We have been debating on this Blog (here,
here
and here)
the concept of “control” in a company in the light of the Securities and
Exchange Board of India’s (SEBI’s) consultation
process that is currently underway. In this context, it would be useful to
consider developments from elsewhere that may be instructive. This post
considers a recent decision of the Delaware Chancery Court that called into
question the concept of “control”, and provided some indication of what would
amount to control of a company.
here
and here)
the concept of “control” in a company in the light of the Securities and
Exchange Board of India’s (SEBI’s) consultation
process that is currently underway. In this context, it would be useful to
consider developments from elsewhere that may be instructive. This post
considers a recent decision of the Delaware Chancery Court that called into
question the concept of “control”, and provided some indication of what would
amount to control of a company.
In Calesa
Associates L.P. v. American Capital Ltd,[1] American
Capital was a shareholder holding 26% shares of Halt Medical Inc. (the
Company). Through a series of contractual arrangements between American Capital
and the Company, American Capital sought to increase its shareholding in the
company that would not only have made it a majority shareholder of the company,
but it would have also substantially diluted the other shareholders. In this background,
the plaintiff Calesa Associates (one of the Company’s shareholders) initiated
an action against American Capital, the Company and its directors. The
plaintiffs alleged that by virtue of its actions, American Capital breached its
fiduciary duties as a controlling shareholder that it owed to the minority
shareholders of the Company.[2] Relevant
to our analysis was the question whether American Capital was indeed the
controlling shareholder of the Company in that it exercised “control” over it.
Associates L.P. v. American Capital Ltd,[1] American
Capital was a shareholder holding 26% shares of Halt Medical Inc. (the
Company). Through a series of contractual arrangements between American Capital
and the Company, American Capital sought to increase its shareholding in the
company that would not only have made it a majority shareholder of the company,
but it would have also substantially diluted the other shareholders. In this background,
the plaintiff Calesa Associates (one of the Company’s shareholders) initiated
an action against American Capital, the Company and its directors. The
plaintiffs alleged that by virtue of its actions, American Capital breached its
fiduciary duties as a controlling shareholder that it owed to the minority
shareholders of the Company.[2] Relevant
to our analysis was the question whether American Capital was indeed the
controlling shareholder of the Company in that it exercised “control” over it.
Based on previous Delaware case law, the Court
stated that a “stockholder is controlling, and owes fiduciary duties to the
other stockholders, “if it owns a majority interest in or exercises control over the business affairs of the corporation””.
Hence, control could be achieved either through majority interest or by virtue
of the shareholder’s exercise of control over the business affairs of the
company. It is the second aspect which was of concern here. Since American
Capital had only 26% shares, the Court found that it must be shown to have
exercised “actual control” over the Company at the time of the relevant
transactions.
stated that a “stockholder is controlling, and owes fiduciary duties to the
other stockholders, “if it owns a majority interest in or exercises control over the business affairs of the corporation””.
Hence, control could be achieved either through majority interest or by virtue
of the shareholder’s exercise of control over the business affairs of the
company. It is the second aspect which was of concern here. Since American
Capital had only 26% shares, the Court found that it must be shown to have
exercised “actual control” over the Company at the time of the relevant
transactions.
At the outset, the fact that American Capital had
entered into contractual arrangements with the Company (that enabled it to
exercise contractual rights over the Company) was found to be insufficient to
constitute “control”. On the other hand, the Court embarked upon an analysis of
whether American Capital exercised influence over at least a majority of the
board of directors of the Company. Such control or influence over the board is
a factual determination to be arrived at specifically in each case. The Court
found that merely because a director was appointed by a shareholder was
insufficient to indicate the control or influence of the shareholder over such
a director. The Court instead embarked upon a fact-specific analysis of whether
at least four out of the seven directors of the Company were beholden to, or
influenced, by American Capital. After going through the background and various
relationships of these four directors with American Capital, the Court found
that there were sufficient facts to support an inference that a majority of the
board was not disinterested or lacked independence from American Capital.
entered into contractual arrangements with the Company (that enabled it to
exercise contractual rights over the Company) was found to be insufficient to
constitute “control”. On the other hand, the Court embarked upon an analysis of
whether American Capital exercised influence over at least a majority of the
board of directors of the Company. Such control or influence over the board is
a factual determination to be arrived at specifically in each case. The Court
found that merely because a director was appointed by a shareholder was
insufficient to indicate the control or influence of the shareholder over such
a director. The Court instead embarked upon a fact-specific analysis of whether
at least four out of the seven directors of the Company were beholden to, or
influenced, by American Capital. After going through the background and various
relationships of these four directors with American Capital, the Court found
that there were sufficient facts to support an inference that a majority of the
board was not disinterested or lacked independence from American Capital.
Although the case is under Delaware law, which bears
significant differences with Indian corporate law on the question of fiduciary duties
of controlling shareholders, it does provide some guidance on the issue of “control”
that SEBI is currently grappling with. As this case indicates, “control” often
tends to be a factual question to be determined with reference to the specific
circumstances in each case. That is consistent with the current definition of control
under the SEBI (Substantial Acquisition of Shares and Takeovers) Regulations,
2011. However, it is due to the lack of certainty under that dispensation that
SEBI is looking at reform process to introduce a bright-line test. The continued
use of a qualitative and subjective understanding of control may function well
in jurisdictions like Delaware where courts play an important role in
developing the law through principles, but whether it would be suitable in a
jurisdiction like India which may call for more objective standards is a
different question. But, at least the case suggests that any criteria for
control cannot ignore such subjective factors, although reliance upon those can
be limited to specific circumstances and not as a general matter.
significant differences with Indian corporate law on the question of fiduciary duties
of controlling shareholders, it does provide some guidance on the issue of “control”
that SEBI is currently grappling with. As this case indicates, “control” often
tends to be a factual question to be determined with reference to the specific
circumstances in each case. That is consistent with the current definition of control
under the SEBI (Substantial Acquisition of Shares and Takeovers) Regulations,
2011. However, it is due to the lack of certainty under that dispensation that
SEBI is looking at reform process to introduce a bright-line test. The continued
use of a qualitative and subjective understanding of control may function well
in jurisdictions like Delaware where courts play an important role in
developing the law through principles, but whether it would be suitable in a
jurisdiction like India which may call for more objective standards is a
different question. But, at least the case suggests that any criteria for
control cannot ignore such subjective factors, although reliance upon those can
be limited to specific circumstances and not as a general matter.
[1] An analysis of this decision is available on the Harvard Law School
Forum on Corporate Governance and Financial Regulation at http://courts.delaware.gov/opinions/download.aspx?ID=237570.
Forum on Corporate Governance and Financial Regulation at http://courts.delaware.gov/opinions/download.aspx?ID=237570.
[2] Note that Delaware law in that sense is dissimilar to corporate law
in India where controlling shareholders do not owe fiduciary duties either to
the company or to the minority shareholders. But that distinction is not
germane to the discussion of how “control” ought to be determined.
in India where controlling shareholders do not owe fiduciary duties either to
the company or to the minority shareholders. But that distinction is not
germane to the discussion of how “control” ought to be determined.