Business judgment rule OK’d in another controlling shareholder deal
In May, when Chancellor Leo Strine of Delaware Chancery Court made new law on going-private deals – holding in In re MFW Shareholders Litigation that boards of companies with controlling shareholders are entitled to deference under the business judgment rule if they appoint an independent special committee to evaluate the buy-back offer and also obtain approval of the deal from a majority of the other shareholders – the judge said that one of the benefits of decision might be to reduce meritless breach-of-duty claims. Boards that provide double-barreled protection for minority shareholders, Strine said, should not have to endure full-blown trials to review those deals under the exacting “entire fairness” standard.
On Tuesday a second Chancery Court judge said the same thing, and this time in a case involving a sale to a third party rather than the controlling shareholder. Plaintiffs had claimed that Provident Equity Capital’s acquisition of the defense contractor SRA, whose founder and former CEO Ernst Volgenau controlled almost 72 percent of the company’s voting rights, should be evaluated under the entire fairness standard. But Vice-Chancellor John Noble ruled that because SRA’s board established an independent committee that engaged in a robust auction, then won approval of the company’s sale price from more than 80 percent of the minority shareholders, it’s entitled to review under the much more deferential business judgment rule. And under that rule, Noble said, there’s no question that SRA, its board members and Provident, fulfilled their fiduciary duties.
“As does MFW,” Noble wrote, “this case serves as an example of how the proper utilization of certain procedural devices can avoid judicial review under the entire fairness standard and, perhaps in most instances, the burdens of trial.” In combination, MFW and SRA should provide powerful incentives for the boards of companies with controlling shareholders to avoid the time and expense of protracted litigation by establishing two tiers of protection for minority equity holders.
The SRA defendants were certainly well tested by shareholder counsel from Chimicles & Tikellis, who deposed several board members about the company’s sale process. (Pamela Tikellis didn’t return my call.) The firm contended that controlling shareholder Volgenau improperly influenced the board to accept Provident’s offer because Provident had brought in former SRA officials who engaged in pre-offer talks with him. Chimicles & Tikellis also claimed that SRA’s CEO, onetime Wilmer Cutler Pickering Hale and Dorr partner Michael Klein, pushed for a deal in hopes of receiving a big bonus for his work chairing the special board committee; and that minority shareholders weren’t adequately informed before voting on the deal of all the particulars, including the $1 million bonus SRA counsel Kirkland & Ellis was awarded.
Vice-Chancellor Noble found there was nothing much to any of these and the other plaintiffs’ allegations. Volgenau, he said, did not stand on both sides of the transaction; his interests were aligned with those of the other shareholders, and he did not unduly influence the board’s special committee. That committee solicited offers from multiple suitors, spurring a bidding war between Provident and another private equity firm, Veritas Capital. SRA would have accepted a Veritas offer were it not for some procedural concerns, Noble said, and even after it agreed to Provident’s offer – which featured a 50 percent premium on SRA’s share price – reached out to other potential bidders during a go-shop period. Noble gave significant attention to the bonus Klein requested (but did not receive), but concluded that there was no evidence the requested bonus impacted the sale process in any way. (And besides, Klein said he wanted to give the money to charity, which is what he did with the smaller bonus he ended up receiving.)
In addition to its connection to Strine’s decision in MFW, Noble’s ruling is a direct descendant of then Chancellor William Chandler‘s 2009 opinion in In re John Q. Hammons Hotels Shareholder Litigation, in which Chandler said that the board of Hammons, a company controlled by founder John Hammons, could have adopted procedures in its sale to a third party that would have entitled it to deference under the business judgment rule, but didn’t. Chandler spelled out the protections for minority shareholders that the Hammons board could have applied, and SRA apparently heeded them. Noble said SRA passed the test Chandler set forth in the Hammons ruling.
SRA counsel James Gillespie of Kirkland & Ellis told me the ruling is important precedent. “I believe this decision reflects the court’s recognition that when a board takes the responsible steps of forming an independent special committee and enfranchising minority shareholders, (judges) will defer to the business judgment of the board – and appropriately so when the board produces a deal as good as this one,” he said. Kirkland also represented all of the SRA board members except for company founder Volgenau, who had counsel from Gibson, Dunn & Crutcher in the case. Provident was represented by Debevoise & Plimpton.
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