Can Business Judgment Review Combat Stockholder Litigation Challenging MA Deals?

Guest post by attorneys at Fried, Frank, Harris, Shriver & Jacobson LLP

Abigail Pickering Bomba, Steven Epstein, Arthur Fleischer, Jr., Peter S. Golden, Philip Richter, David N. Shine, John E. Sorkin, and Gail Weinstein

In KKR Financial Holdings LLC Stockholder Litigation (Oct. 14, 2014), the Delaware Chancery Court has continued its march to the drumbeat of business judgment deference.

In a putative class action by shareholders of KKR Financial (KFN), who were claiming breach of fiduciary duty by KFN’s board in having approved a $2.6 billion merger with private equity firm KKR, Chancellor Andre Bouchard found that KKR had not been a controlling stockholder of KFN– because KKR held less than 1% of KFN’s voting power and had no right to appoint or remove directors or block board actions, even though KKR had “total managerial control” of KFN. The Chancellor also found that KFN’s directors had been independent of KKR (even though they had been nominated by and had various ties to KKR); and that KFN’s merger proxy statement had provided for a fully informed stockholder vote. The court applied business judgment review and dismissed the case at the pleading stage.


KKR had created KFN in 2004 to serve as a public financing vehicle to support KKR’s LBO transactions. In connection with KFN’s initial public offering, KKR retained a 1% ownership interest, entered into a management agreement pursuant to which it had “total managerial control” of KFN, and nominated KFN’s directors (most of whom had ties with KKR). The management agreement could not be terminated by KFN except by paying a fee equivalent to four years of management fees (about $256 million, which exceeded KFN’s cash on hand at the time the merger was being considered). In 2013, KKR sought to acquire KFN in an all-stock merger. The merger was considered and approved by a special committee of the KFN board that had hired its own advisors. The merger was also approved by a majority of the outstanding KFN shares, including a majority of the shares not owned by KKR and its affiliates.

Key Points

Court’s preference for business judgment review

It can be expected that the Chancery Court will apply business judgment review whenever possible. In a line of cases over the past year, the court has maintained a focus on business judgment review, expanding the court’s jurisprudence to permit business judgment review in going private transactions involving controllers (Orchard and MFW) and applying business judgment review in a variety of contexts where application of an entire fairness standard would not have been inconceivable. Over the last weeks, business judgment review has been applied in cases where the pleadings included non-trivial challenges to the process, price and disclosure in a controller transaction (SynQor); and where an insolvent company’s board adopted a risky strategy for the benefit of the sole stockholder at the likely expense of the creditors (Quadrant). Now, in KKR Financial, the court has applied business judgment review to a private equity firm’s merger with a company over which the firm had total managerial control, as well as ties to most of the target directors.

Business judgment review even when a board was not independent

In dictum in KKR Financial, while noting some debate in this regard since the Delaware Supreme Court’s 2009 Gantler decision, Chancellor Bouchard indicated his view that, as established in Delaware Chancery Court precedent, business judgment review would apply in a non-controller transaction even if the directors who approved the transaction had not been independent. Approval by the disinterested stockholders in a fully informed vote, standing alone, the Chancellor said, would invoke application of business judgment review. The Chancellor also indicated his view that this result would obtain whether the stockholder vote had been voluntary or (as in the case of the HFN merger) had been required by statute.

Narrow view of “control”

In furtherance of the trend toward business judgment review, it can be expected that the Chancery Court will apply a generally narrow view of “control” when determining whether a stockholder is a controller. The relevant inquiry to determine controller status, the court said, is whether a stockholder has actual control of the board, as the board has ultimate authority over the management and affairs of a corporation. Thus, control is based on the ability (whether through stock ownership or contract or other rights) to appoint, elect, or remove a majority of directors or to block the board’s decisions. While a less- than-majority stockholder that has this ability may be a controller, KKR, which was a less than 1% stockholder (without the right to appoint or remove directors or to block their decisions), was not a controller, the court said. Further, a firm’s pre-existing arrangements with a target company that limit the target’s business options (and value), and which were disclosed to the stockholders when the target went public, do not cause the firm to be a controller of the target.

