Implications for Stockholders and Corporate Transactions

Delaware Corporations Must Employ Procedural Safeguards When Approving a Reincorporation That Could Benefit a Controlling Stockholder to Avoid Entire Fairness Standard of Review

In Palkon v. Maffei (Del. Ch. Feb. 20, 2024), the Delaware Court of Chancery addressed whether the “entire fairness” standard of review applies to a controlling stockholder’s approval of reincorporation transactions that lacked procedural protections for minority stockholders. This case underscores the importance of procedural safeguards in corporate transactions involving controlling stockholders, particularly when those transactions might disadvantage minority shareholders.

 Case Background

TripAdvisor, Inc. and its controlling stockholder Liberty TripAdvisor Holdings, Inc. (“Holdings”) decided to reincorporate from Delaware to Nevada, citing perceived advantages under Nevada law, such as enhanced liability protections for directors and officers. The conversions were approved by the boards of both Companies, but without procedural protections for minority stockholders. The controlling stockholder, who was also the CEO and Chairman of Holdings, unilaterally approved the reincorporation.

Two stockholders challenged the reincorporation, alleging that the corporate transactions were unfair because they conferred a non-ratable benefit on the controlling stockholder and other insiders, specifically by reducing their exposure to liability. The plaintiffs sought to block the conversions and demanded damages. The defendants moved to dismiss the claims, arguing that the transactions should be reviewed under the more deferential business judgment rule rather than the “entire fairness” standard.

 Court's Ruling

1. Entire Fairness Standard

The Court held that the “entire fairness” standard applies in this case due to the following criteria:

- Lack of Procedural Protections: The board failed to implement procedural safeguards for minority stockholders.

- Transaction with Controlling Stockholder: The corporate transactions involved a controlling stockholder.

- Non-Ratable Benefit: The controlling stockholder and insiders received benefits that were not shared proportionally with minority stockholders.

The Court found that a “non-ratable benefit” is obtained when a transaction materially reduces or eliminates a fiduciary’s risk of liability. In this case, the controlling stockholder and insiders potentially benefited from reduced liability exposure due to the shift from Delaware to Nevada law, which was deemed a significant non-ratable benefit.

2. Applicability Beyond Monetary Transactions

The defendants argued that the entire fairness standard should not apply because the transactions were non-monetary. However, the Court rejected this argument, citing established Delaware case law that applies the entire fairness standard to non-monetary transactions. The key concern is whether the minority stockholders receive a substantive equivalent of their pre-transaction value, including their litigation rights.

3. Stockholder Rights and Procedural Fairness

Before the reincorporation, minority stockholders had litigation rights under Delaware law. After the reincorporation, they would only have rights under Nevada law, which the plaintiffs argued were inferior. The Court agreed that the lack of procedural protections and the unilateral nature of the approval process warranted applying the entire fairness standard. Nevertheless, the Court did not enjoin the conversions, as it found that monetary damages could adequately address any potential loss of stockholder protections.

 Implications and Best Practices

The Palkon decision aligns with Delaware's longstanding practice of applying the entire fairness standard to transactions that appear to benefit controlling stockholders at the expense of minority shareholders. To mitigate the risk of such claims and ensure fairness, companies should consider the following best practices:

- Implement Procedural Protections: Ensure transactions involving controlling stockholders are subject to procedural safeguards, such as full disclosure and independent review.

- Special Committee Approval: Consider having an independent special committee review and approve the corporate transaction.

- Majority of Minority Stockholders: Obtain approval from a majority of minority stockholders to validate the fairness of the transaction.

These measures help ensure that transactions are conducted fairly and in compliance with legal standards, reducing the risk of legal challenges and enhancing the protection of minority stockholders.

Contact Lars Soreide, Esq., at Soreide Law Group to ensure your corporate transactions are conducted fairly and legally:  888-760-6552.