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Delaware Chancery Court Denies Motion to Dismiss and Applies Entire Fairness Standard to Transaction with Controlling Stockholder

September 1, 2014

On April 15, 2014, Kessler Topaz successfully defeated a motion to dismiss in an action brought by a stockholder of Erickson Air-Crane, Inc. (“Erickson” or the “Company”) that alleged the Company’s majority stockholder caused the Company to overpay for the assets of financially troubled Evergreen Helicopters, Inc. (“Evergreen”) and its insolvent parent Evergreen International Aviation, Inc. (“EIA”) to the detriment of Erickson and its minority stockholders. Erickson’s majority stockholder, ZM Funds, held a majority of the $125 million in second lien debt owed by EIA and Evergreen.

As part of the transaction, Erickson was in effect paying off debt owed by EIA and Evergreen to ZM Funds and others at face value in order to protect ZM Funds’ subordinated debt position in EIA/Evergreen. In declining to dismiss the claims, Vice Chancellor J. Travis Laster held that entire fairness review applies in a case where a controlling stockholder stands on both sides of a transaction. Under this standard, the controlling stockholder has the burden of proving that the transaction was fair to the company’s minority stockholders in both its financial terms and the process employed in arriving at the transaction. 

In March 2013, Erickson, EIA and Evergreen entered into a Stock Purchase Agreement (“SPA”) pursuant to which Erickson purchased the capital stock of Evergreen for $185 million in cash, a $17.5 million Erickson unsecured promissory note and approximately 4 million shares of Erickson preferred stock valued at $47.5 million by attributing a value of $11.85 per share. Concurrently with the SPA, Erickson and EIA entered into a Second Lien Stock Purchase Agreement with ZM Funds and other holders of $125 million of second lien debt owed by EIA and Evergreen, pursuant to which 3,375,527 shares of the preferred stock valued at $11.85 per share would be delivered to the second lien debt holders, including ZM Funds, on a dollar-for-dollar basis in exchange for $40 million of second lien debt, valued at face value. Accordingly, ZM Funds received a total of 1,689,155 shares of preferred stock, worth approximately $32.9 million on the date received, at a discounted price of $11.85 per share in exchange for $20 million face value of second lien debt of EIA/Evergreen. 

On August 8, 2013, Kessler Topaz commenced litigation against Erickson, its board of directors and ZM Funds. On December 4, 2013, Kessler Topaz filed an amended complaint seeking: (i) to recover for Erickson’s minority stockholders the dilution and expropriation of value of their Erickson shares that resulted from the elements of the transaction that benefited the holders of first and second lien debt, including ZM Funds; (ii) to force disgorgement and restitution of the improper profits that ZM Funds realized as a result of the transaction; and (iii) equitable remedies, including cancellation of the shares held by ZM Funds. 

After briefing by both parties, on April 15, 2014, Vice Chancellor Laster held oral argument on defendants’ motion to dismiss and denied the motion on three separate grounds. First, Vice Chancellor Laster agreed with plaintiff that defendants provided extensive information outside the pleadings that converted the motion to dismiss into a motion for summary judgment. He denied the motion so plaintiff can have the opportunity to take discovery. Second, Vice Chancellor Laster agreed with plaintiff that the complaint adequately states both direct claims (dilution suffered by Erickson’s minority stockholders) and derivative claims (over-issuance of Erickson shares to ZM Funds) as recognized by the Delaware Supreme Court in Gentile v. Rossette, 906 A.2d 91 (Del. 2006) and Gatz v. Ponsoldt, 925 A.2d 1265 (Del. 2007). Finally, in analyzing demand futility for the derivative claims, Vice Chancellor Laster held that in a case where a controlling stockholder, such as ZM Funds, stands on both sides of a transaction, demand futility is analyzed under the more exacting standard of entire fairness as opposed to the more deferential business judgment standard. Relying on Kahn v. Tremont Corp., 694 A.2d 422 (Del. 1997), Vice Chancellor Laster stated “[b]ecause the transaction involves a controller [ZM Funds], entire fairness is the standard . . . Demand is futile under the second prong of [Aronson v. Lewis, 473 A.2d 805 (Del. 1984)].” 

This outcome represents a substantial accomplishment for Kessler Topaz and will protect minority stockholders of public corporations from a domineering controlling stockholder. Kessler Topaz is continuing to litigate its claims to recover for the Company and its minority stockholders the damages caused as a result of the transaction.

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