Narrow view of “non-independence”

It can also be expected that the Chancery Court will apply a generally narrow view of “non-independence” when determining whether a director was independent of an interested stockholder. As discussed in more detail below, in KKR Financial, the court rejected plaintiffs’ arguments that the directors had not been independent because they had been nominated by, or had past business relationships with, the interested stockholder.

Consideration of the totality of the circumstances

While procedure is critical, the totality of the circumstances may well affect the court’s judgment. Thus, even when a target would appear to have limited negotiating leverage in connection with a merger with a stockholder, the target board should still make efforts to negotiate. In KKR Financial, the management agreement in place between KKR and KFN severely limited KFN’s value, made KKR the only logical buyer, and as a practical matter could not be terminated—suggesting, first, that the only decision really available to the KFN board was whether to sell or not to sell and, second, that a price representing any amount of premium would have been a good deal for KFN’s shareholders. Importantly, KFN had asked KKR if it would consider modifying or eliminating the management agreement termination fee—which would have permitted KFN to terminate the management agreement and either obtain a manager other than KKR or attract competing bidders. Also, the merger price represented a 35% premium. Further, KFN had tried to negotiate for a higher price and had proposed that KKR do a cash deal (as KKR’s units were at their one year high). Although KKR refused KFN’s requests (other than agreeing to increase the merger consideration from 0.51 KKR units per KFN share to 0.52 KKR units per share), these actions, while not cited by the court as support for its conclusions, may well have affected the court’s decision, as a consideration of the totality of the circumstances has been a hallmark of Delaware jurisprudence.

Determining independence of directors

In determining that a majority of the special committee had been independent of KKR, the court discussed the independence of each of the twelve KFN directors.

  • High-level employees of KKR. Directors who had been high-level employees of KKR at the time the merger was approved were not independent.
  • “Longstanding ties” to KKR. The court stated that it was “reasonably conceivable” that directors who were alleged to have had “longstanding ties” to KKR might be found to be not independent. One director had served as a Senior Advisor to KKR and as Chairman of a KKR affiliate at the time of the merger. The other was the Dean of a Business School that had recently received a $100 million donation from a KKR co-founder.
  • Nomination by KKR. All of the KFN directors had been nominated by KKR. The court referred to “well-settled Delaware law” that “independence is not compromised simply by virtue of being nominated to a board by an interested stockholder.”
  • Past business relationships involving KKR. The court rejected the plaintiffs’ “conclusory” allegations that the following directors were not independent of KKR because of being “beholden” to KKR by virtue of past business relationships:
  • One director, plaintiffs alleged, owed his position as CEO of a major corporation to KKR-affiliated directors on that corporation’s board (although the director had joined that corporation after KKR had liquidated its holdings in it and the KKR-affiliated directors did not comprise a majority of that board at any time).
  • One director was alleged to be not independent of KKR because he was beholden to another KFN director, to whom he owed his advancement at another company and who was beholden to KKR (although the events had taken place at least twelve years earlier and had nothing to do with KKR).
  • Plaintiffs alleged that one director was beholden to KKR for his high-level positions and then consulting arrangement at a KKR portfolio company (although there was no allegation that KKR continued to own a position in, nor that the director continued to work for, that portfolio company at the time the merger was being considered.)


The Chancery Court, apparently in an ongoing effort to combat the prevalence of stockholder litigation challenging M&A deals, can be expected to apply business judgment deference to board decisions whenever possible. Moreover, the court may be expected to apply business judgment review even when the directors approving a non-controller transaction were not independent, if the transaction has been approved by disinterested, non-coerced stockholders in a fully informed vote. The court is likely to take a generally narrow view of what constitutes “control” for purposes of determining whether a stockholder was a controller and what constitutes “non-independence” for purposes of determining whether directors were independent of an interested stockholder. In KKR Financial, Chancellor Bouchard found that KKR was not a controller of KFN because, notwithstanding KKR’s “total managerial control”, the KFN board was free to exercise its judgment in determining whether to approve the merger. The Chancellor also found that the KFN directors were independent of KKR despite having been nominated by, and having had various ties to, KKR.

