In In re KKR Financial Holdings LLC Shareholder Litigation, C.A. No. 9210 (Del. Ch. Oct. 14, 2014), the Delaware Court of Chancery dismissed a shareholder derivative suit brought by shareholders of KKR Financial Holdings LLC (KFN) alleging, among other claims, a breach of fiduciary duties by each of (1) KKR & Co. L.P. (KKR), as an alleged controlling stockholder, and (2) KFN’s board of directors, in connection with the acquisition by KKR of KFN in a stock-for-stock merger. 

In dismissing plaintiff’s claims, Chancellor Bouchard held that the business judgment rule, rather than the entire fairness standard, applied because (1) KKR, as a stockholder with less than a one percent ownership interest in KFN and no control over KFN’s board of directors at the time the merger was approved, was not a controlling stockholder of KFN as a matter of law, and (2) plaintiffs failed to show that a majority of the KFN board was not disinterested in the transaction or independent from KKR. The court provided further that, even if a majority of the KFN board was not independent, the business judgment rule still would have applied because the merger was approved by a majority of shares held by disinterested stockholders in a fully informed vote.

Under the seminal case on controlling stockholders under Delaware law, Kahn v. Lynch Communications Systems, Inc., 638 A.2d 1110 (Del. 1994), a stockholder may be considered controlling even if it owns less than 50 percent of the voting power of a company, so long as it nonetheless “exercises control over the business affairs of the corporation.” In relying on recent decisions analyzing the scenarios under which a stockholder may be considered “controlling” under Delaware law, Chancellor Bouchard held that whether a stockholder exercises control over a company turns on whether the stockholder controls the company’s board of directors. The court stated: “[I]n 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.” 

In this case, the court held that KKR was not a controlling stockholder because (1) KKR’s less than one percent ownership interest in KFN would not create any concern among KFN’s directors that it possessed sufficient voting power to remove them from their positions and (2) KKR did not possess any contractual rights to appoint any (let alone a majority) of the members of the KFN board or to direct any action by the KFN board and could not exercise actual control over the KFN board. The court did not find it persuasive that an affiliate of KKR exercised day-to-day control over KFN’s business operations since the ultimate authority to manage KFN remained with KFN’s board. 

The full opinion can be found here.