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In re KKR Financial Holdings LLC Shareholder Litigation: Court of Chancery Rejects Controlling-Stockholder Allegations and Dismisses Merger Case Under Business Judgment Rule

October 14, 2014

In In re KKR Financial Holdings LLC Shareholder Litigation, Consol. C.A. No. 9210-CB (Del. Ch. Oct. 14, 2014), the Court of Chancery granted defendants’ motions to dismiss with prejudice a suit challenging the acquisition of KKR Financial Holdings LLC (“KFN”) by KKR & Co. L.P. (“KKR”).

In December 2013, KKR and KFN executed a stock-for-stock merger agreement, which was subject to approval by a majority of KFN shares held by persons other than KKR and its affiliates. The merger was approved on April 30, 2014, by the requisite majority vote.

Nine lawsuits challenging the merger were brought in the Court of Chancery and consolidated. The operative complaint alleged that the members of the KFN board breached their fiduciary duties by agreeing to the merger, that KKR breached its fiduciary duty as a controlling stockholder by causing KFN to enter into the merger agreement, and that KKR and its subsidiaries aided and abetted the KFN board’s breach of fiduciary duty.

The Court ruled that KKR, which owned less than 1% of KFN’s stock, was not a controlling stockholder. Plaintiffs focused on a management agreement by which a KKR affiliate managed the day-to-day business of KFN, but the Court ruled that the plaintiffs’ allegations were not sufficient to support an inference that KKR thereby controlled the KFN board “such that the KFN directors could not freely exercise their judgment in determining whether or not to approve and recommend to the stockholders a merger with KKR.” Therefore, the Court dismissed the claim premised on KKR’s status as an alleged controlling stockholder.

The Court then held that business judgment review applied to the merger because a majority of the KFN board was disinterested and independent. The Court held alternatively that, even if a majority of the KFN directors were not independent, “the business judgment presumption still would apply because of the effect of untainted stockholder approval of the merger.” The Court rejected the plaintiffs’ disclosure challenges and ruled that the business judgment standard of review would apply to the merger “because it was approved by a majority of the shares held by disinterested stockholders of KFN in a vote that was fully informed.” Accordingly, the Court dismissed the claim against the KFN directors. Because the plaintiffs had not pleaded a viable claim against the KFN directors, the Court also dismissed the claim for aiding and abetting.