This case involves a challenge to a stock-for-stock merger by a group of stockholders of the target company who alleged breaches of fiduciary duty by both the board of directors of the target (the “Board”) and an alleged controlling stockholder who held less than 1% of the stock of the target. The transaction (the “Merger”) involved the acquisition of KKR Financial Holdings LLC (“KFN”) by KKR & Co. L.P. (“KKR”). KFN was managed by an affiliate of KKR, which was responsible for day-to-day operations of KFN, subject to the oversight of the Board pursuant to a management agreement between the parties. In October 2013, KKR expressed interest in acquiring KFN to a member of the Board. Over the next several months, the Board began to discuss the approach from KKR, set up a transaction committee to review the potential transaction, and met several times with representatives from KKR to negotiate for better terms. In mid-December 2013, the Board approved the Merger and KFN and KKR executed a merger agreement. The transaction was valued at approximately $2.6 billion.
This case is the consolidated result of nine separate actions that were filed challenging the Merger in December 2013 and January 2014. KFN and KKR moved for summary judgment, which the plaintiffs sought to overcome by arguing that the Merger should be subject to “entire fairness” review, instead of the presumed business judgment review. The Court held that the business judgment rule applied, granted summary judgment to KFN and KKR and dismissed the suit with prejudice.
In its analysis, the Court stated that the business judgment rule, and not the enhanced judicial “Revlon” scrutiny, presumptively applied because the Merger involved widely-held, publicly traded companies and therefore did not involve a “sale or change in control” under Revlon. In order to rebut the business judgment presumption, a plaintiff can show that (1) a controlling stockholder stands on both sides of a transaction, or (2) at least half of the directors who approved the transaction were not disinterested or independent. The plaintiffs argued both that (1) KKR was a controlling stockholder of KFN who owed fiduciary duties to the stockholders of KFN, and (2) the majority of the KFN board was not disinterested and independent. KKR and KFN disagreed with the plaintiffs’ arguments, but also argued that, even if the majority of the board of KFN was not independent and disinterested, the business judgment rule still applies because the Merger was approved by a fully informed majority of disinterested stockholders of KFN.
The Court concluded that the plaintiffs failed to state a claim that KKR was a controlling stockholder of KFN. Under Delaware law, a minority stockholder can be found to be a controller if it “exercises control over the business affairs of the corporation.” In order to survive a motion to dismiss on this theory, a plaintiff must allege facts demonstrating “actual control with regard to the particular transaction that is being challenged.” In prior cases analyzing this scenario, Delaware courts have noted that this test is “not easy to satisfy” and can only be met where “stockholders who, although lacking a clear majority, have such formidable voting and managerial power that they, as a practical matter, are no differently situated than if they had majority voting control.” Here, though KFN’s day-to-day business was managed by an affiliate of KKR pursuant to the management agreement, the actual affairs of KFN were governed by the Board, which KKR did not control. The Court concluded that “in deciding whether a stockholder owes a fiduciary obligation to the other stockholders of a corporation in which it owns only a minority interest, the focus of the inquiry is on whether the stockholder can exercise actual control over the corporation’s board.” Here, KKR had no such control.
The Court also held that the business judgment rule applied because a majority of the Board was disinterested and independent. When the Merger was approved, KFN’s board consisted of 12 directors. Two of those directors were high-level KKR employees who did not vote on the Merger. Another two had recent ties to KKR that would reasonably impugn their independence. However, the plaintiffs failed to allege specific facts demonstrating that any of the remaining eight directors could reasonably be determined to be beholden to KKR.
The Court further concluded that, even if a majority of KFN’s directors were not independent, the business judgment rule applies because the Merger did not involve a controlling stockholder and was approved by a fully informed vote of KFN’s disinterested stockholders. The plaintiffs argued that KFN’s proxy soliciting a vote on the Merger was deficient and omitted material information relating to the independence of various directors and more fulsome financial analysis, but the Court determined these claims to be without merit.