Non-Majority Stockholder’s Ability to Control a Transaction Did Not Render Him a Controller As He Did Not Try to Control—Oracle

In In re Oracle Corporation Derivative Litigation (May 12, 2023), certain former stockholders of Oracle Corporation brought a derivative suit claiming that Oracle had overpaid when, in 2016, it acquired NetSuite Corporation for $9.3 billion. The plaintiffs contended that Larry Ellison (the founder and a major stockholder of both Oracle and NetSuite), aided by Safra Catz (Oracle’s CEO), had used his outsized influence at Oracle to cause Oracle to overpay for NetSuite, which advantaged him because he owned a larger percentage of NetSuite than of Oracle. The transaction did not require, or involve, an Oracle stockholder vote.

After a ten-day trial, the Delaware Court of Chancery found that, based on Ellison’s “outsized influence” at Oracle, he likely could have controlled the transaction had he wanted to, but that the record at trial established that he had not tried to. The court therefore concluded that he was not a controller. The court also found that, although Ellison and Catz had withheld certain information from the special committee, the information was not material and did not indicate that they had exercised control of the committee. The court therefore held that business judgment review, rather than entire fairness, applied and the court held in favor of the defendants.

Key Points

• Important amplification of the law on controllers and entire fairness. The court held that a challenged transaction involving a conflicted non-majority stockholder who had the ability to control the transaction but did not attempt to do so will be reviewed under the business judgment rule, rather than entire fairness. The court emphasized that Ellison had absented himself from the process, and that a special committee that was independent of him had functioned effectively to consider and negotiate the transaction.
• Critical role of the independent special committee. The decision underscores the advantages of a board’s use of an independent special committee to lead the process for a potentially conflicted transaction. The court emphasized that the committee’s members and advisors were independent and experienced; the committee had conducted extensive due diligence on NetSuite; and the committee and Catz had negotiated hard on Oracle’s behalf, including having been willing to walk away from the deal and ultimately having obtained agreement for a price below the maximum the committee had decided Oracle should pay.
• Reminder that a pleading-stage inference of control does not foreclose business judgment review at trial. In an earlier decision, at the pleading stage of the litigation, the court, applying plaintiff-friendly inferences (as it is required to do at that stage), had concluded that Ellison may have been a controller with respect to the NetSuite acquisition and therefore that the entire fairness standard of review would apply. At trial, however, as the record established that Ellison in fact was not a controller, the court applied business judgment review (under which it ruled in favor of the defendants). The decision thus underscores the importance of a board’s establishing a record as to a potential controller’s actions with respect to a transaction—and, also, in the event the transaction is challenged, how the record potentially could be used at the pleading stage to increase the likelihood of avoiding trial (which in this case continued for over six years).
• Open questions. The court did not address whether, if the court finds that a person was a controller with respect to a transaction, the effective functioning of an independent special committee would “cleanse” a non-squeeze-out merger transaction that did not require a stockholder vote. The court also did not address whether there might be circumstances under which a person with the ability to control a transaction could, by virtue of his or her general influence and clout, be deemed to have controlled a transaction even if he or she had been fully absented from the process.

Background. Ellison founded Oracle in 1977 and NetSuite in 1998. He served on Oracle’s board and was CEO until 2014, at which time he resigned that position to become the Chief Technology Officer and Executive Chairman of the Board (and Catz became CEO). Over many years, Oracle had pursued a strategy of growth through the acquisition of other companies. Ellison had long advocated that, at the right time, Oracle should acquire NetSuite. In early 2016, when NetSuite was struggling financially and Ellison allegedly believed that it could not survive competitively, Oracle began to consider seriously an acquisition of NetSuite. At this time, Ellison owned 28.4% of Oracle common stock and 39.8% of NetSuite stock.

