      IN THE COURT OF CHANCERY OF THE STATE OF DELAWARE


In re KKR FINANCIAL HOLDINGS LLC
                                                 Consol. C.A. No. 9210-CB
SHAREHOLDER LITIGATION




                                    OPINION

                           Date Submitted: July 29, 2014
                          Date Decided: October 14, 2014


Stuart M. Grant, Mary S. Thomas, Nathan A. Cook and Bernard C. Devieux of Grant &
Eisenhofer P.A., Wilmington, Delaware; Mark Lebovitch, Jeroen van Kwawegen and
Adam Hollander of Bernstein Litowitz Berger & Grossmann LLP, New York, New York;
Christine S. Azar, Peter C. Wood, Jr. and Ned C. Weinberger of Labaton Sucharow LLP,
Wilmington, Delaware; Christopher J. Keller, Eric J. Belfi and Michael W. Stocker of
Labaton Sucharow LLP, New York, New York, Co-Lead Counsel for Plaintiffs.

Gregory P. Williams, Blake Rohrbacher and Susan M. Hannigan of Richards, Layton &
Finger, P.A. of Wilmington, Delaware; Paul C. Curnin, Peter E. Kazanoff and Janet A.
Gochman of Simpson Thacher & Bartlett LLP, New York, New York, Attorneys for
Defendants KKR & Co. L.P., KKR Fund Holdings L.P., and Copal Merger Sub LLC.

Collins J. Seitz, Jr., Garrett B. Moritz and Eric D. Selden of Seitz Ross Aronstam &
Moritz LLP, Wilmington, Delaware; William Savitt, Ryan A. McLeod and David Zhou
of Wachtell, Lipton, Rosen & Katz, New York, New York, Attorneys for Defendants
Tracy Collins, Robert L. Edwards, Craig J. Farr, Vincent Paul Finigan, Jr., Paul M.
Hazen, R. Glenn Hubbard, Ross J. Kari, Ely L. Licht, Deborah H. McAneny, Scott C.
Nuttall, Scott Ryles, Willy Strothotte, and KKR Financial Holdings LLC.

BOUCHARD, C.
I.     INTRODUCTION

       This action involves the novel claim that a holder of less than one percent of the

stock of a Delaware corporation was a controlling stockholder and thus owed fiduciary

obligations to the other stockholders of the corporation.

       In April 2004, KKR & Co. L.P. (“KKR”) acquired KKR Financial Holdings LLC

(“KFN”) in a stock-for-stock merger involving two widely-held, publicly-traded

companies. Seeking to overcome the presumption that business judgment review would

apply to such a transaction, plaintiffs argue that entire fairness should apply because

KKR was a controlling stockholder of KFN despite its less than one percent ownership

and because a majority of the twelve members of the KFN board that approved the

merger was beholden to and not independent from KKR.

       Plaintiffs’ controlling stockholder theory is based on the terms of a management

agreement whereby an affiliate of KKR managed the day-to-day business of KFN,

making KFN operationally dependent on KKR. Since KFN’s inception, however, the

ultimate authority for managing its business and affairs, including the decision whether to

approve a merger with KKR, was in the hands of a board of directors subject to annual

stockholder election.

       In this opinion, I conclude that, although the allegations of the complaint

demonstrate that KKR’s affiliate managed the day-to-day operations of KFN, they do not

support a reasonable inference that KKR controlled the board of KFN when it approved

the merger, which is the operative question under Delaware law for determining whether

a stockholder is controlling in this case. For this reason, I dismiss plaintiffs’ fiduciary

                                             1
duty claim against KKR premised on the theory that KKR was a controlling stockholder

of KFN.

          I also conclude that plaintiffs’ fiduciary duty claim against the directors of KFN

fails to state a claim for relief because the board’s approval of the merger is subject to

business judgment review for two independent reasons. First, plaintiffs have failed to

allege facts from which it is reasonably inferable that a majority of the KFN board was

not disinterested in the transaction or independent from KKR. Second, even if plaintiffs

had alleged sufficient facts to reasonably support such an inference, business judgment

review still would apply because the merger was approved by a majority of disinterested

stockholders in a fully-informed vote.

          For these reasons, and others stated below, this action is dismissed with prejudice

under Rule 12(b)(6) for failure to state a claim for relief.

II.       BACKGROUND 1

          A.    The Parties

          Plaintiffs Pompano Beach Police & Firefighters’ Retirement System, Robert A.

Corwin, Eric Greene, Margaret DeMauro and Pipefitters Local Union No. 120 Pension

Fund were stockholders of KFN who owned shares of KFN at all times relevant to this

action.




1
  Unless otherwise noted, the facts recited in this Opinion are based on the allegations in
the complaint, documents integral to or incorporated in the complaint, or facts of which
the Court may take judicial notice.

                                               2
       Defendant KKR, a Delaware limited liability partnership, is a private equity firm

based in New York that specializes in leveraged buyouts. The company was founded in

1976. Today it is a multinational investment firm. KKR completed an initial public

offering on July 15, 2010, and its common stock trades under the ticker symbol “KKR”

on the New York Stock Exchange.

       Defendant KFN, a Delaware limited liability company, was a specialty finance

company whose business was generating income and capital appreciation, primarily

through investing in sub-investment grade corporate debt securities.

       Defendants Tracy Collins, Robert L. Edwards, Craig J. Farr, Vincent Paul Finigan,

Jr., Paul M. Hazen, R. Glenn Hubbard, Ross J. Kari, Ely L. Licht, Deborah H. McAneny,

Scott C. Nuttall, Scott Ryles, and Willy Strothotte (together, the “KFN board”) were the

twelve members of the KFN board of directors in December 2013, when the decision was

made to merge with KKR.

       Defendants KKR Fund Holdings L.P., an exempted limited partnership formed

under the laws of the Cayman Islands (“Holdings”), and Copal Merger Sub LLC, a

Delaware limited liability company (“Copal”), are wholly owned subsidiaries of KKR.

They were parties to the merger agreement along with KKR and KFN.

       B.    The Formation of KKR Financial

       In 2004, KKR formed KKR Financial Corp., a Maryland real estate investment

trust (“KKR Financial”). In June 2005, KKR Financial engaged in an initial public

offering.   The prospectus for that offering described KKR Financial as “a specialty



                                            3
finance company created to invest across multiple asset classes with the objective of

achieving attractive leveraged risk-adjusted returns.” 2

          The 2005 prospectus disclosed that KKR Financial would be “externally managed

and advised by KKR Financial Advisors LLC, an affiliate of KKR, pursuant to a

management agreement.” 3        The prospectus describes the management agreement in

detail. 4 The terms of the management agreement, as amended following the restructuring

of KKR Financial into KFN, are described below.

          C.    The Restructuring of KKR Financial into KFN

          In April 2007, KKR Financial announced a proposed restructuring whereby KKR

Financial would be reincorporated as a subsidiary of KFN, a newly created entity. The

transaction was subject to the approval of the stockholders of KKR Financial. The

prospectus for the transaction (the “2007 Prospectus”) disclosed that KFN would

“assume all obligations of KKR Financial Corp. under the management agreement,”

which would be amended and restated (hereafter, the “Management Agreement”), and

that the “economic terms of the amended and restated management agreement will not be




2
  KKR Fin. Corp., Prospectus (Form B4) 1 (June 24, 2005) (KFN Defs.’ Op. Br. Ex. 1 at
1). Although this document is not referenced in the complaint, I take judicial notice of its
text, which cannot reasonably be disputed. See Narrowstep, Inc. v. Onstream Media
Corp., 2010 WL 5422405, at *5 (Del. Ch. Dec. 22, 2010) (“For example, a court may
take judicial notice of the contents of an SEC filing, but only to the extent that the facts
contained in them are not subject to reasonable dispute.”).
3
    Id. at 6.
4
    Id. at 6-8, 20-22, 101-03, 115-25.

                                              4
changed.” 5 KKR Financial’s stockholders approved the restructuring, which became

effective in May 2007.

      D.     The Management Agreement

      Under the terms of the Management Agreement, KFN delegated responsibility for

its day-to-day operations to KKR Financial Advisors LLC (“KFA” or the “Manager”),

the same affiliate of KKR that had served as the manager of KFN’s predecessor:

                   (b) . . . The Manager will be responsible for the day-to-day
      operations of the Company and will perform (or cause to be performed)
      such services and activities relating to the assets and operations of the
      Company as may be appropriate, including, without limitation: . . .

