IRA Trust FBO Bobbie Ahmed Ex rel. Class A Stockholders of NRG Yield, Inc. v. Crane: Court of Chancery Suggests Dual Class Reclassification Confers Unique Benefit on ControllerIRA Trust FBO Bobbie Ahmed Ex rel. Class A Stockholders of NRG Y
March 8, 2018
In IRA Trust FBO Bobbie Ahmed Ex rel. Class A Stockholders of NRG Yield, Inc. v. Crane, 2017 WL 6335912 (Del. Ch. Dec. 11, 2017), as revised (Jan. 26, 2018), the Court of Chancery granted the defendants’ motion to dismiss breach of fiduciary duty claims against NRG Energy, Inc. (“NRG”), the controlling stockholder of NRG Yield, Inc. (“Yield”), and the Yield directors in connection with a reclassification of Yield’s shares. While the Court found that plaintiff adequately pleaded that the reclassification was a conflicted transaction and the entire fairness standard would apply, it ultimately held that the transaction met the requirements for application of the business judgment rule under Kahn v. M&F Worldwide, 88 A.3d 635 (Del. 2014) (“MFW”), and dismissed the case.
NRG, a power company, incorporated Yield as a dividend-growth-oriented company to serve as the primary vehicle through which NRG would own, operate and acquire energy generation and infrastructure assets. Under a Management Services Agreement, NRG provided Yield management and other services. NRG also always appointed Yield’s senior management, and Yield depended on NRG as a source for income-producing assets. NRG took Yield public in 2013, after which Yield had two classes of voting stock—Class A and Class B—each of which was entitled one vote per share. Through its ownership of Yield’s Class B shares, which were never offered to the public, NRG held approximately 65% of Yield’s voting power at the time of the IPO. Public stockholders represented the remaining 35% through their ownership of Class A shares.
Yield’s business model required the continual acquisition of new income-producing assets, which Yield often acquired through new issuances of Class A shares. Because the Class A and Class B shares had equal voting rights at the time of the IPO, the post-IPO issuances of Class A shares diluted NRG’s voting control over Yield to 55% by the autumn of 2014. To stem the dilution of its voting control, NRG proposed that Yield undertake a recapitalization pursuant to which Yield would issue new Class C non-voting common stock to the holders of Class A shares on a pro rata basis, and gain the ability to finance future acquisitions with non-voting Class C stock. NRG conditioned the proposal on obtaining approval of a majority of the minority of Yield’s public stockholders.
After negotiation between Yield’s Conflicts Committee (composed of independent directors) and NRG, the parties agreed that Yield would create two new classes of stock, Class C and Class D, each with 1/100 vote per share, which were distributed pro rata to holders of then outstanding Class A and Class B shares, respectively, through a stock split (the “Reclassification”). NRG also agreed to make certain additional assets of NRG subject to a right of first offer (“ROFO”) in favor of Yield. On May 5, 2015, the Reclassification was approved by a majority of the Class A and Class B stockholders, voting together, as well as a majority of the Class A stockholders unaffiliated with NRG.
The Court determined that three key questions needed to be answered to resolve the motion to dismiss: (1) Is the Reclassification subject to entire fairness review even though it involved a pro rata distribution of shares? (2) If entire fairness did apply, should the analytical framework articulated in MFW (a squeeze-out merger case) apply to the Reclassification? (3) If MFW does apply, have defendants satisfied that framework on the face of the pleadings?
As to the first issue, the Court, agreeing with the plaintiffs, found that at the pleading stage, the complaint had adequately alleged that NRG received a “uniquely valuable or ‘non-ratable’” benefit in the Reclassification not shared with Yield’s other stockholders, i.e., the ability to retain its majority voting control of Yield. Thus, the Reclassification would be viewed as a conflicted controller transaction presumptively subject to entire fairness review.
As to the second issue, the Court found that the transaction’s procedural protections—including the independent Conflicts Committee and majority-of-the-minority approval condition—warranted application of the business judgment rule under MFW. Citing other recent Court of Chancery decisions in which the MFW protections were applied to transactions other than a squeeze-out merger (e.g., EZCORP, where the Court endorsed applying the MFW framework to any conflicted controller transaction; and Martha Stewart, which applied MFW to challenged side deals with the controlling stockholder), the Court found there was no principled basis not to apply MFW to the Reclassification.
Finally, the Court rejected the plaintiff’s “only serious challenge” to application of the MFW framework—the assertion that the stockholder vote was inadequately informed. The Court concluded that the proxy disclosed all material information and that the defendants had not misled stockholders concerning, and/or were not required to disclose, (1) all possible alternatives to the Reclassification, (2) the impact of the new ROFO assets on Yield’s cash available for distribution, (3) the fact that the Conflicts Committee’s financial advisor did not analyze the “potential value transfer” to NRG as a result of the Reclassification, (4) the hypothetical scenario whereby NRG’s ownership could fall below 50.1% by 2015, (5) whether the issuance of Class C stock was a “sunset provision” on NRG’s control, and (6) the financial advisor’s fee.
As a result, because MFW applied and the plaintiff had “made no effort to overcome” the business judgment rule, the Court granted the defendants’ motion to dismiss.