Abigail Pickering Bomba, Partner, Corporate,

Abigail Pickering Bomba is a corporate partner resident in Fried Frank’s New York office. She joined the Firm in 2003.

Ms. Bomba concentrates her practice on private equity transactions and mergers and acquisitions representing both private equity firms and public and private companies. She also advises clients in connection with corporate governance issues, defensive strategy, securities law compliance and other general corporate matters, and frequently represents investment banking firms who are serving in a financial advisory role.

Full Biography

Steven Epstein, Partner, Corporate,

Steven Epstein is a partner in the Corporate Department, resident in the New York Office, and Co-Head of the Firm’s Mergers & Acquisitions practice.

Mr. Epstein has a diverse transactional practice which includes strategic mergers and acquisitions and private equity transactions. He has represented both public and private companies, investment banking firms and financial sponsors in connection with mergers, acquisitions, divestitures, takeover preparedness, and corporate governance matters. He also has significant experience in unsolicited M&A transactions, representing clients in both offensive and defensive situations.

Full Biography

Arthur Fleischer, Jr., Senior Counsel, Corporate,

Arthur Fleischer, Jr. is senior counsel, resident in the Firm’s New York office. He joined the Firm in 1958 and became partner in 1967.

Mr. Fleischer’s practice encompasses negotiated as well as contested transactions. He frequently advises special committees formed to review buyout proposals and corporate restructurings, and boards of directors on corporate governance.

Full Biography

Peter S. Golden, Partner, Corporate,

Peter S. Golden is a corporate partner resident in Fried Frank’s New York office. He joined the Firm in 1980 and became a partner in 1986.

Mr. Golden’s practice focuses primarily on mergers and acquisitions and corporate governance and counseling.

Full Biography

Philip Richter, Partner, Corporate,

Philip Richter is co-head of the Firm’s Mergers and Acquisitions Practice. He joined the Firm in 1994 and became a partner in 2002.

Mr. Richter represents clients in mergers and acquisitions transactions involving both public and private companies, minority investments, proxy fights and unsolicited proposals, and strategic partnerships and joint ventures.

Full Biography

David N. Shine, Partner, Corporate,

David N. Shine is co-head of the Firm’s Mergers and Acquisitions Practice. He joined the Firm as an associate in 1986 and became a partner in 1994.

Mr. Shine’s practice is focused on mergers and acquisitions, private equity investments, joint venture transactions and private equity fund formation. He has substantial experience in the aerospace and defense, energy, healthcare, telecom and financial services industries. Representative clients include Merck & Co., Inc.; Northrop Grumman Corporation; GE Capital; Medco Health Solutions, Inc.; and Vodafone Group Plc.

Full Biography

John E. Sorkin, Partner, Corporate,

John E. Sorkin is a corporate partner resident in Fried Frank’s New York office. He joined the Firm as partner in 2007.

Mr. Sorkin focuses his practice on domestic and cross-border merger and acquisition transactions and leveraged buyouts, as well as advisory work related to corporate governance.

Full Biography

Gail Weinstein, Senior Counsel, Corporate,

Gail Weinstein, as lead legal counsel on many of the seminal contested and negotiated transactions during the advent of M&A, has been at the forefront of market-shaping transactions for many of the world’s leading companies, private equity firms, and investment banks.

With over 25 years of M&A-related experience, Ms. Weinstein, who was a partner in the Corporate Department, has returned to the firm after having taken a leave from practicing law for several years. She is again counseling many of the world’s leading companies, private equity firms, and investment banks on their most critical challenges in corporate strategy, defense preparedness, shareholder activism and corporate governance.

Full Biography

Fried, Frank, Harris, Shriver & Jacobson LLP (

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Material in this work is for general educational purposes only, and should not be construed as legal advice or legal opinion on any specific facts or circumstances, and reflects personal views of the authors and not necessarily those of their firm or any of its clients. For legal advice, please consult your personal lawyer or other appropriate professional. Reproduced with permission from Fried, Frank, Harris, Shriver & Jacobson LLP. This work reflects the law at the time of writing.

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