Chancery Dismisses Claims that Minority Stockholders who Rolled Over Equity in a Controlling Stockholder Merger Joined a “Control Group”
Gilbert v. Perlman, C.A. No. 2018-0453-SG (Del. Ch. Apr. 29, 2020)
Delaware law imposes fiduciary duties upon controlling stockholders who use their power to control the corporate machinery. For that reason, determining who comprises a control group affects who may owe fiduciary duties. In some circumstances, where minority stockholders pool their interests to gain majority control and then bind themselves to act together to effectuate a transaction, minority stockholders may take on the duties of a controlling stockholder as members of a control group. But where an already existing controlling stockholder effectuates a cash-out merger, minority stockholders who roll over their shares and enter into a voting agreement to support the transaction will not be deemed part of a control group unless a plaintiff can plead that “the minority-holder’s participation [was] material to the controller’s scheme to exercise control of the entity, leading to the controller ceding some of its control power to the minority-holders.”
In this case, Francisco Partners (the “Controller”), a 56% owner of Connecture, Inc. (“Connecture”) effectuated a cash-out merger. Two minority stockholders, Chrysalis Ventures II, L.P. (“Chrysalis”) and David A. Jones, Jr. (collectively, the “Minority Defendants”), rolled over their respective 11 and 1% interests in Connecture. The plaintiffs, on behalf of the remaining minority stockholders, argued that the Minority Defendants formed a control group with the Controller and breached fiduciary duties by implementing a merger with an unfair process and at an unfair price. The Court of Chancery granted the Minority Defendants’ motion to dismiss, finding that plaintiffs failed sufficiently to allege the existence of a control group.
To establish a control group in this circumstance: the Court held (i) “[t]here must be an arrangement between the controller and the minority stockholders to act in consort to accomplish the corporate action, and [ii] the controller must perceive a need to include the minority holders to accomplish the goal, so that it has ceded some material attribute of its control to achieve their assistance.” Here, the Court found that plaintiffs’ allegations that the Minority Defendants (i) executed a voting agreement in which they agreed to vote for the merger, and (ii) had engaged in prior coordinated actions with the Controller by investing alongside the Controller in two private placements to acquire a combined 68% stake in Connecture, sufficed to meet the first element of the control group test.
The Court also found that the plaintiffs failed to plead that the Controller relinquished any of its control to gain the support of the Minority Defendants. The Court held that the mere fact that the Controller agreed to dilute its interest in the newly private Connecture did not suffice as a material limitation of the Controller’s power. If dilution were sufficient to establish a control group, then every time minority shareholders participated in a transaction with a Controller through rolling over their shares, the minority shareholders would be deemed fiduciaries. The Court held that the plaintiffs’ bare allegation that the Minority Defendants had rolled over their shares, without an allegation that the rollover was in exchange for anything the Controller “needed or ceded,” did not suffice to establish their participation in a control group. The Court thus dismissed plaintiffs’ claim that the Minority Defendants owed and breached fiduciary duties as members of a control group.