We have been debating on this Blog (here, here and here) the concept of “control” in a company in the light of the Securities and Exchange Board of India’s (SEBI’s) consultation process that is currently underway. In this context, it would be useful to consider developments from elsewhere that may be instructive. This post considers a recent decision of the Delaware Chancery Court that called into question the concept of “control”, and provided some indication of what would amount to control of a company.
In Calesa Associates L.P. v. American Capital Ltd, American Capital was a shareholder holding 26% shares of Halt Medical Inc. (the Company). Through a series of contractual arrangements between American Capital and the Company, American Capital sought to increase its shareholding in the company that would not only have made it a majority shareholder of the company, but it would have also substantially diluted the other shareholders. In this background, the plaintiff Calesa Associates (one of the Company’s shareholders) initiated an action against American Capital, the Company and its directors. The plaintiffs alleged that by virtue of its actions, American Capital breached its fiduciary duties as a controlling shareholder that it owed to the minority shareholders of the Company. Relevant to our analysis was the question whether American Capital was indeed the controlling shareholder of the Company in that it exercised “control” over it.
Based on previous Delaware case law, the Court stated that a “stockholder is controlling, and owes fiduciary duties to the other stockholders, “if it owns a majority interest in or exercises control over the business affairs of the corporation””. Hence, control could be achieved either through majority interest or by virtue of the shareholder’s exercise of control over the business affairs of the company. It is the second aspect which was of concern here. Since American Capital had only 26% shares, the Court found that it must be shown to have exercised “actual control” over the Company at the time of the relevant transactions.
At the outset, the fact that American Capital had entered into contractual arrangements with the Company (that enabled it to exercise contractual rights over the Company) was found to be insufficient to constitute “control”. On the other hand, the Court embarked upon an analysis of whether American Capital exercised influence over at least a majority of the board of directors of the Company. Such control or influence over the board is a factual determination to be arrived at specifically in each case. The Court found that merely because a director was appointed by a shareholder was insufficient to indicate the control or influence of the shareholder over such a director. The Court instead embarked upon a fact-specific analysis of whether at least four out of the seven directors of the Company were beholden to, or influenced, by American Capital. After going through the background and various relationships of these four directors with American Capital, the Court found that there were sufficient facts to support an inference that a majority of the board was not disinterested or lacked independence from American Capital.
Although the case is under Delaware law, which bears significant differences with Indian corporate law on the question of fiduciary duties of controlling shareholders, it does provide some guidance on the issue of “control” that SEBI is currently grappling with. As this case indicates, “control” often tends to be a factual question to be determined with reference to the specific circumstances in each case. That is consistent with the current definition of control under the SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 2011. However, it is due to the lack of certainty under that dispensation that SEBI is looking at reform process to introduce a bright-line test. The continued use of a qualitative and subjective understanding of control may function well in jurisdictions like Delaware where courts play an important role in developing the law through principles, but whether it would be suitable in a jurisdiction like India which may call for more objective standards is a different question. But, at least the case suggests that any criteria for control cannot ignore such subjective factors, although reliance upon those can be limited to specific circumstances and not as a general matter.
 An analysis of this decision is available on the Harvard Law School Forum on Corporate Governance and Financial Regulation at http://courts.delaware.gov/opinions/download.aspx?ID=237570.
 Note that Delaware law in that sense is dissimilar to corporate law in India where controlling shareholders do not owe fiduciary duties either to the company or to the minority shareholders. But that distinction is not germane to the discussion of how “control” ought to be determined.