On October 28, 2016, Justice Ramos of the New York County Commercial Division issued a post-trial decision in Zheng v. Icahn, Index No. 601296/2009, dismissing the complaint.
The decision covered two consolidated actions wherein minority shareholders of XO Holdings, Inc., a Delaware telecommunications company, challenged (a) a 2008 refinancing of XO’s debt to financier Carl Icahn, and (b) a 2011 cash-out merger between XO and an entity controlled by Icahn. The plaintiffs alleged that the 2008 transaction unfairly diluted their interests, and that the price per share they received in the 2011 transaction was unfairly low. Plaintiffs also argued that the transactions unfairly allowed Icahn to obtain the use of XO’s net operating losses (“NOLs”), which were worth hundreds of millions of dollars to him.
The bulk of this long decision describes the evidence set forth at trial and the facts ultimately proven, but the legal points of primary interest are as follows:
Because both transactions were approved by Special Committees, which the court had previously found to be independent, Plaintiffs’ claims were adjudicated under Delaware’s “entire fairness” standard, which examines whether the Special Committees were “well-functioning” and whether the price per share paid to the minority shareholders was fair.
In 2003, XO emerged from bankruptcy with Icahn holding 83% of XO’s equity and 85% of its debt, as well as the rights to use XO’s NOLs until the company became profitable. In 2007-2008 it became clear that, without more capital, XO would be bankrupted a second time. A Special Committee first tried to sell XO or its assets, but received no firm offers. They then turned to Icahn and negotiated a restructuring of XO’s debts and additional financing in exchange for preferred shares. The Special Committee also obtained various other benefits—including a share of Icahn’s NOL tax savings. The court found that the Special Committee negotiated diligently and was not dominated by Icahn, and also found that the NOLs did not provide the company with any leverage because Icahn was the only party who could make any significant use of them.
By 2011, XO’s financial position had not improved. When Icahn offered to buy XO outright, a new Special Committee was formed to consider the offer. The Special Committee decided against seeking outside offers, because no serious offers were expected (as before, Icahn was the only party who could make significant use of the NOLs, substantially reducing XO’s value to third party buyers), shopping the company unsuccessfully might well lower its value even further, and Icahn had indicated that he was unwilling to sell. The Special Committee’s financial advisors opined that the per-share value was less than $0.75. The transaction was ultimately consummated at $1.40 per share, far above the estimated value, and far above Icahn’s initial offer of $0.70 per share, and the Special Committee also negotiated further concessions.
The court held that both transactions met the “entire fairness” standard, finding, among other things, that Icahn’s post-merger use of the NOLs was not required to be factored into the share price—under Delaware law, post-merger “synergies” (unique benefits accruing to the buyer) are not part of the valuation process, which is limited to valuing the company before the sale: “the relevant factor as to price is whether XO received fair consideration—any benefits that accrued to Icahn post-merger are simply not relevant.” Nor was the Special Committee required to seek third-party buyers, in light of Icahn’s assertion that he would not sell.
Concerning the 2008 refinancing, the court noted that Delaware law did not constrain a shareholder’s enforcement of their rights as a creditor: “indeed, where a controlling shareholder owns a majority of a company’s debt, it may choose to enforce those obligations, even if it that means minority shareholders might be wiped out.” The court also held that the 2008 refinancing did not dilute the minority voters’ interests—although the retained a lower percentage of XO’s stock, they did not lose any control rights (which they did not have to begin with) and they did not prove that their shareholdings lost economic value.
Finally, the court noted that mere disagreement with the Special Committee’s negotiating strategy, or dissatisfaction with the results obtained, are insufficient to establish a breach of fiduciary duty—plaintiffs need more than “we could have done better.”
This decision is of interest because it explains that a majority shareholder’s potential assertion of its rights as creditor, or to block a sale, can properly be considered when evaluating a merger or other corporate transaction. It is also of interest because the opinion sets forth the various steps in the Special Committees’ deliberations in detail—any attorney advising such a body would be well advised to review this decision in detail.