Controlling non-controlling shareholders: The case of effective control

Moran Ofir

doi:10.1515/til-2024-0009

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Controlling non-controlling shareholders: The case of effective control

Moran Ofir

Published/Copyright: July 10, 2024

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From the journal Theoretical Inquiries in Law Volume 25 Issue 1

Abstract

One of the most important developments underlying capital markets in recent years is the increase in the influence of activist minority shareholders. In a company without a controlling shareholder, dominant and activist shareholders, who hold only a low proportion of the company’s shares, can influence and even tip the scales in the decisions made and direct the company’s business. The legal system therefore imposes a fiduciary duty not only on controlling shareholders but also on those with effective control. Alongside the obligation, however, the absence of a clear and explicit definition of the concepts of effective power and effective control stands out.

The Article empirically analyzes key court decisions litigated under Delaware law and finds that only two explanatory variables significantly explain court decisions in cases where the question of effective control arises. It therefore proposes a test for estimating shareholders’ effective power borrowed from the field of cooperative game theory. The test is based on the Shapley Value and Shapley and Shubik’s Power Index. The Article presents its application to decisions made at shareholders’ meetings to estimate the effective power of activist minority shareholders in various decisions. This test is simple to operate, objectively examines the situation based on the factual system that existed at the time the decision was made, and is not limited to specific ownership structures, particular markets, or current times. Adoption of the test is expected to increase the legal certainty regarding the imposition of duties on activist minority shareholders with effective control, thereby reducing the agency costs created as a result of the gap between their formal share in the corporation and their effective power.

^* I would like to thank Michal Agmon-Gonen, Lucian Bebchuk, Danielle Chaim, Steven Davidoff Solomon, Kobi Kastiel, David Kershaw, Beni Lauterbach, Yaron Nili, Ed Rock, Edmund Shuster, Dov Solomon and the participants of the Controlling Shareholders and Control-Enhancing Mechanisms Conference at Tel Aviv University, LSE Law School Faculty Workshop, International Meeting in Law and Economics (IMLE), University of Paris Nanterre, and Bar-Ilan University Law and Economics Workshop for their useful comments and suggestions, Carmel Cohen for excellent research assistance, and the TIL editorial board members for their valuable contribution.

