Delaware Court of Chancery Holds that Third-Party Stockholder has Standing to Enforce Anti-Takeover Protections
In Arkansas Teacher Retirement System v. Alon USA Energy, Inc., et al., C.A. No. 2017-0453-KSJM (Del. Ch. Jun. 28, 2019), the Delaware Court of Chancery found that a plaintiff stockholder, in connection with a merger, had standing as a third-party beneficiary to bring claims for breach of fiduciary duty and breach of a stockholder agreement.
In 2015, Delek US Holdings, Inc. (“Delek”) acquired 48% of the common stock of Alon USA Energy, Inc. (“Alon”). Section 203 of the Delaware General Corporation Law (“DGCL”) prohibits a stockholder from engaging in a business combination with a company within three years from the date it acquires 15% or more of the company’s outstanding voting equity; however, this limitation may be evaded if the company’s board pre-approves the transaction by which the stockholder acquires such a stake. To avoid this three-year standstill period, Delek requested, and Alon’s board of directors granted, pre-approval of the stock purchase under Section 203 of the DGCL. However, Alon’s board conditioned such pre-approval on Delek entering into a stockholder agreement. The stockholder agreement established certain anti-takeover protections similar to those imposed by Section 203 — but only for a one-year standstill period, as opposed to three years — and broadly prevented Delek and its affiliates from acquiring or seeking to acquire more than a majority of Alon’s equity.
During the one-year standstill period established by the stockholder agreement, Delek’s CEO publicly announced Delek’s intent to acquire the remaining 52% of Alon’s outstanding equity; Alon’s board formed a special committee of independent directors to evaluate a prospective bid; and Delek’s representatives and the special committee engaged in substantive negotiations, including exchanging several offers. After the expiration of the standstill period, Delek submitted a final offer, Alon’s special committee and its board approved the transaction, and the merger was consummated in mid-2017.
On behalf of itself and Alon’s common stockholders, Arkansas Teacher Retirement System (the “Plaintiff”) filed a class action lawsuit challenging the merger against Delek and Alon’s individual directors (collectively, the “Defendants”). The Plaintiff filed claims for breach of fiduciary duty and breach of the stockholder agreement. The Defendants filed a motion to dismiss.
First, the Court upheld the Plaintiff’s breach of fiduciary duty claims. In rejecting the Defendants’ argument that the transaction should be reviewed under the business judgment rule, the Court agreed with the Plaintiff’s contention that Delek’s position as a controlling stockholder standing on both sides of the merger subjected the merger to the entire fairness standard of review. As a practical matter, the Court found that Delek’s 48% equity interest and employment of five of Alon’s eleven board members rendered Delek a controller with corresponding fiduciary duties. Therefore, the merger was presumptively subject to the entire fairness standard. The Court held that the Plaintiff’s complaint adequately alleged both unfair process and unfair price under the entire fairness standard: Delek disregarded contractual obligations prohibiting negotiation of the merger during the standstill period and the merger consideration was keyed to the values of Alon and Delek stock, which Delek manipulated through public statements made before the merger. As a result, the Court allowed the Plaintiff’s claims to proceed alleging breach of fiduciary duty against both Delek as a controlling stockholder and Alon’s individual directors.
Second, the Court found that the Plaintiff had adequately alleged that, by seeking to enter into the merger during the standstill period, Delek breached the stockholder agreement. During the one-year standstill period established by the stockholder agreement, Delek publicly announced its intent to acquire Alon stock; Delek met with the special committee’s chairperson multiple times and negotiated substantive terms; Delek and Alon entered into a confidentiality agreement to permit the exchange of non-public information; and Delek proposed a deal structure. In particular, the Court rejected Delek’s contention that the Plaintiff was not a third-party beneficiary of the stockholder agreement and thus lacked standing to enforce it. In doing so, the Court held that the Delek stockholders met all three elements under Delaware law for being treated as third-party beneficiaries of the stockholder agreement: (i) the contracting parties must have intended to confer a benefit directly to the third party; (ii) the contracting parties conveyed the benefit as a gift or in satisfaction of a pre-existing obligation; and (iii) conveying the benefit to the third party must be a material part of the purpose for entering into the agreement. The Court found that, by seeking to incorporate and reproduce the protections of Section 203 of the DGCL, the stockholder agreement was intended to effectuate Section 203 and to directly benefit Alon stockholders. Accordingly, the Court held that the Plaintiff had third-party standing to enforce the stockholder agreement and had sufficiently made out a claim that Delek breached the anti-takeover protections of the stockholder agreement.
Finally, the Court found that the Plaintiff had pleaded facts sufficient to allege that, due to Delek’s insufficient deal disclosures and breach of the stockholder agreement, this vitiated the Alon board’s approval under Section 203 and restored the protections of the DGCL. The Court described the Plaintiff’s argument on this point as “creative” at the pleading stage, while noting that it “might not ultimately land.”