In re Delphi Financial Group Shareholder Litigation, Cons. C.A. No. 7144 -VCG (Del. Ch. Mar. 6, 2012). This is the third Delaware Court of Chancery decision in as many weeks that denied injunctive relief, in an expedited opinion, in response to a challenged transaction–despite criticism in two of the cases, of the process and the players, but ultimately leaving it up to the shareholders to decide whether to accept offers of a substantial premium to sell their shares. See In Re El Paso, summarized here, and In Re Micromet, summarized here. See also, Alison Frankel’s insightful commentary on the Delphi decision. Professor Larry Hamermesh provides a scholarly perspective on the case here, based on his recent presentation at the ABA Business Law Section meeting in Las Vegas. David Marcus provides a helpful review of the case in his article for The Deal.
UPDATE: Prof. Lawrence Hamermesh, Director of the Delaware Corporate & Business Law Institute, writes on April 9, 2012 about a post-decision settlement of this matter.
This Delaware Court of Chancery decision is a 56-page classic that dispatches with grace and erudition a motion for preliminary injunction challenging the proposed takeover of Delphi Financial Group by Tokio Marine Holdings Inc.
The Court addressed whether the board of Delphi breached its fiduciary duties in connection with the flawed process employed in connection with the sale of the company. The terms of the deal were also challenged. The Court determined that the prerequisites for injunctive relief were not satisfied even though, potentially, monetary damages might be proven after trial.
In part because this decision has already been the subject of extensive review in the trade press and the mainstream media, the very detailed factual background provided by the Court will only be cursorily reviewed. Delphi is an insurance holding company founded by defendant Robert Rosenkranz, who took the company public in 1990. In doing so, he created two classes of stock: Class A, largely owned by the public, and Class B, retained by Rosenkranz. Although Rosenkranz retained less than 13% of the shares outstanding, because of the superior voting rights of Class B stock, he retained control of Delphi. Among the rights associated with that control was the ability to seek a control premium if Delphi was sold, but he conveyed that right to the Class A stockholders by means of a charter provision which provided that on the sale of the company, each share of Class B stock would be converted to Class A, which would be entitled to the same consideration as any other Class A stock. This concession to the Class A holders presumably would result in a higher purchase price for Class A stock than would have been the case without the provision. One of the deal provisions that was challenged was a proposed charter amendment to change this provision in order to allow Rosenkranz to receive a higher premium for his Class B stock.
Before creating Delphi, Rosenkranz established an investment advisory firm called Acorn which provided services to Delphi, using Delphi employees and resources. Acorn provided investment advisory services to Delphi pursuant to agreements referred to as the RAM contracts under which Acorn would bill Delphi through another Rosenkranz entity called Rosenkranz Asset Management LLC. The RAM contracts were terminable upon 30-days notice from either party. The revenue from the sale of Acorn Services went to Rosenkranz.
Claims of Plaintiffs
(1) The plaintiffs claimed that Rosenkranz was not entitled to any differential in the price paid for his shares; (2) The Delphi board breached its duty to stockholders in structuring a deal to include a differential price for his shares at the expense of Class A stockholders; (3) The fiduciary duties of Rosenkranz and the board were wrongfully aided by Tokio Marine Holdings (“TMH”); (4) The RAM contract was nothing but a device for Rosenkranz to skim money from Delphi for work that Delphi could have provided for itself at lower costs; (5) The Acorn services sold to third parties represented an opportunity of Delphi that was usurped by Rosenkranz; (6) The agreement that was tentatively agreed to by TMH and Rosenkranz to retain the RAM contracts or to buy RAM outright, in essence was a disguised payment to Rosenkranz for his consent to the deal between Delphi and TMH, which should have been additional consideration belonging to all the stockholders.
Summary of Court’s Holding
The Court determined that even though the plaintiffs demonstrated a likelihood of success on the merits at least regarding the allegations against Rosenkranz, because the deal represented a large premium over the market price and because damages would be available as a remedy, and because no other potential purchaser had come forth or seemed likely to come forth to match or best the offer by TMH, the balance of the equities did not favor an injunction over letting the stockholders exercise their franchise, and allowing the plaintiffs to pursue damages at trial. Therefore, the request for a preliminary injunction was denied.
