Professor Talley Poses a SB 21 Question: I resort to AI

Over on LinkedIn, my friend and fellow corporate law prawf Eric Talley poses a thought question about new Delaware SB 21, about which I have been blogging extensively:

A new and historically significant set of proposed Delaware corporate law reforms dropped yesterday (see my hot take here: https://lnkd.in/eqZtfDBq ). The proposed reforms are significant and worthy of substantive debate (which I hope and expect they will receive). One of the proposed measures will overturn the 2024 Match Group opinion, which applied a uniform standard to cleansing controller conflicts. Instead, the proposal would materially reduce judicial scrutiny on conflicted controller acts *except* for "squeeze-outs" (controller going-private transactions where all or substantially all of minority stockholders' shares are transferred to the controller or eliminated). Such squeeze-out transactions would still be subject to the MFW "belt and suspenders" cleansing test (albeit in now weaker form). This was the same carve-out that was (unsuccessfully) asserted in the Match Group case, and it reminded me of a challenge I gave to my M&A students at the time.

HERE IS THE CHALLENGE: Your client is a Delaware corporation with a controller. Design a conflicted controller transaction structure for your client that is *technically not* a controller squeeze-out (per the above definition), but accomplishes substantially the same economic effects, thereby giving the controller a hall pass under the proposal, allowing them to evade 2-level cleansing / heightened judicial scrutiny. For the "best" entry I will send (at my own cost) a much coveted "I <3 Corporations" t-shirt (the same type that I have been known to throw out to my students in a shameless gesture of pedagogical pandering). 1, 2, 3, Go!

As regular readers know, I've been blogging and tweeting up a storm about SB 21 and I'm feeling tired. Also, it's almost dinner time. So I dumped the question onto "Larry The Scholarly Legal Writing Instructor" at ChatGPT developed by my good friend JW Verret. Here's Larry's answer:

To structure a conflicted controller transaction that avoids classification as a "squeeze-out" under SB 21—while still achieving similar economic effects—a controller could implement a Minority Stockholder Migration & Reclassification Strategy. This would avoid triggering the MFW two-step cleansing requirement while materially reducing judicial scrutiny. Here’s how:

Step 1: Controller Purchases Minority Shares on the Open Market

• The controller gradually acquires a substantial portion of minority-held shares via open-market purchases and negotiated private transactions.
• Since these are voluntary sales, the transaction avoids being classified as a squeeze-out or mandatory elimination of minority interests.
• Delaware courts have historically been hesitant to impose entire fairness scrutiny on mere open-market acquisitions by controllers.

Step 2: Creation of a New Non-Voting Class & Reclassification

• The company adopts a charter amendment (approved by a controller-majority board and ratified via majority vote, where the controller holds effective control).
• The amendment reclassifies the remaining minority shares into a new class of non-voting, illiquid, or otherwise economically impaired stock (e.g., non-transferable, dividend-subordinate, or convertible into a different class only under controller-defined terms).
• Courts have sometimes declined to treat reclassification as a per se squeeze-out if shares technically continue to exist, especially when framed as an internal corporate governance matter.

Step 3: Issuance of Special Dividend / Asset Transfer to a New Entity

• The company issues a special dividend in the form of a security or cash distribution, available only to holders of the original common stock (which the controller exclusively holds after Step 2).
• Alternatively, the company transfers valuable assets to a new entity in which the controller has disproportionate ownership or control, leaving the reclassified minority stockholders with shares in a hollowed-out corporate shell.
• Since minority stockholders technically retain shares, this avoids the formal "elimination" trigger under SB 21's squeeze-out definition.

Step 4: Subsequent Tender Offer or Buyout at Depressed Prices

• Once the reclassification and economic dilution have been implemented, the controller offers to buy out remaining minority holders at a heavily discounted price (since their shares are now structurally inferior).
• At this stage, the remaining minority shareholders are effectively coerced into selling, as their equity position is functionally worthless.

Legal Positioning & Justification

• The controller avoids the "squeeze-out" label because:
  1. No forced elimination of all or substantially all minority shares. Instead, shares remain outstanding but economically impaired.
  2. No direct cash-out merger or similar structured buyout. The transactions occur through market purchases, reclassification, and asset transfers.
  3. Tender offer is nominally voluntary. While practically coercive, the offer does not require minority holders to tender their shares.

End Result: Economic Equivalent of a Squeeze-Out, Without Heightened Scrutiny

This structure achieves nearly identical economic effects as a formal controller squeeze-out while avoiding SB 21’s strict MFW requirements. By relying on piecemeal steps (open-market purchases, charter amendments, asset shifts, and coercive tender offers), the controller evades the two-level cleansing process, ensuring a hall pass under the proposed lower scrutiny framework.

So then I decided to see what Claude would do with it. Here's his answer:

Controller Asset Extraction Strategy

The controller could implement a multi-step transaction that:

1. Creates a wholly-owned subsidiary ("HoldCo")
2. Transfers substantially all valuable assets from the controlled public company ("PublicCo") to HoldCo
3. Leaves the public minority shareholders with technically intact ownership, but in a hollowed-out entity

Transaction Structure Details

Step 1: Strategic Asset Identification and Transfer

• The controller identifies PublicCo's most valuable assets/operations
• PublicCo transfers these assets to HoldCo in exchange for HoldCo debt instruments
• The debt is structured with minimal interest, extremely long maturity, and subordinated status

Step 2: Management Agreement

• HoldCo enters into a management agreement with PublicCo
• The agreement grants HoldCo complete operational control of remaining PublicCo assets
• Management fees are set at levels that extract nearly all future free cash flow

Step 3: Capital Structure Reconfiguration

• PublicCo issues a special dividend-in-kind of the HoldCo debt to the controller only
• This is structured as a non-pro rata distribution to the controller class of stock
• Alternatively, PublicCo issues new preferred stock with liquidation preference approximating enterprise value

Step 4: Operational Stranglehold

• PublicCo enters into exclusive supply/distribution agreements with controller affiliates
• Terms are structured to transfer economic value from PublicCo to controller entities
• May include trademark licenses that can be terminated, making PublicCo wholly dependent

Legal Analysis

This structure avoids being a technical "squeeze-out" because:

1. No shares are being transferred to the controller
2. No shares are being eliminated
3. Minority shareholders retain their exact same percentage ownership
4. PublicCo remains a public entity with technically viable operations

Yet economically, this achieves the squeeze-out effect by:

1. Stripping economic value from the public entity
2. Transferring future value creation potential to controller-owned entities
3. Leaving minority shareholders with shares that have minimal economic value
4. Creating practical impossibility for minority shareholders to realize value

This structure exploits the narrowly drafted definition of "squeeze-out" in the proposed legislation while accomplishing substantively identical economic results, thereby evading the cleansing requirements.

I'm going to stop and go make dinner. I'll invite Eric to drop by and leave his thoughts in the comment section, although he'll probably just say something snarky about my letting AI do my work for me.