                                         * * *

             (vii) providing executive and administrative personnel, office space
      and office services required in rendering services to the Company;
             (viii) administering the day-to-day operations of the Company and
      performing and supervising the performance of such other administrative
      functions necessary in the management of the Company as may be agreed
      upon by the Manager and the Board of Directors . . . . 6

Plaintiffs’ complaint quotes public filings of KFN describing its dependence on KFA as a

result of the Management Agreement:


5
  KKR Fin. Corp., Prospectus (Form B4) 2 (Apr. 2, 2007) (KFN Defs.’ Op. Br. Ex. 2 at
2). I take judicial notice of the text of this document, which cannot reasonably be
disputed. See Narrowstep, Inc., 2010 WL 5422405, at *5.
6
  Management Agreement § 2(b)(vii)-(viii) (KFN Defs.’ Op. Br. Ex. 4 § 2(b)(vii)-(viii)).
The complaint discusses the Management Agreement at length. See Compl. ¶¶ 45-49.
Thus, I view the Management Agreement to be integral to the complaint and appropriate
to consider in its entirety on a motion to dismiss. In re New Valley Corp. Deriv. Litig.,
2001 WL 50212, at *4 (Del. Ch. Jan. 11, 2001) (“The Court may … ‘consider, for certain
purposes, the content of documents that are integral to or are incorporated by reference
into the complaint.’”) (citation omitted).

                                           5
         We are highly dependent on our Manager and may not find a suitable
         replacement if our Manager terminates the Management Agreement.

         We have no employees . . . We have no separate facilities and are
         completely reliant on our Manager, which has significant discretion as to
         the implementation and execution of our business and investment
         strategies and our risk management practices. 7

Similar disclosures were made in the 2007 Prospectus, when KFN was created to replace

KKR Financial. 8

         According to plaintiffs, the Management Agreement made KFA responsible for,

among other things, “(i) selecting, purchasing and selling KFN’s investments; (ii) KFN’s

financing and risk management; and (iii) providing investment advisory services to

KFN.” 9 Plaintiffs also allege that KFN was reliant on KKR to value its assets.

         KFN’s primary asset was a portfolio of subordinated notes in collateralized loan

transactions that financed the leveraged buyout activities of KKR. The vast majority of

KFN’s holdings and liabilities were “Level 2” and “Level 3” assets, meaning that there

were no observable market prices for those holdings and liabilities. KFN valued those

assets and liabilities by applying a valuation model, which relied on inputs, estimations

and judgments that KKR supplied and controlled.

7
 Compl. ¶ 45 (quoting KKR Fin. Hldg. LLC, Annual Report (Form 10-K) 43-44 (Feb.
28, 2013).
8
  See 2007 Prospectus at 23 (“We have no employees. … We have no separate facilities
and are completely reliant on our Manager, which has significant discretion as to the
implementation and execution of our business and investment strategies and our risk
management practices. We are also subject to the risk that our Manager will terminate
the management agreement and that no suitable replacement will be found.”).
9
    Compl. ¶ 46.

                                             6
       In exchange for the services they provided, KKR and its affiliates were entitled to

receive from KFN a base management fee equal to one-twelfth of KFN’s equity

multiplied by 1.75%, certain incentive compensation based on a complex formula and

reimbursement of certain expenses. These fees (without expenses) equated to $60.5

million and $65.8 million, respectively in 2011 and 2012.

       The Management Agreement renewed automatically each year by its own terms.

KFN and its stockholders could terminate the Management Agreement under certain

circumstances. According to plaintiffs, “they can do so only under certain conditions,

generally with nearly six months advance notice, and with a Termination Fee of four

times the sum of the average annual base management and incentive fee for the two years

preceding termination.” 10   Plaintiffs allege that, if the Management Agreement was

terminated without cause on December 31, 2012, KFN would have been required to pay

KKR approximately $252.6 million, which exceeded the amount of cash and cash

equivalents on its balance sheet at that time (approximately $221.9 million).

       Notwithstanding KFN’s reliance on KFA to manage KFN’s day-to-day operations,

the Management Agreement explicitly provided that KFA would be subject to the

supervision of KFN’s board of directors:

       The Manager, in its capacity as manager of the assets and the day-to-day
       operations of the Company, at all times will be subject to the supervision of
       the Company’s Board of Directors and will have only such functions and

10
   Compl. ¶ 48. The payment of the Termination Fee referenced in the complaint is
triggered under Section 15(a) of the Management Agreement. Section 13(a) of the
Management Agreement further provides that the Manager may be terminated “for
cause” under certain circumstances without paying the Termination Fee.

                                            7
         authority as the Company may delegate to it including, without limitation,
         the functions and authority identified herein and delegated to the Manager
         hereby. 11

More broadly, the Amended and Restated Operating Agreement of KFN (the “LLC

Agreement”), the original version of which was disclosed publicly as part of the 2007

Prospectus, empowers KFN’s board of directors using language similar to Section 141(a)

of the Delaware General Corporation Law. It provides that, except as otherwise provided

in the LLC Agreement, “the business and affairs of [KFN] shall be managed by or under

the direction of its Board of Directors.” 12

         E.    The Merger Negotiations

         In October 2013, KKR expressed an interest in acquiring KFN to Hazen, one of

KFN’s directors. At this time, and at all times relevant to this action, KKR owned less

than 1% of the shares of KFN. 13


11
     Management Agreement § 2(b) (KFN Defs.’ Op. Br. Ex. 4 § 2(b)).
12
   Amended and Restated Operating Agreement of KKR Fin. Hldg. LLC § 6.2 (KFN
Defs.’ Op. Br. Ex. 5 § 6.2) (hereafter, the “LLC Agreement”). As discussed above, I take
judicial notice of the text of the 2007 Prospectus because it cannot reasonably be
disputed. Section 6.3 of the LLC Agreement provides for the elimination of fiduciary
duty claims against KFN’s directors to the fullest extent permitted by law if they act in
accordance with the Management Agreement.
13
   Citing KKR’s Form 10-K filed on February 22, 2013, plaintiffs allege that, as of
December 31, 2012, KKR owned 0.1% of KFN’s outstanding shares and would own
0.35% if it exercised all of its vested options to buy KFN shares. Compl. ¶ 44. This is
the only allegation in the complaint concerning KKR’s ownership position in KFN. In
briefing the motion to dismiss, all parties assumed that this was the level of KKR’s
ownership position at all relevant times. KKR’s Form 10-K filed on February 24, 2014,
states that, if KKR were to exercise all of its outstanding vested options, its ownership
interest in KFN would be less than 1% of KFN’s outstanding shares as of December 31,
2013. KKR & Co. L.P., Annual Report (Form 10-K) 234 (Feb. 24, 2014). Consistent
                                               8
      On October 22, 2013, Hazen raised KKR’s interest in acquiring KFN at a KFN

board meeting. During the meeting, the KFN board granted KKR permission to use

confidential information about KFN it had obtained through KFA’s service as Manager in

order to make an acquisition proposal.

      After the October 22 board meeting, Hazen asked Farr, a senior executive of KKR

who was serving as the President, CEO and a director of KFN, whether KKR would

consider modifying or eliminating the Termination Fee in the Management Agreement.

Farr contacted KKR and was informed that KKR was unwilling to do so.

      On October 31, 2013, KFN formed a Transaction Committee (the “Transaction

Committee”) to consider a potential transaction. 14 The Transaction Committee consisted

of six of the twelve directors on the KFN board: Edwards, Collins, Finigan, Kari,

McAneny, and Ryles. Edwards was named Chair of the Transaction Committee. The

Transaction Committee retained Sandler O’Neill + Partners L.P. as its financial advisor

and Wachtell, Lipton, Rosen & Katz as its legal advisor.

      On November 21, 2013, Hazen attended a meeting of the Transaction Committee

to update its members on KFN’s prospects as a stand-alone company. Plaintiffs allege



with the foregoing, and for simplicity, I refer to KKR’s ownership position in KFN as
being less than 1%.
14
   Compl. ¶ 86. Plaintiffs’ complaint omits the publicly-disclosed fact that KKR
submitted a proposal to acquire KFN in an all stock transaction the day before, on
October 30, which was conditioned on the approvals of an independent KFN board
committee and a majority of KFN common stockholders unaffiliated with KKR. KKR
Fin. Corp., Definitive Proxy Statement (Schedule 14A) 31 (Mar. 25, 2014) (KFN Defs.’
Op. Br. Ex. 9 at 31) (hereafter, the “2014 Proxy”).

                                            9
that the Transaction Committee recognized that an all-stock deal could be

disadvantageous to KFN because its shares were trading near their one-year low while

KKR’s units were trading near their one-year high.        The Transaction Committee

proposed a cash deal to KKR, but KKR rejected it.         The Transaction Committee

negotiated for improvements to KKR’s proposal, which plaintiffs allege were

“meager.” 15

         On December 9, 2013, Hubbard, KFN’s Lead Independent Director, met with

KKR co-heads and founders Henry Kravis and George Roberts for the purpose of

attempting to negotiate a higher price for KFN’s stockholders. At the meeting, Kravis

and Roberts refused to increase the merger consideration above 0.50 KKR units for each

KFN share. 16

         The next day, on December 10, 2013, Kravis and Roberts met with the KFN

board. After the meeting, KKR revised its offer to a “best and final offer” of 0.51 KKR

units per KFN share. 17 At the request of Edwards, Chair of the Transaction Committee,

Hazen contacted KKR and asked for consideration of 0.52 KKR shares per KFN share.

