Andrew J. Czerkawski of the Lewis Brisbois Delaware office prepared this post.
Minority shareholders of a former publicly traded telecommunications company brought suit in the Delaware Court of Chancery, alleging the controlling shareholder, with the aiding and abetting of the company’s pre-spin-off parent, breached his fiduciary duty of loyalty he owed to the minority. The lead plaintiff claimed the controller caused the company to unfairly sell a litigation asset in In re Straight Path Communications Inc. Consolidated Stockholder Litigation, 2023 Del. Ch. LEXIS 387 (Del. Ch. Oct. 3, 2023).
BRIEF FACTUAL OVERVIEW
The prior parent spun off a patent infringement portfolio to insulate itself from potential counterclaims and transferred various IP assets, including a portfolio of broadcast spectrum licenses. As part of the separation agreement’s stock swap ratio, the prior parent’s founder and chairman became the new company’s controller.
As a result of a regulatory investigation concerning broadcast spectrum licenses, the company entered into a multi-million dollar settlement with the regulator, consisting of fines and other penalties. Under the spin-off separation agreement, the company could seek indemnification for those penalties from the parent. The company’s board considered this indemnification claim a valuable company asset. The company formed a fully independent special committee to handle the sale of the company’s IP assets and pursue the indemnification claim. But, as detailed below, the controller usurped the process and used his positional influence to cause an unfair settlement of the claim.
As a threshold matter, the Court determined that the defendant parent’s founder and chairman controlled more than seventy percent of the spun-off company’s voting power. Similarly, because of the parent’s flagship status and through his familial ownership ties, the company’s release of the indemnification claim against the parent conferred a non-ratable benefit to the controller. Thus, entire fairness review of the indemnification claim release applied.
The Court employed the unified entire fairness test, considering the fairness of both the price and the process. Though it discussed at length the viability of the indemnification claim as a company asset, due to the company’s failure to comply with the separation agreement’s notice and consent requirements, the Court found the indemnification claim “had no economic value.” Thus, because the parent paid the company $10 million to release an essentially worthless claim, the parent paid a “not unfair” price.
Yet, the decision highlighted the controller’s “steamrolling” tactics and the “overwhelming evidence of unfair process.” Reiterating the process factors (timing, initiation, structure, negotiation, disclosures, approval), the Court wrote: “This court is frequently asked to make findings of controller overreach based on only circumstantial evidence, cryptic communications, or inference. This is not one of those cases.” The controller “made every effort to bully the Special Committee towards his desired outcome.”
The Court observed the controller’s “campaign of abuse and coercion.”
Emphasizing the unified analysis, finding a fair price paid did not end the Court’s decision: “the question is one of entire fairness, and what the stockholders could have achieved, absent the iniquities.” The Court pointed out its precedent on fair process—“[t]his court has held that a fair price ‘does not ameliorate a process that was beyond unfair.” The defending fiduciary must satisfy “[b]oth aspects of the entire fairness test – fair dealing and fair price.” “This assessment provides an opportunity to evaluate the transaction holistically and ‘eliminate the ability of the defendants to profit from their breaches of the duty of loyalty.’”
Noting that a claim for breach of fiduciary duty does not require the plaintiff shareholder to prove actual damages, the Court found the controller’s “coercion” of the special committee “breached his duty of loyalty to the minority stockholders” and held the controller liable for nominal damages.
In disputes challenging the fairness of conflicted controller transactions, fiduciary liability does not live and die on price alone. Even if the controller forces an otherwise sweetheart deal, the court will still closely scrutinize the manner in which the controller exercised that force. If the transaction’s process tips the deal’s unfairness past equipoise, then the controller faces nominal damages along with a judicial rebuke.