In re KKR Financial Holdings LLC Shareholder Litigation: Delaware Chancery Court Rejects Claim that Manager Is a Controlling Stockholder; Applies Business Judgment Review to Merger Approved by Independent Board and Fully Informed Stockholders

Sullivan & Cromwell LLP - October 27, 2014
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In an October 14, 2014 decision on a motion to dismiss, the Delaware Court of Chancery (C Bouchard) held that business judgment review applied to breach of fiduciary duty claims asserted against directors in connection with a stock-for-stock sale of KKR Financial Holdings LLC (“KFN”) to KKR & Co. L.P. (“KKR”), an entity which held 1% of KFN’s stock and whose affiliate managed KFN’s day-to-day operations under a management agreement having terms making it difficult for KFN to sell to anyone other than KKR.  The Court held business judgment to be the appropriate standard of review because (i) the contractual arrangements did not make KKR a controlling stockholder of KFN, (ii) a majority of the directors of KFN were disinterested and independent and (iii) even if the KFN board was not independent, the merger was approved by a fully informed majority of disinterested stockholders. The Court found that Revlon duties did not apply because the merger involved two widely held public companies.

The opinion, in addition to being an affirmation of the power of the business judgment standard of review in a stock-for-stock acquisition transaction, emphasizes the Delaware law requirement that, to be “controlling,” a less than 50% stockholder must be shown to exercise “actual control with respect to the particular transaction that is being challenged” and that the “actual control” test “is not easy to satisfy.”  The decision also clarifies that an informed shareholder vote will permit business judgment judicial review of interested director actions even when the shareholder vote is required to effect the underlying transaction rather than taken for the purpose of shareholder ratification.