In Re CNX Gas Corp. S’holder Litig., C.A. No. 5377-VCL (Del. Ch. July 5, 2010), read opinion here.
This 33-page opinion of the Court of Chancery, issued yesterday on a holiday, grants an application for an interlocutory appeal of the original decision in this case dated May 26, 2010, which was highlighted on this blog here. The major issue in the first opinion was the applicable standard of review in a freeze-out transaction by a controlling shareholder. (In the first footnote of the latest opinion, the Court refers to what is described as the “M&A argot” that uses a variety of terms for transactions that eliminate the minority shareholders, including squeeze-out, freeze-out and buy-outs, among others.)
The standard applied by the Court of Chancery to certify an interlocutory appeal from the denial of an injunction is the initial focus of this decision. The Court of Chancery concluded that the “current state of our law warrants interlocutory review” regarding the appropriate standard of review for a controller’s unilateral two-step freeze-out. Even though the Motion for Preliminary Injunction by the plaintiff was denied, the Court of Chancery explained that there was an exception to the general rule that a prevailing party may not appeal a decision in its favor. While explaining that this exception means that the defendants have standing to appeal, that did not equate with a right to appeal.
Supreme Court Rule 42 governs interlocutory appeals. Rule 42 refers to the criteria in Rule 41(b) which provides examples of the reasons for accepting an appeal, such as the following: “The decision of the trial courts are conflicting upon the question of law.”
Specifically, the Court of Chancery explained that the decisions of the Court of Chancery “conflict over the standard of review that governs a controller’s unilateral two-step freeze-out.” Moreover, the Court explained that “at least three different standards of review have been applied.”
Although the Court of Chancery in the instant case held that the entire fairness standard applies to a unilateral two-step freeze-out unless the transaction was structured to provide arms-length third-party transactional approvals of both the board and stockholder members, the Court explained that there was a second line of Court of Chancery decisions holding that a unilateral two-step freeze-out will not be reviewed substantively if certain conditions apply.
Moreover, the Court described another “line of Court of Chancery decisions [that] holds that a unilateral two-step freeze-out will not be reviewed for entire fairness unless the offer is structurally coercive.” See footnote 4.
The Court of Chancery went on to observe that the conflicting standards are a result of many different circumstances, including the absence of Delaware Supreme Court precedent directly addressing a unilateral two-step freeze-out – – although the Supreme Court has reviewed a single-step freeze-out merger on multiple occasions that were subject to the entire fairness standard. Likewise, the Supreme Court has reviewed a negotiated two-step freeze-out and held that it too was subject to entire fairness. See footnotes 5 and 6.
Conflict over Inherent Coercion
The Court also described decisions of the Court of Chancery that conflict over the degree to which a controller’s unilateral two-step freeze-out is inherently coercive, and that the “Siliconix line of cases do not recognize any possibility of inherent coercion when a controller implements a unilateral two-step freeze-out, but the Pure Resources test and the Cox Communications test recognize some degree of inherent coercion but differ as to the degree of procedural protections necessary.
Conflict over the Role of a Target Board
The Court also explained that decisions in the Court of Chancery conflict as to the degree to which a target board has a role in responding to the tender offer of a controlling shareholder.
Issue of First Impression for Delaware Supreme Court
The Court of Chancery explained that another reason why the Delaware Supreme Court should hear this interlocutory appeal is because the standard of review for a unilateral two-step freeze-out has not been squarely addressed by the Delaware Supreme Court and in addition, pursuant to Supreme Court Rule 41(b)(iii), it is a question of law that relates to an application of the statute which “has not been, but should be, settled by the [Supreme] Court."
The Decision Appealed From Determines a “Substantial Issue”
Under Supreme Court Rule 42(b), a ruling determines a substantial legal issue if it relates to the merits of the case, not to collateral matters such as discovery. As the Court discussed, the standard of review in corporate litigation is a substantial issue that is often determinative of the outcome. This is another basis for allowing the interlocutory appeal.
The Issue Framed on Appeal
In addition to reviewing all of the important cases in Delaware that relate to these standard of review issues, the Court of Chancery in this opinion explains that the Delaware Supreme Court will determine for itself how best to frame the analysis and it would not be appropriate for the Court of Chancery nor for the appellant to determine what the specific question is that the Supreme Court should answer if it accepts the interlocutory appeal.
Procedurally, even if the Court of Chancery grants a Motion for an Interlocutory Appeal, it still must be accepted by the Delaware Supreme Court before it will be heard.
Regardless of whether the Delaware Supreme Court accepts this interlocutory appeal, this opinion of the Court of Chancery serves a valuable public purpose for practitioners and scholars alike by summarizing the existing Delaware law on the applicable standard used by the Delaware Courts in controlling shareholders transactions.
SUPPLEMENT: The Delaware Supreme Court issued an Order here denying the request for an interlocutory appeal. Thus, the case stays in the Court of Chancery for the time being.
Postscript: On September 17, a helpful review of the trial court decision, and a frank assessment of the three-possible standards of review that may apply in this type of case, was made available by Lewis Lazarus here.