Synthes-is: Strine on Pro Rata Treatment in a Sale of a Company with a Controlling Stockholder

Should courts permit deal litigation to go forward when there’s no evidence that the sale process was rushed, or was tainted by an interest on the part of those influencing the process in favoring themselves at the expense of public shareholders generally?

In his typically colorful opinion in In re Synthes, Inc. Litigation (Aug. 17, 2012), Chancellor Strine says no, because facts matter. The overwhelmingly significant fact in the case, according to the Chancellor, was that the allegedly controlling stockholder (Wyss) would receive exactly what all other stockholders would receive, no more, no less. And speaking of no less, the Chancellor was adamant – and supported by long-standing case law – that the controller wasn’t obligated to pursue a partial bid for the company that might have given public stockholders a marginally better deal, perhaps, but would have required the controller to retain a significant equity interest in the continuing enterprise, and thus sacrifice the ability, available to public stockholders, to sell his entire holdings.

Two aspects of the opinion seem particularly notable. The first is probably dictum, because the opinion rejects the application of Revlon to the transaction at issue, in which the stock component represented 65% of the total consideration. But the Chancellor notes that “even if Revlon applied, … there are no pled facts from which I could infer that Wyss and the Board did not choose a reasonable course of action to ensure that Synthes stockholders received the highest value reasonably attainable.” This is a powerful statement, and a welcome one. In particular, it is a useful reminder that the application of Revlon does not dispense with the requirement that a complaint adequately allege a breach of the fiduciary duties implicated in that case. Nor does Revlon’s application preclude dismissal simply because the transaction includes what are widely recognized as standard deal protection measures (3% breakup fee, no-solicitation provision with fiduciary out, and matching rights).

The second notable aspect of the opinion also bears on the question of dismissing deal litigation at the pleading stage. The plaintiffs’ main theory for applying the entire fairness standard was the notion that the controller’s interest in liquidity created a conflict in relation to the public stockholders, for whom a potentially higher bid would be preferable even though it would deny the controller the full liquidity he desired and that the public stockholders would have. According to the opinion, and most remarkably, plaintiffs did not rely “in any way” on McMullin v. Beran, 765 A.2d 910 (Del. 2000). Perhaps because of that, the Chancellor addresses that opinion only in a footnote, albeit an extended one. That footnote (fn. 91) bears close reading, because I would have thought that plaintiffs would have relied extensively on McMullin. As the Chancellor explained, that opinion might have assisted the plaintiffs in Synthes because “the Supreme Court accepted the contention that a duty of loyalty claim could be filed against the parent for negotiating an ‘immediate all-cash [t]ransaction’ to satisfy a liquidity need by accepting as true the plaintiff’s allegation that the full value of the subsidiary “might have been realized in a differently timed or structured agreement.” Id. at 921.

The Chancellor’s footnote, however, closely questions the financial reasoning implicit in McMullin:

McMullin seems to contemplate that that it was disloyal for the controlling stockholder to accept an all-cash deal in part because a ‘differently … structured’ deal (e.g., a stock-for-stock deal) ‘might have’ delivered more shareholder value, but the controller accepted a lower-valued all-cash deal because of its need to use that cash to fund an acquisition of a separate company. McMullin, 765 A.2d at 921. But, this reasoning glosses over the reality that the present value of stock depends on the currency value into which it can be converted, plain and simple.

Appropriately enough, the Chancellor recognizes in Synthes that a controller’s interests could in some case inappropriately conflict with the interests of public stockholders, even where the deal consideration is shared pro rata:

It may be that there are very narrow circumstances in which a controlling stockholder’s immediate need for liquidity could constitute a disabling conflict of interest irrespective of pro rata treatment. Those circumstances would have to involve a crisis, fire sale where the controller, in order to satisfy an exigent need (such as a margin call or default in a larger investment) agreed to a sale of the corporation without any effort to make logical buyers aware of the chance to sell, give them a chance to do due diligence, and to raise the financing necessary to make a bid that would reflect the genuine fair market value of the corporation. In those circumstances, I suppose it could be said that the controller forced a sale of the entity at below fair market value in order to meet its own idiosyncratic need for immediate cash, and therefore deprived the minority stockholders of the share of value they should have received had the corporation been properly marketed in order to generate a bona fide full value bid, which reflected its actual market value.

But the lesson of Synthes, as I see it, is that a complaint should do more than speculate about possible inconsistency of interests between controller and public: to survive a motion to dismiss, it should lay out facts indicating in some reasonably specific way why it is conceivable that such an inconsistency actually exists.

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