KKR rejected this request.




15
     Compl. ¶ 88.
16
   Compl. ¶ 89.     Plaintiffs’ complaint omits any reference to a series of interim
discussions and the Transaction Committee’s previous rejection of proposals involving
lower exchange ratios (0.46 and 0.48) that are described in the 2014 Proxy. 2014 Proxy
at 31-33 (KFN Defs.’ Op. Br. Ex. 9 at 31-33).
17
     Compl. ¶ 90.

                                          10
       On December 13, 2013, the KFN board, excluding Farr and Nuttall, met to discuss

the proposed transaction. The Transaction Committee then met and voted to recommend

the proposed transaction to the KFN board. The full KFN board, again excluding Farr

and Nuttall, reconvened and approved the transaction.        Sandler O’Neill delivered a

fairness opinion to the Transaction Committee concluding that, as of December 16, 2013,

the exchange ratio was fair, from a financial point of view, to KFN’s stockholders.

       On December 16, 2013, KKR and KFN executed the merger agreement. At an

exchange ratio of 0.51 KKR units per KFN share, the transaction reflected a 35%

premium to KFN’s closing price on that day. Based on KKR’s common unit price on

December 16, 2013, the transaction was valued at approximately $2.6 billion.

       F.     The Merger Agreement and Stockholder Approval

       The merger agreement contained several deal protection provisions: (1) a

termination fee of $26.25 million, representing approximately 1% of the estimated $2.6

billion value of the transaction when the merger agreement was signed, (2) a no-shop

provision barring KFN from soliciting or negotiating alternative proposals with third-

parties, subject to a “fiduciary out” if a third party made an unsolicited bid for at least

15% of KFN that could reasonably be expected to lead to a competing bid, and (3) a

“matching rights” provision requiring KFN to submit any alternative proposal to KKR

within one day and giving KKR four business days to match or better the alternative

proposal before KFN can engage with the competing bidder.

       The merger was subject to the approval of holders of a majority of KFN’s

common shares. The merger agreement required that the requisite majority include a

                                            11
majority of shares held by persons other than KKR and its affiliates. 18 The merger

agreement’s definition of “affiliate” excludes investment funds, other investment

advisory vehicles, and portfolio companies of investment funds. 19

         On March 24, 2014, a definitive proxy statement was issued soliciting KFN’s

stockholder to approve the proposed merger (the “2014 Proxy”). On April 30, 2014,

KFN’s stockholders voted in favor of the proposed merger, including a majority of the

outstanding KFN common shares entitled to vote on the merger held by common

stockholders other than KKR and its affiliates. 20

         G.    Procedural History

         On December 27, 2013, the first of nine actions were filed in this Court

challenging the proposed merger. These actions were consolidated on January 31, 2014.



18
     Compl. ¶ 98.
19
     Compl. ¶ 99.
20
   In their answering brief, plaintiffs state that “[o]n April 30, 2014, KFN filed a Schedule
13E-3 with the U.S. Securities and Exchange Commission announcing that a majority of
the outstanding KFN common shares entitled to vote at a special meeting held that day
had approved the Merger Agreement.” Pls.’ Ans. Br. 16. The cited Schedule 13E-3
more fully states as follows: “On April 30, 2014, at a special meeting of KFN’s common
shareholders, the holders of a majority of the outstanding KFN common shares entitled to
vote on the adoption of the Merger Agreement, including a majority of the outstanding
KFN common shares entitled to vote on the Merger Agreement held by common
shareholders other than KKR and its affiliates, affirmatively voted to adopt the Merger
Agreement.” KKR Fin. Hldg. LLC, Amended Going Private (Schedule 13E-3) 3 (Apr.
30, 2014). I take judicial notice of the result of the transaction, which is not disputed.
See In re General Motors (Hughes) S’holder Litig., 897 A.2d 162, 170-71 (Del. 2006)
(holding that Court of Chancery did not err when it took judicial notice of stockholder
vote approving transactions where there existed no reasonable dispute as to whether
stockholder approval had occurred).

                                             12
         On February 21, 2014, plaintiffs filed a Verified Consolidated Class Action

Complaint (referred to herein as the “complaint”) asserting three claims for relief. Count

I asserts that the members of the KFN board breached their fiduciary duties of due care

and loyalty by agreeing to the merger. Count II asserts that KKR breached its fiduciary

duty of loyalty in its capacity as a controlling stockholder of KFN by causing KFN to

enter into the merger agreement at an unfair price and following an unfair process. Count

III asserts that KKR, Holdings and Copal (KFN’s counterparties to the merger

agreement) aided and abetted the KFN board’s breach of fiduciary duty.

         On March 7, 2014, defendants moved to dismiss the complaint in its entirety under

Rule 12(b)(6) for failure to state a claim upon which relief can be granted. Plaintiffs

made no effort to challenge the sufficiency or accuracy of the disclosures in the 2014

Proxy before the meeting of KFN’s stockholders was held on April 30, 2014, or to seek

to enjoin the closing of the transaction on any other basis.

III.     LEGAL ANALYSIS

         “A cardinal precept of the General Corporation Law of the State of Delaware is

that directors, rather than shareholders, manage the business and affairs of the

corporation.” 21 Enhanced judicial scrutiny under Revlon is not implicated in this action

because the stock-for-stock merger involved widely-held, publicly traded companies. 22

Thus, the business judgment rule presumptively applies.


21
     Aronson v. Lewis, 473 A.2d 805, 811 (Del. 1984) (citing 8 Del C. § 141(a)).
22
   See Arnold v. Soc’y for Sav. Bancorp, Inc., 650 A.2d 1270, 1290 (Del. 1994) (“[T]here
is no ‘sale or change in control’ when ‘[c]ontrol of both [companies] remain[s] in a large,
                                             13
         Under the business judgment rule, “the judgment of a properly functioning board

will not be second-guessed and ‘[a]bsent an abuse of discretion, that judgment will be

respected by the courts.’” 23 “To avoid application of the deferential business judgment

standard, the plaintiff must produce evidence that rebuts the business judgment

presumption.” 24

         There are a number of ways a plaintiff can rebut the business judgment

presumption, including by showing that: (1) a controlling stockholder stands on both

sides of a transaction 25 or (2) at least half of the directors who approved the transaction

were not disinterested or independent. 26 “If the plaintiff rebuts the business judgment

presumption, the Court applies the entire fairness standard of review to the challenged

action and places the burden on the directors to prove that the action was entirely fair.” 27

         If the plaintiff is able to rebut the business judgment presumption, dismissal at this

stage of the litigation would, in all likelihood, be inappropriate. 28 If, however, plaintiffs



fluid, changeable and changing market.’”) (quoting Paramount Commc’ns Inc. v. QVC
Network Inc., 637 A.2d 34, 47 (Del. 1994)).
23
  Orman v. Cullman, 794 A.2d 5, 20 (Del. Ch. 2002) (quoting Aronson, 473 A.2d at
812).
24
     eBay Domestic Holdings, Inc. v. Newmark, 16 A.3d 1, 36 (Del. Ch. 2010).
25
  See Williamson v. Cox Commc’ns Inc., 2006 WL 1586375, at *4 (Del. Ch. June 5,
2006).
26
     See Aronson, 473 A.2d at 812.
27
     eBay Domestic Holdings, Inc., 16 A.3d at 36-37.
28
  See Hamilton P’rs, L.P. v. Highland Capital Mgmt., L.P., 2014 WL 1813340, at *12
(Del. Ch. May 7, 2014) (“[T]he possibility that the entire fairness standard of review may
                                               14
are unable to rebut the business judgment presumption, they “will not be entitled to any

remedy unless the challenged transaction constitutes waste.” 29 Having not alleged waste,

plaintiffs’ complaint here will be dismissed if they fail to rebut the business judgment

presumption.

         Plaintiffs argue that entire fairness review of the transaction is implicated, thereby

precluding dismissal at this stage of the litigation. As to Count II, which is based on

KKR’s alleged breach of fiduciary duty, plaintiffs contend that KKR was a controlling

stockholder of KFN. As to Counts I and III, which are based on the KFN board’s alleged

breaches of fiduciary duty, plaintiffs argue that entire fairness review is appropriate

because the majority of the KFN board was not disinterested and independent.