The board established a Special Committee to consider and negotiate the acquisition. The Special Committee determined that $110 per share would be the price above which an offer for NetSuite would no longer be accretive. The parties ultimately agreed on a price of $109 per share. The Committee received a fairness opinion at that price. The transaction was structured as a tender offer with a back-end merger. The tender offer was conditioned on at least a majority of the shares unaffiliated with Ellison being tendered. T. Rowe Price (Oracle’s largest stockholder other than Ellison) refused to tender, insisting on a price of $133 per share. Oracle decided twice to extend the tender offer but did not increase the price. Ultimately, the tender offer closed with 53.2% of the unaffiliated shares tendered. The acquisition closed in November 2016. Ellison received about $3.48 billion in the transaction for his NetSuite shares.

In 2017, certain Oracle stockholders brought suit. In a pleading-stage decision issued in March 2018, Vice Chancellor Glasscock noted that Ellison allegedly maintained “a firm grip on Oracle’s day-to-day operations, and [had] shown a willingness to remove directors and officers who cross him.” The Vice Chancellor thus found it reasonable to infer, at the pleading stage. that a majority of the Oracle board was not independent of Ellison and stated that entire fairness review would apply. In 2019, after a year-long investigation by a special litigation committee, the Oracle board authorized the stockholders to pursue the derivative case on behalf of the company. In this recent post-trial decision, the Vice Chancellor found that the trial record established that Ellison was not a controller; that a majority of the Special Committee members were independent of Ellison; and that Ellison and Catz had not committed a fraud on the Committee. Applying business judgment review, the Vice Chancellor ruled in favor of the defendants.

Discussion

Law on controllers and entire fairness. Under Delaware law, a non-majority stockholder generally is not a controller, but may be a controller if the stockholder is in a position (for example, through contractual rights or outsized influence based on the stockholder’s roles at the company) (i) to exercise general control of the corporation on a day-to-day basis or (ii) to control the transaction at issue. Transactions involving a controller who has a conflict of interest (e.g., by virtue of standing on both sides of the transaction), if challenged, are reviewed by the court under the entire fairness standard. However, if the transaction included the protections of MFW (i.e., approval both by an independent special committee and by an informed, uncoerced majority of the disinterested stockholders), then business judgment review applies. In this case, Oracle did not structure the acquisition to be MFW-compliant.

Ellison had the ability to control the transaction. Ellison was Oracle’s founder, director, past long-time CEO, Chief Technology Officer, key “creative force” and public “face,” and largest stockholder. The court found that he had significant “clout,” and was a “potent force,” at the company; and that he was “so closely identified with Oracle that [his] insistence on a particular policy or result had the potential to sway the business judgment of the directors and the [Oracle] executives.” The court thus concluded, at the pleading stage, that it was plausible that Ellison could have influenced the NetSuite acquisition had he chosen to. Further, Catz, who was the primary negotiator for the transaction, had made comments in a magazine interview to the effect that Ellison was her boss and a brilliant leader and that her job was simply to effect his vision. Thus, the court found it plausible, at the pleading stage, that Ellison may have been able to control the transaction indirectly through Catz. However, after trial, the court concluded that the factual record established that Ellison was not a controller as he did not generally control Oracle and he had not attempted to control the transaction. Vice Chancellor Glasscock wrote:

The concept that an individual—without voting control of an entity, who does not generally control the entity, and who absents himself from a conflicted transaction—is subject to entire fairness review as a fiduciary solely because he is a respected figure with a potential to assert influence over the directors, is not Delaware law, as I understand it.

Ellison did not generally control Oracle. The court noted that, at the time Oracle began to seriously consider the acquisition of NetSuite, Ellison was the CTO, and the record did not show that he had “controlled the day-to-day function of the company nor dictated the operation of the company to the board.” The court pointed to an instance in which the board had forced Ellison to fire a senior member of his team over his strong objection. Similarly, the court concluded that Ellison’s ideas received “a respectful hearing” from senior management, but that the executives “did not appear cowed or overawed by him.” The court noted a time when Catz had determined it was not in Oracle’s best interests to continue to pursue a certain project with Microsoft, and after she shut the program down, “it took Ellison in his capacity as CTO a year to convince her to change her mind.”

