January 16, 2016
The Cleansing Effect of a Statutorily Required Shareholder Vote on a Troubled Transaction
By Stephen B. Brauerman and Sara E. Bussiere
Delaware law has long recognised that the uncoerced vote of fully informed stockholders can cure even the most questionable of self-interested transactions. This policy is enforced through the standard of review Delaware courts use to judge these otherwise interested transactions. This article discusses Delaware’s increasing comfort with the curative powers of fully-informed stockholder votes, as evidenced by the Delaware Supreme Court’s recent decision in Corwin v. KKR Financial Holdings, LLC, in which the Court extended deferential judicial review to transactions approved by a majority of disinterested stockholders, even where the stockholder vote was statutorily required. Corwin exemplifies the sanitising benefits of a vote – even when the company did not call the vote for its sanitising effect.
The standard of review determines the deference the court will apply in reviewing a challenged transaction and is often outcome determinative. Thus, the application of the appropriate standard of review is “essential to a proper judicial review of challenges to the decision-making process of a corporation’s board of directors”. Omnicare, Inc. v. NCS Healthcare, Inc., 818 A.2d 914, 927 (Del. 2003). Delaware courts employ three levels of judicial review: (i) the business judgment rule; (ii) enhanced scrutiny; and (iii) entire fairness.
The business judgment rule, the most deferential standard, reflects the “cardinal precept of the General Corporation Law of the State of Delaware… that directors, rather than shareholders, manage the business and affairs of the corporation”. As such, under the business judgment rule, Delaware courts will uphold corporate decisions “absent an abuse of discretion”. However, a plaintiff may rebut the business judgment rule in various ways, including by showing that a controlling stockholder stood on both sides of the transaction, a majority of the board was interested in a particular transaction or lacked independence, or that the board failed to act in good faith in approving the transaction (Id.; see also eBay Domestic Holdings, Inc. v. Newmark, 16 A.3d 1, 36 (Del. Ch. 2010).
If a plaintiff successfully rebuts the business judgment rule, the burden of proof shifts to the defendant director to prove that the challenged transaction was entirely fair to the company – an exacting standard. Entire fairness requires the defendant director to “establish to the court’s satisfaction that the transaction was the product of both fair dealing and fair price”. Cede & Co. v. Technicolor, 634 A.2d 345, 361 (Del. 1993) (emphasis in original). Somewhere between the business judgment rule and entire fairness lies enhanced scrutiny, an intermediate level of judicial review that requires the defendant director to prove that the actions he or she took were reasonable”. Paramount Communications Inc. v. QVC Network, Inc., 637 A.2d 34 (Del. 2000).
In Corwin, the Delaware Supreme Court affirmed the dismissal of a complaint for breaches of fiduciary duty, and aiding and abetting such breaches, because “the voluntary judgment of the disinterested stockholders to approve the merger invoked the business judgment rule standard of review”, which plaintiffs failed to rebut. Plaintiffs’ claims arose from a stock-for-stock merger whereby KKR & CO. L.P. (KKR) acquired KKR Financial Holdings LLC (KFN).
Plaintiffs argued the Court should apply entire fairness review because KKR, which held less than 1 percent of KFN’s stock, constituted a controlling stockholder and a majority of the KFN board lacked independence. After finding that it could not re
Delaware law has long recognised that the uncoerced vote of fully informed stockholders can cure even the most questionable of self-interested transactions. This policy is enforced through the standard of review Delaware courts use to judge these otherwise interested transactions. This article discusses Delaware’s increasing comfort with the curative powers of fully-informed stockholder votes, as evidenced by the Delaware Supreme Court’s recent decision in Corwin v. KKR Financial Holdings, LLC, in which the Court extended deferential judicial review to transactions approved by a majority of disinterested stockholders, even where the stockholder vote was statutorily required. Corwin exemplifies the sanitising benefits of a vote – even when the company did not call the vote for its sanitising effect.
Delaware’s standards of judicial review
The standard of review determines the deference the court will apply in reviewing a challenged transaction and is often outcome determinative. Thus, the application of the appropriate standard of review is “essential to a proper judicial review of challenges to the decision-making process of a corporation’s board of directors”. Omnicare, Inc. v. NCS Healthcare, Inc., 818 A.2d 914, 927 (Del. 2003). Delaware courts employ three levels of judicial review: (i) the business judgment rule; (ii) enhanced scrutiny; and (iii) entire fairness.
The business judgment rule, the most deferential standard, reflects the “cardinal precept of the General Corporation Law of the State of Delaware… that directors, rather than shareholders, manage the business and affairs of the corporation”. As such, under the business judgment rule, Delaware courts will uphold corporate decisions “absent an abuse of discretion”. However, a plaintiff may rebut the business judgment rule in various ways, including by showing that a controlling stockholder stood on both sides of the transaction, a majority of the board was interested in a particular transaction or lacked independence, or that the board failed to act in good faith in approving the transaction (Id.; see also eBay Domestic Holdings, Inc. v. Newmark, 16 A.3d 1, 36 (Del. Ch. 2010).
If a plaintiff successfully rebuts the business judgment rule, the burden of proof shifts to the defendant director to prove that the challenged transaction was entirely fair to the company – an exacting standard. Entire fairness requires the defendant director to “establish to the court’s satisfaction that the transaction was the product of both fair dealing and fair price”. Cede & Co. v. Technicolor, 634 A.2d 345, 361 (Del. 1993) (emphasis in original). Somewhere between the business judgment rule and entire fairness lies enhanced scrutiny, an intermediate level of judicial review that requires the defendant director to prove that the actions he or she took were reasonable”. Paramount Communications Inc. v. QVC Network, Inc., 637 A.2d 34 (Del. 2000).
Corwin and mandatory votes
In Corwin, the Delaware Supreme Court affirmed the dismissal of a complaint for breaches of fiduciary duty, and aiding and abetting such breaches, because “the voluntary judgment of the disinterested stockholders to approve the merger invoked the business judgment rule standard of review”, which plaintiffs failed to rebut. Plaintiffs’ claims arose from a stock-for-stock merger whereby KKR & CO. L.P. (KKR) acquired KKR Financial Holdings LLC (KFN).
Plaintiffs argued the Court should apply entire fairness review because KKR, which held less than 1 percent of KFN’s stock, constituted a controlling stockholder and a majority of the KFN board lacked independence. After finding that it could not re