In this opinion, the Court of Chancery dismissed a class action brought by a minority stockholder alleging that the directors of NRG Yield, Inc. (“Yield”) breached their fiduciary duties in connection with the approval of a reclassification of Yield’s shares that went into effect in May 2015. The Court held that the recapitalization was a conflicted controller transaction that would presumptively be subject to entire fairness review. The Court further concluded, however, that the framework to determine the appropriate standard of review set forth in the Delaware Supreme Court opinion Kahn v. M&F Worldwide, Corp. (“MFW”) applied to the reclassification and that, because the plaintiff failed to plead any facts sufficient to call into question the satisfaction of any of the elements of MFW, the reclassification was subject to the business judgment rule.
Following its initial public offering in 2013, Yield had two classes of voting stock, Class A and Class B, each of which was entitled one vote per share. Through its ownership of Yield’s Class B shares, which were never offered to the public, NRG Energy, Inc. (“NRG”) held approximately 65% of Yield’s voting power. The remaining voting interests were held by public stockholders though their ownership of Class A shares. In response to the significant and increasing dilution of its voting control as a result of Yield’s issuance of Class A shares to fund various acquisition transactions, NRG proposed that Yield undertake a recapitalization pursuant to which Yield would issue non-voting common stock to the holders of Class A shares, on a pro rata basis, which could be used for future issuances of stock to finance the acquisition of additional assets, thereby avoiding any continued dilution of NRG’s voting control.
From the outset, the reclassification proposal was conditioned on obtaining approval of a majority of the minority Class A stockholders not affiliated with NRG. In addition, after Yield management presented the proposal to the board of directors, the Yield board formed a Conflicts Committee, consisting solely of independent directors, to evaluate and negotiate the proposed reclassification. The Conflicts Committee, with the advice of its legal and financial advisors and after negotiating certain adjustments to the reclassification proposal, approved a proposed transaction pursuant to which Yield would establish two new classes of common stock that would be distributed to the holders of the Class A and Class B shares through a stock split. Each of the two new classes of common stock would be entitled to 1/100 of one vote per share, rather than no vote at all. The reclassification was conditioned on the approval by Yield’s stockholders of the amendments to Yield’s certificate of incorporation to establish the new classes of stock and to effectuate the stock split. Both amendments were approved by a majority of the outstanding shares of Class A and Class B common stock, voting together as a single class, and by a majority of the Class A shares unaffiliated with NRG.
The Court first considered whether the reclassification should be considered a conflicted transaction and, therefore, subject to entire fairness. Although all of the Yield stockholders received identical treatment in the reclassification, Chancellor Bouchard explained that NRG received a non-ratable benefit that was not shared with Yield’s other stockholders, namely the ability to perpetuate its majority control over Yield at a time when NRG was “on the cusp of losing its control position in Yield[.]” Because NRG received something from Yield in the reclassification to the exclusion of the minority stockholders, the Court concluded that the reclassification was a controller transaction that would presumptively be subject to entire fairness review.
Chancellor Bouchard then considered whether the MFW framework should extend to forms of controller transactions other than squeeze-out mergers, such as the reclassification. The plaintiff argued that MFW should not apply in this instance for two reasons – first, because in MFW the Supreme Court repeatedly stated that the holding applied in the context of mergers between a controlling stockholder and its subsidiaries and, second, because transactions like the reclassification lacked other characteristics that may be present in a squeeze-out merger to protect minority stockholders, such as the availability of appraisal rights, the provision of a fairness opinion, and the loss of board seats held by directors of the controlled subsidiary, which would suggest a greater likelihood of such directors acting independently. Addressing those arguments in turn, the Court first explained that the Delaware Supreme Court in MFW did not indicate that the rationale for its holding applied only to mergers; rather, the repeated use of the word “merger” in MFW was merely a reflection of the factual scenario that was then before the Supreme Court. Next, the Court determined that the protections identified by the plaintiff as present in the squeeze-out merger context were unconvincing, as (i) appraisal rights are a means for stockholders to be paid for that which has been taken from him, but in a transaction such as the reclassification, the stockholders do not lose their interest in the corporation and retain the choice whether to remain owners, (ii) a fairness opinion is not required for a merger nor is a fairness opinion one of the elements of MFW, and (iii) there is no legally-recognized protection based on directors of controlled companies losing their board seats, nor, in the Court’s view, was there any support for the contention that directors who lose their board seats are less likely to be susceptible to future retribution by a controller. Finding no reason that the protections of MFW should not apply to forms of controller transactions other than squeeze-out mergers, the Court held that the MFW framework applied to the reclassification. In so doing, the Court reasoned that MFW-type protections should be encouraged to protect the interests of minority stockholders in a variety of controller transactions.
Having concluded that the MFW framework should apply to the reclassification, the Court determined that the plaintiff had failed to plead any facts sufficient to call into question the satisfaction of any of the six MFW elements. Therefore, the business judgment rule applied. As the plaintiff had made no effort to plead facts sufficient to overcome the business judgment rule, the Court granted the defendant’s motion to dismiss.