Thanks to a new Delaware Court of Chancery decision, special committees will play a bigger role in protecting minority stockholders in freeze-out transactions.
Prior Delaware law required the target subsidiary board to appoint a special committee when the controlling stockholder proposed a minority freeze-out through a tender offer followed by a short-form merger. However, the controlling stockholder was not required to bargain with the committee or get its approval as a condition of receiving lenient judicial review in shareholder litigation challenging the deal. A favorable standard of review makes it easier for the board and controlling stockholder to win the shareholder lawsuit and more cost-effective to settle.
The special committee's job description in controlling stockholder freeze-outs was rewritten with In re CNX Gas Corp. Shareholder Litigation. Under the new standard adopted in CNX Gas Corp., the lesser so-called business judgment review applies only "when a freeze-out is conditioned on both the affirmative recommendation of a special committee and the approval of a majority of the unaffiliated stockholders."
Consol Energy Inc. is the largest U.S. producer of high-BTU bituminous coal. In 2005, Consol spun off its natural gas operations into CNX Gas, but it retained more than 80% of the stock. The CNX Gas board consisted of three Consol directors and John Pipski, the sole independent director.
In March 2010, Consol agreed to acquire the gas assets of Dominion Resources Inc., a CNX Gas competitor, for $3.5 billion in cash. Consol also decided to acquire the shares of CNX Gas that it did not already own. CNX Gas privately negotiated a deal with T. Rowe Price Group Inc., the owner of 37% of the CNX Gas public float, for T. Rowe Price to sell its shares in a tender offer for $38.25 per share, a 46% premium over the closing price of CNX Gas stock on the day before Consol announced the Dominion acquisition.
Consol structured the CNX Gas freeze-out transaction consistent with established Delaware law by making the first-stage tender offer subject to a nonwaivable condition that a majority of the outstanding minority shares be tendered. With the T. Rowe Price shares already locked up, Consol needed only a further 13% of the public float to satisfy this majority-of-the-minority condition.
The Consol directors on the CNX Gas board appointed Pipski as a special committee, but they refused to give the committee the full powers and authority of the board with respect to the tender offer.
The committee hired Lazard as its investment banker. The firm advised Pipski that it would be able to opine that an offer of $38.25 was fair from a financial point of view but believed that Consol was not paying the highest price it was prepared to pay.
The committee advised Consol that it could not recommend the tender offer at a price of $38.25 but likely could do so at $41.20. Consol, however, was unwilling to negotiate the offer price. The committee determined to remain neutral with respect to the offer and cited concerns about the impact of the T. Rowe Price lock-up and the process by which Consol determined the price.
In an effort to block the deal, minority stockholders filed suit against the three CNX Gas directors, Pipski and Consol as the controlling stockholder.
Rather than apply the historical, lenient standard of review, the Delaware Court of Chancery applied a new test, conditioning business judgment review on the affirmative recommendation of the special committee as well as a majority-of-the-minority stockholder approval. Presumably, if Consol had known about this standard in advance, it would have negotiated with the committee and sweetened its offer in order to secure the committee's endorsement.
Under CNX Gas, the special committee must be provided with authority comparable to what a board would possess in a third-party takeover situation, including the right to explore strategic alternatives, to file litigation and to deploy a poison pill. The mere threat of a poison pill could be sufficient to prompt the controlling stockholder to give a special committee more time to negotiate or to evaluate how to proceed.
Vice Chancellor J. Travis Laster, author of the decision, concluded that under the new standard, "[i]ndependent directors and unaffiliated stockholders are given the tools to negotiate with controllers, backstopped by meaningful judicial review for fairness when those tools are withheld."
Gardner Davis is a partner and Danielle Whitley is senior counsel in the transactional and securities practice of law firm Foley & Lardner LLP.