In Frank v. Mullen, et al., the Delaware Court of Chancery dismissed a breach of fiduciary duty claim against a minority shareholder arising out of the merger of a Delaware corporation where the plaintiff failed to plead facts demonstrating the minority shareholder’s actual control over the corporation’s affairs. The court distinguished the legal standard of actual control from the dynamic of bargaining power, ruling that exercising leverage in an arm’s-length transaction does not constitute actual control. The ruling implies that where an independent committee and an independent board have approved the terms of the sale, a fiduciary duty claim under a controlling shareholder theory will likely fail.
In Frank, B. Riley Financial, Inc. (BRF) owned 46.4% of National Holding Corporation’s stock. In April 2020, BRF sought permission for a going-private transaction. National’s board granted BRF a limited waiver of a standstill agreement, and BRF made an offer to purchase nonmanagement shares for $2 per share. National’s board required compliance with the procedural safeguards set forth in Kahn v. M&F Worldwide Corporation: (1) approval by an independent, special committee and (2) approval or tender by a majority of shareholders unaffiliated with BRF. Upon receipt of the offer, National’s board formed a special committee, which retained its own legal and financial advisors.
National’s management opposed the going-private transaction. Following BRF’s initial proposal, National’s management formed a consortium and made an offer to purchase five million shares for $2.75 per share. BRF opposed this proposal and indicated its intent not to sell its shares.
In June 2020, the special committee entered into negotiations with BRF. At that time, the management consortium proposed a plan for raising capital. The alternate proposal, along with the expiration of the waiver of the standstill agreement, empowered the special committee to seek a counteroffer from BRF to increase the price to $2.75 per share and extend the offer to all shareholders. BRF sought additional consideration, and the special committee countered at $3.25 per share. In response, BRF increased its offer to $2.75 per share. After several days of silence, BRF indicated that it would pursue a change-of-control transaction after the standstill agreement expired. Two days later, the special committee decided to focus on a transaction with BRF alone. The parties were unable to reach an agreement, and BRF withdrew its proposal.
Renewed interest on the part of BRF and the management consortium led National’s board to reconstitute the special committee. However, BRF remained opposed to selling its shares. As a result, the special committee concluded that the management consortium’s offer was not in the shareholder’s best interests, and the committee focused its efforts on negotiations with BRF. During the course of negotiations, National’s value increased, which led the special committee to seek $3.50 per share. BRF countered at $3.25 per share, the special committee accepted the offer, and the parties executed a merger agreement in January 2021. The transaction closed in February 2021.
Delaware law imposes fiduciary duties on those individuals or entities that exercise control over a corporation. As a general rule, a shareholder does not owe fiduciary duties. However, a shareholder that owns more than 50% of the voting power in a corporation or exercises actual control over the affairs of the corporation is an exception to the rule. If a shareholder meets either of these criteria, it assumes fiduciary duties. In the event of a controlling shareholder transaction, the court will apply the entire fairness standard as opposed to the deferential business judgment rule.
In this case, the plaintiff alleged that BRF owed and subsequently breached its fiduciary duties as a result of its exercise of actual control over the corporation. Whether a minority shareholder exercised actual control over a transaction requires a fact-intensive analysis or, in the court’s own words, “a holistic evaluation of sources of influence.” The plaintiff bears the burden of proving that the minority shareholder controlled the corporation’s affairs such that independent directors could not freely exercise their judgment. The mere possibility of control is not sufficient. Similarly, negotiating leverage does not equate to actual control. Where the parties negotiated at arm’s length and the transaction received the approval of an independent body, a minority shareholder lacks the level of control necessary to give rise to a fiduciary duty.
The Delaware Court of Chancery concluded that BRF did not exercise actual control over the transaction. First, BRF’s 46.4% equity stake conferred voting power but not actual control. While the minority shareholder’s refusal to sell its shares to the management consortium affected the special committee’s analysis, arm’s-length leverage does not equate to control. Second, the facts failed to demonstrate that BRF controlled National’s board. BRF neither held a high-status role on the board nor employed or controlled a board member. Rather, it possessed a single, nonvoting board observer. Third, the minority shareholder’s threats did not taint the process. The record includes a series of decisions by independent bodies, including an arm’s-length negotiation by the special committee that resulted in a price increase. Although BRF made threats relating to the standstill agreement, the special committee and board remained free to exercise their independent judgment.
Frank demonstrates the importance of process and the value of independence in the court’s evaluation of business transactions. The plaintiff was unable to sustain the difficult burden of demonstrating the minority shareholder’s actual control over the corporation. Although the minority shareholder possessed leverage, mere bargaining power does not give rise to a fiduciary duty. The board’s creation of a special committee, which, in turn, retained its own legal and financial advisors, resulted in an arm’s-length negotiation with the minority shareholder and an increase in share price. The special committee, along with the minority shareholder’s absence from the board, allowed the exercise of independent judgment. These independent bodies were free to exercise their judgment in light of the economic realities, but the minority shareholder’s mere leverage did not taint the transaction.