In In re CNX Gas Corp. Shareholders Litigation, C.A. No. 5377-VCL, 2010 WL 2291842 (Del. Ch. May 25, 2010) (Laster, V.C.), the Delaware Court of Chancery held that minority stockholders established a likelihood of success on the merits of their claim challenging the “entire fairness” of a tender offer by a controlling stockholder intended to “freeze-out” minority stockholders. The court held that the transaction was not entitled to the less onerous “business judgment” standard of review — which would have applied only if the transaction was (1) negotiated and recommended by a special committee of independent directors and (2) conditioned on the affirmative tender of a majority of the minority shares— because, inter alia, the company’s special committee did not recommend the deal. The court nevertheless declined to enjoin the tender offer, holding that the minority stockholders did not demonstrate a risk of irreparable harm. In this decision, Vice Chancellor Laster applied a “unified standard” to controlling stockholder “freeze-out” transactions that differed from the standard applied in other Chancery Court decisions, urging the Delaware Supreme Court to resolve the conflicting approaches.
CONSOL Energy Inc. is the controlling stockholder of CNX Gas, owning over 80% of CNX Gas’s outstanding shares. On March 15, 2010, CONSOL announced that it had agreed to acquire gas assets of Dominion Resources, Inc, a CNX Gas competitor. CONSOL then negotiated with CNX Gas’s largest minority stockholder, T. Rowe Price, to tender its shares in an upcoming tender offer. On April 28, 2010, CONSOL commenced a tender offer to acquire the outstanding public shares of CNX, which was to be followed by a short-form merger. The tender offer was also subject to the majority-of-the-minority condition.
Following CONSOL’s announcement of its tender offer, CNX formed a special committee, which only included the independent director of CNX. The special committee was authorized to evaluate the tender offer, to prepare a Schedule 14D-9, and to engage legal and financial advisors for those purposes. The committee was not authorized to negotiate the terms of the tender offer. The plaintiffs, CNX minority stockholders, argued that by entering into the agreement with T. Rowe Price, CONSOL “capped the price of the CNX Gas stock and hamstrung the Special Committee.”
In examining the transaction, the Chancery Court relied upon the “unified standard” reflected in In re Cox Communications, Inc. Shareholders Litigation, 879 A.2d 604 (Del. Ch. 2005), whereby the business judgment standard of review applies if a freeze-out merger is structured to mirror both elements of an arms-length merger. The Cox Communications standard essentially synthesizes the standards of review applicable to transactions designed to achieve the same end result. Thus, under the Cox Communications framework, if a freeze-out merger is (1) negotiated and approved by a special committee of independent directors and (2) conditioned on an affirmative vote of a majority of the minority stockholders, the business judgment rule presumptively applies. If both devices are not present, then the transaction is subject to entire fairness review. Similarly, under the Cox Communications framework, if a first-step tender offer is both (1) negotiated and recommended by a special committee of independent directors and (2) conditioned on an affirmative tender of a majority of the minority shares, then the business judgment rule presumptively applies to the freeze-out transaction. Again, if both requirements are not met, the transaction is viewed for entire fairness.
The Chancery Court held that CONSOL’s tender offer did not pass muster under this approach. The court held that since the special committee had neither recommended in favor of the transaction, nor was provided with authority comparable to what a board would have in a third-party transaction, a separate and independent basis existed to review the controlling stockholder freeze-out for entire fairness. The court further noted that since T. Rowe Price owned 6.5% of CONSOL’s outstanding common stock and 6.3% of CNX Gas, the effectiveness of the majority-of-the-minority was called into question.
Despite applying the unified approach and finding that plaintiffs had shown a probability of success on the merits regarding the fairness of the transaction, the court ultimately declined to grant the preliminary injunction. The court attributed this to the fact that the plaintiffs could obtain money damages if the defendants fail to establish that the tender offer price is fair.
Vice Chancellor Laster acknowledged that Delaware law regarding the proper analysis of controlling stockholder “freeze-out” transactions is muddled:
I recognize that by applying the unified standard, I reach a different conclusion than the recent [In re Cox Radio, Inc. Shareholders Litigation, 2010 WL 1806616 (Del. Ch. May 6, 2010)] decision, which opted to follow [In re Pure Resources Shareholders Litigation, 808 A.2d 421 (Del. Ch. 2002)]. The choice among [Kahn v. Lynch Communications Systems, Inc., 638 A.2d 1110 (Del. 1994)], Pure Resources, and Cox Communications implicates fundamental issues of Delaware law and public policy that only the Delaware Supreme Court can resolve. Until the Delaware Supreme Court has the opportunity to address Lynch and [In re Siliconix Inc. Shareholders Litigation, 2001 WL 716787 (Del. Ch. June 19, 2001)] definitively, I believe the unified standard from Cox Communications offers the coherent and correct approach.
On July 5, 2010, Vice Chancellor Laster granted defendants’ motion to certify the matter for an interlocutory appeal to the Delaware Supreme Court. As the Chancery Court explained, “[w[hether a unilateral two-step freeze-out merits these adjectives constitutes but one of several issues upon which trial court precedents conflict and which only the Delaware Supreme Court can resolve.” Nevertheless, on July 8, 2010, the Delaware Supreme Court declined to grant the petition for interlocutory appeal [here]. The Court held that “appellants’ application for interlocutory review should be refused based upon the current state of the record. The issues raised in this application should be addressed after the entry of a final judgment.” In the unlikely event the case does not settle, then the Delaware Supreme Court will finally address this important issue.
For further information, please contact John Stigi at (310) 228-3717.