The Court was quite critical of the role that Rosenkranz played in structuring the transaction and in negotiating the transaction despite the existence of a Special Committee and despite the potential conflict based on the insistence by Rosenkranz that he receive additional compensation for his class of shares, and in negotiating a potential separate deal in connection with the RAM contracts. The Court referred to Shakespeare’s Hamlet at footnote 35 to describe the tension between the Special Committee and Rosenkranz, and how the Special Committee distrusted Rosenkranz as a negotiator, even though they still let him negotiate the deal as the lead negotiator. See reference at footnote 35 to act 3, sc. 4 of Hamlet, in which Hamlet refers to trusting his friends as he would an “adder fanged.” The Court also refers to the classic text of Elisabeth Kűbler-Ross entitled “On Death and Dying,” and the Five Stages of Grief it made famous, in connection with describing the following: “Rosenkranz’ gamut of emotions confirmed that the Kűbler-Ross Model indeed applies to corporate controllers whose attempt to divert merger consideration to themselves at the expense of minority stockholders are rebuked by intractable special committees.”
The Court reiterated the truism that under Delaware law a controller remains free to sell its stock for a premium not shared with the other stockholders except in narrow circumstances, and that a controlling stockholder is generally under no duty to refrain from receiving a premium upon the sale of his controlling stock. See footnote 63.
Comparison with Recent Chancery Decision in El Paso Case
The Court addressed the similarity of this case and the reasoning in the recent Court of Chancery decision in the matter styled In Re El Paso Corp. Shareholder Litigation, 2012 WL 653845 (Del. Ch. Feb. 29, 2012). In that case, the Chancellor identified numerous deficiencies in the manner in which the deal was negotiated, which were compounded by a lead negotiator and a financial advisor with conflicts of interest at odds with the interests of the El Paso stockholders. However, because that proposed transaction offered a substantial premium over the stock price of El Paso and was the only bid on the table, the Chancellor declined to enjoin the merger even though he was troubled by the conduct of the El Paso fiduciaries and advisors, reasoning that the stockholders were “well positioned to turn down the offeror’s price if they did not like it” and noting that even is not a perfect remedy, damages would be available.
Likewise, in the current case, a 76% premium was offered by TMI which dwarfs the premium offered in the El Paso case. See also footnote 87 (comparing Rosenkranz to the CEO of El Paso, Doug Foshee, who failed to disclose to the board of El Paso his interest in pursuing a post-deal management buyout of a significant component of the company’s business.” See generally Thorpe v. CERBCO, Inc., 676 A.2d 436, 437 (Del. 1996) (conceding that a breach of fiduciary duty renders one liable to disgorge any benefits emanating from, and providing compensation for, any damages attributable to that breach.”
The Court reasoned that the stockholders have a fair if not perfect ability to decide whether to tender their shares or seek appraisal rights under Section 262 of the Delaware General Corporation Law. Moreover the following supported the Court’s decision: (1) The substantial premium offered at 76% above the stock price on the day before the merger was announced; (2) No party has suggested that another suitor is in the wings or is likely to be developed at a greater or even equal price; (3) Nothing beyond the speculation of the plaintiffs indicates that injunctive relief would lead to the negotiation of a significant increase in price. Rather, the re-negotiation of a deal might lead to a loss of a merger entirely.
In addition, the Court rejected the deterrent effect of an injunction and that the Court would be: “To paraphrase Chairman Mao, letting a thousand little Rosenkranzes bloom.” Rather, the Court reasoned that available damages as a remedy would serve as a sufficient deterrent to discourage similar behavior in the future.
In sum, the Court found that it was in the best interests of the stockholders that they be given the opportunity to decide for themselves whether the merger negotiated by Rosenkranz and the defendant directors offered an acceptable price for their shares, despite the deficiencies and how the final deal was reached.