In re Zhongpin Inc. S’holders Litig., C.A. No. 7393-VCN (Del. Ch. Nov. 26, 2014) (V.C. Noble)
In this memorandum opinion, the Court of Chancery denied motions to dismiss breach of fiduciary duty claims against Xianfu Zhu (“Zhu”), an alleged controlling stockholder of Zhongpin Inc. (“Zhongpin” or the “Company”), and members of the Zhongpin board of directors (the “Board), holding that plaintiffs had raised reasonable inferences that (i) Zhu was a de facto controlling stockholder of the Company because, although Zhu held only 17.3% of the Company’s outstanding stock, as CEO and Chairman of the Board he possessed both latent and active control over the Company and (ii) the sale process was not entirely fair to the unaffiliated stockholders.
In March 2012, Zhu submitted a preliminary, non-binding proposal to acquire all of the outstanding shares of the Company’s common stock for $13.50 per share in cash (the “Proposal”). Zhu informed the Board that he was interested only in being a buyer, not a seller, and that he would not sell his stake in the Company to a third party. In response to the Proposal, a facially independent special committee of the Board was formed (the “Special Committee”), which retained Barclays Bank PLC as its independent financial advisor. The Special Committee, with the assistance of Barclays, conducted a pre-signing market check, and on November 15, 2012, a potential strategic buyer submitted a non-binding offer to acquire all of the Company’s stock not owned by Zhu for $15 per share. The offer was conditioned on Zhu’s participating in the transaction as a rollover stockholder and his agreement to continue as CEO of the Company—conditions that Zhu refused.
On November 21, 2012, Zhu informed the Special Committee that continued delay in accepting the Proposal would seriously jeopardize his financing, rendering the Proposal moot. Zhu again refused to increase the offer price, and made it clear that $13.50 per share was his best and final offer. Shortly thereafter, Barclays reported to the Special Committee that it could not render an opinion on the fairness of the Proposal and terminated its engagement as the Special Committee’s financial advisor. On November 23, 2013, the Special Committee unanimously approved the going-private transaction with Zhu, and on November 26, 2012, the Company announced that it had entered into a merger agreement with Zhu conditioned on, among other things: (i) a non-waiveable majority-of-the-minority voting requirement; (ii) a 60-day go-shop period, and (iii) a termination right allowing the Company to terminate the Merger Agreement at any time and for any reason during the go-shop period with no termination fee (the “Merger Agreement”). During the go-shop period, the Special Committee’s new independent financial advisors contacted over eighty strategic and financial firms; none made a competing bid or even entered into a non-disclosure agreement (even after the go-shop was extended for an additional three weeks).
After the execution of the Merger Agreement, Zhongpin filed a Form 10-K (the “10-K”) which stated, among other things, that Zhu had “significant influence over [Zhongpin’s] management and affairs and could exercise this influence against [other stockholder’s] best interests,” and that “the concentration of ownership may delay or prevent a change of control or otherwise discourage a potential acquirer from making a tender offer or otherwise attempting to obtain control of [Zhongpin] which could decrease the market price of [its] shares.” The 10-K also referred to Zhu as Zhongpin’s “controlling shareholder.”
In their complaint, plaintiffs alleged that Zhu was a de facto controlling stockholder who owed fiduciary duties to the Company, and that he and the other members of the Board breached their fiduciary duties by facilitating a transaction that was not entirely fair to the public stockholders.
In addressing plaintiffs’ allegation that Zhu was a de fact controlling stockholder, the Court acknowledged that a stockholder who owns less than 50% of a corporation’s outstanding stock is presumptively not a controlling stockholder, but nonetheless held that the complaint sufficiently established that Zhu was a de facto controlling stockholder by alleging that he had both “latent” and “active” control of the Company. The Court concluded that the complaint adequately alleged that Zhu had latent control, or control via stock ownership, because the Company’s disclosures in the 10-K implied that Zhu “could exercise significant influence over shareholder approvals for the election of directors, mergers and acquisitions, and amendments to Zhongpin’s bylaws,” and that Zhu may have the ability to impede a potential acquirer’s submission of a competing bid. The Court found that the complaint also sufficiently alleged that Zhu had “active” control over the Company’s daily operations. Relying again on the 10-K, the Court cited the Company’s statements that it “rel[ies] substantially” on Zhu to manage operations and that Zhu’s departure could have a “material adverse effect” on the Company. The Court concluded that, while Zhu’s ownership interest in the Company was much smaller than a typical controller’s, plaintiffs had pled sufficient indicia of domination to raise an inference that Zhu exercised control over the Company.
Because Zhu – a presumptive controlling stockholder – stood on both sides of the going-private transaction, the Court next considered whether entire fairness or business judgment review applied. The Court noted that in Kahn v. M&F Worldwide Corp. (“MFW”), the Delaware Supreme Court held that in going-private mergers where there is a controlling stockholder, the use of both a truly independent special committee and a majority-of-the-minority stockholder vote may allow for judicial review under the deferential business judgment standard. Although the Zhongpin going-private transaction employed both of these structural devices, the Court held that the prerequisites set forth in MFW had not been met because the transaction was not conditioned on both sets of approvals from the outset. Rather, the majority-of-the-minority provision was included “at the tail end” of the process, after the Special Committee had accepted the $13.50/share price. As a result, entire fairness applied.
In applying entire fairness review, the Court concluded that the complaint adequately pled unfair dealing and unfair price, noting that (i) the Special Committee had no real power to generate superior proposals because Zhu’s cooperation – which he refused to give – was necessary to attract third party acquisition proposals; (ii) the Special Committee first approved the transaction without receiving a fairness opinion from Barclays, which had resigned; (iii) Zhu conditioned his acceptance of the majority-of-the-minority provision on the Special Committee’s acceptance of his price; and (iv) certain valuation data indicated that the transaction did not compare favorably to comparable transactions and represented a 42% discount to the three-year high for Zhongpin’s stock.
Finally, the Court considered whether plaintiffs’ claims against the independent members of the Board should be dismissed in light of the Company’s Section 102(b)(7) provision. The Board’s independent members argued that plaintiffs sought only money damages and otherwise failed to state a non-exculpated claim. The Court rejected this argument, noting that, when entire fairness applies, a determination that directors are exculpated from monetary damages can be made only after the basis for their liability has been decided.