Dive Brief:
- A controlling shareholder that leverages its voting power to change the status quo of a company has a fiduciary duty to act with care and in good faith but, unlike directors, doesn’t have to promote the best interests of the company, the Delaware Chancery Court ruled last week in a widely watched case.
- The ruling has implications for private equity funds and others by making clear a majority shareholder can exercise the kind of power that boards typically assume – like pushing through a governance change or forcing a change in directors – but if they do that, they have to show they acted in good faith and weren’t trying to harm the company or the minority shareholders.
- The ruling also makes clear that, when a majority shareholder blocks a board decision, the shareholder’s action is subject to an enhanced level of court review. Under that level of review, the shareholder has to show it believed the move was in the company’s best interest and was a reasonable way to achieve the aim.
Dive Insight:
The case involves what’s left of the old Sears, Roebuck and Co. For years the company has been split into two entities – a money losing entity that owns and also has agreements with dealerships to sell Sears brands such as Craftsman hardware, Kenmore appliances and Diehard batteries, and an outlet entity that, after years of losses, has started to make money operating stores that sell reconditioned appliances.
The board wanted to liquidate the money-losing Sears-brand business and retain the moneymaking outlet business, but the company’s majority shareholder, an investment fund controlled by turnaround specialist Eddie Lampert, pushed back, arguing the board was overly optimistic in what the company would get from liquidation of the money losing entity.
When the company sought to move forward despite his concerns, Lampert leveraged his controlling interest to change the process for getting board approval of the liquidation and also pushed out two directors.
The board and Lampert eventually agreed to a deal, enabling Lampert’s fund to acquire the company, which triggered a lawsuit by minority shareholders.
In his ruling, Vice Chancellor J. Travis Laster required Lampert to pay the minority shareholders $18.3 million to make them whole based on a revised determination of what the value of the deal should have been. But for the legal community, the main interest in the case are the rulings on the duties a controlling stockholder owes and the standard of review that applies when the controlling stockholder takes actions that thwart the board.
The ruling confirms that controlling stockholders are not statutorily prohibited from taking stockholder-level action to interfere with board-level decision-making, according to a Troutman Pepper analysis.
“Majority stockholders can use their voting power to block the board’s desired course of action and … such action is not prohibited as a matter of law,” the analysis says.
The ruling also makes clear that a controlling stockholder can use its voting power to maintain the status quo of the corporation without fear of judicial review, but when the action changes the status quo, as in this case, the controlling stockholder owes the company the fiduciary duties of good faith and care.
“A controlling stockholder … owes limited duties when voting in favor of a transaction that alters the status quo,” the analysis says.
The court also said that, when the controlling stockholder uses its vote to block board action, an enhanced level of scrutiny applies when the action is challenged. That means the shareholder must believe a particular outcome is in the company’s best interests and have an objectively reasonable basis for that belief.
“This is a first of its kind decision” of importance especially to private equity firms, the Troutman Pepper analysis says. It “makes clear what private equity funds must heed before exercising voting rights to change the company’s status quo.”
