In re KKR Financial Holdings LLC Shareholder Litigation
2014 Del. Ch. LEXIS 207, 101 A.3d 980, 2014 WL 5139489 (2014)
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Rule of Law:
A minority stockholder (owning less than 50% of voting power) is not considered a controlling stockholder simply because its affiliate manages the corporation's day-to-day operations and holds significant contractual influence; actual control over the board of directors must be demonstrated. Furthermore, a fully informed, uncoerced vote by a majority of disinterested stockholders triggers business judgment review for a transaction with a non-controlling stockholder, even if a majority of the board approving the merger was not independent.
Facts:
- In 2004, KKR & Co. L.P. (KKR), a private equity firm, formed KKR Financial Corp., which engaged in an initial public offering in 2005 as a specialty finance company.
- KKR Financial Corp. was externally managed and advised by KKR Financial Advisors LLC (KFA), an affiliate of KKR, under a management agreement that made KKR Financial Corp. operationally dependent on KFA.
- In 2007, KKR Financial Corp. was restructured into KKR Financial Holdings LLC (KFN), which assumed the Management Agreement with KFA; under this agreement, KFN delegated responsibility for its day-to-day operations to KFA and faced a significant termination fee (approximately $252.6 million in 2012) if the agreement was terminated without cause.
- In October 2013, KKR, which owned less than 1% of KFN's shares, expressed interest in acquiring KFN.
- The KFN board of directors formed a six-member Transaction Committee to consider KKR's acquisition proposal, retaining independent financial and legal advisors.
- After negotiations, KKR made a 'best and final offer' of 0.51 KKR units per KFN share, which the Transaction Committee and subsequently the full KFN board (excluding two KKR-affiliated directors) approved.
- The merger agreement included deal protection provisions (e.g., termination fee, no-shop, matching rights) and required approval by a majority of KFN's common shares, including a majority of shares held by persons other than KKR and its affiliates.
Procedural Posture:
- On December 27, 2013, the first of nine actions challenging the proposed merger was filed in the Delaware Court of Chancery.
- These actions were consolidated on January 31, 2014.
- On February 21, 2014, plaintiffs filed a Verified Consolidated Class Action Complaint, asserting claims against the KFN board for breach of fiduciary duty (Count I), against KKR as a controlling stockholder for breach of fiduciary duty (Count II), and against KKR and its subsidiaries for aiding and abetting (Count III).
- On March 7, 2014, defendants moved to dismiss the complaint in its entirety under Rule 12(b)(6) for failure to state a claim upon which relief can be granted.
- On April 30, 2014, KFN's stockholders approved the proposed merger, including a majority of disinterested stockholders, after a definitive proxy statement was issued soliciting their approval.
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Issue:
1. Does a minority stockholder, who owns less than 1% of a company's shares but whose affiliate manages the company's day-to-day operations and holds significant contractual power, constitute a controlling stockholder such that entire fairness review applies to a merger with that stockholder? 2. Does the business judgment rule apply to a merger approved by a majority of disinterested stockholders in a fully-informed vote, even if a majority of the board of directors approving the merger may not have been independent?
Opinions:
Majority - Bouchard, C.
No, KKR was not a controlling stockholder of KFN, and yes, the business judgment rule applies to the merger because it was approved by a majority of disinterested stockholders in a fully-informed vote. The court found that while KKR's affiliate managed KFN's day-to-day operations through the Management Agreement, this operational dependence did not translate into actual control over the KFN board's decision-making regarding the merger. KKR owned less than 1% of KFN's shares and lacked the power to appoint, remove, dictate, or veto the board's actions. The court clarified that the relevant inquiry for minority stockholder control focuses on the stockholder's ability to dominate the board, not merely contractual influence or operational constraint. Furthermore, the court concluded that even if a majority of the KFN board was not independent, business judgment review would still apply. This is because the merger was approved by a majority of KFN's disinterested stockholders in a fully-informed vote. The court analyzed plaintiffs' disclosure challenges concerning director independence and the negotiation process, finding them to be without merit, thus upholding the validity of the stockholder vote. It also clarified that the Supreme Court's Gantler v. Stephens decision redefined "ratification" to apply only to voluntary stockholder votes, but did not alter the legal effect of a statutorily required, fully informed, uncoerced stockholder vote in invoking business judgment review. Consequently, all claims, including aiding and abetting, were dismissed.
Analysis:
This case significantly clarifies the high bar for establishing minority stockholder control under Delaware law, emphasizing the necessity of demonstrating actual control over the board of directors, beyond mere operational dependence or contractual influence. It reinforces the robust cleansing effect of a fully informed, disinterested stockholder vote on the standard of review for transactions involving non-controlling stockholders, thereby strengthening the default application of the business judgment rule. The decision provides crucial guidance on distinguishing legitimate contractual constraints from coercive control and offers a definitive interpretation of the 'ratification' doctrine's scope post-Gantler, assuring that statutorily required, fully informed stockholder approvals still largely insulate transactions from judicial second-guessing.
