The Dilemma that Should Never Have Been: Minority Freeze Outs in Delaware

Abstract

Traditionally, controlling shareholders of Delaware corporations seeking 100% ownership have compelled minority shareholders to sell their shares through transactions negotiated with, and approved in advance by, the controlled corporation's board of directors. Generally taking the form of long-form mergers under Del. G.C.L. Section 251, reverse stock splits under Del. G.C.L. Section 242, or tender offers coupled with pre-approved mergers under Del. G.C.L. Section 251, these pre-approved transactions have long been reviewed by the Delaware courts under the exacting standard of Weinberger v. UOP. Since 2001, however, a type of freeze-out transaction has become increasingly popular. This type of freeze out takes the form of a tender offer, conditioned on the minority's tender of enough shares to give the controlling shareholder 90% ownership, followed by a short-form merger under Del. G.C.L. Section 253. Unlike traditional freeze-out transactions, these freeze-outs can be effected without any formal action by the controlled subsidiary's board of directors. In a now well-known trilogy of cases - Siliconix, Aquila and Pure Resources - the Delaware Chancery Court has established, as practically beyond question, the principle that Weinberger's entire fairness obligation does not apply to the tender offer/short-form mergers. As a result, courts and commentators have focused on the policy dilemma of applying less demanding fiduciary duty standards to tender offer/short-form mergers than to traditional freeze-outs. This paper contends that this policy dilemma is a false one, arising largely from a misreading of the key precedent on which Siliconix, Aquila and Pure Resources are based: Solomon v. Pathe Communications Corp. Properly understood, Solomon rejects any duty of controlling shareholders to offer minority shareholders a fair price for their shares in a truly voluntary tender offer, but says nothing about the duty of controlling shareholders to establish entire fairness under Weinberger, particularly in voluntary tender offers that (unlike the tender offer in Solomon) constitute the first step in a freeze-out transaction. Therefore, the paper concludes, the Delaware Chancery Court should feel free to apply a unified entire fairness test to both types of freeze-outs, if it determines that the new freeze-outs pose the very same risks to minority shareholders as the old.