In Re John Q Hammons Hotels Inc. Shareholder Litigation, No. 758-CC 2009 Del. Ch. LEXIS 174 (Del. Ch. October 2, 2009), the Delaware Chancery Court granted plaintiffs’ motion for summary judgment regarding the proper standard of review for trial, holding the entire fairness standard applied. Additionally, the court granted defendants’ motion for summary judgment to dismiss a breach of the fiduciary duty of disclosure claim for mischaracterizing a merger approval process in the proxy statement.  The court denied the following motions for summary judgment: the party responsible for bearing the burden of demonstrating entire fairness, unfair dealing, breaches of the fiduciary duty of disclosure, and aiding and abetting breaches of fiduciary duty.

Plaintiffs, Jolly Rogers Fund and Jolly Rogers Offshore Fund, were minority owners of John Q. Hammons Hotels Inc. (“Company”) Class A shares.  The Company owned and operated hotel franchises. Defendant John Hammons served as Company’s CEO and Chairman of the Board. Hammons and the Company’s Board frequently disagreed about Hammons’ actions as CEO and controlling shareholder.

In 2004, the Company began receiving acquisition offers. Hammons controlled seventy-six percent of the Company’s vote, providing him the power to veto any proposed acquisition offer. He made it clear that to approve any acquisition required significant individual tax advantages and personal benefits, regardless of shareholder benefit. In recognition of Hammons’ veto power over proposed acquisitions, the Board formed a three-person committee (“Special Committee”) to represent minority shareholder interests. The Special Committee hired Lehman Brothers to value the Company and retained the law firm Kat­ten Muchin to advise the Board during the acquisition process.  Lehman valued the Class A stock at $21 per share. In 2005, Hammons and the Special Committee approved an offer from purchaser Jonathan Eilian, which included a $24 per share tender offer for plaintiffs’ Class A stock, as well as several hundred million dollars in personal benefits for Hammons. A majority of minority shareholders also approved the acquisition.

In response to the acquisition, plaintiffs brought numerous claims against Hammons, the Board, and the Acquisition Vehicle (Defendants).  At issue was whether the “business judgment” standard or the “entire fairness” standard governed defendants’ conduct. The court reasoned “robust procedural protections” are necessary to ensure minority shareholders have sufficient bargaining power when a minority shareholder and a majority shareholder “compete” for a purchaser’s consideration. Therefore, the business judgment standard applied only if (1) a “disinterested and independent special committee” recommended the transaction, and (2) shareholders approved the transaction “in a non-waiveable vote of all the minority stockholders.”

Here, defendants argued the business judgment standard applied because Eilian’s negotiation with minority shareholders did not include Hammons, the independent “special committee” adequately represented minority shareholders and a majority of minority shareholders approved the merger in a fully informed vote. The court held, however, that because the shareholder vote could have been vetoed by the Special Committee and did not meet the requirement that a majority of all minority stockholders approve the acquisition, the entire fairness standard applied. Thus, the court granted plaintiffs’ motion for summary judgment for the application of the entire fairness standard.  The court, however, denied plaintiffs’ motion for summary judgment to establish defendants had the burden of showing the entire fairness of the acquisition because material issues of fact remained.

Application of the entire fairness standard requires the court to determine fairness by looking at all aspects of the entire transaction based on two components of fairness: fair dealing and fair price. Plaintiffs contended that Hammons veto power rendered the transaction inherently unfair. As a shareholder, however, Hammons had the freedom to retain his shares, and thus, the “mere possibility that the situation would return to the status quo” because he vetoed an agreement is not sufficient to “render the Special Committee ineffective for the purposes of evaluating fair dealing.” While noting that plaintiffs may be able to prevail at trial if they can establish that Hammons’ self-dealing depressed the share price, the court held material factual issues regarding fair dealing and fair price remained; neither plaintiffs nor defendants were entitled to summary judgment on the unfair dealing claim.

Next plaintiffs alleged defendants breached the fiduciary duty of disclosure by mischaracterizing the Special Committee process in the Company’s proxy statement. The court held that the Proxy statement adequately described the Special Committee’s process. Moreover, plaintiffs conceded that the Proxy Statement disclosed the Special Committee’s recognition that it could not broadly market the Company in light of Hammons’s ability to block potential acquisitions and Hammons’ interest in any transaction would be influenced by personal tax implications.  Accordingly, the court granted defendants’ motion for summary judgment and dismissed the claim.

Conversely, the court dismissed all motions for summary judgment regarding three alleged proxy statement omissions. The first two related to possible conflicts of interest of Lehman and Katten Muchin because both firms solicited acquisition-related business from Eilian. Despite each firm’s contention that the groups soliciting new business were isolated from the Special Committee’s advisors, the court held that these potential conflicts of interest are important and generally must be disclosed to stockholders before a vote. The third omission involved a presentation Eilian made to the Special Committee where the valuation of Company’s Class A stock was estimated to be between $35 and $43 per share. The court held that issues of fact remained for trial because the impropriety of the omission depended on whether the valuation was contingent upon a hypothetical scenario that the Board, in good faith, determined was unlikely to occur. 

Finally, plaintiffs asserted a claim against the acquisition vehicle for aiding and abetting Hammons’ and the Board’s breach of fiduciary duties. There remains a material issue of fact as to whether Eilian was aware that Hammons’ alleged improper self-dealing depressed Company’s stock price. Therefore, the court did not grant either party’s motion for summary judgment on this issue.

In sum, the court held that because minority shareholders needed significant procedural protections not provided here, the entire fairness standard applied. Except for dismissal of an alleged proxy statement mischaracterization, all other claims had significant issues of material facts that remained for trial. As such, that the court denied all other motions for summary judgment.

The primary materials for the post are available on the DU Corporate Governance website.