Appendix 1: List of Delaware Courts’ Key Decisions

Puma v. Marriott, 283 A.2d 693 (Del. Ch. 1971).
In re Sea-Land Corp. S’holders Litig., 1988 WL 49126 (Del. Ch. May 13, 1988).
Citron v. Steego Corp., 1988 WL 94738 (Del. Ch. Sept. 9, 1988).
Siegman v. Tri-Star Pictures, Inc., 1989 WL 48746 (Del. Ch. May 5, 1989).
In re Shoe-Town, Inc. S’holders Litig., 1990 WL 13475 (Del. Ch. Feb. 12, 1990).
In re Tri-Star Pictures, Inc., Litig., 634 A.2d 319 (Del. 1993).
Kahn v. Lynch Commc’n Sys., Inc., 638 A.2d 1110 (Del. 1994).
In re Wheelabrator Techs., Inc. S’holders Litig., 663 A.2d 1194 (Del. Ch. 1995).
Emerson Radio Corp. v. Int’l Jensen Inc., 1996 WL 483086 (Del. Ch. Aug. 20, 1996).
Harbor Fin. Partners v. Sugarman, 1997 WL 162175 (Del. Ch. Apr. 3, 1997).
Odyssey Partners, L.P. v. Fleming Companies, Inc., 735 A.2d 386 (Del. Ch. 1999).
O’Reilly v. Transworld Healthcare, Inc., 745 A.2d 902 (Del. Ch. 1999).
In re W. Nat. Corp. S’holders Litig., 2000 WL 710192 (Del. Ch. May 22, 2000).
In re Cysive, Inc. S’holders Litig., 836 A.2d 531 (Del. Ch. 2003).
Zimmerman v. Braddock, 2005 WL 2266566 (Del. Ch. Sept. 8, 2005), rev’d on other grounds, 906 A.2d 776 (Del. 2006).
Williamson v. Cox Commc’ns, Inc., 2006 WL 1586375 (Del. Ch. June 5, 2006).
Superior Vision Servs., Inc. v. ReliaStar Life Ins. Co., 2006 WL 2521426 (Del. Ch. Aug. 25, 2006).
In re Loral Space & Commc’ns Inc., 2008 WL 4293781 (Del. Ch. Sept. 19, 2008).
Hokanson v. Petty, 2008 WL 5169633 (Del. Ch. Dec. 10, 2008).
In re Morton’s Rest. Grp., Inc. S’holders Litig., 74 A.3d 656, 658 (Del. Ch. 2013).
In re Primedia, Inc. S’hlders Litig., 67 A.3d 455, 477 (Del. Ch. 2013).
Hamilton Partners, L.P. v. Highland Cap. Mgmt., L.P., 2014 WL 1813340 (Del. Ch. May 7, 2014).
In re Crimson Expl. Inc.Stockholder Litig., 2014 WL 5449419 (Del. Ch. Oct. 24, 2014).
In re KKR Fin. Holdings LLC S’holder Litig., 101 A.3d 980 (Del. Ch. 2014), aff’d sub nom., Corwin v. KKR Fin. Holdings LLC, 125 A.3d 304 (Del. 2015).
In re Sanchez Energy Derivative Litig., 2014 WL 6673895 (Del. Ch. Nov. 25, 2014), rev’d sub nom. on other grounds, Delaware Cty. Emps. Ret. Fund v. Sanchez, 124 A.3d 1017 (Del. 2015).
In re Zhongpin Inc.Stockholders Litig., 2014 WL 6735457 (Del. Ch. Nov. 26, 2014), rev’d sub nom. on other grounds, In re Cornerstone Therapeutics Inc, S’holder Litig., 115 A.3d 1173 (Del. 2015).
Larkin v. Shah, 2016 WL 4485447 (Del. Ch. Aug. 25, 2016).
In re Rouse Properties, Inc., 2018 WL 1226015 (Del. Ch. Mar. 9, 2018).
In re Tesla Motors, Inc. S’holder Litig., 2018 WL 1560293 (Del. Ch. Mar. 28, 2018).
Basho Techs. Holdco B, LLC v. Georgetown Basho Invs., LLC, 2018 WL 3326693 (Del. Ch. July 6, 2018), aff’d sub nom., Davenport v. Basho Techs. Holdco B, LLC, 221 A.3d 100 (Del. 2019).
Arkansas Tchr. Ret. Sys. v. Alon USA Energy, Inc., 2019 WL 2714331 (Del. Ch. June 28, 2019).
FrontFour Cap. Grp. LLC v. Taube, 2019 WL 1313408 (Del. Ch. Mar. 11, 2019).
Klein v. Wasserman, 2019 WL 2296027 (Del. Ch. May 29, 2019).
Reith v. Lichtenstein, 2019 WL 2714065 (Del. Ch. June 28, 2019).
Genuine Parts Co. v. Essendant Inc., 2019 WL 4257160 (Del. Ch. Sept. 9, 2019).
Voigt v. Metcalf, 2020 WL 614999 (Del. Ch. Feb. 10, 2020).
Skye Min. Invs., LLC v. DXS Cap. (U.S.) Ltd., 2020 WL 881544 (Del. Ch. Feb. 24, 2020).
In re Pattern Energy Grp. Inc. S’holders Litig., 2021 WL 1812674 (Del. Ch. May 6, 2021).
In re GGP, Inc. S’holder Litig., 2021 WL 2102326 (Del. Ch. May 25, 2021).

Appendix 2: Table of Key Decisions Under Delaware Law (source: Troutman Pepper)

