Delaware Court Of Chancery Applies MFW To Stockholder Challenge To An All-Stock Transaction With Allegedly Controlling Stockholder
On July 20, 2018, Vice Chancellor Joseph R. Slights of the Delaware Court of Chancery dismissed a stockholder challenge to an all-stock business combination between Earthstone Energy, Inc. (“Earthstone”) and Bold Energy III LLC (“Bold”). Olenik v. Lodzinski, et al., C.A. No. 2017-0414 (Del. Ch. July 20, 2018). Plaintiffs claimed that Earthstone’s directors, officers, and an allegedly controlling stockholder, Oak Valley Resources, LLC (“Oak Valley”), breached their fiduciary duties by entering into an unfair transaction that benefited Oak Valley and EnCap Investments, L.P. (“EnCap”), a private equity firm with majority stakes in both Bold and Oak Valley, at the expense of Earthstone and its minority stockholders. Plaintiffs argued that, because EnCap was a majority stockholder in Oak Valley, and thus also a beneficial controlling stockholder in Earthstone, as well as a majority stockholder in Bold, Oak Valley and EnCap stood on both sides of the transaction, making it unfair. The Court dismissed plaintiffs’ claims, concluding that, because Earthstone structured the transaction in the manner prescribed by Kahn v. M&F Worldwide, 88 A.3d 635 (Del. 2014) (“MFW”), the business judgment rule standard of review applied.
Plaintiffs argued that MFW did not apply because (i) deal negotiations began before MFW conditions (approval of a special committee and a majority-of-the-minority vote) were imposed, (ii) the special committee was neither well-functioning nor independent because its members had ties to both Oak Valley and EnCap, (iii) the Special Committee did not act with due care because it allowed Earthstone’s Chairman to control all aspects of the negotiation process, and (iv) the vote of the minority stockholders was uninformed due to material deficiencies in the proxy.
The Court disagreed, finding that even though Earthstone’s chairman engaged in preliminary discussions with EnCap and Bold before making a formal offer that met the MFW requirements, such discussions “never rose to the level of bargaining” and “were entirely exploratory in nature.” Nor did the complaint plead facts showing that the Special Committee was not independent, was not empowered, and did not act with due care. The Court deemed the existence of financial and social ties between certain directors and Oak Valley and EnCap, without more, to be insufficient to undercut the committee’s independence; the Court also noted as evidence of due care the committee’s sixteen meetings and changes between the formal offer letter and Earthstone management’s preliminary presentation to Bold. Finally, the Court concluded that the allegedly inadequate proxy disclosures did not render the stockholder vote uninformed. Specifically, the Court found that the proxy adequately described the advisor’s analysis, that the advisor’s refusal to commit to provide a fairness opinion early in the process was immaterial, that the committee’s authorization of Earthstone’s Chairman to speak directly with the financial advisor to the committee was immaterial, and that the proxy adequately disclosed Bold’s financial position and liquidity.
Having reached these conclusions, the Court determined that all of the MFW requirements were met and that the business judgment rule applied. Finding no allegations that rose to the level of corporate waste, and noting that 99.7% of non-interested stockholders approved the transaction, the Court found that plaintiffs failed to state a claim and dismissed the complaint with prejudice.