Corporate Governance

Gentile v. Rossette: Even 95% Majority Shareholders Must Be Entirely Fair

By Michael Silverman

In Gentile v. Rossette, C.A. No. 20213-VCN, 2010 WL 2171613 (Del. Ch. May 28, 2010), the Delaware Chancery court declared that defendant P. David Rossette, the largest shareholder of the now defunct company SinglePoint Financial, Inc. and one of two directors, had engaged in self-dealing through a debt conversion plan that benefitted him at the expense of fellow shareholders.

Rossette was the largest shareholder in SinglePoint. He had lent the company considerable sums, causing the court to observe that the "balance sheet reflected a staggering (for an entity of its size) amount of debt--virtually all of it owed to Rossette."  To reduce the amount of debt on the company's balance sheet, Rossette opted to convert some of the loans to equity.  The Debt Conversion Agreement provided that debt of $2,220,951 would be converted into shares of the Company at $0.05 per share.  The result was that Rossette's percentage increased from 61% to 95% of the Company's equity. 

Plainitiff challenged the agreement.  The court first had to determine the standard of review.  The board contained two directors, with one of them independent.  As a result, plaintiffs had the burden of showing the unfairness of the transaction.  The court, however, disagreed. 

• "Bachelor [the independent director] had no experience as a director. He was intensely familiar with the Company's technical matters and was aware of its financial difficulties. However, he had no firm basis for determining what a fair conversion price would have been. More importantly, he had no help. He received no independent legal or financial guidance." 

Instead, the burden of establishing fairness rested with the board.  According to the court, '[f]air dealing ‘embraces questions of when the transaction was timed, how it was initiated, structured, negotiated, disclosed to the directors, and how the approvals of the directors and the stockholders were obtained.' Fair price ‘relates to the economic and financial considerations of the proposed merger, including all relevant factors: assets, market value, earnings, future prospects, and any other elements that affect the intrinsic or inherent value of a company's stock.'' Boyer v. Wilmington Materials, Inc., 754 A.2d 881, 898-99 (Del. Ch. 1999).

The court found that the process used to determine the debt conversion price was not "fair." 

• Rossette set the conversion rate with limited or no pushback from Bachelor, who was in no position to bargain effectively on behalf of the minority stockholders. Although the Company's financial condition  may have afforded Bachelor little leverage, the lack of any independent assistance--legal or financial--precluded a material effort on behalf of the constituency he represented. Furthermore, as set forth above, the so-called fairness opinion obtained by Rossette is not a substitute for a thoughtful and helpful analysis.

As the court noted, "[f]rom a tainted process, one should not be surprised if a tainted price emerges."  The court examined evidence on value provided by both plaintiffs and defendants and opined that there "is no reliable way to 'calculate' a 'fair value'" for the shares at the time of conversion.  Nonetheless, weighing all of the evidence, the court concluded that the value was "a number in the mid-range between $ 0.10 per share and something a little less than $ 0.75 per share is as accurate as one can be."  As a result, the court selected a value of $.40 per share.

As for damages, the court found that Bachelor was not liable.  The waiver of liability provision in the articles eliminated monetary damages in the absence of personal benefit.

• Bachelor is entitled to the protection of this exculpatory provision. He received no personal benefit from the Debt Conversion. Indeed, as the holder of the largest block of Company stock other than Rossette, its dilutive effects affected him more than anyone else. He thought for himself and attempted to do the best that he could in difficult circumstances. His ability to discharge his duties effectively was crimped by his lack of experience as a director and the lack of resources to advise him separately and independently of Rossette. At most, Bachelor breached his fiduciary duty of care. He has demonstrated that otherwise he acted loyally and in good faith. Accordingly, he may not be held liable for any money damages.

The primary materials for this case may be found on the DU Corporate Governance Website.

A subsequent related decision was made in Gentile v. Rossette, C.A. No. 20213-VCN, 2010 WL 3582453 (Del. Ch. Sept. 10, 2010).

Full post as published by The Race to the Bottom on October 18, 2010 (boomark / email).