Court of Chancery Finds Merger Between Controlling Stockholder and Subsidiary Unfair
Gesoff v. IIC Indus. Inc., C.A. No. 19473, 2006 WL 1458218 (Del. Ch. May 18, 2006).
Plaintiff filed a class action, claiming a merger was the subject of unfair dealing and produced an unfair price. Another plaintiff filed a statutory appraisal claim based on the same merger.
Plaintiffs were minority stockholders of defendant IIC Industries, Inc. Defendant CP Holdings owned 80% of IIC, which acted as an intermediate holding company for overseas assets including Hungarian hotels and an Israeli company that distributed tractors. In 2000, CP decided to take IIC private and expected the minority to demand $16.20 a share. Paul Filer, Finance Director of CP Holdings, investigated taking IIC private, with the assistance of IIC and CP's U.S. lawyer, Samuel Ottenoser. In May 2001, Filer presented a reported to directors of CP Holdings regarding a going-private transaction, which included a quote from investment bankers Jesup & Lamont. This report showed CP was presently required to pay $13 a share for IIC shares on the open market. Subsequently, the CP Holdings board authorized a bid approach to the IIC board at $13 per share. It was envisioned that there would be a tender offer followed by a short-form merger under 8 Del. C.
The IIC board decided to appoint a special committee in order to comply with Delaware law. The special committee consisted of only one IIC director, Alfred Simon, because he was the only independent director capable of performing the necessary work. The consent appointing Simon to the special committee authorized him to make a recommendation on the proposed transaction. Filer met with Jesup & Lamont before Simon retained them and stated Jesup & Lamont would have the engagement soon. Ottenoser was presented to Simon as the choice of the conflicted IIC board. Although Simon pressed Ottenoser about his conflict of interest in representing IIC, CP and the special committee, Ottenoser said there was no conflict.
Filer and Ottenoser exchanged emails discussing how CP would make a low bid, Jesup & Lamont would recommend a slightly higher bid, CP would meet that new price, Jesup & Lamont would approve it and then CP would make its tender offer. The negotiations followed this pattern. During the negotiations, Filer received much of Jesup & Lamont's work for the special committee and shared it with CP. Without knowledge of this, Simon approved a $10.50 per share tender offer. Shortly thereafter, the events of September 11, 2001 occurred and the tender offer was unsuccessful. After the tender offer closed, CP proceeded to acquire the remaining minority shares of IIC by a long-form merger. Filer told Simon the price would remain the same, even though it should be lower as a result of September 11. Relying on information from Filer, Simon decided to recommend the merger without receiving a new fairness opinion or conducting any additional formalities on behalf of IIC's minority stockholders. Simon did not attend the IIC board meeting approving the merger, but did give his proxy to Filer to vote in favor of the transaction.
One plaintiff filed a class action alleging that the merger between IIC and CP was the product of unfair dealing and produced an unfair price and another plaintiff filed a statutory appraisal action. The defendants argued that the merger was entirely fair because any unfair dealing did not affect the fairness of the merger price. They also argued that the events of September 11th depressed the value of IIC and made the price paid more than fair. The defendants relied on their expert report to assert that the fair appraisal value of IIC was somewhere between $6.22 and $12.98. Simon alone argued that IIC's Section 102(b)(7) provision protected him from personal liability.
After trial, the Court held that the merger was the result of unfair dealing and produced an unfair price. Because the question of whether the merger was the result of unfair dealing depended on the special committee's negotiations and CP, the Court focused on the special committee and found numerous flaws. First, the Court held that the composition of a special committee is of central importance and should preferably have more than one member, which was not the case here. Second, the Court stated that the special committee should be given a clear mandate and have the power to say no to a transaction. Simon's mandate was vague and did not make it clear to Simon that he could veto a merger. In addition, Simon did not understand the difference between the tender offer and merger transactions. Third, a special committee should have access to independent legal and financial advisors; in this case, the special committee's legal counsel was hopelessly conflicted and its financial advisor was selected by CP and disloyal to the special committee throughout the negotiations. As a result of these flaws, the Court found the merger was the result of unfair dealing.
The Court also found the price paid unfair. The Court rejected the defendants' argument that September 11 depressed the value of IIC so much that the price paid was fair, finding that the defendants failed to prove that September 11 materially affected the value of IIC, which was based wholly overseas.
Exercising its discretion to craft an appropriate remedy because this was a consolidated entire fairness and appraisal action, the Court determined the value of IIC by evaluating the reports of both side's experts, conducting its own DCF analysis and testing the results of its financial analysis. Applying this process and mostly utilizing defendants' expert reports, the Court concluded that IIC was worth $14.30 per share.
Finally, the Court found that Simon had breached his duty of care, but not his duties of loyalty or good faith, and was therefore protected from personal liability by IIC's Section 102(b)(7) provision. The Court concluded that Simon was not personally conflicted, did not derive a personal benefit from the transaction and did not collude with Filer and others to squeeze out IIC's minority at an unfair price.