638 A.2d 1110 (Del. 1994)
In 1981, Alcatel acquired 30.6 percent of Lynch Communication Systems, Inc., a Delaware corporation that designed and manufactured electronic telecommunications equipment.1 As part of the stock purchase agreement, Lynch amended its certificate of incorporation to require an 80 percent affirmative vote for any business combination, Alcatel obtained proportional representation on the Lynch board and the right to purchase 40 percent of any equity securities offered to third parties, and Alcatel was precluded from holding more than 45 percent of Lynch stock prior to October 1, 1986.2 By the time of the contested merger, Alcatel owned 43.3 percent of Lynch's outstanding stock, designated five of the eleven members of Lynch's board of directors, two of three members of the executive committee, and two of four members of the compensation committee.3
In the spring of 1986, Lynch determined that it needed to obtain fiber optics technology to remain competitive and identified Telco Systems, Inc. as a target company that had expressed interest in being acquired by Lynch.4 Because of the supermajority voting provision, Lynch needed Alcatel's consent to proceed with the Telco combination. Alcatel opposed the acquisition of Telco and instead proposed a combination of Lynch with Celwave Systems, Inc., an indirect subsidiary of Alcatel's parent company.5 At the August 1, 1986 Lynch board meeting, Alcatel representatives vetoed the Telco acquisition and opposed renewal of compensation contracts for Lynch's top five managers, after which the board unanimously established an Independent Committee consisting of Hubert L. Kertz, Paul B. Wineman, and Stuart M. Beringer to negotiate with Celwave and make recommendations concerning the terms of a combination.6
On October 24, 1986, Alcatel's investment banking firm Dillon Read proposed an exchange ratio of 0.95 shares of Celwave per Lynch share. The Independent Committee's advisors Thomson McKinnon and Kidder Peabody concluded that the ratio was unattractive, and the Independent Committee unanimously opposed the Celwave merger on October 31.7 Alcatel responded on November 4 by withdrawing the Celwave proposal and making a simultaneous offer to acquire the remaining 57 percent of Lynch at $14 cash per share. On November 7 the Lynch board authorized the Independent Committee to negotiate the cash merger offer.8
The Independent Committee rejected the $14 offer and countered at $17 per share. Alcatel responded with offers of $15 and then $15.25 per share, both of which the committee rejected. Alcatel then made a final offer of $15.50 per share.9 At the November 24, 1986 meeting of the Independent Committee, its chairman Beringer advised the other members that Alcatel was ready to proceed with an unfriendly tender at a lower price if the $15.50 price was not recommended and approved. After meeting with its advisors, the Independent Committee voted unanimously to recommend the $15.50 price, and the Lynch board later approved the merger with Alcatel's nominees abstaining.10
Kahn, a Lynch shareholder holding shares as custodian for his daughters, instituted suit in 1986 seeking to enjoin the acquisition. After the Court of Chancery denied a preliminary injunction, Kahn amended the complaint to seek monetary damages. The Court of Chancery certified the action as a class action on behalf of all Lynch shareholders other than the named defendants who tendered their stock or whose stock was acquired in the merger. Following a three-day trial held April 18-20, 1993, the Court of Chancery entered judgment in favor of the defendants. Kahn appealed to the Delaware Supreme Court.11
Whether Alcatel was a controlling shareholder of Lynch despite owning only a 43.3 percent minority interest?12
A shareholder owes a fiduciary duty only if it owns a majority interest in or exercises control over the business affairs of the corporation.13 For a dominating relationship to exist in the absence of controlling stock ownership, a plaintiff must allege domination by a minority shareholder through actual control of corporation conduct.14
Yes. The established facts demonstrate that Alcatel exercised actual control over Lynch's business affairs despite its minority stake.15 At the August 1, 1986 board meeting Alcatel representatives vetoed the proposed acquisition of Telco Systems and opposed renewal of compensation contracts for Lynch's top managers.16 Although independent directors initially favored both actions, they deferred after Alcatel reminded the board of its significant stockholdings and the supermajority requirement it had negotiated.17
The Court of Chancery found that the non-Alcatel directors deferred to Alcatel because of its position as a significant stockholder and not because they decided in the exercise of their own business judgment that Alcatel's position was correct.18 This pattern of domination continued through the merger process.19
Alcatel was a controlling shareholder of Lynch that owed fiduciary duties to the corporation and its minority shareholders.20
Whether the Independent Committee negotiated the cash-out merger at arm's length with Alcatel?21
No. The established facts show that the Independent Committee did not negotiate at arm's length.24 After rejecting three lower offers the committee was informed by its chairman that Alcatel was ready to proceed with an unfriendly tender at a lower price if the $15.50 offer was not recommended and approved.25 The committee had investigated alternatives including a white knight acquisition, repurchase of Alcatel's shares, and a shareholder rights plan but found each impracticable because of Alcatel's blocking power under the supermajority provision and its explicit opposition.26 One committee member testified that he voted for the merger even though he did not believe $15.50 was a fair price because he perceived no alternative.27
The ultimatum from Alcatel compromised any semblance of arm's length bargaining.28
The Independent Committee did not negotiate the cash-out merger at arm's length with Alcatel.29
Whether approval by the Independent Committee shifted the burden of proving entire fairness to the plaintiff shareholder?30
The initial burden of establishing entire fairness rests upon the party who stands on both sides of the transaction.31 However, an approval of the transaction by an independent committee of directors shifts the burden of proof on the issue of fairness from the controlling or dominating shareholder to the challenging shareholder-plaintiff only if the committee was truly independent and replicated a process as though each of the contending parties had in fact exerted its bargaining power at arm's length.32
No. Because the Independent Committee did not negotiate at arm's length due to Alcatel's threats and domination, the approval by the committee did not shift the burden.33 The Court of Chancery erred in concluding that the committee had appropriately simulated a third-party transaction where negotiations are conducted at arm's length and there is no compulsion to reach an agreement.34 The record reflects that the ability of the Committee effectively to negotiate at arm's length was compromised by Alcatel's threats to proceed with a hostile tender offer if the $15.50 price was not approved.35 The fact that the committee rejected three initial offers cannot alter the conclusion that any semblance of arm's length bargaining ended when the committee surrendered to the ultimatum that accompanied Alcatel's final offer.36
Therefore the burden of proving the entire fairness of the merger transaction remained on Alcatel.37
Approval by the Independent Committee did not shift the burden of proving entire fairness to the plaintiff shareholder.38