The last decade has witnessed a number of developments: 70% of the shares of public companies are held by institutional investors, many of which are widely diversified; institutional shareholders are more active in corporate governance than ever before; and Delaware courts, when called on to determine whether a transaction is fair, have viewed the approval of a transaction by these sophisticated shareholders as conclusive, or at least prima facie, evidence of fairness.  In particular, disinterested shareholder approval of a transaction not involving a controlling shareholder can constitute a so-called “cleansing act” that extinguishes breach of fiduciary duty claims. And disinterested shareholder approval of a transaction involving a controlling shareholder can, on its own, shift the burden of proof as to fairness from defendant to plaintiff and, in conjunction with disinterested director approval, likewise extinguish breach of fiduciary duty claims.

In today’s environment, however, the shareholders who vote on transactions are increasingly common owners—shareholders that, for example, hold stock not only in the target of an acquisition but also in the acquirer. How does, and how should, common ownership affect the legal and normative significance of shareholder approval of a transaction? What significance should be given to approval by a majority of non-controlling shareholders in a parent subsidiary freezeout merger when some of the non-controlling shareholders own shares in both the parent and the subsidiary? When two public companies controlled by the same person merge with each other, what significance should be given to a vote of non-controlling shareholders who hold shares in both companies? Should shareholder approval of a merger between two public companies without a controlling shareholder extinguish fiduciary duty claims when there is substantial overlapping ownership?  And in all of these, if the shareholder vote is given significance, whose votes should count?

The answers to these questions turns on the normative significance of shareholder approval when there is common ownership.  In the paradigm cases of a privately-held controller freezing out shareholders of a controlled public company or of an acquisition of a public company by a privately-held entity, there is a strong theoretical basis for according normative weight to the approval of the transaction by an uncoerced, informed majority of target shareholder unaffiliated with the acquirer: those shareholders have a clear and unconflicted economic interest in maximizing the value of their investment in the target.

This logic, however, breaks down in the presence of common ownership. Under common ownership, shareholders unaffiliated with the acquirer may nevertheless have economic interests that materially diverge from those of target-only shareholders.  Unlike in the private/public paradigm case, in a merger between companies with common owners, a “majority of unaffiliated shareholders” will differ from a “majority of target-only shareholders.”  Yet, Delaware law has not fully addressed whether and when votes by common owners count for purposes of determining whether a shareholder vote constituted a cleansing act.

We develop a framework for evaluating the degree to which common owners’ economic interests differ from those of target-only shareholders in an M&A transaction. We highlight the importance of three factors: whether the transaction produces joint gains; the amount of joint gains as a percentage of target company value; and a variable we call the ownership stake multiplier, which is the fraction of a common owner’s stake in the acquirer divided by the stake in the target less the stake in the acquirer, a function of a common owner’s stakes in the target and in the acquirer. The ownership stake multiplier can thus be interpreted as a metric that reflects the degree to which a common owner’s interests diverge from the interests of target-only shareholders.  Our analysis shows that conflicts can arise even if a common owner has a higher stake in the target than in the acquirer and, in this case, conflicts increase as joint gains increase and as the multiplier rises.  Moreover, in controller freezeouts of subsidiaries, conflicts depend not on a common owner’s absolute stake in the target, but in its stake as a percentage of the shares not owned by the controller. We then use this framework to provide an empirical overview of the degrees of conflict that have actually been present in four illustrative cases.

Evaluating degrees of conflict is an important starting point but does not resolve the broader issue of whether the kind of conflict introduced by common ownership should ever disqualify a common owner’s vote for cleansing act purposes. We present three plausible doctrinal approaches to deal with this broader issue: not count common owners’ votes for cleansing act purposes when the conflict generated by common ownership is material; count common owners’ votes for cleansing act purposes even if the conflict generated by common ownership is material as long as they are not affiliated with a conflicted fiduciary; and eliminate the binary effect of shareholder approval on cleansing and instead incorporate the degree and nature of shareholder support into the analysis of the fair dealing prong of the entire fairness standard.

While all of these approaches to the common ownership dilemma have their pitfalls, we think the third alternative is the least bad when common ownership is widespread and there is a material level of no votes. In these cases, the effort it would take to determine the actual degree of conflict and the low level of confidence that all materially conflicted owners can be properly identified, even after undertaking such efforts, are not commensurate to the benefits of the binary effect accorded to a majority cleansing vote.  Rather than expending resources to develop an imprecise voting metric of “disinterested” shareholders, where a marginal change in assumptions or some overlooked derivative holdings can make the difference between full cleansing and no cleansing at all, courts should acknowledge their epistemological limitations and accord only a graduated effect to shareholder voting under the “fair dealing” rubric.