Mendel v. Carroll

Court of Chancery of Delaware, New Castle County
651 A.2d 297 (1994)

ELI5:

Rule of Law:

A board of directors is not under a 'Revlon' duty to grant a dilutive stock option to facilitate a third-party merger over the objection of a controlling shareholder. The board's duty in a transaction with a controlling shareholder is to protect the minority shareholders from exploitation and ensure fair treatment, not to force the controller to sell or cede control.

Facts:

The Carroll Family held a controlling block of stock in Katy Industries, Inc., owning between 48% and 52% of the company's shares.
The Carroll Family proposed a cash-out merger to acquire all non-Carroll shares for $25.75 per share, while stating they had no interest in selling their own shares.
A third party, Pensler, proposed a friendly merger to acquire all of Katy's shares for a higher price, eventually settling at $27.80 per share.
Pensler's offer was conditioned on the Katy board granting it an option to purchase up to 20% of Katy's stock, which would dilute the Carroll Family's voting power from over 50% to approximately 40%.
The Carroll Family voiced strong opposition to the dilutive option and subsequently withdrew their own merger proposal.
The Katy board's Special Committee, after receiving inconclusive legal advice on the legality of the dilutive option, declined to grant the option to Pensler.
Following the termination of negotiations with Pensler, the Katy board recommended a special cash dividend of $14.00 per share.

Procedural Posture:

Stockholder plaintiffs filed consolidated actions in the Delaware Court of Chancery against the board of directors of Katy Industries, Inc.
Plaintiffs filed a motion for a mandatory preliminary injunction seeking to compel the Katy board to grant a dilutive stock option to Pensler.
Plaintiffs also sought to enjoin Katy from distributing a proposed $14.00 special dividend.

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Issue:

Does a corporate board have a fiduciary duty to grant a dilutive stock option to a third-party bidder to facilitate a higher-priced merger that the corporation's controlling shareholder opposes?

Opinions:

Majority - Chancellor Allen

No, a corporate board does not have a fiduciary duty to grant a dilutive stock option to facilitate a higher-priced merger over the objection of a controlling shareholder. The board of Katy Industries is not under any special 'Revlon' duty to maximize the current value of the company's stock by forcing a sale. The court's reasoning is that the two proposed transactions were fundamentally different. The Carroll Family's $25.75 offer was for non-controlling stock from a party that already held control, meaning no control premium was being paid. In contrast, Pensler's $27.80 offer was for the entire company and included a control premium distributed across all shares; therefore, the prices are not comparable for judging fairness. The Carroll Family, as controlling shareholders, have no fiduciary duty to sell their shares or give up control. The board's duty is to protect the public minority shareholders from overreaching by the controller, not to deploy corporate power against the majority stockholder in the absence of a threatened breach of fiduciary duty. Granting the dilutive option would have improperly forced the controlling shareholders to cede control, which the board could not do consistent with its fiduciary duties to all stockholders.

Analysis:

This decision clarifies the scope of a board's fiduciary duties in the presence of a controlling shareholder, particularly the limits of the duties established in Revlon. It establishes that a controlling shareholder's decision not to sell its stake effectively prevents the creation of a Revlon auction scenario, even if a third party offers a higher price for the whole company. The case distinguishes between a change-of-control transaction that triggers Revlon duties and a cash-out merger proposed by an existing controller, which is instead governed by the entire fairness standard. This holding reinforces the principle that controlling shareholders are not obligated to sell their shares and that a board's duty is to ensure the fairness of transactions with the controller, not to force a sale of the company against the controller's will.

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