CLIENT ALERT: Delaware Supreme Court Finds That Fully Informed Stockholder Vote Approving Merger Invoked Business Judgment Rule
In this opinion affirming the Court of Chancery’s dismissal of a purported class action challenging an acquisition transaction, the Delaware Supreme Court held that the approval of the merger by a fully informed, disinterested stockholder majority invoked the business judgment rule standard of review.
Before the Court of Chancery, the plaintiffs’ primary argument was that the entire fairness standard of review applied to the acquisition of KKR Financial Holdings LLC (“KFH”) by KKR & Co. L.P. (“KKR”) because KKR was a controlling stockholder of KFH. The plaintiffs supported this argument by asserting that KFH’s business was financing KKR’s leveraged buyout activities and KFH was managed by an affiliate of KKR under a management agreement.
On the defendants’ motion, the Court of Chancery dismissed the plaintiffs’ complaint pursuant to Rule 12(b)(6), concluding that it was not reasonably inferable from the complaint that KKR was KFH’s controlling stockholder because KKR owned less than 1% of KFH’s stock, had no right to appoint any directors, and had no contractual right to veto any board action. The Court of Chancery also found that, when a merger transaction is not subject to the entire fairness standard of review, the business judgment rule is invoked for a post-closing damages action if the merger is approved by a fully informed, uncoerced majority of the disinterested stockholders.
On appeal, the plaintiffs contended that, even if the Court of Chancery were correct in determining that KKR was not a controlling stockholder, it should not have dismissed the complaint because they had adequately pled a claim under Revlon v. MacAndrews & Forbes Holdings, Inc., 506 A.2d 173 (Del. 1986). In response, the defendants argued, among other things, that the transaction was subject to the business judgment rule because it had been approved by a fully informed, uncoerced stockholder vote. The Supreme Court agreed with defendants and affirmed the Court of Chancery’s dismissal of the complaint for three reasons.
First, the Supreme Court explained: “Unocal and Revlon are primarily designed to give stockholders and the Court of Chancery the tool of injunctive relief to address important M & A decisions in real time, before closing. They were not tools designed with post-closing money damages claims in mind, the standards they articulate do not match the gross negligence standard for director due care liability under Van Gorkom, and with the prevalence of exculpatory charter provisions, due care liability is rarely even available.”
Second, and “most important” in the Court’s view, “the doctrine applies only to fully informed, uncoerced stockholder votes, and if troubling facts regarding director behavior were not disclosed that would have been material to a voting stockholder, then the business judgment rule is not invoked.”
Third, and finally, the Court stated that, when a transaction is not subject to the entire fairness standard of review, the “long-standing policy” of Delaware law has been “to avoid the uncertainties and costs of judicial second-guessing when the disinterested stockholders have had the free and informed chance to decide on the economic merits of a transaction for themselves.” According to the Court, “[w]hen the real parties in interest—the disinterested equity owners—can easily protect themselves at the ballot box by simply voting no, the utility of a litigation-intrusive standard of review promises more costs to stockholders in the form of litigation rents and inhibitions on risk-taking than it promises in terms of benefits to them.” Therefore, “where the stockholders have had the voluntary choice to accept or reject a transaction, the business judgment rule standard of review is the presumptively correct one and best facilitates wealth creation through the corporate form.”
The Supreme Court’s decision clarifies that its previous ruling in Gantler v. Stephens, 965 A.2d 695 (Del. 2009), should be interpreted as a narrow decision focused on defining the specific legal concept of “ratification.” The Court’s decision also reinforces the importance of full and complete disclosures. Such disclosures will not only protect against quasi-appraisal risk, but may also invoke the business judgment rule standard of review in certain circumstances. The decision may also serve as an important obstacle to the now ubiquitous stockholder M&A litigation. As a result of the renewed scrutiny courts are applying to disclosure-only settlements, entrepreneurial plaintiffs’ counsel were incentivized to pursue post-closing damages claims even in third-party deals. This decision appears to make such relief more difficult to obtain.
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