Weinberger (Plaintiff), a former minority shareholder of UOP (Defendant), claimed that a cash-out merger between UOP (Defendant) and Signal (Defendant) was unfair, and he brought a class action to have the merger rescinded.
The intrinsic fairness test will be applied in a case where a parent company controls all transactions of a subsidiary, receives a benefit at the expense of the subsidiary’s minority stockholders, which places the burden on the parent company to prove the transactions were based on reasonable business objectives.
Signal, Inc. (Defendant) owned 50.5 percent of UOP (Defendant) stock.Â Seven of UOP’s (Defendant) directors, including the president, were also directors or employees of Signal (Defendant).Â Arledge and Chitiea, who were directors of UOP (Defendant) and Signal (Defendant), prepared a feasibility study for Signal (Defendant).Â The study concluded it would be a good investment for Signal (Defendant) to acquire the remaining 49.5 percent of UOP (Defendant) shares through a cash-out merger at any price up to $24 per share.Â The study was provided to all the Signal (Defendant) directors, including those who also served as a director on UOP’s (Defendant) board.Â However, according to evidence, the study was not disclosed to UOP’s (Defendant) six non-Signal (outside) directors.Â Neither was it disclosed to the minority shareholders who owned the remaining 49.5 percent of UOP (Defendant) stock.Â On February 28, Signal (Defendant) offered UOP (Defendant) a cash-out merger price of $21 per share.Â Four business days later, on March 6, the six non-Signal UOP (Defendant) directors (the seven common Signal-UOP directors abstained from voting) voted to approve the merger at $21 per share.Â The vote was mainly due to the fact that at the time, UOP’s (Defendant) market price was only $14.50 per share, and also there was a â€œfairness opinion letterâ€ from UOP’s (Defendant) investment banker stating that the $21 per share was a fair price.Â The merger was then approved by a majority (51.9 percent) of the minority, i.e., remaining 49.5 percent, UOP (Defendant) shareholders.Â Weinberger (Plaintiff), a former minority shareholder of UOP (Defendant), then brought a class action to have the merger rescinded, claiming it was unfair to the former shareholders of UPO (Defendant).Â The Court of Chancery held for the Defendants.Â Plaintiff appealed.
May a minority shareholder successfully challenge the approval of a cash-out merger that was approved by the majority of the minority shareholders?
(Moore, J.)Â Yes.Â A minority shareholder may successfully challenge the approval of a cash-out merger that was approved by the majority of the minority shareholders if he is able to demonstrate that the corporations involved failed to comply with the fairness test when the approval was secured.Â The fairness test consists of two basic interrelated aspects.Â The first aspect is â€œfair dealings,â€ which imposes a duty on the corporations involved to completely disclose to the minority shareholders all information relevant to the merger.Â In this case, Signal (Defendant) failed to disclose, to the non-Signal UOP (Defendant) directors and the minority shareholders of UOP (Defendant), the Arledge-Chitiea feasibility study that reported it would be a â€œgood investmentâ€ for Signal (Defendant) to acquire the minority shares up to a price of $24 per share.Â Further, UOP’s (Defendant) minority was given the impression that the â€œfairness opinion letterâ€ from UOP’s (Defendant) investment banker had been drafted only after the banker had made a careful study, when, in fact, the investment banker had drafted the letter in three days with the price left blank.Â Therefore, Signal (Defendant) did not meet the â€œfair dealingâ€ aspect of the test.Â The second part of the fairness test is â€œfair price,â€ which requires that the price being offered for the outstanding stock equal an appraisal where â€œall relevant non-speculative factorsâ€ were considered.Â In this case, the Court of Chancery tested the fairness of Signal’s (Defendant) price of $21 per share against the Delaware weighted average method of valuation.Â No longer shall that method exclusively control the determination of â€œfair price.â€Â Instead, a new method which considers â€œall relevant non-speculative factorsâ€ shall now be used for determining fair price.Â The new method is consistent with the method used in determining a shareholder’s appraisal remedy.Â Here, the Court of Chancery did not consider the $24 per share price determined by the Arledge-Chitiea study.Â The court also did not consider Weinberger’s (Plaintiff) discounted cash flow analysis, which concluded that the UOP (Defendant) stock was worth $26 per share on the date of the merger.Â And so, since these factors were not considered, it cannot be said that the $21 per share price paid by Signal (Defendant) meets the new method of determining fair price.Â Lastly, in consideration of the new, more liberal test for determining fair price, along with the Chancery Court’s broad remedial discretion, it is concluded that the business purpose requirement for mergers, as required by the trilogy of Singer [v. Singer, 634 P.2d 766 (1981], Tanzer [v. International General Industries, Inc., 379 A.2d 1121 (Del. 1979)], and [Roland International Corp. v.] Najjar, 407 A.2d 1032 (Del. Sup. Ct. 1979), adds no further protection to minority shareholders.Â Accordingly, the business purpose requirement is no longer law.Â Reversed and remanded.
This case demonstrates the use of a cash-out merger to eliminate or â€œfreeze outâ€ the minority interest.Â A footnote in the case suggests that Signal’s (Defendant) freeze-out of UOP’s (Defendant) minority interest would have met the court’s fairness test if UOP (Defendant) had appointed an independent negotiating committee of its non-Signal directors to deal with Signal (Defendant) at arm’s length.