Hallmark Receives Welcome Greeting: Chancery Approves Recapitalization of Affiliate
S. Muoio & Co. LLC v. Hallmark Entertainment Investments Co., C.A. No. 4729-CC ( Del. Ch. Mar. 9, 2011), read 63-page Delaware Court of Chancery opinion here. Hat tip to Wilmington corporate litigator Kurt Heyman for sending me this opinion today. He and his partners Patricia Enerio and Dominick Gattuso represented some of the prevailing defendants in this case.
Short Overview: This suit challenged the fairness of a recapitalization of Crown Media Holdings, Inc. that was orchestrated by Crown’s controlling shareholder and primary debt holder, Hallmark Cards, Inc. Crown’s inability to make debt payments presented it with choice between default on the debt or bankruptcy–unless the recapitalization plan worked. That plan provided for Hallmark to exchange its Crown debt for an increased percentage of Crown’s Class A common stock, new preferred stock and a new and far smaller amount of debt with a longer maturity. Muoio filed this action in July 2009 seeking to enjon the transaction, a few weeks after it was announced. But the parties agreed to a stay of the litigation to allow time for a special committee to consider the recapitalization plan. The parties also agreed that Muoio would be given sufficient time to pursue a preliminary injunction before the transaction proceeded. Instead, after notice of the transaction was given, Muoio amended its complaint to seek rescissory and related damages. Muoio argued, unsuccessfully, that Crown was undervalued, and that the deal suffered from an unfair process with an ineffective special committee.
Entire fairness, the parties conceded, was the appropriate standard of review for the Court to apply. After a four-day trial in September 2010, and post-trial briefing completed in December 2010, the court issued this opinion today.
The Court observed that its opinion turned on the following factual findings:
- The Crown board’s process was not flawed;
- The special committee was independent and negotiated at arm’s length;
- Crown could not pay its debts as they became due at the time of the deal and absent the deal, faced either default or bankruptcy;
- The valuation issue resulted in a battle of the experts and, as the Court described it: “plaintiff’s expert lost”.
Bottom line: The Court found that the recapitalization was “entirely fair.”
Selected Highlights of Legal Principles and Court’s Legal Analysis
- The Court recognized the well-established principle that “a transaction between a majority stockholder and the company in which it owns a majority stake is generally reviewed under the entire fairness standard”, and the party standing on both sides of the transaction bears the burden of proof.
- The entire fairness standard includes a dual focus on both fair price and fair dealing.
- If the defendant establishes that the challenged transaction was approved by: (i) an independent committee of directors, or (ii) an informed majority of the minority, the burden of proof shifts to the plaintiff. See footnote 73 (if both foregoing protective devices are used, it could obviate entire fairness review.)
- Plaintiff did not establish the lack of independence of the directors on the special committee because no evidence supported the inference that “because of the nature of a relationship or additional circumstances…, the non-interested director would be more willing to risk his reputation than risk the relationship with the interested director.” See slip op., at 26 to 28 for a detailed discussion of the (lack of) evidence profferred in this regard.
- The importance of the special committee’s charter was emphasized, including the need to assure the that special committee has full power to negotiate and evaluate a transaction–including the power to “say no” to the deal.
- The fair price issue was addressed at pages 44 to 48, with reference to prior Delaware cases that dealt with the value of a company on the brink of bankruptcy and unable to pay its bills as they became due.
- The battle of the valuation experts is waged at pages 48 to 63 of the opinion, with extensive analysis and comparison of the competing experts. The views of the plaintiff’s expert are described by the Court in one instance as Panglossian (i.e., inappropriately optimistic).
Postscript: As an aside, regular readers recognize the modest challenge of highlighting a decision of this length in a manner that does not compete with the opinion itself in duration. The length of this opinion is not uncommon in Chancery so the typical practice on these pages has been to provide bullet points or selected highlights of key provisions and then return later for fuller treatment if, when and/or where appropriate.