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Hamilton Partners, L.P. v. Highland Capital Management, L.P.: Court of Chancery Considers a 48% Stockholder and Majority Debt Holder a Controlling Stockholder and Declines to Dismiss Class Action Challenging Going-Private Transaction

June 12, 2014

In Hamilton Partners, L.P. v. Highland Capital Management, L.P., C.A. No. 6547-VCN, 2014 WL 1813340 (Del. Ch. May 7, 2014), the Court of Chancery, by Vice Chancellor Noble, in connection with a challenge to a going-private transaction whereby American HomePatient, Inc. (“AHP”) was acquired by an affiliate of one of its stockholders, Highland Capital Management, L.P. (“Highland”), refused to dismiss breach of fiduciary duty claims against Highland. The Court held that, for purposes of defendants’ motion to dismiss, plaintiff alleged facts sufficient to support an inference that Highland, which owned 48% of AHP’s stock and 82% of AHP’s debt, was the controlling stockholder of AHP and that the merger was not entirely fair.

Before the challenged transaction, AHP was a publicly traded Delaware corporation that specialized in home health services. In February 2006, Highland, which at the time was AHP’s largest secured creditor and owned 9.9% of AHP’s stock, proposed to acquire AHP. After its proposal was rejected, Highland began purchasing AHP’s stock in the public market and, by April 2007, increased its stock ownership in AHP to 48%. Due to its increased ownership in AHP’s stock, Highland became an “interested stockholder” under Section 203 of the General Corporation Law of the State of Delaware (“Section 203”), which limited Highland’s ability to consummate a business combination with AHP for a period of three years. In 2009, when AHP struggled to refinance a large line of credit, Highland, which by that time had acquired 82% of AHP’s debt, agreed to enter into a series of one-month forbearance agreements with AHP, the last of which expired in May 2010. The last forbearance agreement expired shortly after the expiration of the three-year period applicable to Highland as an “interested stockholder” under Section 203.

In April 2009, Highland made another proposal to acquire AHP. The board of directors of AHP formed a special committee, which retained legal and financial advisors, but did not conduct sales efforts beyond phone calls to two potential suitors. In late 2009, following negotiations with Highland that resulted in an increased merger price, AHP and Highland agreed to a restructuring transaction that involved (i) a small debt purchase by AHP, (ii) a reincorporation by merger of AHP into a Nevada corporation (“New AHP”), (iii) a self-tender offer by New AHP, (iv) a debt refinancing by New AHP, (v) resignations of the directors of New AHP and appointment of directors designated by Highland, and (vi) a merger of New AHP with an affiliate of Highland. Although the parties agreed to the restructuring transaction in late 2009, the parties did not enter into a definitive restructuring agreement (the “Restructuring Agreement”) until April 2010, after the three-year waiting period applicable to Highland under Section 203 expired. Part of the special committee’s rationale for recommending the transaction was that Highland was unlikely to agree to continued forbearance agreements.

Plaintiff filed a stockholder class action alleging that, in connection with the merger with a Highland affiliate (which was the final step in the restructuring transaction), Highland was the controlling stockholder of AHP and had used its control to cause AHP to agree to an unfair transaction. Plaintiff further alleged that AHP’s CEO, who was also a director, breached his fiduciary duties through his actions in connection with the merger. The Court noted that plaintiff made the unusual choice to not plead any claims for breach of fiduciary duty against the AHP directors other than the CEO (and implicitly that plaintiff failed to allege that a majority of the directors were interested in the going-private transaction or lacked independence).

As an initial matter, the Court addressed whether plaintiff’s claims arose under Delaware or Nevada law. The Court noted that the “guiding principle” in its determination is the internal affairs doctrine, under which claims relating to a corporation’s internal affairs are governed by the law of the state of incorporation. Applying the internal affairs doctrine, the Court found that actions taken by AHP (a Delaware corporation) and actions contractually agreed to in the Restructuring Agreement (which was executed by AHP), including the merger with Highland, were governed by Delaware law, and actions taken by New AHP (a Nevada corporation), other than those required by the Restructuring Agreement, were governed by Nevada law.

The Court then considered, for purposes of defendants’ motion to dismiss, whether plaintiff’s allegations supported a reasonable inference that, at the time the parties agreed to the merger as part of the Restructuring Agreement, Highland was the controlling stockholder of AHP, despite holding less than a majority of AHP’s stock and having no representatives on the board of directors of AHP. While the Court acknowledged that a corporation’s creditor, even one that owns a majority of a corporation’s debt like Highland, does not owe fiduciary duties to the corporation’s stockholders, the Court held that, when the parties agreed to the Restructuring Agreement, Highland’s ownership of 48% of the stock and 82% of the debt (which was in default) of AHP was sufficient to support an inference of control such that Highland owed fiduciary duties to the minority stockholders of AHP. The Court further noted that Highland’s alleged willingness to enter into multiple forbearance agreements with AHP only until shortly after the expiration of the three-year waiting period required by Section 203 was further support for an inference of Highland’s control over AHP. In addition, the Court found that plaintiff’s allegations that the fairness opinion that the board of directors relied upon as support for its approval of the merger was based upon an unreasonable discount rate supported the inference that the price offered in the merger was not entirely fair. As a result, the Court found that plaintiff sufficiently alleged that Highland exercised its control over AHP to facilitate the restructuring on unfair terms and thus declined to dismiss the allegations for breach of fiduciary duty against Highland as AHP’s controlling stockholder in connection with the merger.

The Court, however, did dismiss the claims against AHP’s CEO under both Delaware and Nevada law. Noting that plaintiff challenged only the actions of the CEO-director in connection with the merger and not the actions of the other four directors, the Court held that under both Delaware and Nevada law, a plaintiff is required to allege facts sufficient to overcome the business judgment rule as against a majority of the directors in order to state a claim. Because plaintiff did not allege facts sufficient to do so as to any of the other four directors, the Court dismissed the breach of fiduciary claims against the CEO-director.