         For their part, defendants argue that business judgment review is appropriate, and

requires dismissal of all claims, because KKR was not a controlling stockholder of KFN

and because the majority of the KFN board that approved the transaction was

independent and disinterested. Defendants also contend that, even if the majority of the

board was not independent and disinterested, the business judgment rule still applies

because the transaction was approved by a fully informed majority of disinterested

stockholders of KFN.




apply tends to preclude the Court from granting a motion to dismiss under Rule 12(b)(6)
unless the alleged controlling stockholder is able to show, conclusively, that the
challenged transaction was entirely fair based solely on the allegations of the complaint
and the documents integral to it.”).
29
     Zutrau v. Jansing, 2014 WL 3772859, at *17 (Del. Ch. July 31, 2014).

                                               15
         For the reasons explained below, I conclude that it is not reasonably inferable from

the complaint that KKR was a controlling stockholder of KFN or that a majority of the

KFN board was not disinterested or independent. I also conclude that, even if the

majority of the KFN board was not disinterested or independent, business judgment

review still applies because the merger was approved by a majority of disinterested KFN

stockholders in a fully informed vote. Thus, all three claims in the complaint will be

dismissed for failure to state a claim upon which relief can be granted.

         A.     Motion to Dismiss Under Rule 12(b)(6)

         A motion to dismiss pursuant to Rule 12(b)(6) for failure to state a claim must be

denied “unless the plaintiff would not be entitled to recover under any reasonably

conceivable set of circumstances.” 30 “In determining whether a pleading meets this

minimal standard, this Court draws all reasonable inferences in the plaintiff’s favor,

accepts all well-pleaded factual allegations as true, and even accepts ‘vague allegations in

the Complaint as ‘well pleaded’ if they provide the defendant notice of the claim.’” 31

         B.     The Complaint Fails to State a Claim that
                KKR was a Controlling Stockholder of KFN

         Plaintiffs argue that “the entire fairness standard applies to the [merger] because

KKR controls KFN.” 32 Relatedly, plaintiffs allege in Count II that KKR breached its


30
  Cent. Mortg. Co. v. Morgan Stanley Mortg. Capital Holdings LLC, 27 A.3d 531, 535
(Del. 2011); see also Winshall v. Viacom Int’l., Inc., 76 A.3d 808, 813 n.12 (Del. 2013).
31
 Seinfeld v. Slager, 2012 WL 2501105, at *2 (Del. Ch. June 29, 2012) (quoting Cent.
Mortg. Co., 27 A.3d at 536).
32
     Compl. ¶ 149.

                                              16
fiduciary duty of loyalty in its capacity as a controlling stockholder of KFN because

“KKR, which through certain of its affiliates is a stockholder of KFN, dominates and

controls KFN by virtue of the Management Agreement through which it provides all of

KFN’s management and operations.” 33

         In 1994, in the seminal case of Kahn v. Lynch Communications Systems, Inc.

(“Lynch”), the Delaware Supreme Court described two scenarios in which a stockholder

could be found a controller under Delaware law: where the stockholder (1) owns more

than 50% of the voting power of a corporation or (2) owns less than 50% of the voting

power of the corporation but “exercises control over the business affairs of the

corporation.” 34 This case concerns the second scenario because KKR owned less than

1% of the KFN common shares when the KFN board approved the merger. To survive a

motion to dismiss under this theory, plaintiffs must allege facts demonstrating “actual

control with regard to the particular transaction that is being challenged.” 35

         In 2003, in what has been recognized as perhaps this Court’s “most aggressive

finding that a minority blockholder was a controlling stockholder,” 36 then-Vice

Chancellor Strine found after trial in In re Cysive, Inc. Shareholders Litigation, 37 that a


33
     Compl. ¶ 157.
34
   Kahn v. Lynch Commc’ns Sys., Inc., 638 A.2d 1110, 1113-14 (Del. 1994) (quoting
Ivanhoe P’rs v. Newmont Mining Corp., 535 A.2d 1334, 1344 (Del. 1987)).
35
     Cox Commc’ns Inc., 2006 WL 1586375, at *4.
36
     In re Morton’s Rest. Gp., Inc. S’holders Litig., 74 A.3d 656, 665 (Del. Ch. 2013).
37
     836 A.2d 531 (Del. Ch. 2003).

                                              17
35% stockholder (Nelson Carbonell) who was the company’s visionary founder and a

“hands-on” Chairman and CEO, was a controlling stockholder. The Court concluded

that, “[i]n practical terms, Carbonell holds a large enough block of stock to be the

dominant force in any contested [Company] election,” especially when the votes of “a

unified voting coalition” consisting of his subordinate and family members are taken into

account along with the fact that “a 100% turn-out is unlikely even in a contested

contest.” 38

           Three years later, again focusing on the second scenario identified in Lynch, then-

Vice Chancellor Strine stated in In re PNB Holding Co. Shareholders Litigation, that the

“actual control” test “is not easy to satisfy,” and can only be met where “stockholders

who, although lacking a clear majority, have such formidable voting and managerial

power that they, as a practical matter, are no differently situated than if they had majority

voting control.” 39 The Court explained that the Lynch line of jurisprudence “has been

premised on the notion that when a controller wants the rest of the shares, the controller’s

power is so potent that independent directors and minority stockholders cannot freely

exercise their judgment, fearing retribution from the controller.” 40

           One week after PNB Holding was decided, this Court considered the second

scenario identified in Lynch in the context of a motion to dismiss. In Superior Vision

38
     Id. at 551-52, 552 n.30.
39
  In re PNB Holding Co. S’holders Litig., 2006 WL 2403999, at *9 (Del. Ch. Aug. 18,
2006).
40
     Id.

                                               18
Services, Inc. v. ReliaStar Life Insurance Co., 41 plaintiff argued that a 44% stockholder of

ReliaStar owed fiduciary obligations as a controlling stockholder regarding the

company’s payment of dividends because the stockholder had a contractual right that

effectively enabled it to veto any dividend payments. In performing its analysis, the

Court asked “whether the actual control must be over the Board or whether separately

negotiated contract rights can supply the requisite degree of control.” 42 Based on its

examination of Lynch and subsequent cases, 43 the Court concluded that “Delaware case

law has focused on control of the board:”

          [T]he focus of the inquiry has been on the de facto power of a significant
          (but less than majority) shareholder, which, when coupled with other
          factors, gives that shareholder the ability to dominate the corporate
          decision-making process. The concern is that the significant shareholder
          will use its power to obtain (or compel) favorable actions by the board to
          the ultimate detriment of other shareholders. 44

The Court granted the motion to dismiss finding that the allegation that ReliaStar had

“taken advantage of its contractual rights for its own purposes” was, without more, “not

41
     2006 WL 2521426 (Del. Ch. Aug. 25, 2006) (granting motion to dismiss).
42
     Id. at *4.
43
   In addition to Lynch, the Court examined Cox Commc’ns, Inc., 2006 WL 1586375
(denying defendants’ motion to dismiss because the allegations in the complaint
supported a reasonable inference that a stockholder group (Cox and Comcast) with
combined holdings of 17.1% of At Home common stock was controlling where “Cox and
Comcast had the ability to shut down the effective operation of the At Home board of
directors by vetoing board actions”); and In re Western Nat. Corp. S’holders Litig., 2000
WL 710192 (Del. Ch. May 22, 2000) (46% stockholder with ability to purchase an
additional 20% during any twelve month period was not controlling because plaintiffs did
not establish that the stockholder “exercised actual control over [the Company]’s
business and affairs”).
44
     Superior Vision Servs., Inc., 2006 WL 2521426, at *4 (emphasis added).

                                             19
sufficient to allege that ReliaStar is a ‘controlling stockholder’ bound by fiduciary

obligations.” 45

          Last year, in In re Morton’s Restaurant Group, Inc. Shareholders Litigation, 46

then-Chancellor Strine again held that the analysis for determining when a minority

stockholder will be deemed controlling focuses on the stockholder’s alleged ability to

control the board:

          When a stockholder owns less than 50% of the corporation’s outstanding
          stock, “a plaintiff must allege domination by a minority shareholder
          through actual control of corporate conduct.” The bare conclusory
          allegation that a minority stockholder possessed control is insufficient.
          Rather, the Complaint must contain well-pled facts showing that the
          minority stockholder “exercised actual domination and control over . . .
          [the] directors.” That is, under our law, a minority blockholder is not
          considered to be a controlling stockholder unless it exercises “such
          formidable voting and managerial power that [it], as a practical matter, [is]
          no differently situated than if [it] had majority voting control.”
          Accordingly, the minority blockholder’s power must be “so potent that
          independent directors . . . cannot freely exercise their judgment, fearing
          retribution” from the controlling minority blockholder. 47

The Court concluded that plaintiffs had failed to plead facts supporting a rational

inference that a 27.7% stockholder who had two employees on the board owed fiduciary

obligations as a controlling stockholder.       The Court stated that “[t]he fact that two

employees of Castle Harlan sat on the board, without more, does not establish actual




