Deal dynamics with controlling shareholders.

Author:Raymond, Doug

Ed./Vote: For the Year in Review issues we give our Directors & Boards "Legal Brief" columnist Doug Raymond the "if you could pick just one" challenge. That is, we ask him to highlight a court ruling from the past year that he feels is of particular consequence to a board's decision-making considerations and fiduciary obligations. The case he selected is In re CNX Gas Corporation Shareholders Litigation, a decision rendered on May 25,2010, in the Delaware Court of Chancery that highlights the position of minority stockholders in a freeze-out transaction.


Directors of a company with a controlling shareholder and directors of a company that is a controlling shareholder should know that they have essentially two different ways to freeze out minority shareholders of a Delaware company and take a target company private: (i) a negotiated merger between the controlling stockholder and target company in which the target merges with an entity wholly-owned by the controller, and (ii) a unilateral tender offer. The first approach requires a merger agreement negotiated by a special committee of the board with independent advisors and approved by a majority (or more, depending on the company's charter) of the target's stockholders. The second approach, the tender offer, can be initiated unilaterally by the acquirer and, so long as less than 10% of the shares remain minority-held following the tender offer, a "short-form" merger can be effected by the controlling stockholder without any input from the target company's board, or its other shareholders, to complete the transaction.

Recent Delaware case law adds a layer of complexity to the choice between these two approaches. If challenged in court, the negotiated merger transaction will be reviewed under the entire fairness doctrine. This is a factually intensive review of both the procedural and substantive fairness of the transaction. Importantly, because of its factually intensive nature, such lawsuits generally cannot be resolved on a motion to dismiss, instead requiring a full trial to adjudicate.

Being prepared to defend such a lawsuit requires precise attention to detail and a commitment to weather protracted litigation, and provides no guarantees of ultimate success. By contrast, if certain procedural elements are included in the tender offer transaction, the business judgment rule, a much more deferential standard, may apply, and any legal challenges may be resolved much...

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