In November 2021, Hertz authorized a buyback of its stock. The effect of the buyback to was transform CK Amarillo from a 39% stockholder – who also had board seats – into a 56% stockholder.
Public stockholders of Hertz sued, alleging that the Hertz directors violated their fiduciary duties by transferring control of Hertz to CK Amarillo, without requiring that CK Amarillo pay a control premium.
One critical question was: Is this claim direct or derivative?
Normally, claims arising out of stock buybacks are derivative claims. And normally, when a stockholder continues to hold shares in the entity, and nothing has changed about those share characteristics, and the stockholder was not asked to vote on anything, claims arising out of corporate action are derivative. And just recently, the Delaware Supreme Court decided Brookfield Asset Management, Inc. v. Rosson, 261 A.3d 1251 (Del. 2021), where it held that if a company sells new shares to a controlling stockholder on the cheap, the claim is derivative, not direct – overruling Gentile v. Rossette, 906 A.2d 91 99 (Del. 2006), which held the claim is both.
But, as I argued in my paper, The Three Faces of Control, Brookfield also implied that claims would in fact be direct if the corporate action caused someone who wasn’t a controller to become one, or if the corporate action gave new control rights to someone who hadn’t had them before. I wrote:
This appears to have been a rather backhanded way of holding that, if an equity issuance did result in a shift from an uncontrolled status to a controlled one, shareholders would be permitted to bring claims for breach of fiduciary duty directly, rather than derivatively….
Additionally, the Brookfield court also seemed to have endorsed the notion that equity issuances might give rise to direct claims even if they did not result in the creation of a new controlling shareholder, so long as they ended up redistributing specific control rights away from the public shareholders
On June 20, in a bench ruling in Cascia v. Farmer, 2023-0520, Chancellor McCormick preliminarily agreed, holding that the plaintiffs could sue both directly and derivatively. She stated that she might revisit matters later in the case, but for the purposes of a motion to dismiss:
Brookfield appeared to leave open the possibility that a transfer of control might give rise to dual-natured claims. The Court expressly stated in Brookfield that Gentile was overruled only "[t]o the extent the corporation's issuance of equity does not result in a shift in control from a diversified group of public equity holders to a controlling interest."
The high court also noted, again, that there was no "practical need for the Gentile carve-out" in part because other legal theories "provide a basis for a direct claim for stockholders to address fiduciary duty violations in a change of control context." Here, plaintiff's case is about the harm resulting from a change of control….
Look, I recognize that this is a clarification of Brookfield that I don't know that our Court has given before. And at base, I'm unwilling to reach a definitive ruling on this factual and legal issue at the pleading stage. But you-all will have litigation ahead and many opportunities to convince me otherwise. At this stage, given the pleading-friendly standard we apply to plaintiffs, I'm denying the motion to dismiss the direct claims ….
So, obviously, I think this is the correct decision, but in the wake of SB 313, it’s more than that.
Suppose a board hands new control rights to someone via the use of a stockholder agreement. Under my interpretation of Brookfield, which Chancellor McCormick has now tentatively endorsed at least in part, challenges to that action may, at least on some occasions, be brought directly rather than derivatively. And it will be interesting to watch courts untangle when the rights are significant enough to be one or the other.