In re PNB Holding Co. Shareholders Litigation, 2006 WL 2403999 (Del. Ch.), opinion by Leo Strine, provides guidance on the longstanding principle that approval of a transaction involving a controlling shareholder by a majority of the minority shareholders provides some insultation from judicial review. As I explain in Corporation Law and Economics:
If a freezeout merger is approved by a majority of the disinterested shareholders—the so-called “majority of the minority,” however, the burden of proof shifts to the plaintiff to show that the merger was unfair. The standard of review remains entire fairness, with its integral fair price and fair dealing components, but the burden is now on plaintiff to show lack of fairness on one or both grounds.
The question unanswered is what do we mean by a majority of the minority? A majority of the outstanding disinterested shareholders or a majority of the disinterested shareholders present and voting?
Strine makes a couple of important doctrinal advances in this opinion. First, he makes clear that the conflicted transaction generally need not be conditioned on approval by a majority of the minority to get the benefit of such approval:
Under Delaware law, ... the mere fact that an interested transaction was not made expressly subject to a non-waivable majority-of-the-minority vote condition has not made the attainment of so-called "ratification effect" impossible. Rather, outside the Lynch context, proof that an informed, non-coerced majority of the disinterested stockholders approved an interested transaction has the effect of invoking business judgment rule protection for the transaction and, as a practical matter, insulating the transaction from revocation and its proponents from liability.
Second, Strine holds that approval of a conflicted interest transaction by a "majority of the minority" means approval by a majority of the outstanding disinterested shares not just a majority of those present and voting:
The cleansing effect of ratification depends on the intuition that when most of the affected minority affirmatively approves the transaction, their self-interested decision to approve is sufficient proof of fairness to obviate a judicial examination of that question. I do not believe that the same confidence flows when the transaction simply garners more votes in favor than votes against, or abstentions from, the merger from the minority who actually vote. That position requires an untenable assumption that those who did not return a proxy were members of a "silent affirmative majority of the minority." That is especially so in the merger context when a refusal to return a proxy (if informedly made) is more likely a passive dissent. Why? Because under 8 Del. C. § 251, a vote of a "majority of the outstanding stock of the corporation entitled to vote" is required for merger approval, and a failure to cast a ballot is a de facto no vote. Therefore, giving ratification effect only if a majority of the disinterested shares outstanding were cast in favor of the transaction also coheres with § 251. [FN74]
FN74. I need not, and do not, hold that a qualifying ratification vote always needs to track the percentage approval required for the underlying transaction. One can posit a situation when a particular type of transaction requires, by charter, a 66.67% supermajority vote, and a conflicted stockholder holds 40% of the total vote, with the rest of the votes held by disinterested stockholders. To promote fair treatment, the board makes approval subject to a majority of the minority vote condition. Nothing in this opinion suggests that ratification effect would not be given if an informed majority of the minority of the remaining 60% of the electorate voted in favor of the transaction.
This strikes me as an eminently reasonable extension of cases like Fliegler and Wheelabrator with respect to the requirement of approval of conflicted interest transactions by disinterested shareholders. I wonder, however, what we might infer from Strine's decision about approval of such transactions by the disinterested directors.
In Corporation Law and Economics, I wrote that:
There is an interesting dichotomy between the general director voting rule set out in DGCL § 141(b) and that of § 144(a)(1). The former looks to whether the proposed action was approved by a “majority of the directors present at a meeting at which a quorum is present.” The latter requires the “affirmative votes of a majority of the disinterested directors.” Note the absence of the qualifying word “present” in the latter. Suppose the corporation has 5 directors, one of whom is interested in the transaction. Two of the four disinterested directors attend the board meeting at which the transaction is to be approved. Because the interested director counts towards a quorum, they can proceed to vote. Assume both disinterested directors vote to approve the transaction, while the interested director abstains. A majority of the directors present at the meeting voted for the transaction, so it is properly approved for purposes of § 141(b). Yet, two out of four disinterested directors is not a majority and, as such, the transaction seemingly has not been approved for purposes of § 144(a)(1). Cf. Beneville v. York, 769 A.2d 80, 82 (Del Ch. 2000) (noting that under “traditional rules of board governance” a motion on which the board is evenly divided fails). Presumably the transaction therefore would have to pass muster under § 144(a)(3).
Strine's decision doesn't address this issue, but the rationale for his decision surely supports my result. Holding that a conflicted interest transaction can be blessed (for lack of a better term) by a majority of the disinterested directors who are present and voting would require "an untenable assumption that those who did not [attend the board meeting] were members of a 'silent affirmative majority of the minority.'" In addition, of course, it would raise undesirable incentives about the timing of the meeting - the interested director (especially if s/he is the board chair) might try to time the meeting at which the related party transaction is approved for an occasion on which likely dissenters are expected to be absent.
All in all, I think my reading of 144(a)(1) as requiring a vote by a majority of all the disinterested directors - whether or not present and voting - thus is reinforced by this opinion.
Update: Francis Pileggi has much more on the various aspects of the PNB Holding case.