Ellison did not try to control the transaction. Ellison had been a longtime, vocal proponent of Oracle’s ultimately acquiring NetSuite—although at various times in the past he had advocated that it was the wrong time to acquire NetSuite. The directors and management knew that, “[a]s far as Ellison was concerned, the question was when, not if, the acquisition should occur.” The court observed, however, that Oracle’s serious consideration of the acquisition began in 2015, after Ellison was no longer the CEO. Also, and critically, once the board was considering the acquisition, Ellison did not indicate his favor or opposition; he absented himself from the board discussions about the acquisition (including with respect to establishing the Special Committee); the board established the Special Committee, which was independent of Ellison; Ellison had no contact with the Special Committee; and the Special Committee functioned effectively.

Rejection of plaintiffs’ arguments relating to (i) a phone call between Ellison and Netsuite and (ii) Catz’s loyalty to Ellison. The plaintiffs pointed to a phone call between Ellison and Evan Goldberg (NetSuite’s Chief Technology Officer and Chair of the Board), which took place soon after Catz, at the board’s direction, had met with NetSuite’s CEO to see if NetSuite would be interested in an acquisition by Oracle. During the call, Ellison said that, post-closing, Oracle intended to retain NetSuite’s management and to provide the business unit with autonomy. The plaintiffs contended that the call reflected Ellison’s trying to control the transaction and that the call had foreclosed the Special Committee from “going hostile.” The court reasoned that the call could not have affected the Committee’s actions because, as the plaintiffs conceded, the Committee did not know about the call as Ellison had not told them about it. While Ellison’s not reporting the call to the Committee may not have been “best practice,” the court wrote, “it was not an exercise of control over the Special Committee.” Moreover, in the same call, Ellison also told Goldberg that he was recusing himself from NetSuite’s consideration of the transaction and that NetSuite’s decision would be “out of his hands.”

The plaintiffs also contended that Catz’s strong loyalty to Ellison allowed Ellison to control the transaction through her. The court stressed that the Special Committee and its advisors, not Catz, ran the negotiation process; that the Committee deliberated only after management had left its meetings; that the Committee questioned management’s assumptions; and that, “[d]uring negotiations, Catz showed herself to be a tough negotiator on behalf of Oracle, who was prepared to let the deal die if it was not in Oracle’s best interests to pursue.” Throughout the process, the court stressed, Catz “agitated for Oracle to pay the lowest price possible, [with] her advice [leading] to several stalls that jeopardized the transaction.”

The Special Committee functioned effectively. The court noted that the Committee (which met fifteen times in the eight months between its being established and the closing of the acquisition) had:

• been fully empowered to consider and negotiate an acquisition of NetSuite;
• been comprised entirely of members who were independent and experienced—namely, Renee James (a former CEO of Intel); Leon Panetta (a former CIA director and Secretary of Defense); and George Conrade (a business executive with 61 years of experience);
• guided by legal and financial advisors who were independent and experienced;
• been “walled off” from, and had no contact, with Ellison during the process;
• “investigated alternatives and the prudence of the acquisition itself” before making an offer;
• conducted extensive due diligence on NetSuite (including once before agreeing to NetSuite’s request to reengage in negotiations after they had stalled over an impasse on price); and
• “negotiated in a hard-nosed fashion”—including having concluded that $110 per share would be the price above which the acquisition would no longer be accretive and having initially offered $100 per share, to which NetSuite countered with $125 per share; and, the court emphasized, having been prepared at times to let the deal die at rather than agree to a higher price; and
• succeeded in obtaining NetSuite’s agreement to a price per share that was $1 below the Committee’s ceiling price.

