By Anne Sherry, J.D.
With over a third of the voting power in NCI Building Systems, along with a proportionate number of insiders on the board and contractual veto rights, private equity firm Clayton, Dubilier & Rice may have controlled the company sufficient to cast doubt on its 2018 acquisition of Ply Gem. The Delaware Court of Chancery denied motions to dismiss a challenge to the merger, except as to four individuals who were effectively exculpated (Voigt v. Metcalf, February 10, 2020, Laster, J.).
In 2018 CD&R completed a leveraged buyout of Ply Gem Holdings, Inc., and combined it with another company, becoming a 70 percent owner of the resulting entity. Three months later, NCI acquired that new Ply Gem entity. An NCI stockholder challenged the merger on the basis that CD&R controlled both sides of the acquisition, requiring the defendants to establish that the transaction was entirely fair. The plaintiff alleged that CD&R had valued the Ply Gem entity at $638 million during the first transaction but insisted on a $1.2 billion valuation in the second.
Largely denying the defendants’ motions to dismiss, the court spent the bulk of its decision determining that there were multiple factors creating a reasonable inference of CD&R’s control over NCI. First, CD&R had the right to nominate four directors out of twelve, and it filled those seats with individuals it controlled. The private equity firm also had relationships with four other directors that contributed to a reasonable inference of actual control over the company.
Another factor contributing to control was the fact that CD&R held 34.8 percent of the voting power in NCI. Although this falls short of a majority, the court noted that stockholders who oppose a significant minority shareholder must vote at supermajority rates. Assuming 80 percent voter turnout, a 35-percent blockholder will win unless 90 percent of unaffiliated shares vote in opposition. The court also viewed CD&R’s voting power in the context of a stockholders agreement that allowed it to block actions the board could otherwise take unilaterally. While the stockholders agreement also contained measures that limited CD&R’s ability to retaliate against directors, CD&R did not give up its ability to vote its shares other than reelection or compensation or its contractual rights. Still other indicia of control included CD&R’s actual influence at the board level and its relationship with management and the company’s advisors.
Having inferred control at the pleadings stage, the court determined not to dismiss the breach of fiduciary duty claim against CD&R in its capacity of controller. Control implicated the entire fairness standard of review, requiring the defendants to demonstrate a fair price and a fair process. The valuation gap between the two transactions involving Ply Gem, occurring just three months apart, supported an inference of unfair price at the pleading stage. The complaint also called into question the fairness of the sale process, particularly undisclosed conflicts and inadequate disclosures in the proxy statement.
Furthermore, although four directors were effectively shielded by an exculpatory clause, the court declined to dismiss the breach-of-duty claims against several other directors with ties to CD&R. It would also be premature to rule on the four CD&R directors’ defense that they could not be liable because they recused themselves and abstained from voting. They did not withdraw from the process entirely, and given that they were dual fiduciaries to both the company and its stockholders, it was unlikely that they could have participated in the process while also obtaining dismissal under an abstention theory. The matter of their compliance with their fiduciary duties would require fact-specific analysis.
The case is No. 2018-0828-JTL.