Palkon v. Maffei, 2024
This was a suit where the minority shareholders challenged the conversion of two Delaware corporations into Nevada corporations with the controlling shareholder delivering the deciding vote the admitted purpose of which was reducing potential liabilities for directors and officers. This particular opinion dealt with a motion to dismiss the case. The Chancery Court in this case granted the defendants’ motion to dismiss the plaintiff’s request for injunctive relief but denied the motion to dismiss the primary complaint, which the defendants argued did not state a claim. The Chancery Court noted that the outcome depended on the standard of review.
As depicted, the conversion was a self-interested transaction a controlling shareholder effectuated. The conversion conferred a nonratable benefit on the controlling shareholder, i.e., it lessened the liability exposure to directors and officers. This triggered the entire fairness standard of review. “There are no protective devices that could lower the standard of review. Entire fairness governs.” Thus, the plaintiffs have a stated claim on which relief can be granted. “The entire fairness standard has two dimensions: substantive fairness (fair price) and procedural fairness (fair dealing).”
After the conversion, the shareholders owned shares carrying a different bundle of rights under Nevada law, including a lesser set of litigation rights. The indication was that the conversion was not substantively fair. The conversion was impliedly procedurally unfair because there was no arm’s-length bargaining. The controlling shareholder delivered the vote. There was thus a claim to be stated, and the controlling shareholder, directors, and officers believed that they had greater protections under Nevada law. If a Delaware corporation converted into a Delaware LLC, a structure similar to the Nevada corporate law could be designed with a similar result. In that case, there would similarly be a claim to be stated.
However, this did not mean that the corporation cannot leave Delaware. “The plaintiffs can only state a claim on which relief can be granted because (1) the corporation has a stockholder controller, and (2) the board did not implement any protective provisions. The defendants also did not make any effort to compensate the stockholders for the reduction in their litigation rights. Change any of those variables and the outcome could be different.” Here, the defendants did not establish the protections upfront, and, therefore, they bore the burden of proving entire fairness. The defendants’ motion to dismiss was denied.
Factual background.
Defendants. Trip Advisor Inc. is a Delaware corporation. It operates the largest travel guidance program. It has a dual class of stock structure. Class A common carried one vote per share and traded publicly, and Class B common carried 10 votes per share and was owned exclusively by Liberty TripAdvisor Holdings Inc. Holdings also owned about 21% of the Class A shares and exercised 56% of the outstanding voting power with only one-fifth of the economic interest.
Holdings also had a dual structure similar to Trip Advisor, but both classes were publicly traded. Gregory Maffei was the CEO and chairman of Holdings. Maffei beneficially owned Series B Holdings shares, carrying 43% of the voting power of Holdings. The defendants conceded that Maffei controlled both Holdings and Trip Advisor. The other defendants were board members of one or the other company.
The company board resolved to convert TripAdvisor into a Nevada corporation. At a meeting in April 2023, the company board approved final resolutions authorizing the conversion from a Delaware to a Nevada corporation. A management presentation noted that the “laws of Nevada would generally permit the Company to offer greater protection to its directors and officers” and reduce the “risk of expensive and time consuming litigation against the Company and its directors and officers.”
The Holdings board resolved to convert holdings into a Nevada corporation. During March 2023, Holdings management presented on potentially converting Holdings into a Nevada corporation. Among other advantages noted in the presentation was that “[c]ases that are subject to ‘entire fairness’ review in Delaware (which requires the defendants to demonstrate that the price and process in a transaction were entirely fair) present a high bar and, because of the factual issues involved, it is often difficult for defendants to prevail in the preliminary stages of litigation[.]” In April 2023, the Holdings Board approved the conversion.
The company and Holdings sought stockholder approval. In June 2023, each company approved each conversion by votes of the majority of the voting power of each. “Assuming Holdings cast all of its votes in favor the Company conversion, only 5.4% of the unaffiliated Company stockholders voted in favor.” Holdings and Maffei provided the decisive votes.
The claim for breach of fiduciary duty.
The standard of review. Delaware employs, progressively, the business judgment rule, enhanced scrutiny, and the entire fairness. The business judgment rule was the default unless a plaintiff rebutted one of the elements of the rule. Only when a decision lacked a conceivable basis will a court infer bad faith and breach of duty.
Enhanced scrutiny was what it implied and was an intermediate step.
The most onerous rule was the entire fairness rule. Under that standard, the fiduciary defendants must establish “to the court’s satisfaction that the transaction was the product of both fair dealing and fair price.” “Not even an honest belief that the transaction was entirely fair will be sufficient to establish entire fairness. Rather, the transaction itself must be objectively fair, independent of the board’s beliefs.”
In this case, the standard of review depended on whether the conversions resulted in a nonratable benefit to the fiduciary defendants.
Nonratable benefits. Under Delaware law, a controller or fiduciary received a nonratable benefit when a transaction materially reduced or eliminated the fiduciary’s risk of liability. In Harris, a reincorporation, the principle was applied. It should likely also be applied in this case. (Editor’s note: Here, the Chancery Court went into a lengthy discussion of potential future liability, which the defendants asserted was not appropriate to consider as to a nonratable benefit. The Chancery Court shared cases and examples of why this position was oxymoronic and not applicable. The discussion continued as to materiality and what was or was not material for purposes of the standard.) The true test of fairness was whether the minority shareholders received substantially equivalent value. The procedural dimension of entire fairness here examined “fair dealing.” The procedural dimension mattered because the substantive dimension was often contestable. Fairness “will inevitably constitute a judicial judgment that in some respects is reflective of subjective reactions to the facts of a case.” (Cinerama, Inc. v. Technicolor, Inc.)
The two conversions in this case acted as stock-to-stock mergers. “The court likewise can conduct an entire fairness inquiry and consider, under the substantive dimension, whether stockholders received the substantial equivalent of what they had before.”
Evidence of unfairness. The plaintiffs presented arguments that brought into question the fairness of the transactions, since, after the transactions, the minority shareholders will have only the litigation rights of Nevada, which were inferably less than Delaware provided. Further, the defendants made no effort to replicate arm’s-length bargaining. Here, the unaffiliated stockholders resoundingly rejected the conversions.
Since the plaintiffs had put forth facts that supported the conversions as being unfair, the complaint, therefore, stated a claim on which relief can be granted.
Preventing litigation rights from becoming second-class rights. Litigation rights cannot become second-class rights. Stockholders had three fundamental rights: to sell, vote, and sue. Each right represents an entitlement stockholders have: economic rights, governance rights, and the right to litigate. The first two are fairly obvious and should not be restricted to be fair. The same should be true for litigation rights. This decision treated litigation rights as first-class rights.
The availability of injunctive relief. In extreme scenarios, a state court can prevent persons and/or assets from leaving the state. Those extreme circumstances did not exist here. The plaintiffs here asked the Chancery Court to enjoin the conversions. The plaintiffs will have to prevail on the merits and prove that other remedies were inadequate, as in the COVID- 19 cases. The standard remedy was monetary damages, which likely can be crafted in this case.
To determine damages, perhaps the change in the company’s trading price would help quantify the harm. A change in the governance structure should offer a clearer question. “Because of the narrow issue that this case presents, it seems likely that the court will have a sufficiently reliable basis to craft a monetary award for any harm that the Company’s stockholders suffer.” The Chancery Court can retain jurisdiction after the conversion. Delaware law provided that by statute.
Injunctive relief was off the table, and the conversion closings will not be delayed.
Conclusion.
“The defendants’ motion to dismiss is granted as to the plaintiffs’ request for injunctive relief. Otherwise, the motion is denied.”