On May 5 2016 New York's highest court confirmed that, under New York law, business judgement deference – rather than the more searching "entire fairness" review – applies to controlling stockholder transactions that are approved by a duly empowered special committee of independent directors and that receive a "majority of the minority" vote from stockholders who are unaffiliated with the controlling party.
In In the Matter of Kenneth Cole Productions Inc Shareholder Litigation,(1) a case in which plaintiffs challenged the take-private of a New York corporation by its controlling stockholder, the New York Court of Appeals affirmed the trial court's dismissal of the case and adopted the Delaware Supreme Court's 2014 holding in Kahn v M&F Worldwide Corp (MFW). In adopting the MFW framework, the court aligned New York law with Delaware law, making the MFW mechanism available to New York corporations and offering a path for New York corporations to reduce litigation risk in connection with controlling party transactions.
The Kenneth Cole litigation arose in 2012 after Kenneth Cole, the controlling stockholder of the prominent fashion retailer bearing his name, offered to purchase all of the outstanding Kenneth Cole stock that he did not already own. He also made clear that he would not sell his shares to another potential acquirer. In response, the company formed a special committee of independent directors to negotiate with Cole. The special committee engaged in successful negotiations to increase Cole's offer and a deal was ultimately approved by the special committee and a majority of the non-controlling stockholders. Nonetheless, several stockholders sued in New York state court, challenging the transaction as unfair. In view of the protections afforded to the non-controlling stockholders – an independent special committee and a majority of the minority vote – the trial court applied business judgement review and dismissed the consolidated action. After the intermediate appellate division affirmed and endorsed the application of business judgement review, the plaintiff appealed to the state's highest court, the New York Court of Appeals, which similarly affirmed the trial court's determination.
The decision makes business judgement review available to controlling party transactions involving New York corporations where the transaction at the outset is conditioned on its approval by:
- a special committee comprised of independent, duly empowered directors; and
- a majority of the minority stockholders in a fully informed vote.
To avoid application of business judgement review at the motion to dismiss stage, the burden is now on the plaintiff challenging such a transaction to "sufficiently and specifically allege" that the protections afforded the minority were not adhered to. In the absence of such allegations (or sufficient allegations of fraud or bad faith), New York law requires business judgement review for challenges to going-private transactions between a company and its controlling stockholder that are structured with the requisite minority protections. Transaction planners for New York corporations can now be confident that New York is aligned with Delaware in deferentially reviewing these types of transaction.
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