Tuesday, July 25, 2017

In re American Capital, Ltd. Shareholder Litigation (Cir. Ct. Mont. Cnty)

Filed: July 12, 2017

Opinion by: Ronald B. Rubin

Holding:  A claim that a transaction is subject to the entire fairness standard of review survives a motion to dismiss under Delaware law where a minority shareholder exercised actual control over corporate decision-making by apparently forcing a quick sale for its own short-term gain, threatening ouster of the board to pressure members to ignore other serious bids and alternative courses of action at better values, and demanding unique and unjustifiable compensation for the deal.


Plaintiffs are the common shareholders of American Capital Ltd. (the “Company”). Following a settlement with the Company’s directors and officers, the only remaining Defendant was a management corporation described as being an activist hedge fund. From 2014 to 2015, the Company’s board regularly considered strategic options for the Company and eventually decided on a plan to spin the Company off into a new business development company, which the Company would manage. On September 20, 2015, the Company announced the spin-off plan and requested shareholder approval.

On November 16, 2015, Defendant emailed the Company CEO reporting an 8.4% ownership interest in the Company, and stating their intention to file a preliminary proxy contesting the spin-off plan. This was followed up by a telephone call informing him of their intention to remove him, the management and the board. Shortly thereafter, Defendant sent a letter criticizing the management and board, an attack on the spin-off plan, and a press release. Defendant urged the Company to drop the spin-off plan, replace the board, and undertake a strategic review. Defendant also filed a proxy statement with the SEC contesting the spin-off and urging shareholders to vote against any proposal by the board. After threatening to publicly call for the resignation of the CEO, Defendant began to by-pass him in dealings with the Company.

Shortly thereafter, the Company announced the formation of a strategic review committee to review the Company’s prospects, including a possible sale. Defendant reported an increase in ownership to 9.1%, and on that same day, a Capital Corporation sent the CEO a letter urging the Company to enter into a transaction with them. Defendant made recommendations regarding the review and sought to meet with the committee and the Company’s investment bankers. It continued to demand a sale and to threaten to seek the replacement of the Company’s board and management. It provided a list of potential buyers and continued to report increases in its ownership. When the board announced the decision to solicit purchase offers, Defendant called it the right course of action. Defendant also requested that the Company postpone the annual shareholder meeting and director nomination deadline.

After the Capital Corporation made an unsolicited purchase offer, Defendant urged the Company to reach a deal as soon as possible. The Company’s financial advisers met with the Defendant’s representatives. Defendant encouraged the investment bankers to finalize the sale even if it meant selling at a loss. In February 2016, the Company proposed three alternative scenarios to a quick sale of the whole Company. The Company’s management believed the shareholders would receive greater returns through an orderly liquidation or by remaining a standalone company. Yet the Company’s board continued to push for a sale, as demanded by the Defendant. The board once again pushed back its annual meeting, which extended the deadline for the Defendant to file a competing proxy. Furthermore, the committee and investment bankers withheld the liquidation scenario projections from the Company’s board.

The Company received several bids to acquire it. Defendant signed confidentiality agreements with the Company affording it unfettered access to the review process, and with the Capital Corporation to view its bid information. In a meeting with the Company’s legal and financial advisers, Defendant expressed a strong preference for the Capital Corporation’s bid—even though other offers appeared to have a better value. It also expressed a preference for a quick sale over an orderly liquidation—even at a lower value.

Soon after, the Company’s board outright rejected a competing bidder who increased its proposal subject to an exclusivity provision. The Capital Corporation submitted a revised bid and negotiated a voting agreement to lock in Defendant’s support. Defendant threatened the Company that if it failed to settle with Defendant for its expenses and close the deal, the Company’s board would be reconstituted. When the Company tried to revise terms of settlement, the Defendant threatened another strategic review unless the sale closed.

In May 2016, a merger with the Capital Corporation was announced. The Company approved a settlement agreement on the following terms: if the deal did not close, the board members would be replaced by the Defendant’s selections, the chairman would resign, and another review would be undertaken. In exchange, the Defendant would not launch a proxy fight before the next annual meeting. The Company also agreed to pay the Defendant $3 million.

Defendant filed a Motion to Dismiss the Plaintiff’s Amended Complaint on the grounds that personal jurisdiction is lacking, and that the transaction is not subject to entire fairness review under Delaware law. The Court denied both Motions.


Defendant satisfied the transacting business prong of the Maryland long-arm statute and the purposeful availment requirement of the Due Process clause because: the Company was headquartered in Maryland where it employed hundreds  (many of which were laid off due to the sale); Defendant initiated many calls to Maryland; Defendant triggered the process and events that led to the filing of the case when it sent the initial email (followed by many others) to the Company; and until the deal closed, Defendant enmeshed itself in the Company’s strategic review process and the board’s deliberations. These constitute repeated and intentional efforts towards the sale of a Maryland-based company. From the facts pleaded, it also appears that Defendant intentionally acquired a large portion of Company stock and increased it for a single purpose—to force a sale and make a short-term gain.

As for the substantive issue, Plaintiffs viewed the merger as the predictable result of Defendant’s pressuring the board to sell or be ousted. Defendant counters that the merger was the best value reasonably available, was vetted through a competitive bidding process, and that the Company’s board merely took the input of a large shareholder seriously.

Where, as here, a shareholder owns less than 50% of the Company’s stock, Plaintiffs must allege domination through actual control of corporate conduct. Under Delaware law, a minority shareholder is a controller if it has such formidable power that it exercises actual control over corporate decision-making. Here, Plaintiffs allege that Defendant was a controller for the specific purpose of forcing the sale, and that Defendant reaped unique benefits unavailable to the other shareholders. The controller test is a fact-based inquiry difficult to satisfy, but this case meets the threshold.

Here, the facts if proven would amount to actual control over the sale. No other shareholder received separate monetary compensation for the deal. The sale was already vetted by the financial advisers, and it is not clear what value Defendants added to merit the $3 million payment. The Plaintiffs adequately laid out the profit-making playbook for activist hedge funds, by forcing quick sales such as this one, which took only about six months.

Also, enough facts were pleaded to show that the board did not act independently. Defendant dominated the process and favored the Capital Corporation to the exclusion of other serious bidders that offered better long-term value. The board effectively took no actions to negotiate with those bidders. Collectively, the active role played by Defendant, the apparent willingness of bidders to pay a higher price, and the discount to book value of the stock gives credence to contention that the board knew the Capital Corporation undervalued the Company, but brushed this concern aside in order not to lose a proxy battle to Defendant. This amounts to a colorable claim of board domination. Thus, Plaintiffs sufficiently invoke the benefit of the entire fairness standard of judicial review.

The full opinion is available in PDF.

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