45
     Id. at *5.
46
     74 A.3d 656 (Del. Ch. 2013).
47
     Id. at 664-65 (emphasis added) (citations omitted).

                                               20
domination of the board, especially given that there were eight directors not affiliated

with Castle Harlan.” 48

          Here, plaintiffs argue that the complaint’s “allegations support the strong inference

that KKR has ‘actual control’ over the ‘corporate conduct’ of KFN” because of the

unique relationship between KKR and KFN, largely defined by the terms of the

Management Agreement. 49         Plaintiffs specifically rely on the allegations that “KKR

created KFN,” “all of KFN’s officers are employees of KKR and its affiliates,” KFN is

admittedly “completely reliant” on KKR’s affiliate (KFA), “KFN’s primary asset and

reason for existence is a portfolio . . . that finance[s] the leveraged buyout activities of

KKR,” and KFN cannot extricate itself from KKR without paying a significant fee.50

Plaintiffs’ counsel acknowledged that their position, which really has nothing to do with

the amount of voting power KKR held in KFN, raises a “novel question.” 51

          In my opinion, the allegations of the complaint do not support a reasonable

inference that KKR was a controlling stockholder of KFN within the meaning of this

Court’s precedents.       Although these allegations demonstrate that KKR, through its

affiliate, managed the day-to-day operations of KFN, they do not support a reasonable

inference that KKR controlled the KFN board—which is the operative question under

Delaware law—such that the directors of KFN could not freely exercise their judgment in

48
     Id. at 665.
49
     Pls.’ Ans. Br. 21 (quoting Cox Commc’ns Inc., 2006 WL 1586375, at *4).
50
     Compl. ¶¶ 2, 7, 45, 48-49; Pls.’ Ans. Br. 17-25.
51
     Hearing Tr. 57 (July 29, 2014).

                                               21
determining whether or not to approve and recommend to the stockholders a merger with

KKR.

       KKR’s less than 1% position in KFN obviously would create no concern in the

mind of KFN’s directors that KKR possessed sufficient voting power to remove them

from their positions if they rejected the merger proposal or took any other action KKR

did not like. The complaint also is devoid of any allegation that KKR had a contractual

right to appoint any (much less a majority) of the members of the KFN board, to dictate

any action by the board, to veto any action of the board or to prevent the board from

hiring advisors and gathering information in order to be fully-informed.

       Plaintiffs’ real grievance, as I see it, is that KFN was structured from its inception

in a way that limited its value-maximizing options. According to plaintiffs, KFN serves

as little more than a public vehicle for financing KKR-sponsored transactions and the

terms of the Management Agreement make KFN unattractive as an acquisition target to

anyone other than KKR because of KFN’s operational dependence on KKR and because

of the significant cost that would be incurred to terminate the Management Agreement. I

assume all that is true. But, every contractual obligation of a corporation constrains the

corporation’s freedom to operate to some degree and, in this particular case, the

stockholders cannot claim to be surprised. Every stockholder of KFN knew about the

limitations the Management Agreement imposed on KFN’s business when he, she or it




                                             22
acquired shares in KFN. 52 They also knew that the business and affairs of KFN would be

managed by a board of directors that would be subject to annual stockholder elections. 53

         At bottom, plaintiffs ask the Court to impose fiduciary obligations on a relatively

nominal stockholder, not because of any coercive power that stockholder could wield

over the board’s ability to independently decide whether or not to approve the merger,

but because of pre-existing contractual obligations with that stockholder that constrain

the business or strategic options available to the corporation. Plaintiffs have cited no

legal authority for that novel proposition, and I decline to create such a rule. 54

         The one case decided within the traditional framework of Delaware controlling

stockholder law that plaintiffs do cite, Williamson v. Cox Communications, Inc., 55 is

readily distinguishable.    There, the Court found at the pleadings stage that it was

reasonably inferable that two stockholders (Cox and Comcast), together holding a 17.1%

stake in At Home, were controlling stockholders.            In doing so, the Court placed

significant weight on the ability of Cox and Comcast “to shut down the effective



52
  As discussed above, the terms of the initial Management Agreement were in place and
publicly disclosed when KKR Financial went public in 2005, and were publicly disclosed
again in 2007 when KFN was created and became the successor entity.
53
 Section 6.5 of the KFN LLC Agreement provides for directors to be elected annually at
meeting of its members. LLC Agreement § 6.5 (KFN Defs.’ Op. Br. Ex. 5 § 6.5).
54
  A separate question is whether a sufficient number of the KFN directors were beholden
to KKR at the time of the merger such that the board could not exercise independent
judgment in considering the merger proposal, thereby rebutting the presumption of the
business judgment rule. That issue is considered below in Section III.C.
55
     2006 WL 1586375 (Del. Ch. June 5, 2006).

                                              23
operation of the At Home board of directors by vetoing board actions.” 56 Apart from the

fact that a 17% stake represents a whole different ballgame than a less than 1% stake, the

complaint here contains no well-pled facts from which it would be reasonable to infer

that KKR could veto any action of the KFN board.

          In sum, in deciding whether a stockholder owes a fiduciary obligation to the other

stockholders of a corporation in which it owns only a minority interest, the focus of the

inquiry is on whether the stockholder can exercise actual control over the corporation’s

board. Here, there are no well-pled facts from which it is reasonable to infer that KKR

could prevent the KFN board from freely exercising its independent judgment in

considering the proposed merger or, put differently, that KKR had the power to exact

retribution by removing the KFN directors from their offices if they did not bend to

KKR’s will in their consideration of the proposed merger. For this reason, the allegations

of the complaint fail to demonstrate that it is reasonably conceivable that KKR was a

controlling stockholder under Delaware law. Thus, Count II fails to state a claim upon

which relief can be granted.

          C.      Business Judgment Review Applies Because a Majority of the
                  KFN Board was Disinterested and Independent

          Plaintiffs alternatively argue that entire fairness review of the merger should apply

because the majority of the KFN board was not independent. Plaintiffs do not allege that

any of the KFN directors were interested in the merger.



56
     Id. at *5.

                                               24
         Delaware law presumes the independence of corporate directors. To overcome

that presumption, a plaintiff must allege facts as to the interest and/or lack of

independence of the individual members of a board.          “Independence means that a

director’s decision is based on the corporate merits of the subject before the board rather

than extraneous considerations or influences.” 57       Plaintiffs can show a lack of

independence “by pleading facts that support a reasonable inference that the director is

beholden to a controlling person or ‘so under their influence that their discretion would

be sterilized.’” 58

         When the merger was approved, the KFN board had twelve members: Collins,

Edwards, Farr, Finigan, Jr., Hazen, Hubbard, Kari, Licht, McAneny, Nuttall, Ryles, and

Strothotte.    Two of the board members, Farr and Nuttall, were high-level KKR

employees at the time of the merger who did not vote on the transaction. 59 Defendants

sensibly do not contend that they were independent.

         In my opinion, it is reasonably conceivable that two other directors, Hazen and

Hubbard, would not be found independent of KKR. According to the complaint, Hazen

57
     Aronson, 473 A.2d at 816.
58
  In re Trados Inc. S’holder Litig., 2009 WL 2225958, at *6 (Del. Ch. July 24, 2009)
(quoting Rales v. Blasband, 634 A.2d 927, 936 (Del. 1993)).
59
  Farr joined KKR in 2006. At the time of the merger, he served as the head of KKR
Asset Management LLC, a subsidiary of KKR. He was also a Member of KKR, oversaw
KKR’s Capital Markets and Origination business, and sat on KKR’s Risk Committee.
Compl. ¶ 22. Nuttall joined KKR in 1996. At the time of the merger, he headed KKR’s
Global Capital and Asset Management Group. He was also involved in funds affiliated
with KKR and has played a significant role in a number of KKR’s private equity
investments. Compl. ¶ 29.

                                            25
had longstanding ties to KKR and, among other things, served as a Senior Advisor to

KKR and as Chairman of KKR affiliate Accel-KKR at the time of the merger. 60

Plaintiffs allege that Hubbard is the Dean of Columbia University Business School,

which recently received a $100 million donation from KKR co-founder Kravis, an

alumnus. 61

         Plaintiffs do not challenge the independence of four of the KFN directors: Collins,

Finigan Jr., Ryles, and Strothotte. For the reasons set forth below, I find that plaintiffs

also have failed to allege facts under which it is reasonably conceivable that any of the

four remaining directors lacked independence from KKR.

