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Court ruling clears path for minority stakeholders

A recent court decision has effectively raised the bar for stockholders challenging a private equity firm’s exit process.

Private equity firms with minority holdings in publicly listed companies can have a voice during sales processes.   

In a recent Delaware court ruling involving mid-market firm Castle Harlan and the sale of its stake in Morton’s Restaurant Group, Chancellor Leo Strine found in favour of Castle Harlan, dismissing allegations that the firm “pressured the Morton’s Board into the transaction in order to obtain liquidity to support the launch of a new investment fund”, according to a statement from law firm Ropes and Gray.

“The argument is if you have a [minority] stock holding that is too large to sell in the public market, you might have a conflict of interest when pushing for a sale because you achieve something that you can’t otherwise achieve, and which isn’t shared with the other stockholders,” said Bill Regner, co-head of Debevoise & Plimpton’s M&A practice.

In the lawsuit, a number of Morton’s stockholders alleged that Castle Harlan “dominated the company’s board” and quickly approved “a lowball transaction”, according to court documents. The terms of the sale included a price of $6.90 per share, which represented a 33 percent premium to Morton’s closing market price.

Strine’s decision that Castle Harlan’s 28 percent stake and two board seats (out of ten) did not allow the firm to improperly influence the sale process could help shed light on future situations involving allegations against private equity firms.

“It does something to kind of debunk that liquidity conflict argument”, said partner at Ropes and Gray Chris Rile. “You had a really good investment bank making an announcement of the deal in advance, they approached over 100 bidders, they went at the process for nine months [and] there was no indication that there was any favouring of any particular bidder.”

While the Castle Harlan case supports the involvement of a large minority stockholder during the sales process, the Delaware courts have been wrestling with this conflict of interest issue for some time, and other cases have ruled differently, according to Debevoise & Plimpton’s Regner.

“There really seems to be a difference of views between judges on this question, which is why it is something private equity sponsors should be focused on,” he said.

Graham Winfrey contributed to this report.