In re Kenneth Cole: New York Court Dismisses Challenge to Going-private Transaction | Practical Law

In re Kenneth Cole: New York Court Dismisses Challenge to Going-private Transaction | Practical Law

A New York trial court dismissed a challenge to a going-private transaction in In re Kenneth Cole Productions, Inc. Shareholder Litigation. The court held that the board of the target company was entitled to the presumptions of the business judgment rule, even though the buyer owned or controlled approximately 46% of the target company's outstanding common stock and 89% of its voting power.

In re Kenneth Cole: New York Court Dismisses Challenge to Going-private Transaction

Practical Law Legal Update 6-542-7645 (Approx. 5 pages)

In re Kenneth Cole: New York Court Dismisses Challenge to Going-private Transaction

by Practical Law Corporate & Securities
Published on 24 Sep 2013 • New York
A New York trial court dismissed a challenge to a going-private transaction in In re Kenneth Cole Productions, Inc. Shareholder Litigation. The court held that the board of the target company was entitled to the presumptions of the business judgment rule, even though the buyer owned or controlled approximately 46% of the target company's outstanding common stock and 89% of its voting power.
On September 3, 2013, a New York trial court dismissed a challenge to a going-private transaction in In re Kenneth Cole Productions, Inc. Shareholder Litigation. The court held that the decisions taken by the special committee of the target company were entitled to the presumptions of the business judgment rule, even though the buyer:
  • Owned or controlled approximately 46% of the target company's outstanding common stock and 89% of its voting power.
  • Had elected half of the directors on the special committee.

Background

The case revolved around the going-private transaction for Kenneth Cole Productions, Inc., a New York corporation ("KCP"), pursuant to a merger agreement with affiliates of KCP's Chairman and Chief Creative Officer, Kenneth D. Cole. The merger agreement was signed on June 6, 2012, and the deal closed on September 25, 2012. For a summary of the merger agreement, see What's Market, Kenneth D. Cole and Kenneth Cole Productions, Inc. Merger Agreement Summary. Before the signing, Cole had been the owner or controller of approximately 46% of KCP's outstanding common stock and 89% of KCP's voting power, resulting from Cole's ownership and control of 100% of KCP's super-voting Class B common stock.
On February 23, 2012, Cole proposed taking KCP private. He initially offered a per share price of $15 and added that he would not entertain any other offers to sell KCP. The $15 per share price represented a 17% premium over the sale price of KCP's stock on the previous day. The proposal was conditioned on:
  • The approval of a special committee of independent directors.
  • The approval of a majority of the shareholders not affiliated with Cole.
The board immediately formed a special committee comprised of four directors (all of the directors of KCP's board other than Cole and Paul Blum, KCP's Vice-Chairman and CEO) to consider the proposal and negotiate with Cole. The proposal was made public the next day. The special committee retained its own legal and financial advisors to help consider the proposal, and negotiated the price with Cole until June 6, 2012, when a merger agreement was announced. The parties settled on a price of $15.25 per share. The deal was financed with a combination of cash on hand, debt financing, new equity financing from Marlin Equities and an equity rollover of Cole's stake in KCP. On September 24, 2012, 99.8% of the shareholders voted to approve the transaction, which closed the next day.
The plaintiff stockholders contended that Cole and the special committee breached their fiduciary duties to the minority shareholders by negotiating an unfair price. Specifically, they argued that:
  • The directors on the special committee were not independent and were controlled by Cole, with two of them having been elected to the board by Cole.
  • The special-committee directors breached their fiduciary duties by failing to solicit superior third-party bids.
  • The special-committee directors breached their fiduciary duties by failing to obtain the highest price possible for the minority shareholders.
  • Cole breached his fiduciary duties by orchestrating a self-interested transaction and hampering the board's ability to negotiate the buyout on terms fair to the minority shareholders by insisting that he would not entertain any alternative third-party transactions.

Outcome

The court dismissed the plaintiffs' complaint. In so doing, it made the following key findings:
  • The special-committee directors, including those elected by Cole, were independent. In the court's words, the plaintiffs "point to no authority for the assertion that a director lacks independence solely on the ground that he or she is elected by a controlling shareholder." The complaint also failed to set forth any other facts that would demonstrate a lack of independence on the part of the other special-committee directors.
  • The special committee did not breach its fiduciary duties by failing to solicit third-party bids, because it knew that Cole would reject any such bids regardless. In addition, the fact that the company received no alternative bids before closing despite the publicity surrounding the transaction indicated that no superior offers were forthcoming.
  • The allegation that the price was unfair was unfounded because:
    • the special committee negotiated for a period of months and obtained an extra $0.25 per share over a bid that already contemplated a premium for the shares;
    • the possibility that the special committee could have obtained a higher price did not mean that the special committee necessarily violated its fiduciary duties, absent any particular facts that indicated a breach of trust or unfair process; and
    • absent a showing of specific unfair conduct by the special committee, the court was bound by the business judgment rule and would not second-guess the committee's negotiation of the terms of the transaction.
  • Although Cole, as the majority shareholder and participant in the company's management, had a duty of trust toward the minority shareholders, he was not prohibited from acting in his own economic interest, as long as his actions did not constitute unfair self dealing. Even Cole's public statement that he would not participate in any third-party transactions was not a violation of that duty, because Cole was not required to acquiesce to any proposed third-party transactions against his own wishes.

Practical Implications

The decision in Kenneth Cole Productions is notable as an example of a how a New York court reached a similar conclusion to what would be expected in Delaware under the same circumstances. The particular findings of the court echo many parallel doctrines of Delaware law, including:
  • The familiar principle that directors are not found to be lacking of independence simply because they were elected by, or have some ordinary business connection to, the controlling shareholder. Substantial ties to the controlling shareholder are necessary to undo the presumption of independence.
  • The oft-repeated truism that there is no "single blueprint" for analyzing the board's performance of its Revlon duties.
  • The finding, recently developed at length in the Synthes decision, that a controlling shareholder is not required to submit himself to a transaction that would harm his own interests for the sake of bettering those of the minority shareholders.
At the same time, it is noteworthy that the decision does not take the same path to these conclusions that the Delaware Court of Chancery might have taken under its MFW framework (see Legal Update, In re MFW: Delaware Court of Chancery Applies Business Judgment Rule to Controlling Stockholder Transaction). Given that the transaction here was entered into with a controlling shareholder, the starting assumption under Delaware law would have been that the standard of entire fairness should apply, unless it can be rebutted. In this case, that standard may very well have been rebutted under MFW, because of the dual conditionality contained in Cole's initial offer.
However, the New York court did not perform that analysis. Rather, once the court found that the directors on the special committee were independent and had not acted in their own interest, it took for granted that they were entitled to the presumptions of the business judgment rule. There is no assumption anywhere in the decision that entire fairness might have been appropriate solely because the target company had entered into a transaction with its controlling shareholder. On the contrary, the court had no issue with Cole negotiating as low a price as possible for his buyout, even though that duality is the very aspect of controlling-shareholder transactions that raises the specter of improper self-dealing and necessitates review under entire fairness absent special circumstances.
The Kenneth Cole Productions decision thus hints at the possibility that going-private transactions are subject to less scrutiny in New York than they are in Delaware.

Court Documents