Case Name	Own %	Board Control	Committee Control	Contractual Rights	Other Commercial Leverage	Other Indicia/Factors	Y/N
KKR	~1%	4/12 (2/12 were insiders of effective controller; another 2/12 conceivably lacked independence from controller).	N/A	N/A	N/A	Effective controller was the founder of the company. Company was “completely reliant” upon affiliate of effective controller. All the company’s officers were employees of the effective controller at the time. Affiliate of effective controller managed day-to-day business pursuant to a Management Agreement.	No
Tri-Star I	9%	3/10 of board lacked independence.	N/A	N/A	N/A	Effective controller purportedly participated in negotiation on behalf of the seller in the transaction.	No
Shoe-Town	10%	0/10.	N/A	N/A	N/A	None	No
Pattern	~1O%	2/7 of board.	0/4 of special committee.	Effective controllers threatened using consent right to channel company toward particular bidder. This affected the special committees decision-making process in connection with the sale. “With these two sources of soft power, [the effective controllers] pervaded the Company’s C-suite, boardroom, and supply chain."	Company controlled by effective controllers was an “essential part of the Company’s upstream supply chain."	Effective controllers had a long history with the company’s high-ranking officers, which gave the effective controllers “the ability to exercise outsized influence in the board room or on committees."	Yes
Essendant	~12%	0/8 of board.	N/A	N/A	N/A	Board allegedly caved to the will of effective controller. Two stockholders with slightly larger holdings.	No
Front Four Capital	15%	5/7 (2 of 7 were effective controllers; i of 7 was close friend of controllers; 2 of 7 demonstrated a lack of independence from effective controllers).	2/4 of special committee tasked with evaluating challenged mergers lacked independence from effective controllers.	N/A	N/A	Effective controllers were founders, directors, and officers of company. Effective controllers owned the majority of the registered investment advisor firms that managed the day-to-day operations of the company. Effective controllers were to be directors and/or high-ranking officers of the combined company after the merger. Effective controllers were directors, and/or high-ranking officers of each of the company’s transaction counterparties in the challenged mergers.	Yes
Petty	17%	1/5 of board were appointed by and beholden to effective controller.	N/A	N/A	N/A	Largest single stockholder of the company. Directors were afforded role in the post-merger company.	No
Cox	17.1%	2/5 of board were appointed by and lacked independence from effective controllers.	N/A	Charter provisions gave the effective controllers veto power over all decisions of the board of directors.	N/A	The effective controllers were the company’s only significant customers and the company depended on their cooperation as customers if it was going to operate profitably. One larger stockholder. Larger stockholder appointed 3 of 5 board members.	Yes
Wasserman	20%	1/3 of board.	N/A	N/A	N/A	One larger stockholder. Larger stockholder appointed 2 of 3 board members.	No
Sanchez	21.5%	2/5 of board were members of effective control group.	N/A	N/A	N/A	Both members of the effective control group were part of the founding family. One of the effective members of the control group was the CEO. One director was long-time friends with a member of the control group (not beholden). One director was effective to have had existing business relationships with members of control group (not beholden).	No
Wheelabrator	22%	4/11 of board were beholden to effective controller.	N/A	N/A	N/A	No other indicia of control.	No
Tesla	22.1%	5/7 of board members lacked independence from controller. 3/5 of board members that voted on the transaction lacked independence from controller.	N/A	N/A	N/A	Effective controller was the company’s visionary, CEO, founder, Chairman, and largest stockholder. Public filings disclosed effective controllers’ outsized influence on the Company and in the boardroom. Effective controller responsible for engaging advisors.	Yes
Larkin	23.1%	3/9 of board were controlled by effective controllers.	N/A	N/A	N/A	2 other members of the board did not lack independence but were granted tax reimbursements by a committee that included directors who lacked independence from the effective controllers. 2 other members of the board did not lack independence but were alleged to have been “handpicked by [the] conflicted directors” and given generous stock options.	No
Zhongpin	26%	2/5 of board were effective controller or beholden to effective controller.	N/A	N/A	N/A	The effective controller was founder, CEO, director, and largest stockholder of company. Company “substantially” relied upon effective controller to manage operations. Losing effective controller would constitute a material adverse effect. Notably, an effective controller used significant leverage to force the company to accept his proposal. He would not cooperate with any third-party bidder and caused the special committee to reject a superior third party offer because he refused to remain CEO or roll over his shares if third party bid was accepted. Initial financial advisor refused to render fairness opinion and terminated its engagement.	Yes
Jensen	26%	1/5 of board was general partner of effective controller.	N/A	N/A	N/A	There was one larger stockholder than effective controller.	No
Mortons	27.7%	2/10 of board were insiders of effective controller.	N/A	N/A	N/A	Effective controller owned 100% of the company before it went public. Effective controller was alleged to be involved in the sale process, including the retention of the company’s financial advisor.	No
Skye Mineral Partners	28.07%	1/3 of board was an insider of effective controller.	N/A	Effective controller allegedly weaponized contractual blocking rights to starve the company of capital, drive it into bankruptcy, and take control of the company through a bankruptcy sale at a discount.	N/A	Company is financially distressed. Additional observer rights.	Yes
