What constitutes 'fair treatment'?
Selling the family silverware can be a point of contention, especially among the younger, marginalized, members of a household.
When the inheritance at stake is a majority share in a public company, troublesome minority stockholders can be like children, taking issue with the ‘fairness’ of their treatment during the sale process.
Ensuring every stockholder is treated fairly is of particular importance for the independent directors of such a public company. But what exactly is ‘fair’ in the context of selling a controlled company?
A recent case before the Delaware Chancery Court provides some practical guidance for directors and managers in this situation.
In In re John Q. Hammons Hotels, Shareholder Litigation, the minority shareholders of a hotel company sued John Hammons, the company’s CEO, chairman and majority stockholder, as well its board of directors, after the hotel company merged with another firm in 2005.
The class action suit alleged Hammons had used his controlling position (more than 75 percent of the effective vote) to negotiate more advantageous consideration in return for his own shares, including an interest in the new entity, which was not extended to the minority shareholders. The plaintiffs also alleged that the board of directors had used a deficient process to negotiate and later approve the sale on behalf of the minority shareholders.
The court ruled in favor of the defendants. ‘The extensive arm’s length negotiation with two active bidders for the period of nine months…demonstrates that the process was entirely fair,’ holds Chancellor Chandler in his post-trial opinion delivered on January 14, 2011.
Chandler takes this view notwithstanding the application of the more stringent ‘entire fairness’ standard of review, determined to apply by earlier summary judgment of the court.
In his post-trial opinion, Chandler expands on the three factors that were crucial to the court in reaching its decision: a fair price, the prior approval of the minority shareholders, and the constitution of the special committee of the board negotiating the sale.
On price, the court holds that the minority stockholders had received relatively more for their stock than Hammons. This determination came down to a battle between experts, with the defendant’s expert proving to be more credible.
Nearly 90 percent of the minority shareholders who voted on the sale did so in favor of the board’s decision. Chandler’s opinion describes this number as ‘overwhelming’.
The plaintiffs dropped their claim against the board of directors prior to the court reaching its decision. All the same, Chandler opines on the overall fairness of the process adopted by the board.
He notes how the independent and disinterested directors on the three-person committee were highly qualified, with extensive experience in the hotel industry. Each director, the judge holds, understood his authority and duty to reject any offer that was not fair to the minority stockholders, which was evidenced by the committee rejecting a competing offer for the company.
Hammons did not sit on the special committee of the board in his capacity as CEO and chairman. Even so, the plaintiffs contended Hammons had coerced the special committee into approving the sale by threatening to veto the sale and return the company to the status quo.
This threat, the plaintiffs claimed, rendered the special committee ineffective. The court dismissed this assertion. Chandler says Hammons was under no obligation to sell his shares. Moreover, the status quo had existed since the company’s formation, which was fully disclosed to investors at the time.
