In Calesa Associates, L.P. v. American Capital, Ltd., a group of minority stockholders of Halt Medical, Inc. (the “company”) filed a lawsuit for breaches of fiduciary duty in connection with a corporate transaction against current and former directors of the company and a stockholder that allegedly controlled them, American Capital, Ltd. and its affiliates (collectively, “American”).[1] According to the minority stockholders, American owned 26% of the company prior to the transaction at issue and exercised sufficient control over the company’s board of directors. Specifically, American appointed three directors and helped fill the so-called independent director seat, all of whom were affiliated with American and consistently took positions favoring American throughout their respective tenure. The transaction involved several complex agreements between the company and American, requiring, among other things, the following: (i) the company would enter into a merger agreement with a merger sub and the company’s stockholders would waive any appraisal rights; (ii) American would loan an additional $73 million to the company, part of which was to be used to repay the existing loan to American; and (iii) American would receive a blanket first priority security interest in the company’s assets.
The company’s minority stockholders received copies of the 297-page set of transaction documents via email just one day before the closing and were asked to sign and return them the following day. The minority stockholders alleged that the terms recorded in these documents were significantly different from the original deal, in favor of American, and some of the exhibits were incomplete, in draft form, or missing entirely. According to the minority stockholders, the pressure to close the deal within one day was manufactured by American, facilitated by American-controlled directors, because if they did not sign, American would demand payment in full of its existing loan, which the company could not pay. The minority stockholders alleged that the board as a whole also received and approved the transaction within one day, without an independent valuation of the transaction and with little or no analysis as to its fairness to the stockholders. After the transaction, American’s position in the company increased from approximately 26% to almost 66% and America had four designated seats out of a total of seven on the board. In the lawsuit, the minority stockholders sought to rescind the transaction.
The Court of Chancery noted that a stockholder is controlling and owes fiduciary duties to the other stockholders “if it owns a majority interest in or exercises control over the business affairs of the corporation.” The court noted that there is no correlation between the percentage of ownership and the control status and that there is no magic formula to find control. In this case, although American only owned some 26% before the transaction, the court found that a majority of the board was under the influence of American with respect to the transaction, such that American was a controlling stockholder at the time of the transaction. And according to the court, this determination, in turn, was sufficient to rebut the business judgment rule with respect to actions of the board.
So, what does “control” in “controlling stockholder” mean under Delaware law? It means either majority ownership interest or ability to exercise control over the business affairs of the corporation, e.g., through control over the corporation’s board of directors.
This post was part of a two-part series on the meaning of “control” in “controlling stockholder.” You can find the other post by searching our blogs at www.mcbrideattorneys.com. If you have any questions about the content of this blog or other business law issues not discussed here, please contact us.
This posting is intended to be a planning tool to familiarize readers with some of the high-level issues discussed herein. This is not meant to be a comprehensive discussion and additional details should be discussed with your transaction planners including attorneys, accountants, consultants, bankers and other business planners who can provide advice for your circumstances. This article should not be treated as legal advice to any person or entity.
Steps have been taken to verify the contents of this article prior to publication. However, readers should not, and may not, rely on this article. Please consult with counsel to verify all contents and do not rely solely on this article in planning your legal transactions.
[1] See generally Calesa Assocs., L.P. v. Am. Capital, Ltd., No. 10557-VCG (Del. Ch. Feb. 29, 2016). Unless otherwise noted, all references to the case are from this citation.