that a stockholder holding less than a majority of a corporation’s outstanding shares can nevertheless be considered a controlling stockholder if it exercises control over the business and affairs of the company. After conducting a review of existing case-law, the Court stated that “a large blockholder will not be considered a controlling stockholder unless they actually control the board’s decision about the challenged transaction”. In applying this principle to this case, the Court was highly skeptical of Plaintiffs’ ability to prove that Oaktree exercised actual control over the Crimson Board given that (i) Oaktree only held 33.7% of Crimson’s equity, (ii) the lead negotiators on the deal were not employed by Oaktree and (iii) Oaktree was an outside investment fund that did not use its ownership interest in a manner that suggested it dominated or controlled the Crimson Board.
Even if Plaintiffs could demonstrate that Oaktree was a controlling stockholder, the Court held that entire fairness would still not be the appropriate standard of review. The Court explained that in order for entire fairness to apply, not only must Oaktree have been a controlling stockholder but it also must have engaged in a conflicted transaction. The Court identified two categories of conflicted transactions pertinent to its analysis: (1) transactions where the controlling stockholder stands on both sides of the transaction and (2) transactions where the controlling stockholder competes with common stockholders for consideration. The Court quickly dismissed the former of these two possibilities as it was undisputed that Oaktree had no affiliation with Contango prior to the Merger. With respect to the latter of these two options, the Court identified three scenarios in which a controlling stockholder could compete with common stockholders for consideration:
- The controller receives disparate consideration, which the board approves;
- The controller receives a continuing stake in the surviving entity and the minority is cashed out; and
- The controller receives a unique benefit despite nominal pro rata treatment of all stockholders.
Applying the facts of this case to the above scenarios, the Court determined that Plaintiffs were alleging a combination of disparate consideration, with respect to the Prepayment, and unique benefit with respect to the RRA. The Court found neither of these arguments convincing and held that neither the Prepayment nor the RRA resulted in Oaktree being involved in a conflicted transaction.
The Court accepted as fact that Contango agreed to pay-off the Term Loan early and with a 1% prepayment penalty. However, as the Merger Agreement did not contain a provision requiring Contango to pay-off the Term Loan, the Prepayment could not qualify as additional or different merger consideration. Additionally, the Court found that Plaintiffs’ complaint did not allege that the Crimson Board was involved in negotiating or approving the Prepayment and that it was reasonable to infer that Contango initiated the Prepayment in its own discretion and to serve its own self-interest.
As with the Prepayment, the Court noted that the Merger Agreement did not contain terms requiring Contango and Oaktree to enter into the RRA and thus could not constitute additional consideration. However, unlike the Prepayment, which appeared to the Court to be made in Contango’s discretion, Oaktree allegedly demanded the RRA. This, coupled with the fact that the Crimson Board was involved in the negotiations of the RRA while the Merger negotiations were ongoing, suggested to the Court that the RRA was more integral to the Merger Agreement than the Prepayment. As a result, the Court was required to consider whether the RRA constituted a unique benefit conferred upon Oaktree.
Referencing existing case-law, the Court identified two situations where, despite all stockholders receiving the same consideration, a controller nonetheless would be deemed to have received a unique benefit requiring a court to apply entire fairness: (1) the controlling stockholder eliminates something bad for it and good for the minority and (2) all parties suffer a sub-optimal sale price, but the controlling stockholder still benefits because it receives cash to satisfy an idiosyncratic liquidity problem. The Court held that neither situation applied to Oaktree as (i) the RRA would have little if any value to Crimson’s other stockholders as they would presumably sell their shares in the public market rather than dispose of them in a private placement, and as a result, Oaktree was not eliminating any value for the common stockholders and (ii) Oaktree was not in a liquidity crisis.
As Plaintiffs failed to allege facts sufficient to support a reasonable inference that Oaktree (i) was a controlling stockholder, (ii) was conflicted in the Merger or (iii) received some sort of additional consideration or unique benefit, the Court found that entire fairness was not the appropriate standard of review with respect to Oaktree. Having arrived at this conclusion, the Court turned next to determining whether the Crimson Board was interested in the transaction or lacked independence.
Under Delaware law, a transaction will be reviewed under entire fairness if a plaintiff alleges facts sufficient to show that a board of directors was interested in the challenged transaction or lacked independence. If a plaintiff can make such a showing, the business judgment rule will be rebutted and entire fairness will apply. To rebut the business judgment rule in this manner, a plaintiff must plead facts demonstrating that a majority of the directors were interested in the transaction or were dominated by a materially interested director.
After summarizing the foregoing law, the Court held that Plaintiffs had failed to allege facts sufficient to rebut the business judgment rule. Specifically, the Court noted that (i) none of the directors on the Crimson Board worked for, held stock in or had any disqualifying relationship with Contango, (ii) at least four, and possibly six, of the seven directors on the Crimson Board were disinterested and independent, (iii) even if three of the directors were interested in the Merger, Plaintiffs’ complaint failed to allege facts sufficient to support a conclusion that they dominated the remaining directors and (iv) as Oaktree was not a conflicted controlling stockholder, there was no reason to impute any Oaktree-based conflict to the Oaktree Directors.
Having determined that entire fairness was not the appropriate standard of review, the Court held that the Crimson Board’s decision to enter into the Merger would be protected by the business judgment rule unless Plaintiffs could show that the Crimson Board acted in bad faith. This is an exacting standard and the Court found that Plaintiffs failed to plead facts from which the Court could conceivable conclude that the Crimson Board had acted in bad faith.
For the foregoing reasons, the Court dismissed Plaintiffs’ claims against Oaktree and the Crimson Board for failure to state a claim under Chancery Court Rule 12(b)(6). As the Court was dismissing the underlying breach of fiduciary duty claims, the Court held that Plaintiffs’ aiding and abetting claim against Contango and Merger Sub must also be dismissed.