Attorney: Darya Kapulina-Filina
Pomerantz Monitor September/October 2017
Many investors are aware that members of the board of directors of public companies owe stockholders fiduciary duties, including the duty to maximize stockholder value in the event of an impending merger. What is less commonly known is that controlling stockholders are also subject to fiduciary duties to the minority public stockholders, and that a controlling stockholder does not have to own the majority of the company’s stock to be considered a “controller.” In a recent victory by Pomerantz, the Circuit Court in Maryland, applying Delaware law, effectively expanded the definition of controller to astockholder that owned a mere 15.9% ownership interest, in light of its conduct that the court determined amounted to “actual control” with respect to the merger transaction in question.
In In re American Capital, Ltd. Shareholder Litigation, Pomerantz, together with co-lead counsel, filed a class action complaint on behalf of public common stockholders of American Capital Ltd., a global asset manager and private equity firm, challenging a $3.43 billion sale of American Capital to Ares Capital Corporation, a specialty finance company. After substantial discovery, plaintiffs filed a second amended consolidated complaint naming an activist hedge fund, Elliott Management Corporation, and its affiliates, as defendants under the controlling stockholder theory. Meanwhile, plaintiffs negotiated an $11.5 million settlement with the former directors and officers of American Capital. Elliott Management filed a motion to dismiss, which was denied. The court found that Elliott Management was “the catalyst for the merger” and that the facts in the complaint established “actual control by Elliott Management over the American Capital board with respect to the process that led to the sale of American Capital to Ares.” In fact, the court determined that Elliott, who had increased its holdings from 10.3% to 15.9%, “acted as a de facto member of the American Capital board.”
The court held that the allegations of the complaint were sufficient to establish that Elliot Management exerted actual control over American Capital in connection with its sale to Ares. The Court recounted that, fearing a proxy contest from Elliott, American Capital abandoned its value-maximizing spin-off plan and, in six months, closed a “fire-sale” of the company to Elliott’s preferred bidder, Ares, to the exclusion of “at least two other serious bidders” that “offered a better economic deal to the common stockholder.” The court also criticized the $3 million so-called “reimbursement” payment the company made to Elliott “for instigating and then advising on the sale” through “unfettered access to the review process of the American Capital Board.” The court found that, reaping a 20% return on its investment, Elliott “intentionally acquired a large portion in American Capital stock for a single purpose, and thereafter increased its position in the Company’s stock for a single purpose: to force American Capital to sell itself quickly to a suitor of Elliott Management’s preference so that Elliott could make a short term gain.” The court described the case as “unique, as it presents the confluence of better offers and the putative influence of a potent and feared stockholder.”
Under Delaware law, a stockholder owning less than 50% of the voting stock is presumed to be a noncontrolling holder; and a plaintiff must plausibly allege facts showing domination by that stockholder through actual control over corporate decision-making. Forexample, in a seminal Delaware decision in 2014 in In re Zhongpin Shareholder Litigation, in which Pomerantz was also co-lead counsel, the Delaware Chancery Court determined that Zhongpin’s CEO, who held 17.3% of Zhongpin’s stock, was a controlling stockholder in connection with his acquisition of the remaining outstanding shares of Zhongpin’s common stock in a going-private transaction. The Zhongpin court noted that “Zhu exercised significantly more power than would be expected of a CEO and 17% stockholder.” In fact, the court found that “Zhu possessed both latent and active control of Zhongpin” because “as a result of his stock ownership, he could exercise significant influence over shareholder approvals for the election of directors, mergers and acquisitions, and amendments to Zhongpin’s bylaws” and “[t]he Company relied so heavily on him to manage its business and operations that his departure from Zhongpin would have had a material adverse impact on the Company.” The court concluded that “[d]espite the fact that Zhu’s ownership interest was much smaller than a typical controller’s, Plaintiffs plead indicia of domination, sufficient to raise an inference that Zhu exercised control over Zhongpin.”
The expanding definition of controlling stockholder means that courts will look at the conduct and formidable power of influential stockholders on the corporate decision-making of the board. If such party exercises actual control of the board through domination, manipulation, and strong-arming, it will be held accountable and liable to minority public stockholders in class action suits.