Commercial Division Allows Stockholder Challenge to Merger to Proceed Due to Allegations that the Special Committee Had a Conflict of Interest
On May 9, 2018, Judge Barry R. Ostrager of the Commercial Division denied a motion to dismiss a shareholder complaint in the Matter of Handy & Harman Ltd. Stockholder Litig., No. 654747/2017, 2018 BL 172083 (Sup. Ct. May 9, 2018), concluding that a plaintiff shareholder had sufficiently alleged that the Board’s Special Committee was conflicted when it recommended a merger transaction.[i]
The litigation arose out of the acquisition of Handy & Harman Ltd., a Delaware company, by Steel Partners Holding LP (“Steel Partners”). Prior to the acquisition, Steel Partners was a controlling shareholder in Handy & Harman, owning about 70% of its outstanding common stock.[ii] Steel Partners made a merger offer to Handy & Harman’s Board of Directors. A Special Committee consisting of three Handy & Harman directors was tasked with negotiating the terms of the offer and retaining financial advisors.
The Special Committee approved a deal calling for the exchange of the outstanding 30% of Handy & Harman shares for Preferred Units in Steel Partners; the deal was valued at $128.3 million.[iii] After the Handy & Harman Board of Directors approved the transaction, a majority of the Company’s minority shareholders approved the deal. Before the deal closed, three shareholders filed suit against the Board and Steel Partners, alleging that each had breached fiduciary duties owed to minority shareholders by recommending the merger.
In considering a motion to dismiss the breach of fiduciary claims against Steel Partners and one of the directors, Justice Ostrager of the Commercial Division first had to determine what standard applied to the Board’s decision to recommend the merger. Under a Delaware decision in Kahn v. M&F Worldwide Corp., 88 A.3d 635 (Del. 2013), if a merger is first approved by a Special Committee that fulfills its duty of care and a majority of the minority shareholders approve the deal, the entire transaction is subject to the business judgment rule and the deal is presumed to be in the corporation’s best interest.[iv] The M&F Worldwide standard requires that a controlling shareholder meet six conditions: (1) the merger decision must be premised on the approval of both the Special Committee and a majority of the minority shareholders; (2) the Special Committee must be independent; (3) the Special Committee must be able to select its own advisors and decline the offer if it so chooses; (4) the Special Committee must satisfy its duty of care; (5) the minority must be adequately informed; and (6) the minority shareholders must not be coerced.[v]
The shareholders argued that the Commercial Division should instead apply a different standard, entire fairness, under a different Delaware decision in Kahn v. Lynch Communications Sys., Inc. 638 A.2d 1110 (Del. 1994). This latter standard applies when there is reason to question the independence of the Special Committee and the burden then shifts to the controlling shareholder to prove that the transaction was entirely fair to the minority shareholders, a much more rigorous standard to satisfy.[vi]
Applying Delaware law, the Commercial Division sided with the plaintiffs, at least at the pleading stage. The Commercial Division concluded that the plaintiffs had sufficiently alleged that: (1) the Special Committee lacked independence; (2) the Special Committee had breached its duty of care; and (3) the minority shareholders were not fully informed.[vii]
The Court concluded that allegations that one of the Special Committee directors had been roommates with the CEO of Steel Partners thirty years earlier and had worked with him eighteen years before were sufficient to call into question the director’s independence. The Court also concluded that the shareholders had sufficiently alleged that the Special Committee failed to satisfy its duty of care because the conflicted director was allowed to spearhead the negotiations and had sufficiently alleged that the minority shareholders were not informed at the time they approved the merger because they were unaware of the director’s prior relationship with the Steel Partners CEO.[viii] As the case proceeds further, the Court will apply the more demanding entire fairness standard in reviewing the transaction.
Justice Ostrager did, however, grant a motion to dismiss claims brought against the director in his individual capacity, notwithstanding the director’s failure to disclose his potential conflict and relationship with the Steel Partners CEO.[ix] The Handy & Harman Certificate of Incorporation contained a provision that “eliminated to the fullest extent” permitted by the Delaware law any personal liability to directors. The court noted that under Delaware law, only an “extreme set of facts” would warrant allowing a claim of bad faith or breach of the applicable duty of care to proceed against a director.[x] Although noting that “best practices” would be to disclose the relationship between the director and the CEO, the Commercial Division held that the facts alleged were not so egregious and that the exculpation clause in the Certificate of Incorporation and Delaware law barred further claims against the director. [xi]
Corporations considering negotiated buyouts and other merger transactions should carefully scrutinize the backgrounds and any overlapping relationships that the directors of the target have with the acquiring company. Particular care should be taken that decision makers on the board or special committee are disinterested, and corporations should consider erring on the side of disclosing possible conflicts of interest, even if a director does not actually stand to derive a personal benefit.
[i] Matter of Handy & Harman Ltd. Stockholder Litig., No. 654747/2017, 2018 BL 172083 (Sup. Ct. May 9, 2018).
[ii] Id. at *1.
[iv] Kahn v. M&F Worldwide Corp., 88 A.3d 635, 645-46 (Del. 2013)
[v] Matter of Handy & Harman Ltd. Stockholder Litig., 2018 BL 172083, at *2.
[vi] Kahn v. Lynch Commc’ns Sys., Inc. 638 A.2d 1110 (Del. 1994)
[vii] Matter of Handy & Harman Ltd. Stockholder Litig., 2018 BL 172083, at *3.
[viii] Id. at *3.
[ix] Id. at *4.
[x] Id. at *5.
[xi] Id. at *6.