Entire fairness does not apply where a potential controller does not actually control. The court posited the question whether its finding—that Ellison was “a holder of potential control over a transaction in which he was interested”—mandated entire fairness review. The court wrote: “[I]f Ellison was a controller, and if the protections of MFW…were not in place, entire fairness review must result.” The Vice Chancellor wrote that, based on the record established at trial:

[Ellison] neither possessed voting control, nor ran the company de facto. He likely had the potential to control the transaction at issue, but made no attempt to do so; in fact, he scrupulously avoided influencing the transaction. In addition, the transaction was negotiated by a special committee of independent directors who hired independent advisors. The Special Committee vigorously bargained for price and demonstrated a willingness to walk away from the transaction.  I find, in light of these facts, that this is not a controlled transaction.

No “fraud on the board” by Ellison and Catz. Notwithstanding the court’s determination that Ellison was not a controller, the transaction would have been subject to entire fairness review if Ellison or Catz had committed a fraud on the board or the Special Committee. To prove a fraud on a special committee, plaintiffs must establish that a fiduciary was materially self-interested; that the committee was inattentive or ineffective; and that the fiduciary materially deceived or manipulated the committee such that its decision-making process was tainted. The plaintiffs pointed to Ellison’s and Catz’s failure to disclose to the Committee Ellison’s belief about NetSuite’s prospects (based on his view that, due to NetSuite’s flawed business strategy, Oracle would “crush” NetSuite competitively) and the phone call between Ellison and NetSuite’s CEO discussed above (relating to post-merger management). The court found that Ellison’s views about NetSuite’s strategy were immaterial as NetSuite had in fact begun to follow the strategy Ellison had recommended; and that Ellison’s phone call was immaterial as the Committee could not have been affected by it because it did not know about it, and the Committee was not affected by Ellison’s thoughts on the post-close running of the company but instead was following its usual practice in M&A transactions to decide on post-closing management after a deal is signed. Also, the court emphasized that the Committee “was not supine or naïve” but, rather, had functioned well and made its own determinations.

Practice Points

• Potential controllers. A non-majority stockholder with outsized influence such that he or she is a potential controller, and who is conflicted as to a transaction, should consider seeking to frame the transaction to meet the prerequisites for application of business judgment review under MFW; or, if a stockholder vote of the acquiring company’s stockholders is not required or desired, then at least should consider having the process led by an independent special committee. If a potential controller scrupulously avoids involvement in the transaction, and if the committee is independent and functions effectively, business judgment review should apply. Notably, as plaintiff-friendly inferences are drawn at the pleading stage, the court may find at that stage that a potential controller likely was a controller—creating pressure on the putative controller to settle the case even though it may be able to prove at trial that it in fact was not a controller.
• Special committees. A special committee should: be fully empowered to consider and negotiate a transaction—including considering alternative transactions and doing no transaction; be comprised of independent and experienced members; retain independent, experienced advisors; be walled off from the possible conflicted controller; conduct appropriate due diligence; and negotiate hard on behalf of the company, including by being willing to let the deal die rather than agree to an inappropriate price. In addition, it is critical that a special committee creates a record—for example, in meeting minutes—establishing the foregoing. In addition, a special committee should consider adopting rules of recusal prohibiting a potential controller from discussing the potential transaction with anyone other than the committee, informing officers and employees working on the transaction of the potential controller’s recusal, and forbidding all officers and employees from being involved in the transaction except with the committee’s knowledge and at its direction.
• Director independence. In Oracle, the plaintiffs asserted that the chair of the Special Committee, had violated her fiduciary duties by conspiring with Ellison and Catz to control the acquisition process so that it would be favorable to Ellison. The plaintiffs claimed that James wanted to curry favor with Ellison so that he would use his influence in the tech industry to help her secure a future CEO position. Vice Chancellor Glasscock wrote that the evidence at trial did not support this theory—and, in a footnote, the Vice Chancellor commented that the plaintiffs’ arguments “had some odor of denigrating the abilities of women executives to succeed based on their merits.”
• Management independence. In several cases, the court has inferred from comments an executive officer made about a controller or potential controller (in an interview, a book, or emails) that the officer was acting in the controller’s rather than the stockholders’ interests. Management should avoid lavish praise of a controller or potential controller or other comments that could be interpreted as suggesting the possibility of blind allegiance.