Delaware Chancery Court Addresses Standard Applicable to Controlling Stockholder Tender Offers and Mergers: In re CNX Gas Corp. Shareholders Litigation
May 26, 2010
In In re CNX Gas Corp. Shareholders Litigation, C.A. No. 5377-VCL (Del. Ch. May 25, 2010), the Delaware Chancery Court attempted to clarify the standard applicable to controlling stockholder tender offers and mergers. In a challenge to a controlling stockholder’s proposed freeze-out transaction (a first-step tender offer followed by a second-step short-form merger), the Court applied a standard derived from In re Cox Communications, Inc. Shareholders Litigation to hold that the presumption of the business judgment rule would apply to a controlling stockholder freeze-out only if the first-step tender offer is both (i) negotiated and recommended by a special committee of independent directors and (ii) conditioned on a majority-of-the-minority tender or vote (as the case may be) condition. The Court held that, because CNX’s special committee did not make a recommendation in favor of the tender offer, the transaction would be reviewed under the entire fairness standard. While that fact, under the Court’s analysis, was sufficient to trigger the application of the entire fairness standard, the Court also noted that the special committee was not provided with the authority to bargain with the controller on an arm’s-length basis and that the majority-of-the-minority tender condition may have been ineffective. Nonetheless, the Court declined to issue an injunction since any harm to the stockholders could be remedied through post-closing money damages.
In 2005, CONSOL formed CNX to conduct its natural gas operations, and CONSOL’s board approved a public offering of less than 20% of CNX’s stock. A few years later, CONSOL sought to acquire all of CNX’s publicly held stock. In March 2010, CONSOL entered into (and publicly announced) an agreement with T. Rowe Price, the holder of 37% of CNX’s public float, in which T. Rowe Price agreed to tender its shares to CONSOL in a public tender offer. CNX’s board then formed a special committee, consisting of CNX’s sole independent director, to evaluate CONSOL’s tender offer. But the special committee’s authority was limited; it was authorized only to evaluate the tender offer, to prepare a Schedule 14D-9 and to engage legal and financial advisors. It was not authorized to negotiate the terms of the tender offer or to consider alternatives.
On April 28, 2010, CONSOL launched its public tender offer with a price of $38.25 per share, committing to effect a short-form merger at the same price. The tender offer was subject to a non-waivable majority-of-the-minority condition. Even though the special committee was not expressly authorized to negotiate the offer, it sought a price increase, indicating that it could not recommend the offer at $38.25, but likely could recommend an offer at $41.20. CONSOL declined to increase the price. In May 2010, the special committee issued a Schedule 14D-9 in which it remained neutral on the tender offer, citing concerns about the determination of the price and CONSOL’s unwillingness to negotiate over price.
Because plaintiffs argued that the tender offer should be reviewed for entire fairness, the Court stated it was required to “weigh in on a critical and much debated issue of Delaware law: the appropriate standard of review for a controlling stockholder freeze-out.” The Court noted that a negotiated merger between a controlling stockholder and its subsidiary is subject to entire fairness review under the Delaware Supreme Court’s holding in Kahn v. Lynch Communication Systems, Inc. But, the Court stated, under In re Siliconix, a controlling stockholder tender followed by a short-form merger is reviewed under “an evolving standard far less onerous than Lynch.” The Court then noted the previous efforts in In re Pure Resources to harmonize these cases and to set forth three elements for determining whether a controlling stockholder tender offer should be viewed as non-coercive (i.e., whether it is subject to a non-waivable majority-of-the-minority tender condition, whether the controller commits to consummate a short-form merger at the same price, and whether the controller has made no retributive threats). The Court suggested that this standard was effectively revised in Cox Communications, indicating that Cox stands for the proposition that “if a freeze-out merger is both (i) negotiated and approved by a special committee of independent directors and (ii) conditioned on an affirmative vote of a majority of the minority stockholders, then the business judgment rule presumptively applies.” (Notably, the Court in Cox essentially indicated that applying its proposed standard in a negotiated merger context would require overturning the Delaware Supreme Court’s holding in Kahn v. Lynch). If either requirement is not met, the Court stated, then the transaction must be reviewed for entire fairness.
The Court applied Cox’s requirements to controlling stockholder tender offers as well (amending the test slightly to require that the special committee affirmatively recommend the transaction), and found that CONSOL’s tender offer failed to meet these requirements. Most important, the special committee did not recommend the transaction, nor was it authorized to negotiate the transaction or consider alternatives. The Court stated that an effective special committee must be “provided with authority comparable to what a board would possess in a third-party transaction,” including (contrary to the holding in Pure Resources) potentially adopting a poison pill. Next, the Court found that the involvement of T. Rowe Price “undercut the effectiveness of the majority-of-the-minority tender condition.” Citing to the Delaware Supreme Court’s recent opinion in Crown EMAK Partners, LLC v. Kurz, which addressed the validity of so-called third-party vote buying arrangements, the Court noted that economic incentives should be taken into account when determining the “effectiveness of a legitimizing mechanism like a majority-of-the-minority tender condition or a stockholder vote.” In this case, the Court expressed concern that T. Rowe Price’s interests were potentially in conflict with those of the public stockholders. Due to its 6.5% ownership stake in CONSOL, the Court stated, T. Rowe Price was either “indifferent to the allocation of value between CONSOL and CNX” or had an incentive to favor CONSOL.
Finally, the Court noted that, if it had evaluated the tender offer under Pure Resources, the structural problems with the tender offer–the defects in the tender condition and the limitations on the special committee’s authority–likely would have counseled in favor of an injunction. Because the Court applied its “Cox Communications unified standard,” however, there was no need to enjoin the transaction. The transaction was an all-cash deal to which no alternative had been identified. Here, given the lack of any evidence casting doubt on CONSOL’s ability to satisfy a money judgment, the remedy of post-trial money damages would be sufficient.