In re Crimson Exploration Inc. Stockholder Litigation: Court Clarifies Application of Entire Fairness Standard

The Delaware Chancery Court dismissed Crimson Exploration, Inc. stockholders’ (“Plaintiffs”) class action lawsuit challenging a stock-for-stock merger between Crimson Exploration, Inc. (“Company”) and Contango Oil & Gas Co. (“Contango”). In re Crimson Exploration Inc. Stockholder Litig., 2014 BL 300486 (Del. Ch. Oct. 24, 2014).

Plaintiffs’ alleged the merger undervalued the Company and deprived stockholders from receiving a fair value for their shares. Plaintiffs argued the entire fairness standard should be applied to the transaction to determine whether the Company’s largest shareholder, Oaktree Capital Management L.P. (“Oaktree”), constituted a controlling shareholder who caused the Company to be sold for inadequate value in exchange for side benefits. The entire fairness standard involves an evaluation of fair dealing and fair price to evaluate the transaction as a whole to determine the overall fairness to the shareholders. In addition, the Plaintiffs’ asserted that the controlling shareholder and the Company’s board breached their fiduciary duties to the shareholders in executing the merger transaction.

The Company, Contango, Oaktree, and Company directors (collectively the “Defendants”) argued Oaktree was not a controlling shareholder and, further, that Plaintiffs had not pleaded sufficient facts to trigger entire fairness review.

First, the court analyzed what constituted a controlling shareholder. It noted that although Oaktree owned less than 50 percent of the Company, it could still be considered a controlling shareholder if it “exercises control over the business affairs of the corporation.” The Vice Chancellor noted that a large shareholder will not be considered a controlling shareholder unless it actually controlled the Company’s board’s decision over the conflicted transaction. A conflicted transaction can occur when a controlling shareholder is on both sides of the transaction or when the controlling shareholder receives some benefit that competes with the common shareholders’ consideration.

Plaintiffs conceded that Oaktree was not on both sides of the transaction, instead alleging that it received some additional considerations from the merger transaction. The court rejected Plaintiffs’ allegations stating that they failed to present specific facts to overcome the presumption that shareholders have an incentive to seek the highest price for their shares. Accordingly, the court declined to apply the entire fairness standard.

Because a majority of the Company’s board were independent and disinterested in the transaction, the court held that the business judgment rule applied. The court ultimately dismissed Plaintiffs’ claims, holding they did not present sufficient facts to rebut the business judgment rule.

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