The Court of Chancery recently decided a case that marks a key development in Delaware’s M&A jurisprudence. For the first time, in the John Q. Hammons Hotels Inc. Shareholder Litigation decision, a Delaware court stated that business judgment will be the applicable standard of review in a transaction where a controlling stockholder receives consideration different from the minority stockholders, but only if the transaction is recommended by a well-functioning, disinterested, and independent special committee and approved by stockholders in a non-waivable vote of the majority of all the minority stockholders.
Hammons provides important guidance in structuring the sale of a corporation where a controlling stockholder insists on receiving different consideration than the other stockholders. It also concludes that such a transaction may nevertheless qualify for business judgment review where it is approved by a properly functioning committee of disinterested directors and is made subject to a strict majority-of-the-minority stockholder vote requirement.
A controlling stockholder is often unwilling to contemplate a sale of the company unless it receives different consideration for various reasons, including tax considerations or even a desire to be compensated for control. Hammons identifies a set of procedural safeguards that allow prop-erly motivated outside directors to negotiate the terms of the transaction and allow minority stock- holders to determine for themselves whether or not to accept the terms proposed. It is to be expected that, where parties employ them, these powerful procedural mechanisms will produce fair outcomes without the need for prolonged litigation over the “entire fairness” of the transaction.
A Prized Chateau
The Hammons case arose out of the sale of John Q. Hammons Hotels, Inc. (JQH) to an acquisition vehicle indirectly owned by Jonathan Eilian, a private investor who had a role in the creation of Starwood Hotel and Resorts Worldwide. JQH was founded and controlled by John Q. Hammons, who held approximately 76 percent of the total voting power in JQH by virtue of his ownership of 5 percent of JQH’s Class A common stock and all of JQH’s super-voting Class B common stock. Hammons was also JQH’s chairman and CEO and, over the years, engaged in numerous related-party transactions with JQH, including owning and developing hotels managed by JQH.
In 2004, Hammons informed the board that he had begun discussions with third parties about a potential sale of JQH. The transactions considered by Hammons contemplated that he would receive different consideration from JQH’s other stockholders due to personal tax considerations and other personal objectives such as obtaining financing to continue his hotel development activities. Recognizing the potential conflict between his interests and those of the minority stockholders, the board formed a special committee to negotiate a transaction on behalf of the minority stockholders. Its role in the sale process was limited, however, because Hammons retained the power to reject any sale he did not favor.
Hammons and the special committee negotiated with several bidders and ultimately cut a deal with Eilian. The special committee negotiated a price of $24 per share of Class A common stock on behalf of JQH’s minority stockholders. Hammons, however, negotiated with Eilian to receive different consideration including an equity interest in the acquiring company; preferred stock with a liquidation preference of $335 million; a $300-million credit line; JQH’s prized Chateau on the Lake Resort; and other contractual benefits and salary. The special committee received an opinion from Lehman Brothers that the $24 share price was fair to the minority stockholders and that the allocation of consideration between Hammons and the stockholders was reasonable.
The transaction was approved by the special committee, JQH’s board, and more than 89 percent of the Class A stockholders that voted on the transaction. Nevertheless, a stockholders’ class action suit was filed, alleging that the price paid for the publicly held Class A shares was inadequate.
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