Earlier this week, the Delaware Court of Chancery ruled that AT&T breached its duty of loyalty by engaging in an unfair and self-interested transaction as part of a minority-partner freeze-out.
In In re Cellular Telephone Partnership Litigation, (C.A. No. 6885-VCL) (Del. Ch. March 9, 2022), Vice Chancellor Laster issued a detailed, 134-page opinion following a five-day trial last year. The decision was a bellwether for 12 other similar freeze-out transactions that AT&T performed around the country.
AT&T’s partnerships originated in the 1980s as part of the Federal Communications Commission’s (FCC) lottery system for awarding cellular telephone networks in various geographic areas. At the time, lottery participants would commonly enter into arrangements similar to an office pool — if one of the pool participants won the FCC’s lottery, the winner received a 50.01% partnership interest and the others received shares of the remaining 49.99% interest. A pool participant for the Salem, Ore. area won and promptly sold its controlling partnership interest to AT&T.
AT&T, as the majority owner, controlled every aspect of the partnership. AT&T controlled the outcome of any partner-level vote. AT&T dominated the partnership’s Executive Committee by having two votes to the minority partner’s single vote. AT&T also controlled the partnership’s daily operations.
As the cell phone industry evolved, AT&T began to explore ways to eliminate its minority partners. AT&T foresaw that wireless voice communication had peaked, but that demand for data services would grow exponentially in connection with the launch of smartphones. With revenues and partnership profits expected to skyrocket, AT&T focused its efforts on eliminating partnerships where minority holders had no ability to block the buyouts.
In 2010, AT&T completed its partnership valuation and offered the minority partners a 5% premium over the $219 million valuation. Several minority partners balked at the offer but were unable to stop it. AT&T sent the objecting partners their pro rata share of the freeze-out price, and litigation ensued in 2011.
Because AT&T controlled the partnership and stood on both sides of the freeze-out, the court applied the entire fairness standard of review. As such, AT&T bore the burden of proving the freeze-out’s process and price were entirely fair. Looking at all the factors, the court concluded that AT&T breached its duty of loyalty by failing to follow a fair process and by imposing an unfair price. Of primary importance, the court determined that:
- AT&T timed the freeze-out to acquire the minority partner’s interests before the data revolution increased the partnership’s value;
- AT&T decided upon every term of the freeze-out and did not negotiate any aspect of the deal with the minority partners;
- AT&T failed to condition the freeze-out on a majority-of-the-minority vote;
- AT&T created a coercive, two-tier offer that pressured the minority partners to accept an offer with a 5% premium or else be cashed out at a lower price;
- AT&T provided false answers and refused to respond to the minority partner’s questions at the partnership meeting where the freeze-out was approved;
- AT&T’s valuation firm had a long relationship with AT&T and followed AT&T’s requests and instructions to lower the final valuation;
- AT&T withheld certain vital information from its valuation firm;
- AT&T failed to account for the full value to which the partnership was contractually entitled;
- AT&T’s internal documents indicated the partnership was worth considerably more than the $219 million freeze-out price; and
- AT&T relied upon unconvincing valuation methodologies.
The court then exercised its “broad powers” to craft its remedy — taking special care to take into account “principles of disgorgement and award of damages designed to eliminate the possibility of profit flowing from the” fiduciary-duty breach. The court ultimately rejected AT&T’s $219 million valuation and concluded the partnership’s actual fair value was $714 million. The court awarded the minority partners their pro rata share of the partnership value, plus 12 years of compounding pre- and post-judgment interest.
- We are tempted to say, “just do the opposite” of what AT&T did here. The court found fault with almost every aspect of AT&T’s process and price. Reading through the opinion, it’s hard to find anything that AT&T did correctly. But let’s focus on a few key things AT&T could have done to improve its chances.
- Any business transaction subject to the “entire fairness” test will be held to an exceptionally high level of judicial review. And the burden shifts from plaintiff to defendant to prove “entire fairness.” Take extra care in such situations and avoid the mistakes AT&T committed here. Take special care if you’re repeating the same transaction multiple times, like AT&T did here.
- AT&T knew it was likely to be drawn into litigation with this freeze-out. It retained “litigation counsel” years before the freeze-out occurred. AT&T and its litigation counsel interviewed potential valuation firms with an eye towards how they would appear and testify in court. AT&T’s strategy in the years before the freeze-out all seemed targeted toward obfuscating and establishing a pre-text for buying out the minority partners. The court drew several adverse inferences from this conduct and recognized that “outside counsel” was brought in “to shape the record for litigation.”
- Here’s an easy one: Once you’re in litigation, don’t infuriate the court with discovery misconduct. The court made a special point of commenting that “AT&T was the most obstructive litigant that this judge has ever seen, whether in private practice or the bench.” Discovery in this case lasted an eye-popping eight years. Vice Chancellor Laster has been on the bench for 13 years and practiced for decades before that. There are no juries in the Delaware Court of Chancery. Your fate is entirely in the judge’s hands. Don’t make the judge mad.
- At trial, AT&T chose not to call the original valuation firm that came up with the $219 million valuation. Instead, AT&T called a long-time testifying expert on freeze-out valuations. Plaintiffs were able to utilize this expert’s past opinions and testimony to show contradictions and inconsistencies. Already skeptical of AT&T, the court looked cross-eyed at this tactic of hiding AT&T’s original valuation firm and instead relying on a separate analysis prepared solely for trial. If you’re going to freeze-out minority partners, put your valuation firm forward to defend the value. And if you use another expert to establish valuation, make sure the expert has been consistent with valuation methodologies over the years. Expert reports and testimony are often publicly available, and they become sitting ducks for impeachment.