In City Pension Fund for Firefighters and Police Officers in the City of Miami v. The Trade Desk, Inc., et al., C.A. No. 2021-0560-PAF (Del. Ch. July 29, 2022), the Delaware Court of Chancery dismissed a stockholder challenge to a charter amendment transaction that eliminated a dilution provision and extended the duration of the company’s dual-class stock structure, which had been proposed by a controlling stockholder, negotiated by an independent special committee, approved by the company’s board of directors, and approved by stockholders through an affirmative vote by a majority of the minority of unaffiliated shares. Although transactions involving a controlling stockholder are presumptively subject to review under the exacting entire fairness standard, the court applied the more deferential business judgment standard after it determined that the plaintiff failed to plead facts sufficient to challenge compliance with the framework set forth in Kahn v. M & F Worldwide Corp. (MFW), 88 A.3d 635 (Del. 2014).
The company at issue had two classes of common stock: Class A stock, which traded publicly and entitled its holder to one vote per share, and Class B stock, which was not publicly traded and was entitled to 10 votes per share. If at any time the outstanding Class B stock represented less than 10% of the aggregate outstanding Class A and Class B stock, the company’s charter provided for the automatic conversion of Class B stock into Class A stock on a 1-for-1 basis and cancellation of the Class B stock (the “Dilution Trigger Provision”).
By March 2020, the Class B stock constituted 11.2% of the total outstanding Class A and Class B stock. This was due to continual sale of Class B shares since the company’s initial public offering in 2016, including by the company’s controlling stockholder (who co-founded the company and served as its president and CEO, and as a director) pursuant to an approved stock trading plan. The controlling stockholder raised the potential to amend the charter to extend the dual-class stock structure to the company’s officers and directors, which led to the formation of a three-person special committee.
The special committee was empowered to evaluate a potential amendment to extend the dual-class stock structure and retained its own legal counsel and financial advisor. After three months of negotiations with the controlling stockholder, the special committee presented a term sheet outlining a transaction that, among other things, would eliminate the Dilution Trigger Provision and extend the company’s dual-class capitalization structure for five years. The charter amendment transaction was conditioned on an affirmative vote by a “majority of the minority.”
After approving the charter amendment transaction in October 2020, the board filed a special proxy to solicit stockholder votes. On December 22, 2020, the charter amendment transaction was approved, with 52% of the unaffiliated shares voting in favor. Between December 2020 and April 2021, with the dual-class stock structure intact, the controlling stockholder converted Class B shares into Class A shares and sold them for approximately $435 million.
The plaintiff filed suit on June 28, 2021, asserting breach of fiduciary duty claims against the controlling stockholder and the company’s officers and directors based on the purported unfairness of the charter amendment transaction and the failure to disclose, among other facts, the controlling stockholder’s desire to sell shares and the date of the anticipated sunset of the dual-class stock structure. None of the parties disputed that the controlling stockholder controlled more than 50% of the voting power of the company’s outstanding voting stock at all relevant times. Although it was undisputed that a controller transaction presumptively is reviewed under the entire fairness standard, the court applied the deferential business judgment standard after holding that the plaintiff failed to plead sufficient facts to support that the special committee was not independent or that the vote of the minority was uninformed, which were the only two MFW factors at issue.
Looking to the plaintiff’s operative complaint, which had been filed after a books-and-records demand and then amended, the court held that plaintiff failed to plead sufficient facts to support that a majority of the special committee was not independent. The plaintiff only challenged the independence of the special committee’s chairperson and otherwise failed to plead sufficient facts to support that the chairperson’s director compensation was material to the point of compromised independence. The court also disagreed that plaintiff sufficiently alleged facts to support that the special committee operated under a “controlled mindset” that was dictated by the controlling stockholder. To the contrary, the court noted the lack of allegations to support that the controlling stockholder sought to interfere with or pressure the special committee.
The court also held that the proxy statement issued by the board in October 2020 sufficiently disclosed and explained the charter amendment transaction and did not contain omissions of material fact that could have led to an uninformed stockholder vote. In particular, the court found that not disclosing the controlling stockholder’s desire to sell stock would not have significantly altered the total mix of information available to stockholders and that the proxy adequately disclosed when the Dilution Trigger Provision could be tripped and that it was the controlling stockholder who initially raised eliminating the provision and extending the dual-class structure.
The Trade Desk decision reinforces the cleansing power of the MFW framework in a transaction involving a conflicted controlling stockholder. It is a useful reminder that conditioning a transaction on approval of (i) a duly empowered and independent special committee and (ii) a well-informed, non-coerced vote in favor of the transaction by a majority of the minority stockholders can mitigate litigation risk by altering the standard of review from the onerous entire fairness standard (i.e., fair process and fair price) to the more lenient business judgment standard. It also reassures practitioners and clients that the Delaware Court of Chancery will dismiss stockholder challenges, even at the pleadings stage, where a plaintiff’s complaint is lacking in factual support and the MFW framework has been followed.