## Facts

- PNB Holding Company, a Delaware holding company for a rural Illinois bank, sought to convert to Subchapter S status, which required reducing stockholders to 75 or fewer.
- PNB had roughly 360 stockholders and about 629,000 outstanding shares.
- The board structured a cash-out merger so only stockholders with at least 2,000 shares or within the largest 68 stockholders would remain; most others were cashed out.
- Directors and their family members, who would remain post-transaction, collectively held 59.5% of PNB stock pre-merger; no single director held more than 10.6%.
- The board obtained a financial advisor’s valuation/fairness opinion of $40.74 per share and set merger consideration at $41.00 per share.
- Stockholders approved the merger in April 2003; some stockholders dissented and perfected appraisal rights, while others accepted the consideration and later pursued class claims for fiduciary breaches.
- Many cashed-out stockholders did not vote; when non-voters were included, about 49% of cashed-out holders voted in favor, along with all directors and family members.
- The consolidated post-trial proceeding included (1) an appraisal action to determine statutory fair value and (2) an equitable class action challenging the merger’s fairness and seeking additional recovery.

## Issues

1. Whether the merger was subject to entire fairness review due to director self-interest, and whether the directors constituted a controlling stockholder group.
2. How to determine “fair value” in appraisal, including the permissibility of a minority-dividend-based approach versus a control-level DCF and how to treat S-corporation tax benefits.
3. Whether the merger process and price satisfied fiduciary duties (fair dealing and fair price), and whether any procedural protections reduced scrutiny or shifted burdens.

## Decision

- The court declined to treat the directors as a unified controlling stockholder group because no director held a large bloc and there were no voting agreements or similar bonds supporting group-control treatment.
- The court held the transaction was presumptively subject to entire fairness because the structure created a conflicted, zero-sum transaction in which directors and their families benefited from paying the lowest possible price while remaining as continuing owners.
- In the appraisal action, the court rejected the company’s expert to the extent his methodology valued shares based on minority-level expected dividends, which the court deemed inconsistent with Delaware appraisal law.
- The court adopted the petitioners’ expert’s DCF approach as more reliable because it valued the enterprise on a controlling, going-concern basis using free cash flows (including the economic impact of S-corporation-related tax attributes).
- The court found fair value materially above the $41.00 merger price, informing the fairness-of-price analysis under entire fairness.

## Legal Principles

- Entire fairness may apply even without a formal controlling stockholder when directors structure a transaction that pits their economic interests as continuing owners against cashed-out stockholders in a zero-sum manner.
- In Delaware appraisal, “fair value” is a going-concern, enterprise-level valuation; methodologies that effectively impose a minority-interest framework (such as valuing based only on minority dividend expectations) are improper.
- DCF is an accepted primary valuation method where reliable projections exist and comparable metrics are less informative, particularly for closely held financial institutions.
- Economic benefits associated with an S-corporation conversion may be reflected in the corporation’s value for appraisal purposes rather than reserved solely for continuing insiders.
- In conflicted transactions, use of procedural protections (e.g., an independent special committee and a fully informed majority-of-the-minority vote) may affect standard of review or burden allocation; absence of such devices supports entire fairness scrutiny.

## Conclusion

The court treated PNB’s insider-favored S-corporation cash-out as a conflicted transaction subject to entire fairness, rejected appraisal methods grounded in minority-level dividend expectations, and relied on a control-level DCF that accounted for S-corporation tax economics, yielding a fair value materially above the merger price.


In re PNB Hldg. Co. S'holders Litig., 2006 WL 2403999 (Del. Ch. Aug. 18, 2006)