Youlu Zheng v. Icahn, Index No. 650499/10, 10/28/2016 (Ramos, J.)

Shareholder Derivative Action; Cash Out Merger; Entire Fairness Doctrine; Derivative Action; Special Committees; Unjust Enrichment; Fair Price; Fiduciary Duty  

By: Mia Piccininni | Staff Member

Defendant is a Delaware corporation that provided wireless telecommunication services.  Plaintiffs are common stock shareholders of XO.  In 2003, XO began emerging from chapter 11 bankruptcy. Five years later, XO began to earn taxable income. Such income was insufficient to repay XO’s debt, address cash flow concerns, and grow as a company. As a result of XO’s poor financial condition, XO’s Board of Directors established a special committee (“2008 Special Committee”) consisting of “well-qualified” individuals who hired independent legal and financial advisors. The 2008 Special Committee met with the advisors on several occasions to determine the best strategy to address XO’s cash flow and debt concerns. Eventually, XO made a deal with Defendant Icahn, a controlling shareholder. The 2008 Special Committee met with its advisors to assess Icahn’s debt restructuring offer. After vigorous negotiations and deliberations spanning several months, XO approved a full refinancing package (“2008 Recapitalization”). The 2008 Special Committee successfully approved of Icahn’s proposed terms Icahn proposed and maintained that the consideration paid to XO was fair.

In 2011, XO formed another special committee (“2011 Special Committee”) to negotiate the terms of a possible cash-out merger with Icahn’s affiliate, ACF. After negotiations, the 2011 Special Committee increased the offer price, doubling the market price of XO’s stock. The 2011 Special Committee subsequently approved of the merger with Icahn.

As a result of the 2008 Recapitalization and 2011 Merger, XO Shareholders commenced a shareholder derivative action alleging: (1) XO, ACF, and Icahn breached their fiduciary duties by agreeing to the 2008 Recapitalization because it diluted value of the shareholders’ interests; (2) the consideration for the 2011 Merger was grossly inadequate and the 2011 Special Committee undervalued XO’s stock price while negotiating the merger price; (3) Icahn was unjustly enriched because he earned “hundreds of millions of dollars” when he obtained all of XO’s net operating losses as a result of the 2008 Recapitalization and 2011 Merger. In opposition, XO, ACF, and Icahn argued that the evidence demonstrated the 2008 Recapitalization and 2011 Merger were fair to XO Shareholders both in the functioning of the special committees and in the cost of the transactions.  XO, ACF, and Icahn also contended that the transactions amounted to “entire fairness” under the law and that XO’s shareholders were not entitled to any benefits received by Icahn after acquiring XO’s net operating losses.

The Court dismissed XO shareholders’ claims in their entirety.  First, the Court held the 2008 Recapitalization and the 2011 Merger were entirely fair and that XO, ACF, and Icahn did not breach their fiduciary duty to its shareholders. Delaware law provides that “when a transaction involving self-dealing by a controlling shareholder is challenged, the applicable standard of judicial review is entire fairness.”  When the entire fairness doctrine applies, a defendant must show that the transaction was approved by a well-functioning committee of independent directors and that it “function[ed] in a manner indicating that the controlling shareholder did not dictate the terms of the transaction and that the committee exercised real bargaining power at an arms-length.”

Here, the 2008 Special Committee consisted of independent members, functioned well, “performed its duties with guidance from independent financial advisors and legal counsel,” and “acted as an effective proxy for arms-length bargaining” because it entered lengthy and contentious negotiations with Icahn in an informed manner.  Icahn did not dictate the terms of the transaction because the 2008 Special Committee improved on the terms Icahn proposed.  Using the standard of Entire Fairness, the Court ruled on the shareholders’ claim of a breach of fiduciary duty. Specifically, the Court held that XO, ACF, and Icahn did not breach their fiduciary duty because the 2008 Special Committee obtained a deal that was fair to the minority shareholders and that XO Shareholders suffered no harm from the 2008 Recapitalization’s dilution of shares.  Here, the price of XO’s common shares increased after the 2008 Recapitalization, therefore, “the market considered the transaction good for shareholders,” because the 2008 Recapitalization was fair and benefitted XO and its minority shareholders to the extent it eliminated XO’s debt and enabled XO to conserve millions of dollars in cash.

Second, the Court concluded the 2008 Recapitalization and 2011 Merger were fairly priced because XO received fair consideration.  In the context of shareholder derivative actions, a commercial transaction comports with fair price when the controlling shareholder does not dictate the terms of the transaction and when the committee exercised real bargaining power at an arms-length.  In addition to an independent and disinterested committee, the 2011 Special Committee engaged in “heated, arm-length negotiations” with ACF which resulted in an offer price that “was far above the valuation range provided by its independent financial advisor.”  Therefore, the Court deemed the 2011 Merger was entirely fair to XO and in the best interests of its minority shareholders.

Third, the Court found that XO’s shareholders failed to prove unjust enrichment.  To prove unjust enrichment, a party must prove that: other parties were enriched at the expense of the party XO; (2) that it is against equity and good conscience to permit the moving party to gain what is sought to be recovered.  Here, the net operating losses were of higher value to Icahn than to anyone else and Icahn did not benefit from any of XO’s net operating losses at Plaintiffs’ expense.  Thus, Icahn was not enriched.  As to the second element, the Court noted that it would “not be against equity and good conscience to allow Icahn to keep the tax benefits he acquired from the net operating losses.”

Therefore, the Court dismissed the complaints with prejudice.

Youlu Zheng v. Icahn, Index No. 650499/10, 10/28/2016 (Ramos, J.)

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