Reprinted with permission from the May 30, 2018 edition of the Delaware Business Court Insider. © 2018 ALM Media Properties, LLC. All rights reserved. Further duplication without permission is prohibited. (ALMReprints.com, 877.257.3382).
What obligations does a board of directors owe to a controlling stockholder? What actions can a board of directors take against a controlling stockholder? These and other important questions have been teed up as the Delaware Court of Chancery grapples with the claims brought in the widely discussed case CBS v. National Amusements, C.A. No. 2018-0342-AGB. On May 17, the court denied the temporary restraining order (TRO) sought by the plaintiffs because they requested unprecedented relief that would restrain the controller defendants' exercise of their rights and powers, which could not be equitably granted.
CBS and five of its independent directors filed a complaint and moved for a TRO against Shari Redstone and her father, Sumner Redstone, and several companies affiliated with them, including National Amusements, Inc. (NAI), seeking to prevent alleged interference with the board's independence and operation. Redstone, through NAI, controls approximately 79.6 percent of the voting power of CBS, despite owning only approximately 10.3 percent of the company's economic interest.
CBS claimed that Redstone sought to exploit her status as a controlling stockholder to force a merger with Viacom, in which Redstone, through NAI, also controls a majority of the voting power. CBS alleged that Redstone refused to agree to the proposed combined CBS/Viacom entity operating as a noncontrolled public company with a majority independent board, and refused to consider "typical public governance" measures or the submission of the transaction to a vote of CBS's unaffiliated public stockholders.
The CBS board had tasked a special committee with evaluating the proposed Viacom transaction. That committee ultimately concluded that such a merger would not be in the best interests of the unaffiliated public CBS stockholders. The special committee also expressed concerns about the steps Redstone might take to accomplish the merger, including replacing current independent CBS board members with affiliated directors, or making changes to CBS's governance documents to impede the board and special committee from blocking the proposed transaction. Before the hearing, the special committee also telegraphed that it "intended to recommend that the Board approve a stock dividend" of voting stock to all stockholders, the effect of which would be to "dilute NAI's voting power from approximately 80 percent to 17 percent, but would not dilute its economic stake or the economic stake of any other CBS stockholder."
In its motion for a TRO, CBS sought an order that would prevent Redstone from "interfering with the composition of CBS's board ... or modifying CBS's governance documents," "taking any other actions to interfere with any decisions to be taken by CBS's board at a special board meeting," and "interfering with the issuance of any shares payable in a stock dividend." As the court observed, there is "no precedent" in Delaware law where such relief has been granted.
The Court's Opinion
The Court denied CBS's motion for a TRO. The court first explained, and then applied, the familiar three-part test for evaluating TRO requests: Has the movant demonstrated that "it has a colorable claim," it "faces a likelihood of imminent, irreparable harm if relief is not granted," and it "will suffer greater hardships if the TRO is not granted than the defendants would if the relief were granted"?
The court first found that CBS had stated a colorable claim for breach of fiduciary duty against Ms. Redstone, Mr. Redstone, and NAI, based on actions Ms. Redstone had taken that "cast significant doubt over the genuineness of CBS's public promises of independent board governance" and were "detrimental to the interests of the stockholders who hold approximately 90 percent of the economic stake in [CBS]."
Notwithstanding its finding that CBS had colorable claims, the court found against CBS on the last two elements of the TRO analysis. The court explained that, while the defendants might take actions with the potential to harm CBS, none would cause irreparable harm because the company or its stockholders could seek further legal redress, if necessary. The court also found that the balance of the equities weighed in the defendants' favor. While no case was directly on point, the clearest precedent laid out in Adlerstein v. Wertheimer, C.A. No. 19101, 2002 Del. Ch. LEXIS 13 (Jan. 25, 2002), "expressly endorsed a controller's right to make the first move preemptively to protect its control interest." As a result, the court determined that the relief CBS sought-which would effectively enjoin the controller defendants' exercise of their first-mover advantage-could not be equitably granted.
Since the complaint was filed on May 14, several new developments have arisen. First, one hour before the May 16 hearing on CBS's TRO motion, NAI purported to amend CBS's bylaws to require a 90 percent supermajority vote of the CBS board to declare a dividend such as the one proposed by the special committee. Nonetheless, on May 17, the CBS board voted 11-3 ostensibly to issue the dilutive dividend as proposed by the special committee. NAI disputes the validity of that vote, and CBS has since amended its complaint to challenge the validity of NAI's bylaw amendment.
The court explicitly stated that it was "expressing no opinion" as to the validity of the actions undertaken and proposed by either party. But these actions bring to the forefront several questions that have yet to be squarely addressed by Delaware law. What obligations does a board of directors owe to a controlling stockholder? What actions can a board of directors take against a controlling stockholder? How can a board satisfy its fiduciary obligations to all stockholders when a controller may attempt to exploit its voting power at the expense of unaffiliated public stockholders?
The court has yet to tackle these difficult questions head on. But it did touch on them in evaluating the balance of the equities in CBS's TRO motion. At present, an apparent conflict in Delaware law exists: On one side of the debate, cases like Adlerstein recognize a controlling stockholder's right to preemptively tackle threats to its control. It remains unclear where the outer bounds of that right lie, but preemptive amendments to a corporation's governance documents or replacement of directors—actions NAI and the Redstones could possibly take—may fall within them.
On the other side of the debate are cases like Mendel v. Carroll, 651 A.2d 297 (Del. Ch. 1994), which found that a board of directors is vested with the authority to protect the corporation and its minority stockholders, even from a controlling stockholder like NAI. But the extent of that authority has yet to be determined. Concluding this case may require resolution of this apparent tension, which has the potential to impact board-controller relations long down the road.
As this case moves forward, the primary consideration for practitioners is the court's hesitancy to grant injunctive relief of the type sought by CBS. Corporations with controlling stockholders should be aware that Delaware courts will likely give careful consideration to the rights and expectations of controlling stockholders before issuing rulings that prevent controllers from exercising the full extent of their powers.
The material in this publication was created as of the date set forth above and is based on laws, court decisions, administrative rulings and congressional materials that existed at that time, and should not be construed as legal advice or legal opinions on specific facts. The information in this publication is not intended to create, and the transmission and receipt of it does not constitute, a lawyer-client relationship.