Kahn v. Lynch Communication Systems, Inc.

Supreme Court of Delaware · 1994 · Corporations

Corporationscontrolling shareholderdominating shareholderentire fairnessfair dealingfair priceindependent committeeburden shifting

Facts

Alcatel owned 43.3% of Lynch's stock, had board and committee representation, and the Court found that on important matters Lynch's non-Alcatel directors deferred to Alcatel because of its stock position rather than their own business judgment. After Alcatel blocked Lynch's preferred Telco acquisition and withdrew a proposed Celwave transaction that the Independent Committee opposed, Alcatel offered to buy the remaining Lynch shares for cash. The Independent Committee rejected Alcatel's first three offers and investigated alternatives, but those alternatives were found impracticable. When Alcatel made a final $15.50 offer, the committee was told Alcatel was ready to proceed with an unfriendly tender offer at a lower price if the offer was not recommended and approved, and the committee then recommended the deal.

Issue

In a cash-out merger proposed by a stockholder owning less than 50% but found to dominate the corporation, does entire fairness remain the standard of review, and may the burden of proving fairness shift away from the controlling shareholder based on approval by an independent committee under these circumstances? Also, was the record sufficient to support treating Alcatel as a controlling shareholder?

Rule

A shareholder that owns less than 50% is a controlling shareholder only if it exercises actual control over the corporation's conduct. In an interested cash-out merger by a controlling or dominating shareholder, the exclusive standard of judicial review is entire fairness, encompassing fair dealing and fair price. The initial burden of proving entire fairness rests on the controlling shareholder, and that burden shifts only if approval by an independent committee of disinterested directors or an informed majority of the minority reflects a process in which the parties in fact exerted bargaining power against each other at arm's length; the mere existence of a committee is insufficient, and the committee must have real bargaining power and the controller must not dictate the terms.

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North Harbor Devices, Inc., a Delaware corporation based in Portland, Maine, has a 44% stockholder, Orion Crest Holdings. Orion has four of ten board seats. On two major matters—renewing the CEO's contract and approving a strategic acquisition—the outside directors initially disagreed, but after Orion's representatives reminded them of Orion's stake and ability to block the plans, the outside directors abandoned their own positions.

If Orion later proposes a cash-out merger for the remaining shares, which is the strongest conclusion about Orion's status?

Explanation. A stockholder owning less than 50% is not controlling by ownership alone, but it becomes a controlling or dominating shareholder if it exercises actual control over the corporation's conduct. Here, the facts show the outside directors yielded on important matters because of Orion's stock position rather than their own business judgment, supporting controlling-shareholder status.