(Article from Securities Law Alert, October 2015)
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On October 2, 2015, the Delaware Supreme Court affirmed dismissal of an action brought by stockholders of KKR Financial Holdings LLC (“Financial Holdings”) who sought post-closing damages in connection with Financial Holdings’ acquisition by KKR & Co. L.P. (“KKR”). Corwin v. KKR Financial Holdings LLC, 2015 WL 5772262 (Del. 2015) (Strine, C.J.) (KKR II). The Delaware Supreme Court found that plaintiffs’ allegations failed to support an inference that KKR was a controlling stockholder of Financial Holdings. The Court further held that “the voluntary judgment of the disinterested stockholders to approve the merger invoked the business judgment rule standard of review.” The Delaware Supreme Court reasoned that “Delaware corporate law has long been reluctant to second-guess the judgment of a disinterested stockholder majority that determines that a transaction with a party other than a controlling stockholder is in their best interests.”
Delaware Supreme Court Finds the Complaint Does Not Allege Facts Supporting an Inference That KKR Was a Controlling Stockholder of Financial Holdings
The Delaware Supreme Court found that the Chancery Court had properly rejected plaintiffs’ contention that “KKR was a controlling stockholder of Financial Holdings” and that “the transaction was [therefore] presumptively subject to the entire fairness standard of review.” The Chancery Court found it significant that “KKR owned less than 1% of Financial Holdings’ stock, had no right to appoint any directors, and had no contractual right to veto any board action.”
The court recognized that a KKR affiliate managed Financial Holdings pursuant to “a contractual management agreement that could only be terminated by Financial Holdings if it paid a termination fee.” Applying Delaware precedent, the Chancery Court “looked for a combination of potent voting power and management control such that [KKR] could be deemed to have effective control of the [Financial Holdings] board without actually owning a majority of stock.” The Chancery Court found “no well-pled facts from which it [was] reasonable to infer that KKR could prevent the [Financial Holdings] board from freely exercising its independent judgment in considering the proposed merger or . . . that KKR had the power to exact retribution by removing the [Financial Holdings] directors from their offices if they did not bend to KKR’s will in consideration of the proposed merger.” In re KKR Fin. Holdings LLC Shareholder Litig., 101 A.3d 980 (Del. Ch. 2014) (Bouchard, C.) (KKR I). The Chancery Court expressly declined “to impose fiduciary obligations on [KKR]” even if “pre-existing contractual obligations with [KKR] that constrain[ed] the business or strategic options available to [Financial Holdings].” KKR II, 2015 WL 5772262.
The Delaware Supreme Court determined that the Chancery Court had “correctly applied the law” in holding that KKR was not a controlling stockholder of Financial Holdings and in finding that the transaction was therefore not subject to the entire fairness standard of review.
Delaware Supreme Court Holds the Business Judgment Rule Standard of Review Applied Because a Fully Informed Majority of Financial Holdings’ Stockholders Voluntarily Approved the Merger
The Delaware Supreme Court found that the Chancery Court had properly applied the business judgment rule standard of review to the KKR-Financial Holdings transaction “because the merger was approved by a disinterested stockholder majority.” The court explained that “when a transaction not subject to the entire fairness standard is approved by a fully informed, uncoerced vote of the disinterested stockholders, the business judgment rule applies.”
The Delaware Supreme Court found that the Chancery Court had correctly held that Gantler v. Stephens, 965 A.2d 695 (Del. 2009) “did not alter the effect of legally required stockholder votes on the appropriate standard of review.” In Gantler, the Delaware Supreme Court determined that the entire fairness standard of review applied to a reclassification of a corporation’s shares that was approved by a majority of the corporation’s disinterested stockholders where the proxy disclosures were allegedly materially misleading. The KKR II court agreed with the Chancery Court that “the effect a statutorily required vote [would have] had on the appropriate standard of review . . . was not even squarely before the Court in Gantler because [the Gantler Court had] found the relevant proxy statement to be materially misleading.” The KKR II court also concurred with the Chancery Court’s view that if Gantler had “intended to unsettle a long-standing body of case law” on the effect of a fully-informed vote of a majority of disinterested stockholders on the appropriate standard of review, the Delaware Supreme Court would “likely have said so.” “To erase any doubt on the part of practitioners,” the KKR II court clarified that Gantler did not address “the question of what standard of review applies if a transaction not subject to the entire fairness standard is approved by an informed, voluntary vote of disinterested stockholders.”
The KKR II Court emphasized that the business judgment rule only applies in cases involving “fully informed, uncoerced stockholder votes.” In the event that “troubling facts regarding director behavior were not disclosed that would have been material to a voting stockholder, then the business judgment rule is not invoked.”
Finally, the KKR II Court explained that “the long-standing policy of [Delaware] law has been to avoid the uncertainties and costs of judicial second-guessing when the disinterested stockholders have had the free and informed chance to decide on the economic merits of a transaction for themselves.” The Court stated that “the core rationale of the business judgment rule . . . is that judges are poorly positioned to evaluate the wisdom of business decisions and there is little utility to having them second-guess the determination of impartial decisionmakers with . . . an actual economic stake in the outcome.” Provided “stockholders have had the voluntary choice to accept or reject a transaction,” the Delaware Supreme Court stated that “the business judgment rule standard of review is the presumptively correct one and best facilitates wealth creation through the corporate form.”