Delaware Court of Chancery Rules That a Major Debt Holder and 48 Percent Stockholder Is a Controlling Stockholder and Owes Fiduciary Duties to Minority Stockholders
In Hamilton Partners, L.P. v. Highland Capital Management, L.P., the Delaware Court of Chancery denied a motion to dismiss breach of fiduciary duty claims brought by former stockholders of American Home Patient, Inc. (AHP) against Highland Capital Management, L.P in connection with a going-private transaction.
Following a failed attempt to acquire AHP in 2006, Highland acquired large positions in AHP’s common stock and secured debt in the public markets. By 2007, Highland held 82 percent of AHP’s secured debt and owned 48 percent of AHP’s common stock. Due to its ownership of 48 percent of AHP’s common stock, Highland became an “interested stockholder” for purposes of Section 203 of the Delaware General Corporation Law and was prohibited from effecting a business combination with AHP until 2010. In 2009, AHP and Highland entered into a series of forbearance agreements relating to AHP’s senior debt, which was in default. The forbearance agreements expired in May 2010 shortly after the expiration of the statutory three-year moratorium on Highland’s ability to enter into a business combination with AHP. Prior to the expiration of the statutory moratorium and during the forbearance period, Highland proposed to acquire all of the shares of common stock of AHP not owned by it pursuant to a restructuring and subsequent cash tender offer. Highland also indicated that, if the proposed transaction were not approved, it would not extend the forbearance agreement. In response to Highland’s proposal, AHP formed a special committee of independent directors, which engaged its own counsel and financial advisor. After the expiration of the forbearance period, the special committee approved the transaction without conducting a market check or sale auction.
AHP’s stockholders brought suit alleging that Highland was AHP’s controlling stockholder, despite holding less than a majority of AHP’s common stock and having no representatives on the board of directors of AHP and that, as AHP’s controlling stockholder, Highland breached its fiduciary duties by exercising control over AHP to facilitate a transaction on unfair terms. Highland moved to dismiss the stockholders’ claims, asserting that Highland was not AHP’s controlling stockholder and, therefore, did not owe any fiduciary duties to AHP or its minority stockholders.
The court denied Highland’s motion to dismiss. While the court acknowledged that creditors do not owe fiduciary duties to a borrower or its stockholders, the court reasoned that, when the parties agreed to the going-private transaction, the combination of Highland’s ownership of AHP’s common stock and AHP’s defaulted senior debt was sufficient to support an inference of control and, accordingly, that Highland owed fiduciary duties to the minority stockholders of AHP. The court further noted that Highland’s alleged willingness to enter into multiple forbearance agreements with AHP only until after the expiration of the three-year business combination moratorium required by Section 203 of the Delaware General Corporation Law supported the plaintiff’s assertion that Highland controlled AHP.
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Stanley Polit, a summer associate, contributed to this article.