               1.     Deborah H. McAneny

         The complaint alleges that McAneny was appointed by KKR to the board of KKR

Financial, KFN’s predecessor, in April 2005. 62 Plaintiffs stipulated that McAneny has

been reelected (albeit in uncontested elections) each year since she joined the KKR

60
   Compl. ¶¶ 63-64. Defendants vigorously dispute the allegation that Hazen was a
Senior Advisor to KKR at the time of the merger. KFN Defs.’ Reply Br. 18-19. They
cite to the 2014 Proxy, which states that Hazen served as a Special Advisor to KKR from
2001 to 2011. 2014 Proxy at 223. The 2014 Proxy also states that Accel-KKR, of which
Hazen was the Chairman, “is not an investment fund managed by the KKR Group and
operates independently from it.” Although I am skeptical of the accuracy of the
complaint’s allegations concerning Hazen’s relationship with KKR given these
disclosures, I accept them as true for purposes of this decision.
61
   See Off v. Ross, 2008 WL 5053448, at *11 (Del. Ch. Nov. 26, 2008) (“Ross’s
substantial donation [of $100 million] raises considerable doubt as to the independence of
Dolan. . . . [T]he donation of such a prodigious sum coupled with the fact that Ross
became the eponym of the benefiting institution calls into question the independence of
Defendant Dolan.”).
62
     Compl. ¶ 61.

                                             26
Financial board nine years ago. 63     It is well-settled Delaware law that a director’s

independence is not compromised simply by virtue of being nominated to a board by an

interested stockholder. 64 The complaint fails to allege any additional facts to support the

contention that McAneny was not independent. Consequently, plaintiffs have failed to

allege facts that support a reasonably conceivable inference that McAneny was beholden

to KKR.

                 2.     Robert L. Edwards

         Plaintiffs argue that Edwards is beholden to KKR because he “owes his position as

CEO of Safeway to KKR-affiliated directors on the Safeway board.” 65 This assertion is

conclusory. In March 2004, after KKR liquidated its holdings in Safeway, Edwards

joined Safeway as its Executive Vice President and Chief Financial Officer. 66 At that

time, there allegedly were four KKR-affiliated directors on the Safeway board, including


63
     Hearing Tr. 19 (July 29, 2014).
64
   See Aronson v. Lewis, 473 A.2d 805, 815 (Del. 1984) (finding that directors who were
“personally selected” by a 47% stockholder did not lack independence); Frank v.
Elgamal, 2014 WL 957550, at *22 (Del. Ch. Mar. 10, 2014) (“Merely because a director
is nominated and elected by a large or controlling stockholder does not mean that he is
necessarily beholden to his initial sponsor.”); Blaustein v. Lord Baltimore Capital Corp.,
2013 WL 1810956, at *18 n.114 (Del. Ch. Apr. 30, 2013) (stating that allegations that a
director was appointed to the board by and has consistently voted with alleged controller
are insufficient to challenge the director’s independence), aff’d, 84 A.3d 954 (Del. 2014);
Western Nat. Corp. S’holders Litig., 2000 WL 710192, at *15 (Del. Ch. May 22, 2000)
(“As a preliminary matter, I note that even if American General nominated some of the
outside directors . . . such nomination, without more, does not mandate a finding that
these directors were beholden to American General . . . .”).
65
     Pls.’ Ans. Br. at 34.
66
     Compl. ¶¶ 64(a), 67.

                                            27
KKR co-founder Roberts and defendant Hazen. The complaint does not allege, however,

that those KKR-affiliated directors ever constituted a majority of the Safeway board or

that they had the power to hire or promote Edwards. 67 Absent such allegations, the

complaint fails to allege facts that support a reasonably conceivable inference that

Edwards was beholden to KKR. 68

               3.     Ross J. Kari

         The complaint does not allege any facts suggesting a direct relationship between

Kari and KKR. Plaintiffs instead attempt to impugn Kari’s independence based on a

transitive theory under which Kari is not independent from KKR because he allegedly is

beholden to Hazen, who allegedly is beholden to KKR. Specifically, the complaint

alleges that Kari and Hazen previously worked together at Wells Fargo. 69 Kari was



67
    Because Safeway is a public corporation, one easily could ascertain the full
composition of its board of directors at relevant times. In fact, plaintiffs attached to their
answering brief Safeway’s Form 8-K, filed on October 19, 2004, which shows that KKR
co-founder Roberts left the Safeway board in October 2004, seven months after Edwards
joined Safeway as CFO in March 2004.
68
   Plaintiffs cite to Rales v. Blasband and Harbor Finance Partners v. Huizenga as
support for their contention that Edwards was beholden to KKR. The non-conclusory
allegations made by plaintiffs here do not approach the active relationships that existed in
either case. See Rales v. Blasband , 634 A.2d 927 (Del. 1993) (finding that it could be
inferred that Ehrlich was beholden to the Rales brothers where Ehrlich was president,
earning annual compensation of $300,000, and his two brothers were vice presidents of a
company in which the Rales brothers were directors and owned a majority stake); Harbor
Finance Partners v. Huizenga, 751 A.2d 879 (Del. Ch. 1999) (finding reasonable doubt
that Hudson could impartially evaluate demand that would have an adverse effect on his
brother-in-law, Huizenga, because of their familial relationship and pattern of mutually
advantageous business relationships that spanned over 30 years).
69
     Compl. ¶ 18.

                                             28
employed by Wells Fargo for 18 years, beginning in 1983, including as Chief Financial

Officer from 1998 to 2001. 70       Hazen was employed by Wells Fargo for 31 years,

including as Vice Chairman from 1978 to 1984, President and COO from 1984 to 1995,

Chairman and President and CEO from 1995 to 1998, and Chairman from 1998 to

2001. 71

           Although the complaint alleges that Kari “owed [his] advancement and success to

[Hazen] for many years,” the complaint offers no factual allegations to support this

conclusory allegation. 72 Plaintiffs’ argument can be properly characterized as asserting

that Kari is beholden to Hazen by virtue of their past business relationship. But, this

Court has held in the context of dismissing claims under Rule 12(b)(6) that the “naked

assertion of a previous business relationship is not enough to overcome the presumption

of a director’s independence.” 73 This conclusion has particular force here, where the past

business relationship ended twelve years before the transaction at issue in this case.
70
     Compl. ¶ 68.
71
     Id.
72
     Id.
73
   Orman v. Cullman, 794 A.2d 5, 27 (Del. Ch. 2002); see also Crescent/Mach I P’rs,
L.P. v. Turner, 846 A.2d 963, 980-81 (Del. Ch. 2000) (“Second, plaintiffs assert that
Turner dominated and controlled Hunt. In support, they allege that Turner controls Hunt
because of their long-standing 15-year professional and personal relationship. This
allegation alone fails to raise a reasonable doubt that Hunt could not exercise his
independent business judgment in approving the transaction.”); In re MFW S’holders
Litig., 67 A.3d 496, 509 (Del. Ch. 2013) (“Our law is clear that mere allegations that
directors are friendly with, travel in the same social circles, or have past business
relationships with the proponent of a transaction or the person they are investigating, are
not enough to rebut the presumption of independence.”), aff’d sub nom., Kahn v. M & F
Worldwide Corp., 88 A.3d 635 (Del. 2014).

                                              29
Thus, the complaint fails in my view to allege facts that support a reasonably conceivable

inference that Kari was not independent from KKR when the KFN board approved the

merger in 2013, because of a business relationship Kari had with Hazen, having nothing

to do with KKR, which ended twelve years earlier.

               4.     Ely L. Licht

         Plaintiffs assert the same transitive theory to challenge the independence of Licht

as they did with Kari. Specifically, plaintiffs allege that Licht lacks independence from

KKR by virtue of being beholden to Hazen because Licht was employed at Wells Fargo

for 18 years that overlapped with Hazen’s tenure there, including when Licht was Chief

Credit Officer from 1998 to 2001 and Executive Vice President for Credit Administration

from 1990 to 1998. 74 For the reasons discussed above, this past business relationship

does not raise a reasonable inference that Licht was not independent from KKR in 2013.

         The complaint further alleges that Licht is “indebted” to KKR because he was the

Executive Vice President and Chairman of Credit Policy of Capmark from March 2007 to

February 2009 and served as a consultant to Capmark from March 2009 to August

2009. 75 The complaint alleges that as of March 31, 2006, an investor group led by KKR

owned 75% of Capmark. The complaint does not allege, however, that KKR continues to

own a position in Capmark or that Licht continues to work for Capmark. 76             Thus,


74
     Compl. ¶ 68.
75
     Compl. ¶69.
76
  Capmark Fin. Gp. Inc., Application for Qualification of Indentures (Form T-3) 1 (July
11, 2011). Licht’s tenure at Capmark concluded no later than October of 2009 when the
                                             30
plaintiffs’ contention that Licht is beholden to KKR again rests solely on a previous

business relationship, which is insufficient in my view to support a reasonable inference

that Licht was beholden to KKR in 2013.

