In 2005 John Q. Hammons Hotels, Inc. was sold to a private company. The minority shareholders received $24 per share for their 24% interest and John Q. himself received different consideration for his 76% stake. Hammond's consideration included a small stake in the buyer with a preferential buyout, a line of credit and other consideration. The parties disagreed on whether his consideration was worth more or less than $24 per share.
The plaintiffs brought a class action alleging that Hammons and the board of directors breached their fiduciary duties by negotiating different consideration and allowing the merger to be approved through a deficient process, respectively. In re John Q. Hammons Hotels, Inc. Shareholder Litigation (Del. Ch. October 2, 2009).
The plaintiffs argue that Kahn v. Lynch Communication Systems, Inc. is the controlling case. In Lynch the Delaware court held that when a controlling shareholder makes a cash out merger offer to the minority the standard of review is entire fairness of the transaction and the burden is on the controlling shareholder. The burden shifts to the plaintiff when the approval of the cash-out merger is required of (1) an independent committee of directors or (2) an informed majority of minority shareholders. The defendants countered that the business judgment rule should apply because of the safeguards built into the deal.
The court in Hammons declined to find Lynch controlling because John Q was not the purchaser (i.e. not on both sides of the transaction. But it did find that the business judgment rule could not be invoked because the merger process was deficient.
To make a long story short, in merger transactions involving a controlling shareholder (but not as buyer)the business judgment rule will not be available and instead entire fairness (fair dealing and fair price) will be applied unless (1) an independent committee of disinterested directors approve the deal and (2) a majority of the minority shareholders (not just those voting) approve the merger in a vote that is not waivable by the independent directors. The court made clear that it was not enough that the committee did not waive even though they could have or a majority of all minority shareholders approved the merger even though only those attending the meeting were required to. The form controls the substance in this regard.
-Marc Ward
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