The Delaware Court of Chancery has issued an important decision clarifying the application of the "entire fairness" and "business judgment rule" standards in a going-private transaction involving a controlling stockholder. In re John Q. Hammons Inc., Shareholder Litigation, C.A. No. 758-CC (Del. Ch. Oct. 2, 2009). The decision provides excellent guidance as to how a special committee should navigate an interested-party transaction.
John Q. Hammons Hotels, Inc., ("JQH") was a publicly traded hotel chain founded and controlled by John Hammons. It merged in 2005 into an acquisition vehicle formed by the acquiror, Jonathan Eilian.
Eilian was previously unaffiliated with the issuer, but Hammons informed the special committee formed to manage this transaction that he would consider a transaction only if he participated in the surviving entity. He ultimately negotiated directly with Eilian to receive a small equity position in the surviving company, a preferred interest with large liquidation preferences and other contractual rights, including a line of credit for further hotel development.
Plaintiffs alleged that John Q. Hammons, JQH's controlling stockholder, used his control position to negotiate an array of private benefits for himself that were not shared with the minority stockholders. Plaintiffs also asserted that the JQH directors breached their fiduciary duties by allowing the merger to be negotiated through an allegedly deficient process, and by voting to approve the merger. They also asserted that the proxy pursuant to which the shareholders approved the merger suffered from material misstatements and omissions.
Key Holdings in the JQH Case The court in JQH determined that the use of sufficient procedural protections for the minority stockholders in the case at bar could have resulted in application of the business judgment standard of review, but that the procedures actually used were not sufficient to invoke business judgment review. Accordingly, the court applied the more stringent entire fairness standard of review. The court further determined that it would not grant a defense motion for summary judgment, and that sufficient facts were presented to warrant a trial on the issues of fair price and fair dealing. Similarly, the court determined that certain of plaintiffs' claims of omissions and misstatements in the proxy would not be dismissed on summary judgment, and warranted a trial. Discussion JQH formed a special committee in 2004 to respond to a different proposed transaction involving a different acquiror. The special committee realized that it lacked the ability to broadly market the company in light of Hammons's controlling interest and his ability to reject any transaction. Thus, the special committee determined that its goal was to pursue the best price reasonably available to minority stockholders.
The Eilian offer came about as a result of the committee's rejection of the initial proposed transaction. On the advice of its counsel, the special committee adopted guidelines that provided that the special committee would conduct a process in which (1) stockholders would be provided a reasonable opportunity to express their views to the committee, (2) all parties interested and willing to explore a transaction would be afforded a level playing field, from the company's perspective, on which to pursue a transaction in terms of timing and...