New York Court of Appeals Adopts MFW Business Judgment Standard of Review for Squeeze-Out Mergers
In In the Matter of Kenneth Cole Productions, Inc. Shareholder Litigation, 1 the New York Court of Appeals (Stein, J.) adopted the Delaware Supreme Court’s 2014 approach in Kahn v. M&F Worldwide Corp.2 (“MFW”), holding that business judgment is the standard of review for squeeze-out mergers with controlling stockholders so long as the MFW-established conditions exist—the transaction from the outset is subject to the approval of a well-functioning independent special committee empowered to select its advisors and reject the transaction and an informed, uncoerced vote of a majority of the minority shares. The Court of Appeals noted that the MFW standard serves as an attempt to achieve a balance between protecting minority shareholders and preventing frivolous litigation and unwarranted judicial interference in independent corporate decision-making.
The Kenneth Cole Productions decision involved the attempted take-private of Kenneth Cole Productions, Inc. (“KCP”) by Kenneth Cole, its founder and controlling shareholder (holding approximately 89% of the vote). In February 2012, the KCP board, without Cole present, established a special committee comprised of two directors elected by Class A shares (of which Cole held 46%) and two directors elected by Class B shares (of which Cole held 100%) to consider Cole’s proposal to take KCP private. Cole made an initial offer of $15.00 per share, contingent on approval from the special committee and a majority of the minority shares. He stated that he would not approve any other type of merger as a shareholder and that the failure to approve the proposal would not adversely affect his future relationship with KCP. Following months of negotiations, the KCP special committee recommended approval of Cole’s offer of $15.25 per share, and 99.8% of the minority shares approved the transaction.
Shortly after Cole made his offer, certain minority shareholders filed class action suits against Cole and the KCP directors alleging, among other claims, that the directors lacked independence and breached their fiduciary duty by failing to seek other bids for KCP. The New York Supreme Court granted the defendants’ motion to dismiss, and the Appellate Division affirmed. The Court of Appeals granted review of the case to determine the appropriate standard of review to apply.
The Court of Appeals declined to be constrained by its decision in Alpert v. 28 Williams St., 3 which applied the entire fairness standard of review to a two-step freeze-out merger. The Court of Appeals emphasized that the Alpert decision was expressly limited to the two-step freeze-out structure, whereas the KCP transaction was a going-private merger, and that the Alpert situation had not featured the independent committee or minority shareholder vote that are key components of the MFW conditions. However, the Court of Appeals noted that any complaint that alleges a reasonably conceivable set of facts showing that any of the MFW conditions to the application of business judgment review did not exist will survive a motion to dismiss, and if the evidence demonstrates that any of those elements did not exist, the transaction will be subject to entire fairness review, which places the burden on directors to demonstrate that they engaged in a fair process and obtained a fair price.
Applying the MFW standard, the Court of Appeals determined that the lower courts were correct in dismissing the allegations in Kenneth Cole Productions. The Court of Appeals noted that under the business judgment standard of review, absent fraud or bad faith, the determinations of the KCP special committee and board would be deferred to. In addition, in finding that the plaintiffs had not alleged sufficient facts showing that the MFW conditions had not been met, the Court of Appeals, among other things, rejected the allegations that the special committee directors lacked independence because Cole and his personally selected directors were responsible for nominating and electing the special committee members. “Friendships, traveling in the same circles, some financial ties, and past business relationships are not enough to rebut the presumption of independence; the ties must be material in the sense that they could affect impartiality,” the Court of Appeals stated.4
The Kenneth Cole Productions opinion provides a controller of a New York corporation a path to avoid entire fairness review; the certainty of business judgment review, however, likely will be accompanied by focused challenges to the independence of the special committee and the adequacy of disclosure to shareholders concerning the transaction.