Delaware Court Of Chancery Holds That Controlling Stockholder Conduct Did Not Breach Fiduciary Duties But Rendered Buyout Transaction Unfair
M&A and Corporate Governance Litigation
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  • Delaware Court Of Chancery Holds That Controlling Stockholder Conduct Did Not Breach Fiduciary Duties But Rendered Buyout Transaction Unfair


    On January 24, 2024, Vice Chancellor J. Travis Laster of the Delaware Court of Chancery awarded a stockholder plaintiff class more than $18 million, finding that the acquisition of the “Hometown” division of Sears Hometown and Outlet Stores, Inc. (“SHOS”) by its controlling stockholder failed the entire fairness test.  In re Sears Hometown and Outlet Stores, Inc. Stockholder Litigation, C.A. No. 2019-0798-JTL (Del. Ch. Jan. 24, 2024).  The Court so ruled, even after finding, that the controlling stockholder’s conduct leading up to the transaction—including the ouster of two members of SHOS’s Special Committee and a bylaw amendment limiting the company’s alternatives—did not breach his fiduciary duties.

    Plaintiffs brought claims for both breach of fiduciary duties and unjust enrichment, alleging that the controlling stockholder bought Hometown at an unfairly low price after using his position to stop SHOS from liquidating Hometown while continuing to operate the other, more profitable division of the company, Outlet.  The controlling stockholder did not believe that this approach, which the Special Committee supported, was in the best interest of stockholders.  To limit the Special Committee, the controlling stockholder removed two of the three directors who comprised the Special Committee and amended the SHOS bylaws to require 90% board approval of the liquidation and two separate board votes, taken at least 30 days apart (effectively rendering a liquidation impossible).  The controlling stockholder thereafter negotiated with the sole remaining member of the Special Committee to buy Hometown at $2.25 per share; Outlet was sold to a third party.  (Shearman & Sterling advised SHOS’s board and Special Committee.)

    In evaluating whether the controller’s unilateral action to amend bylaws and remove directors breached his fiduciary duties, the Court applied enhanced scrutiny.  Under that standard, the Court concluded that the controller had a reasonable, good-faith belief that the liquidation plan was based on overly optimistic estimates of resulting value and would harm stockholders.  The Court found that, accordingly, the controller’s actions were a “drastic but necessary” means of achieving his objective.

    The Court nevertheless found the controller liable to minority stockholders because the resulting Hometown acquisition failed the entire fairness test.  The Court determined that, even though the remaining member of the Special Committee performed his duties in exemplary fashion, the controller had limited the negotiating power of the committee by removing two of its three members, rendering the process unfair.  The Court also concluded that the price paid by the controller for Hometown was not fair, even though he subjectively believed that it was.  Accordingly, the Court held that the transaction as a whole failed the entire fairness test, even though one of its two component parts—the sale of Outlet—was executed with fair price and fair dealing.