This is the fourth in a series of posts discussing certain issues and lessons for practitioners arising out of the recently settled dispute between CBS and its controlling stockholder.[1]  Relevant background can be found here and additional posts in this series can be found here.

In the first week of the CBS-NAI litigation, the Court of Chancery denied CBS’s request for a temporary restraining order (“TRO”), which would have prevented NAI from exercising its rights as a controlling stockholder to protect its voting control before the CBS board could meet and vote on a proposed stock dividend to dilute such voting control.[2]  In so ruling, the Court of Chancery resolved an “apparent tension” in the law between, on the one hand, past decisions suggesting the possibility that a board might be justified in diluting a controlling stockholder in extraordinary circumstances (arguably implying that, in such circumstances, the board should be permitted to act without interference by the controlling stockholder) and, on the other hand, cases recognizing the right of a controlling stockholder to have the opportunity to take action to avoid being disenfranchised.  The court found the well-established right of a controlling stockholder to take measures to protect its voting control “weigh[ed] heavily” against granting a TRO that would restrain it from doing so, and that “truly extraordinary circumstances” would therefore be required to support such a TRO.  At the same time, the court noted that it had the power to review and, if necessary, “set aside” any such action taken by the controlling stockholder after the fact (itself another reason why a TRO in these circumstances was not warranted).

We described the background of this dispute in a prior post.  As relevant here, on May 14, 2018, a special committee of the CBS board called a special meeting of the full CBS board (to take place on May 17) to consider and vote on a stock dividend intended to dilute NAI’s voting control.  The special committee and CBS simultaneously filed a lawsuit against NAI in the Delaware Court of Chancery seeking approval of such dividend, alleging that the dividend was necessary to prevent NAI from breaching its fiduciary duties as a controlling stockholder (which they claimed included threatened removal of directors to force an allegedly unfair merger with Viacom, which is also controlled by NAI).  CBS also immediately moved for a TRO preventing NAI from taking action to protect its controlling stake, whether by removing directors or amending the corporation’s bylaws or otherwise, until the board had a chance to approve the proposed dividend at the special meeting.

NAI had no prior notice that the special committee was considering such a drastic, unprecedented step.  After expedited briefing and a hearing on CBS’s TRO motion, the court issued its decision denying CBS’s request for a TRO on May 17, just hours before the special meeting took place.  Prior to a hearing on the TRO motion on May 16, however, NAI had already exercised its right to amend the company’s bylaws by written consent to require, among other things, that any dividend be approved by at least 90% of the CBS directors.  Since three of the fourteen CBS directors were affiliated with NAI, these bylaw amendments likely would preclude the declaration of the dilutive dividend, if such amendments were valid and effective.

Chancellor Bouchard’s decision to deny the TRO rested on two related grounds:  first, a controlling stockholder’s well-established right to avoid disenfranchisement weighed heavily against granting the TRO and, second, CBS failed to show it would suffer irreparable injury in the absence of a TRO.

On the first issue, the court observed that there was “an apparent tension in our law between a controlling stockholder’s right to protect its control position and the right of independent directors . . . to respond to a threat posed by a controller, including possible dilution of the controller.”[3]  On the one hand, the court acknowledged precedent suggesting “the possibility that a situation might arise in which a board could, consistently with its fiduciary duties, issue a dilutive option in order to protect the corporation or its minority shareholders from exploitation by a controlling shareholder who was in the process of threatening to violate his fiduciary duties to the corporation.”[4]  The court noted that “[i]t could be argued that, implicit in this reasoning, it would be reasonable in an appropriate circumstance to afford a board ‘breathing space’ to deliberate over such options free from the preemptive power of a controller by affording temporary relief of the type plaintiffs seek here.”[5]  Otherwise, the court asked, “how would a board be able to take such action as a practical matter[?]”[6]

On the other hand, the court observed that Delaware courts have long “recognize[d] a controller’s right to address threats to its control preemptively.”[7]  For example, the Delaware Supreme Court has held that a controlling stockholder’s preemptive enactment of amendments to the bylaws was “a permissible part of [the controlling stockholder’s] attempt to avoid its disenfranchisement as a majority shareholder.”[8]  And in Adlerstein v. Wertheimer, the Court of Chancery held the board acted inequitably by keeping the controlling stockholder “in the dark” about a plan to dilute his voting control because the controller had the power to prevent such dilution by unseating directors and “was fully entitled to the opportunity” to exercise such power if he chose to do so.[9]

Despite identifying this “tension” in the law, the court acknowledged that there was no precedent in which the court had “ever entertained, much less sanctioned, the type of request for relief that plaintiffs make here,” i.e., a request for preliminary injunctive relief preventing a controlling stockholder from exercising its rights to protect its voting control from dilution for all purposes and all time.[10] “In and of itself,” the court noted, “this suggests that a truly extraordinary set of circumstances would be necessary to grant such a request.”[11]  By contrast, “a controller’s right to make the first move preemptively to protect its control interest” had been clearly recognized in Delaware jurisprudence, including Adlerstein, which the court found “weigh[ed] heavily” against granting the TRO under these circumstances.[12]