Rouse	33-5%	3/10 of board members were beholden to effective controller. 2/10 of the board—had ties to effective controller, but not enough to lack independence.	2/5 of special committee charged with considering the merger.	N/A	N/A	Effective controller proposed the challenged transaction. The Special Committee was comprised of members who were placed on the board by an affiliate of the effective controller. Company disclosed in its Form 10–K that the effective controller was a “substantial stockholder” that “may exert influence over” the company.	No
Crimson	33·7%	3/7 of board were insiders of effective controller.	N/A	N/A	Affiliate of effective controller was a significant creditor.	One other director, who was also the company’s CEO, had a prior business relationship with effective controller, but did not lack independence. Remaining directors were elected to the board after the effective controller invested, but did not lack independence. CFO was alleged to be handpicked by effective controller. Other executive officers joined after effective controller invested. Effective controller neither proposed transactions nor led board discussions of transaction.	No
Voigt	35%	8/12 (4 of 12 were insiders of effective controller; another 4 of 12 conceivably lacked independence from effective controller).	N/A	The effective controller had contractual veto rights over actions that boards of directors could normally take unilaterally. Effective controller had contractual right to representation on key board committees proportionate to ownership percentage.	N/A	The effective controller had relationships with banker and law firm hired by special committee to evaluate deal.	Yes
Cysive	35%	2/5 (i was effective controller; i was beholden to effective controller). 1 other affiliated with effective controller (not beholden).	N/A	N/A	Options to purchase another 0.5% to 1% of additional company stock.	Financially distressed company. The controller was the Chairman, director, CEO, largest stockholder, and founder. The controller was company’s “inspirational force.” The CFO was beholden to the controller. The company employed two of the controller s family members. Management buy-out transaction was proposed by controller, after sale process failed. The special committee negotiated more favorable terms and conducted pre- and post-signing market checks. The Controller did not have any relationship with special committee financial advisor but did confer with financial advisor during sale process and directly reached out to potential bidders.	Yes
GGP	35-3%	3/9 of board.	1/3 of nominating and governance committee. 0/5 of special committee negotiating the transaction.	The Standstill agreement prevented effective controller from acquiring more than 45% ownership. Effective controller had the right to nominate three members to the company’s board. Contractual provisions in investment agreement required: company to have majority of independent directors under the NYSE Rules; a majority of the Nominating and Governance Committee to be “disinterested directors” unaffiliated with the effective controller; for the election of directors other than the effective controller nominees, the effective controller must vote any shares it held in excess of 10% of company outstanding stock in proportion to the votes cast by stockholders unaffiliated with effective controller; transactions under which the effective controller would receive disparate consideration needed to be approved by a majority of the disinterested directors and stockholders unaffiliated with the effective controller.	N/A	The transaction was between company and effective controller. Conditioned upon majority of unaffiliated stockholder vote. A special committee was formed to negotiate the transaction. Stockholder vote was sufficient to approve the transaction even without counting effective controller’s vote. No concern with low voter turnout. Seven of nine board members were originally nominated or recruited by effective controller. Not beholden. Directors associated with effective controller did not participate in the special committee’s decisionmaking process. Effective controller co-authored, co-filed, and co-signed the Proxy statement soliciting approval of the transaction. Deemed not to be an important factor. Effective controller issued press releases on company’s behalf in connection with transaction. Deemed not to be an important factor. SEC filings noted the effective controller’s influence.	No
Lichtenstein	35-6%	3/6 of the board leading up to transaction were affiliated with and beholden to the effective controller; 2 of 5 lacked independence at the time the transaction was approved. Note: after the transaction was in motion, but before transaction was approved and closed, one director that lacked independence passed away.	N/A	N/A	N/A	Effective controller strongly influenced management. An executive of the effective controller served as interim CEO of the company and was replaced by an individual with significant connections to effective controller. CFO was long-standing executive of effective controller s affiliate. One of the effective controller s affiliates provided the company services through a Management Services Agreement. Officers of the effective controller acted as Me facto investment bankers” for the Company during period leading up to the challenged transaction.	Yes
Loral Space	35-9%	5/8 of board beholden to controller, including chairman.	1/2 of special committee beholden to controller.	Contractual rights to block strategic initiatives.	Controller was a significant creditor, with unilateral ability to force redemption of notes.	Financially distressed company. Effective controller publicly maintained that it controlled the board. Company roKs identified effective controller as the controlling stockholder. CEO beholden to controller.	Yes