                                          * * * * *

         For the foregoing reasons, I conclude that plaintiffs have failed to allege facts that

support a reasonable inference that eight of the twelve KFN directors, constituting eight

of the ten who voted on the transaction, were not independent from KKR.                  Thus,

plaintiffs have failed to rebut the presumption that the business judgment rule applies to

the KFN board’s decision to approve the merger.           Plaintiffs have not challenged the

merger as being irrational or on the grounds of waste or gift, nor could the allegations of

the complaint support such a claim. Accordingly, Count I of the complaint, asserting that

the members of the KFN board breached their fiduciary duties of due care and loyalty by

agreeing to the merger, fails to state a claim upon which relief may be granted.

         D.     Business Judgment Review Applies Because KFN’s Disinterested
                Stockholders Approved the Merger in a Fully Informed Vote

         Relying on Chancellor Strine’s decision last year in Morton’s (discussed above)

and his earlier decision in Harbor Finance Partners v. Huizenga, 77 defendants argue that,

because the merger did not involve a controlling stockholder and was approved by a fully


company filed for bankruptcy. Although this information was not contained in the
complaint, I take judicial notice of Capmark’s SEC filings to this effect, which cannot
reasonably be disputed. See Narrowstep, Inc., 2010 WL 5422405, at *5.
77
     751 A.2d 879 (Del. Ch. 1999).



                                               31
informed vote of KFN’s stockholders, the business judgment rule applies and insulates

the merger from all attacks other than on the grounds of waste.              Put differently,

defendants argue that, even if a majority of the KFN’s directors were not independent, the

business judgment presumption still would apply because of the effect of untainted

stockholder approval of the merger.

         Plaintiffs do not take issue with defendants’ position concerning the legal effect of

a fully informed vote where a controlling stockholder is not involved. They instead argue

that the complaint alleges that the 2014 Proxy omitted material information. 78 They

make this argument even though the complaint does not contain a disclosure claim per se

and even though plaintiffs made no effort to enjoin the stockholder vote on the merger

based on any alleged disclosure deficiencies.

                1.     Plaintiffs’ Disclosure Challenges

         For stockholder approval of any corporate action to be valid, the vote of the

stockholders must be fully informed. 79 In this context, that means that the 2014 Proxy

must have disclosed all facts material to the KFN stockholders. Defendants, who have

asserted this defense, bear the burden of establishing that the 2014 Proxy disclosed all

material facts. 80




78
     Pls.’ Ans. Br. 40-46.
79
     See Citron v. E.I. DuPont de Nemours & Co., 584 A.2d 490, 502-03 (Del. Ch. 1990).
80
     See Bershad v. Curtiss-Wright Corp., 535 A.2d 840, 846 (Del. 1987).

                                              32
          In an effort to avoid the effect of stockholder approval, plaintiffs claimed that the

2014 Proxy omitted material facts.         The alleged omissions appear to concern three

matters: (1) the independence of the Transaction Committee, (2) the role of Hazen and

Farr in the merger negotiations, and (3) the adequacy of the disclosures regarding the

financial analysis of Sandler O’Neill. For reasons set forth below, I find that these

disclosure challenges are without merit and thus that defendants have established that the

stockholder vote was fully informed. 81

                        a.     The Independence of the Transaction Committee

          Plaintiffs’ first disclosure argument is difficult to discern. Citing two parts of the

2014 Proxy, plaintiffs assert that “Defendants . . . have claimed that their directors,

including the members of the Transaction Committee, are independent.” 82               Without

identifying any fact concerning any particular director that allegedly was omitted from

the 2014 Proxy, plaintiffs then recite a legal proposition:           “Whether directors are

conflicted – particularly those charged with negotiating the terms of a strategic

transaction – is an undeniably material fact that must be disclosed.” 83



81
   See Solomon v. Armstrong, 747 A.2d 1098, 1127-32 (Del. Ch. 1999) (determining on
motion to dismiss that plaintiffs disclosure claims were without merit and thus defendant
satisfied burden of establishing that stockholder vote was fully informed), aff’d, 746 A.2d
277 (Del. 2000); In re Gen. Motors Class H S’holders Litig., 734 A.2d 611, 616-17 (Del.
Ch. 1999) (same).
82
   Pls.’ Ans. Br. 41-42. Both of the cited parts of the 2014 Proxy refer only to the
independence of the members of the Transaction Committee and not to any other
director.
83
     Id. at 42.

                                                33
       Plaintiffs appear to be taking issue with the fact that the 2014 Proxy did not state

that some or all of the members of the Transaction Committee were not independent. As

an initial matter, the factual premise underlying plaintiffs’ position rings hollow because,

as discussed above, the complaint fails to allege facts sufficient to overcome the

presumption of independence of any of the members of the Transaction Committee. 84

Even if that were not the case, however, the duty of disclosure does not require directors

to admit wrongdoing. To necessitate such a disclosure would require that directors

“engage in self-flagellation and draw legal conclusions,” in conflict with well settled

Delaware law. 85 Consequently, plaintiffs have failed to identify any deficiencies in the

2014 Proxy regarding the independence of the members of the Transaction Committee.

                     b.     Hazen’s and Farr’s Role in the Negotiations

       Plaintiffs’ second disclosure argument appears to concern Hazen’s and Farr’s roles

in the merger negotiations. Plaintiffs assert in their brief that the complaint alleges that

“Hazen, not the Transaction Committee, was truly responsible for heading the

negotiations between KKR and KFN, a direct challenge to the story told by the Company




84
   The Transaction Committee consisted of six members. Plaintiffs did not even
challenge the independence of four of them (Collins, Finigan, Ryle Strothote) and, for the
reasons discussed above, it is not reasonably inferable from the allegations of the
complaint that either of the other two (Edwards and Kari) was not independent.
85
   Stroud v. Grace, 606 A.2d 75, 84 n.1 (Del. 1992) (“We recognize the long-standing
principle that to comport with its fiduciary duty to disclose all relevant material facts, a
board is not required to engage in ‘self-flagellation’ and draw legal conclusions
implicating itself in a breach of fiduciary duty from surrounding facts and circumstances
prior to a formal adjudication of the matter.”).

                                            34
regarding the sales process.” 86 In an accompanying string citation, plaintiffs cite the

allegation that the “Proxy contains no explanation as to why the admittedly and clearly

conflicted Farr spearheaded the negotiation of [the termination fee in the Management

Agreement].” 87

           In fact, the 2014 Proxy explains in detail the roles Hazen and Farr played in the

merger negotiations. Specifically, it discloses that Kravis and Roberts informed Hazen

(through Farr) in October 2013, that KKR was considering making an offer; 88 that Hazen

relayed that information to the KFN board on October 22, 2013; 89 that Hazen and Farr

had discussions regarding the possibility of modifying the Termination Fee in the

management agreement, but that Farr was informed by KKR that they were unwilling to

do so; 90 that Hazen attended a meeting of the Transaction Committee on November 21,

2013, for the purpose of updating the members of the Transaction Committee on KFN’s

financial performance and viability as a stand-alone entity; 91 and that Hazen (at Edwards’

request) contacted Roberts on December 10, 2013, to request that KKR increase the

proposed ratio to 0.52 KKR common units per KFN common share. 92 The 2014 Proxy


86
     Pls.’ Ans. Br. 43.
87
     Id. at 44.
88
     2014 Proxy at 31.
89
     Id.
90
     Id.
91
     Id. at 33.
92
     Id. at 35.
                                              35
also discloses Hazen’s and Farr’s relationships with KKR, which form the basis for

plaintiffs’ contention that Hazen and Farr were not independent. 93

         Plaintiffs’ real grievance appears to be that the 2014 Proxy did not explain “why”

Hazen and Farr allegedly spearheaded the merger negotiations. But, as this Court has

held, “[a]sking ‘why’ does not state a meritorious disclosure claim.” 94

                       c.     Sandler O’Neill’s Financial Analysis

         Plaintiffs challenge the adequacy of the disclosures concerning Sandler O’Neill’s

financial analysis based on the allegation in their complaint that “[t]he Proxy provides no

explanation why KFN, a sophisticated investment vehicle controlled by a global private

equity firm, did not prepare basic management financial projections to assist Sandler

O’Neill in its valuation analysis.” 95 Once again, however, “asking why” does not state a

meritorious disclosure claim.

