## Facts

- FLS Holdings, Inc. was formed in a leveraged buyout of Florida Steel Company, creating two main equity classes: voting common stock held largely by insiders/sponsors and nonvoting preferred stock held largely by former Florida Steel shareholders.
- The preferred stock carried a high fixed dividend rate (17.5%) but lacked voting rights, leaving preferred holders structurally unable to influence board decisions through elections.
- After poor performance and financial distress, FLS pursued a sale to a third-party acquirer, Kyoei Steel Ltd.
- Kyoei’s initial proposal allocated consideration between classes at roughly $10 per common share (about $5 million total) and $27 per preferred share (about $43.2 million total).
- The board, advised by an investment bank, rejected early allocations as undervaluing the common and overvaluing the preferred.
- As negotiations proceeded, the proposed allocation shifted: the amount to common increased while the amount to preferred decreased from earlier offers.
- The final deal allocated approximately $9 million to common and $29 million to preferred; in percentage terms, common recovered about 36% of original LBO investment, while preferred recovered about 62% of what they had exchanged in the earlier transaction.
- Preferred stockholders sued, alleging the directors—aligned with and holding control through the voting common—breached fiduciary duties by steering allocation decisions to favor common holders over the nonvoting preferred class.
- The parties proposed a class settlement that provided no additional cash to preferred holders and largely preserved the challenged allocation; proponents characterized the settlement’s benefit as allowing preferred holders to retain an asserted $1.7 million amount that, on a “corrected” allocation, would have shifted to common.
- Some preferred holders objected that the settlement failed to remedy the alleged unfair allocation while releasing potentially valuable fiduciary-duty claims.

## Issues

1. Whether directors who controlled and aligned with the voting common breached fiduciary duties by allocating merger consideration between common and nonvoting preferred in a manner favoring common holders.
2. Whether a class settlement providing no incremental monetary recovery to the preferred class, and effectively ratifying the contested allocation, was fair, reasonable, and adequate to absent class members.

## Decision

- The Court of Chancery treated the allocation dispute as requiring heightened judicial scrutiny focused on fairness, given the directors’ conflict in allocating value between classes where they controlled one class.
- The court refused to approve and confirm the proposed class settlement because the record did not demonstrate that the compromise fairly addressed the preferred class’s allocation-based claims or provided a proportionate benefit for the release of those claims.
- As a result, the court declined to enter an order dismissing the action based on the proposed settlement.

## Legal Principles

- When directors who control or materially favor one class of stock determine the allocation of merger consideration among stock classes with divergent rights, the allocation decision is subject to fairness-based review rather than routine business-judgment deference.
- A conflicted allocation process may warrant an “entire fairness”-type inquiry into both process and price as between the affected classes.
- Court approval of a fiduciary-duty class settlement requires a showing that the settlement is fair, reasonable, and adequate to the class in light of the claims’ apparent strength and the consideration received.
- A settlement that offers only modest or largely theoretical benefits, while releasing claims challenging a conflicted allocation, will not be approved absent an adequate evidentiary basis showing the compromise reasonably reflects the litigation risks and potential recovery.

## Conclusion

The Court of Chancery subjected a board’s inter-class allocation of merger consideration to fairness scrutiny where directors were aligned with the advantaged class, and it rejected a settlement that provided no meaningful incremental recovery to the disadvantaged class while extinguishing conflict-based fiduciary-duty claims.


In re FLS Holdings, Inc. S’holders Litig., 1993 WL 104562 (Del. Ch. Apr. 2, 1993)