Court of Chancery Applies Entire Fairness Standard to Conversion of Delaware Corporation to Nevada Corporation
In Short
The Case: TripAdvisor and its controlling corporation, both publicly traded Delaware companies, announced plans to convert to Nevada corporations. Shareholders sued to enjoin the conversions, alleging that the boards of directors had approved the conversions in order to reduce their potential liability in future transactions. The defendant directors and companies moved to dismiss.
The Result: The Delaware Court of Chancery ruled that because both converting companies had a controlling shareholder that would receive a unique benefit from the conversions, and the conversions had not been "cleansed" by being conditioned on the approval of independent directors and the minority shareholders, the entire fairness standard of review applied. While the court refused to dismiss the complaint, it did not enjoin the conversions.
Looking Ahead: The court's ruling underscores that corporations are free to leave Delaware. The court also set out a roadmap for doing so without facing significant litigation risk: If a corporation has no controlling shareholder, then a fully informed vote of the shareholders will result in a complaint being dismissed, and if a corporation has a controlling shareholder, then approval of independent directors and minority shareholders could likewise lead to a dismissal.
The Delaware Court of Chancery recently applied the entire fairness standard of review to the conversion of two controlled Delaware corporations from Delaware to Nevada entities. Dennis Palkon, et al. v. Gregory B. Maffei, et al., — A.3d —, 2024 WL 678204 (Del. Ch. Feb. 20, 2024).
TripAdvisor is a well-known online travel company, with a controlling shareholder. At the time the lawsuit was filed, 43% of the controlling shareholder's voting power was controlled by its CEO and chairman. Both TripAdvisor and its controlling shareholder were (and still currently are) Delaware corporations.
Under Section 266 of the Delaware General Corporation Law, a Delaware corporation may convert to a non-Delaware corporation upon a resolution of its board of directors and a majority vote of its shareholders. This statute was amended in 2022 to make conversions easier. Previously, it had been necessary to obtain unanimous shareholder consent, which in the case of a public corporation would be extremely difficult.
In November 2022, TripAdvisor's management made a presentation to its board regarding the possibility of converting to a Nevada corporation. The benefits of the conversion included saving money on franchise taxes and greater protection against litigation for directors and officers. In Nevada, a director can be liable for breach of the duty of loyalty only if he or she commits intentional misconduct, fraud, or a knowing violation of law. In April 2023, TripAdvisor's board approved the conversion of TripAdvisor into a Nevada corporation. Its controlling shareholder's board similarly approved the conversion of that company.
At meetings in June 2023, holders of a majority of the voting power of both entities approved the conversions, though only a minority of the unaffiliated shareholders approved each. Shareholders of TripAdvisor and its controlling shareholder filed suit in the Delaware Court of Chancery in April 2023. The shareholders sought to enjoin the conversions and claimed they were unfair.
In a decision issued on February 20, 2024, the Court of Chancery refused to enjoin the conversions, but also declined to dismiss the plaintiffs' claims. The court held that the plaintiffs had adequately alleged that the controlling shareholders of each corporation had obtained a non-ratable benefit from the conversions. This asserted benefit was reduced risk of litigation against the corporations and them.
The court held that the entire fairness test could be applied even though the shareholders were not receiving any "price" in the conversions, and were instead receiving new Nevada shares to replace their Delaware shares. Having determined that the entire fairness test applied, the court ruled that plaintiffs had adequately alleged that the "price" and the process were unfair. The Nevada shares that the plaintiffs would receive had fewer litigation rights than the Delaware shares, and the companies had not adopted any protections to safeguard the rights of the minority shareholders in the conversions. The court ruled, however, that it would not enjoin the conversions because if the minority shareholders had suffered harm, they could be compensated by money damages, measured by the change in the companies' stock prices upon conversion from Delaware to Nevada.
It remains to be seen whether there will be a sustained trend of companies reincorporating from Delaware to jurisdictions perceived to be more protective of fiduciaries.
Three Key Takeaways
- A Delaware court is unlikely to enjoin the conversion of a Delaware corporation to a non-Delaware corporation. In the event that plaintiff shareholders are able to allege that the conversion is unfair, it is likely that money damages will suffice to remedy any harm.
- A court will rigorously scrutinize a conversion that appears intended to benefit defendant directors or a controlling shareholder.
- Even in the case of a company with a controlling shareholder, however, it is possible for a company to ensure that the business judgment rule applies to a conversion by conditioning it on a resolution of independent directors and a vote of unaffiliated shareholders.