                                          * * * * *

         For the foregoing reasons, I find that plaintiffs’ challenges to the 2014 Proxy are

without merit and that the KFN stockholder vote approving the merger was fully

informed. 96



93
  Id. at 223. The 2014 Proxy discloses that Hazen was a Senior Advisor for the KKR
Group from 2001 to 2011. As discussed above, defendants vigorously dispute that Hazen
held this position at the time of the merger.
94
     See In re Sauer-Danfoss, 65 A.3d at 1131.
95
     Pls.’ Ans. Br. 43 (citing Compl. ¶ 131).
96
 In their answering brief, plaintiffs bemoan the fact that identifying disclosure violations
was made more difficult by their inability to take discovery. Pls.’ Ans. Br. 46. Plaintiffs
                                                36
                  2.   The Effect of Stockholder Approval

         As noted above, plaintiffs do not disagree with defendants’ position that the legal

effect of a fully-informed stockholder vote of a transaction with a non-controlling

stockholder is that the business judgment rule applies and insulates the transaction from

all attacks other than on the grounds of waste, even if a majority of the board approving

the transaction was not disinterested or independent. This position is supported by

numerous decisions, including then-Vice Chancellor Jacobs’ 1995 decision in In re

Wheelabrator Technologies, Inc. Shareholders Litigation, 97 and then-Vice Chancellor

Strine’s later decision in Harbor Finance, which, in turn, recited numerous supporting

authorities. 98

         In light of the Delaware Supreme Court’s 2009 decision in Gantler v. Stephens, 99

there has been some debate as to whether the standard articulated in Wheelabrator,

Harbor Finance and other decisions remains good law when the stockholder vote is


are not entitled to discovery to make disclosure challenges as a matter of right. See
Weinberger v. Palm Beach, Inc., 1985 WL 11581, at *2 (Del. Ch. July 9, 1985)
(“[P]laintiffs are not entitled to discovery in search of a new cause of action. To the
extent that the complaint, as it presently reads, fails to state a cause of action, any
discovery effectively would be in search of a new cause of action.”) (citation omitted).
97
  663 A.2d 1194, 1200 (Del. 1995) (holding that “the effect of the shareholder vote” in a
case involving a duty of loyalty claim challenging an interested transaction was to
“invoke the business judgment standard, which limits review to issues of gift or waste
with the burden of proof resting upon the plaintiffs”).
98
  Harbor Fin., 751 A.2d at 890 (Del. Ch. 1999) (citing Marciano v. Nakash, 535 A.2d
400, 405 n.3 (1987); In re General Motors Class H S’holders Litig., 734 A.2d 611, 616
(Del. Ch. 1999); Solomon v. Armstrong, 747 A.2d 1098, 1113-17 (Del. Ch. 1999)).
99
     Gantler v. Stevens, 965 A.2d 695 (Del. 2009).

                                             37
statutorily required as opposed to a purely voluntary stockholder vote. For reasons

discussed below, which are similar in substance to those articulated by Vice Chancellor

Laster in a recent article, 100 I do not read Gantler to have altered the legal effect of a

stockholder vote when it is statutorily required.    Instead, I read it simply to clarify the

meaning of the term “ratification.”

         In Gantler, stockholders approved a reclassification of the corporation’s shares. A

stockholder vote was required under 8 Del. C. § 242 because the reclassification required

an amendment to the corporation’s certificate of incorporation. Applying the standard

articulated in Wheelabrator and its progeny, this Court dismissed a breach of fiduciary

duty claim challenging the reclassification. After finding that a majority of the board

may have been interested or not independent when it decided to effect the

reclassification, the Court determined that the reclassification was subject to the business

judgment rule because it had been approved by a majority of the corporation’s

unaffiliated stockholders. 101

         On appeal, the Delaware Supreme Court reversed, finding that the complaint

sufficiently alleged that the proxy disclosures were materially misleading. After doing

so, Justice Jacobs, writing for the Court, quoted at length from his Court of Chancery

decision in Wheelabrator to explain that the “scope and effect of the common law




100
  See J. Travis Laster, The Effect of Stockholder Approval on Enhanced Scrutiny, 40
Wm. Mitchell L. Rev. 1443 (2014).
101
      Gantler v. Stephens, 2008 WL 401124, at *1, 15-23 (Del. Ch. Feb. 14, 2008).

                                             38
doctrine of shareholder ratification is unclear.” 102      He then wrote that, “[t]o restore

coherence and clarity to this area of our law, we hold that the scope of the shareholder

ratification doctrine must be limited to its so-called ‘classic’ form; that is, to

circumstances where a fully informed shareholder vote approves director action that does

not legally require shareholder approval in order to become legally effective.” 103 The

Court further explained that “the only director action or conduct that can be ratified is

that which the shareholders are specifically asked to approve.” 104

            The Supreme Court in Gantler did not expressly address the legal effect of a fully

informed stockholder vote when the vote is statutorily required. Having determined that

the proxy disclosures were materially misleading, the Supreme Court did not need to

reach that question.

            Although the language from the Supreme Court’s decision quoted above could be

interpreted to imply that the legal effect of a fully informed stockholder vote would be

different when the vote was voluntary as opposed to statutorily required, I do not read it

that way. To read it that way would mean that the Supreme Court intended to overrule

extensive precedent, including Justice Jacobs’ own earlier decision in Wheelabrator,

which involved a statutorily required stockholder vote to consummate a merger. 105 Had



102
      Gantler II, 965 A.2d at 712.
103
      Id. at 713.
104
      Id.
105
  Wheelabrator involved the merger of Wheelabrator Technologies, Inc. (“WTI”) into a
wholly-owned subsidiary of Waste Management, Inc. (“Waste”) in a stock-for-stock
                                                39
the Supreme Court intended to do so, I believe the Court would have expressly stated

such an intention. 106 Instead, I read the Supreme Court’s discussion of the doctrine of

ratification in Gantler to have been intended simply to clarify that the term “ratification”

applies only to a voluntary stockholder vote. 107     As the Supreme Court stated in a

footnote at the end of its decision, “[t]his Opinion clarifies that ‘ratification’ legally

describes only corporate action where stockholder approval is not statutorily required for

its effectuation.” 108

                                          *****


merger whereby Waste went from being a 22% stockholder of WTI to a 55% stockholder
of WTI. Similar to the merger at issue in this case, a stockholder vote was statutorily
required (see 8 Del. C. § 251(c)) and the transaction was “conditioned upon the approval
of a majority of WTI’s disinterested stockholders.” Wheelabrator, 663 A.2d at 1197.
106
    By contrast, for example, the Supreme Court in Gantler did expressly overrule Smith
v. Van Gorkom, 488 A.2d 858 (Del. 1985), to the extent it held that the “cleansing” of a
ratifying stockholder vote is to “extinguish” a claim altogether as opposed to subjecting
the challenged director action to business judgment review. Gantler, 965A.2d at 713 n.
54.
107
    Notably, in two decisions involving stockholder approval of merger transactions
issued after the Supreme Court’s decision in Gantler, then-Chancellor Strine reiterated
the view that approval of disinterred stockholders has the effect of invoking business
judgment review. In re S. Peru Copper Corp. S’holder Derivative Litig., 52 A.3d 761,
793 n.113 (Del. Ch. 2011)(“[I]t has long been my understanding of Delaware law, that
the approval of an uncoerced, disinterested electorate of a merger (including a sale)
would have the effect of invoking the business judgment standard of review.”); In re
Morton’s, 74 A.3d at 663 n.34. (“[W]hen disinterested approval of a sale to an arm’s-
length buyer is given by a majority of stockholders who have had the chance to consider
whether or not to approve the transaction for themselves, there is a long line and sensible
tradition of giving deference to the stockholders’ voluntary decision, invoking the
business judgment rule standard of review, and limiting any challenges to the difficult
argument that the transaction constituted waste.”).
108
      Gantler II, 965 A.2d at 714 n.55.

                                            40
         For the foregoing reasons, I conclude that, even if plaintiffs had pled facts from

which it was reasonably inferable that a majority of KFN’s directors were not

independent, the business judgment standard of review still would apply to the merger

because it was approved by a majority of the shares held by disinterested stockholders of

KFN in a vote that was fully informed. Accordingly, and because plaintiffs have not

alleged a claim for waste or gift, Count I of the complaint is dismissed for this

independent reason.

         E.     Aiding and Abetting

         Count III of the complaint alleges that KKR and two of its subsidiaries that were

parties to the merger agreement (Holdings and Copal) aided and abetted the individual

defendants’ breach of fiduciary duties. “To state a claim for aiding and abetting, a

plaintiff must allege: (1) the existence of a fiduciary relationship; (2) a breach of the

fiduciary’s duty; (3) knowing participation in that breach by the defendants; and (4)

damages proximately caused by the breach.” 109 An aiding and abetting claim “may be

summarily dismissed based upon the failure of the breach of fiduciary duty claims against

the director defendants.” 110 Having found that Count I fails to state a claim for breach of

breach of fiduciary duty claim against the individual defendants, Count III also is

dismissed.




109
      Dent v. Ramtron Int. Corp., 2014 WL 2931180, at *17 (Del. Ch. June 30, 2014).
110
      Meyer v. Alco Health Servs. Corp., 1991 WL 5000, at *2 (Del. Ch. Jan. 17, 1991).

                                             41
IV.   CONCLUSION

      For the foregoing reasons, defendants’ motions to dismiss all three counts of the

complaint under Court of Chancery Rule 12(b)(6) for failure to state a claim for relief are

GRANTED. The complaint is dismissed in its entirety with prejudice.

      IT IS SO ORDERED.




                                            42