Tri-Star II	36.8%	8/10 (3 of 10 were insiders of effective controller; another 2 of 10 were insiders of company with significant financial ties to effective controller; another 3 of 10 were significant stockholders of controllers, 2 of which were appointed by controller).	N/A	N/A	N/A	Effective controller had stockholder agreement with other large stockholders, which together owned 56.6% of the company. Effective controller had stockholder agreement with a 9% stockholder, under which each party agreed to nominate 4 members to the company’s board (for a total of 8 directors) and vote for each other’s nominees.	Yes
Sea-Land	39-5%	None	N/A	N/A	N/A	Other shares were widely held. Effective controller blocked third-party merger bid until third party agreed to pay effective controller a premium. The board rejected the effective controller s bid, which was $2 per share less than third party bidders. In response to effective controller s bid, the board contacted other potential acquirers.	No
Basho	-40%	2/7 of board lacked independence from effective controller.	N/A	Controller used contractual blocking rights to cut off company’s access to other sources of funding such that the company had no option other than to accept the controller s unfair financing proposal.	The controller was a significant creditor. Failed to comply with financing obligations to starve company of funding.	The company was financially distressed. Controller s board appointees interfered with the financing process. The effective controller controlled management by subverting them, threatening them, or getting rid of them. The controller used its relationship with the financial advisor to control the company.	Yes
Primedia	40.34%	Majority of board lacked independence from the effective controller.	N/A	N/A	N/A	Public disclosures stated that effective controller was the “influential force” behind the challenged transactions.	Yes
Lynch	43-3%	5/11 of board were designated by and beholden to controller.	2/3 of the executive committee were beholden. 2/9 of compensation committee were beholden.	The controller had contractual rights to block any business combination. The controller blocked deals with third party and funneled the company to deal with an affiliate of the controller. When that was rejected, the controller pursued a cash-out merger of the majority.	N/A	The factual record was replete with instances of the controller making it known to the board and then prevailing in its wishes. The controller ultimately threatened to proceed with a less favorable tender offer if special committee did not accept the controller s cash-out merger offer.	Yes
Superior Vision	44%	2/5 of board arguably lacked independence from effective controller.	N/A	Effective controller exercised contractual right to block dividend. Effective controller had the right to appoint 2 members of 5-person board.	N/A	N/A	No
Marriott	46%	4/9 of board were members of effective control group.	N/A	N/A	N/A	Effective controllers were the founders of the company. Effective controllers owned 100% of the company before it went public.	No
Highlan	48%	1/5 of board allegedly beholden to effective controller.	N/A	Effective controller exercised its contractual rights as a debtholder to prevent the company from refinancing its defaulted debt or considering other third-party acquisitions in order to force the company to agree to a transaction with it at a price that was below the stocks trading price.	Owned 82% of the company’s debt, which was in default.	Company was financially distressed. Effective controller was an affiliate of one of the company’s other stockholders.	Yes
Priceline	48%	6/11 (3 of 11 were members of control group; another 3 of n conceivably lacked independence from control group).	N/A	N/A	N/A	The largest member of control group (32% owner) was founder and former CEO. Another member of control group was chairman of company’s board at the time of the transaction.	Yes
Alon USA Energy	48%	6/11 (5 of 11 members were executives of the effective controller; 1 of 11 was beholden due to financial ties).	N/A	The effective controller failed to comply with contractual provisions that prevented it from acquiring more than 49.99% of the company’s equity or entering into any material contract with the company unless the effective controller first obtained approval from an independent committee of directors.	N/A	The company was financially distressed. Effective controller was on record that it wanted to obtain 100% ownership and proposed the challenged transaction. Effective controller exercised its influence to remove and replace two directors of the board in order to work the same change upon the composition of the special committee charged with considering the transaction. Committee allowed member that was beholden to effective controller to lead negotiations on behalf of the committee/minority. Allegations suggest that the effective controller dictated the timing, structure, and price of the merger. Effective controller effectively muzzled the special committees public statements to reduce share price for the benefit of the effective controller.	Yes
Steego	48.8%	2/9 of board lacked independence from effective controller.	N/A	N/A	N/A	The effective controller consulted with the board on various business matters. Board was agreeable to IEP designating two members of the board after consummation of share offer.	No
Transworld	49%	0/4	N/A	Effective controller had option to acquire an additional 2% of company stock.	Effective controller held substantially all company debt.	The company was financially distressed. Effective controller allegedly blocked alternative asset sale with third party in favor of its proposed cash-out merger. After cash-out merger closed, effective controller caused company to enter into the third-party asset sale that it previously blocked.	Yes

Published Online: 2024-07-10

Published in Print: 2024-06-25

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https://doi.org/10.1515/til-2024-0009