In The Frederick Hsu Living Trust v. Oak Hill Capital Partners III, L.P., et al., C.A. No. 12108-VCL (Del. Ch. May 4, 2020), the Delaware Court of Chancery (the “Court”) held that the controlling stockholder, directors, and named officers of ODN Holding Corporation (the “Company”) had not breached their fiduciary duties to the Company when they chose to pursue a cash-accumulation strategy in anticipation of redeeming preferred shares, rather than investing in the Company’s business for long-term growth for the possible benefit of common stockholders.
Private equity firm Oak Hill Capital Partners (“Oak Hill”) beneficially owned all of the Series A Preferred Stock (the “Preferred Stock”) and a majority of the common stock of the Company, a holding company for Oversee.net (“Oversee”). The second-largest common stockholder was The Frederick Hsu Living Trust (the “Plaintiff”), a trust controlled by Oversee co-founder Frederick Hsu.
In Vice Chancellor Laster’s 97-page opinion, the Court provided detailed factual background. The Company, at its peak, consisted of four business units and derived its revenues from several distinct website-based strategies. In 2008, Oak Hill invested $150 million in the Company and negotiated the right, beginning in February 2013, to compel the Company to redeem $150 million of the Preferred Stock from legally available funds (the “Redemption Right”). Almost immediately, the Company found itself in decline amid a consolidation of the online advertising market and fallout from the Great Recession. After Oak Hill unsuccessfully sought transformational M&A opportunities for the Company in 2010 and 2011, it then shifted its focus to maximizing “legally available funds” in anticipation of exercising the Redemption Right. It directed aggressive cost-cutting internally and supported the piecemeal sale of Company business units. Although the Company had historically reinvested profits, the Oak Hill-controlled board of directors (the “Board”) resolved by mid-2011 to aggressively accumulate cash rather than reinvest cash, and management was promised cash payouts upon the successful exercise of the Redemption Right. The Company sold two of its four business units in 2012 and sold its flagship business unit in 2014. After each round of sales, a special committee of ostensibly independent directors, with whom Oak Hill retained significant levels of contact and influence, approved a redemption of Preferred Stock pursuant to the Redemption Right. The two redemptions collectively totaled $85 million. There were no remaining available funds for common stockholders.
Plaintiff’s complaint alleged that Oak Hill and its Board representatives breached their fiduciary duties to the Company by causing the Company to accumulate cash rather than reinvest at prior levels, and that certain senior officers of the Company and other Board members breached their fiduciary duties by going along with Oak Hill’s strategy.
The Court first determined each named defendant bore a fiduciary duty to the Company and the common stockholders. Oak Hill was a fiduciary based on its majority-voting power and other levers of control. Each individual defendant owed a fiduciary duty to the Company in such defendant’s capacity as an officer or director.
The Court next determined that the entire fairness standard of review applied to Oak Hill’s conduct. The Court found Oak Hill leveraged its controlling position to make the Company pursue a strategy that maximized the near-term value of its Redemption Right rather than investing cash productively for the benefit of the Company and its common stockholders. The Court explained that the concept of fairness has two basic aspects – fair dealing and fair price – but that the test for entire fairness required examination of these aspects as a whole.
The Court first concluded the defendants had failed to establish fairness of process. The Court focused on how Company came to consider the cash-accumulation strategy, how the decision was made, and how the Board came to approve the strategy. Despite what the court suggested as superficial indicators of valid process, such as the establishment of successive independent committees, the Court concluded that Oak Hill was in control. Oak Hill directed removal of the CEO, major spending cuts, and management bonus agreements to incentivize support for the Preferred Stock redemption strategy. Oak Hill maintained a direct pipeline to management throughout the process, communicating regularly via phone and email, and in formal and informal meetings, and even reviewing management presentations and business plans before circulation to the full Board. Further, the outside directors did not recall any discussions about whether the retained funds should instead be reinvested, suggesting the determination of the Board was effectively a determination made by Oak Hill.
Turning to fairness of price, the Court determined the cash-accumulation strategy was substantively fair to the common stockholders. The Court concluded the defendants had proved that the root of the Company’s decline was not Oak Hill’s conduct, but industry trends and competitive pressures that dated to the late 2000s. Neither the factual record nor expert testimony established with any certainty that an alternative course of action would have improved outcomes for common stockholders, and the Board was under no obligation to pursue a “lottery-like” possibility of outsized benefits under a different strategy. The Court also noted that Oak Hill, as the majority common stockholder, had an incentive to maximize returns for the other common stockholders. It further noted that there was no showing of deficiency in process, price, or timing with respect to each sale of the Company business units. The Court agreed with defendants’ expert that the common stockholders could not have been harmed by the Company’s failure to reinvest cash, because “[r]egardless of the defendants’ actions, the common stockholders would have received the same value: nothing.”
Considering both fairness of process and price as a whole, the Court concluded defendants had proved by a preponderance of the evidence that common stockholders would not have benefitted if the Company had invested funds in growth opportunities rather than retaining cash. Because common stockholders were in as good a position as they would have been had the Company followed a different course of action, the Court found that the defendants’ actions were entirely fair. As a result, the Court ordered judgment be entered for the defendants on Plaintiff’s claims for breach of duty.