The second reason the court decided against granting the TRO was that any action taken by the controlling stockholder in response to the board’s proposed dilution of its controlling stake “is subject to judicial review, which can afford full relief,”[13] meaning any injury caused by such action (even if cognizable) would not be “irreparable.”[14]  In particular, the court reasoned that:

  • To the extent a controlling stockholder amends the corporation’s bylaws, the court has the power to “set aside” such bylaw amendment after the fact if it “is proven to be invalid or inequitable.”[15]
  • To the extent a controlling stockholder removes directors, a proceeding under Section 225 of the Delaware General Corporation Law is available to determine whether such removals were “improper.”[16]
  • To the extent a controlling stockholder takes steps to force a merger—which was the primary supposed threat alleged by the special committee—“recourse always is available in this court for a merger that is the product of a fiduciary breach.”[17]

Shortly after the court’s decision, the CBS board met and voted on the proposed dividend, which (although it was approved by a majority of the board) failed to garner the 90% vote required by CBS’s bylaws, as amended by NAI.  Accordingly, in order for the court to declare the proposed dividend valid, CBS was required to prove (among other things) that the bylaw amendment should be set aside as invalid or inequitable under Delaware corporate law or, even if not, that the bylaw amendment had not become effective because stockholders had not been furnished with an information statement 20 days in advance as CBS claimed was required under SEC Rule 14c-2 (as discussed in our prior post).  CBS subsequently amended its complaint to add claims to those effects.  The validity and effectiveness of the bylaw amendment were thus threshold issues to be litigated in the subsequent trial, but the parties settled before trial.

*          *          *

In sum, the Delaware Court of Chancery has made clear that it will not issue a TRO or preliminary injunctive relief restraining a controlling stockholder from protecting its controlling stake absent “a truly extraordinary set of circumstances” in which potentially cognizable harm could not be addressed in subsequent litigation.  Otherwise, regardless of any alleged breaches of fiduciary duty by the controlling stockholder, the court will allow the controlling stockholder to take action, but will review such action in subsequent proceedings, including to determine whether it was equitable.

Litigation over board action to dilute a controlling stockholder is rare, and may become rarer still after this decision.  To the extent such cases are brought in the future, the result may be less of an emphasis on the preliminary stages of the litigation, and whether the court should intervene before the parties act.  Instead, the focus of such litigation is more likely to be on the ultimate issues, to be determined on a full record after discovery and trial, including whether the board had “compelling justification” to dilute the controlling stockholder,[18] and whether the controlling stockholder was justified in taking steps to protect itself from such dilution.[19]

[1] Cleary Gottlieb was litigation and corporate counsel for NAI in the matters discussed herein.

[2] CBS Corp. v. Nat’l Amusements, Inc., C.A. No. 2018-0342-AGB (Del. Ch. May 17, 2018) (“TRO Decision”).

[3] TRO Decision at 14-15.

[4] Id. at 15-16 (citing Mendel v. Carroll, 651 A.2d 297, 306 (Del. Ch. 1994)).

[5] TRO Decision at 16.

[6] Id.

[7] Id. at 15

[8] Frantz Mfg. Co. v. EAC Indus., 501 A.2d 401, 407 (Del. 1985).

[9] 2002 WL 205684, at *9 (Del. Ch. Jan. 25, 2002).

[10] TRO Decision at 16.

[11] Id.

[12] Id. at 17.

[13] Id.

[14] See id. at 12-14.

[15] Id. at 13.

[16] Id.

[17] Id. at 13-14.

[18] See Mendel v. Carroll, 651 A.2d 297, 306 (Del. Ch. 1994) (Allen, Ch.) (board not authorized “to deploy corporate power against the majority stockholders [through dilutive option issuance], in the absence of a threatened serious breach of fiduciary duty by the controlling stockholder”); Blasius Indus., Inc. v. Atlas Corp., 564 A.2d 651, 661 (Del. Ch. 1988) (Allen, Ch.) (“board bears the heavy burden of demonstrating a compelling justification” when it acts for “primary purpose of impeding the exercise of stockholder voting power”); Phillips v. Insituform of N. Am., Inc., C.A. No. 9173, 1987 WL 16285, at *7 (Del. Ch. Aug. 27, 1987) (Allen, Ch.) (issuance of shares held “unjustified and invalid corporate act” where no adequate justification was shown for the “extraordinary step” of depriving controlling stockholder of control).

[19] Hollinger Int’l, Inc. v. Black, 844 A.2d 1022, 1079-81 (Del. Ch. 2004) (Strine, V.C.) (“[I]n Frantz, the Delaware Supreme Court ruled that bylaws requiring that the full board decide matters by unanimous vote are permissible. . . . In the circumstances of that case, the Supreme Court found the very restrictive bylaws at issue proper because the majority stockholder—which had committed no acts of wrongdoing—was acting to protect itself. . . . In this case, the Bylaw Amendments were clearly adopted for an inequitable purpose and have an inequitable effect. . . . Although it is no small thing to strike down bylaw amendments adopted by a controlling stockholder, that action is required here because those amendments complete a course of contractual and fiduciary improprieties.”).