What you need to know:
A recent decision by the Delaware Court of Chancery holds that a going-private merger with a controlling stockholder will be subject to the business judgment rule, not entire fairness review, if the deal is conditioned from the outset on approval by a special committee of independent directors and the majority of the minority stockholders.
What you need to do:
When contemplating a going-private transaction with a controlling stockholder, companies now have a clear incentive to utilize both a properly functioning independent special committee and a majority-of-the-minority requirement in order to be subject to the less stringent business judgment rule, as opposed to the strict entire fairness review. Transactions subject to the business judgment rule may be eligible for dismissal on the pleadings (nearly impossible when entire fairness review applies), thus greatly reducing the settlement leverage plaintiffs enjoy simply by having filed suit.
Subject to certain important procedural safeguards, going-private mergers with controlling stockholders that are conditioned from the outset on approval by both a special committee of independent directors and a majority of the minority stockholders will only have to pass muster under the business judgment rule – not the stricter entire fairness standard – under a recent Delaware Court of Chancery decision by Chancellor Strine in In re MFW Shareholders Litigation.
Under settled law from the Delaware Supreme Court, approval by a special committee or a majority of the minority would shift the burden on entire fairness from the defendant to the plaintiff. The Court of Chancery viewed the appropriate standard where both procedural protections are in place as an open question (despite dicta in prior Supreme Court cases that entire fairness was the appropriate standard of review for mergers with controlling stockholders). It then concluded that the business judgment rule applied and that both protections were employed properly in the case before it, and granted summary judgment for defendants.
The decision offers an important view on the scrutiny applicable to such deals when challenged by minority stockholders, but could set up a clash between the Chancery Court and the Delaware Supreme Court if the matter makes it to the higher court on appeal or in the context of other litigation. It was the first time a Delaware court had been squarely confronted with the question. Previously, entire fairness applied and companies would typically focus on using either a special committee of independent directors or a majority of the minority vote (not both) in order to shift the burden of proof back to plaintiffs.
Background of the Case
MacAndrews & Forbes, a holding company owned by defendant Ronald Perelman, owned 43% of M&F Worldwide. MacAndrews & Forbes offered to purchase the portion of M&F Worldwide that it did not already own in a going-private transaction for $24 per share (reflecting a 41% premium). Perelman’s holding company made it clear from the beginning that it would not go forward with the transaction unless it was approved by a special committee of independent directors and a majority of stockholders not affiliated with MacAndrews & Forbes. Importantly, the holding company also made it clear it would not pursue any going-private transaction without special committee approval.
The M&F Worldwide board established a special committee of independent directors to evaluate the offer with a broad mandate and gave the committee the right to engage qualified legal and financial advisors (which it did), and full power to negotiate over terms and to say no definitively if it did not believe the ultimate terms were fair to the minority.
After meeting on eight occasions and negotiating for a $1 per share price increase, the special committee approved the merger. Nonetheless, a minority stockholder filed suit, initially seeking a preliminary injunction in advance of the stockholder vote. The plaintiffs later dropped the injunction request in favor of a post-closing damages remedy for an alleged breach of fiduciary duty. The parties consummated the deal after 65% of the unaffiliated stockholders voted in favor.
After discovery, the parties moved for summary judgment. Before the Court of Chancery could reach the question of the appropriate standard, it considered whether the special committee and majority-of-the-minority employed by M&F Worldwide “qualif[ied] as cleansing devices” under Delaware law. The Court concluded that the special committee qualified because there was no triable issue of fact regarding:
- the independence of the special committee;
- its ability to employ financial and legal advisors and its exercise of that ability; and
- its empowerment to negotiate the merger and definitively say no to the transaction.
As to the stockholder vote, plaintiffs did not dispute that the vote was fully informed and there was no evidence of coercion.
Accordingly, Chancellor Strine had to consider the plaintiffs’ argument that Delaware Supreme Court authority holds that, as a matter of law, the entire fairness standard still applies. However, Chancellor Strine concluded that this argument was based only on dicta in a number of cases, which he distinguished on the facts, most notably Kahn v. Lynch Commc’n Sys. In Kahn v. Lynch, the Delaware Supreme Court stated, “A controlling or dominating stockholder standing on both sides of a transaction, as in a parent-subsidiary context, bears the burden of proving entire fairness,” seemingly ruling out the possibility of using the business judgment rule under some transactions with controlling stockholders. Similarly, Chancellor Strine brushed aside language in Ams. Mining Corp. v. Theriault, stating that, “When a transaction involving self-dealing by a controlling stockholder is challenged the applicable standard of judicial review is entire fairness, with the defendants having the burden of persuasion.” Chancellor Strine noted that neither party in the case had argued for a different standard; in fact, the parties agreed that the appropriate standard was entire fairness.
After concluding that the precedent asserted by plaintiffs was not controlling, Chancellor Strine concluded that the combination of a special committee of independent directors and a majority-of-the-minority vote was sufficient to invoke the business judgment rule in the controlling stockholder context in large part because they “replicate the protections of a third-party merger” under the Delaware General Corporate Laws, Del. C. § 251(b)-(c), which require board approval and approval by the stockholders of both corporations.
As Chancellor Strine noted, the rule announced in MFW should make it easier for corporations to obtain dismissal of frivolous challenges to mergers with controlling stockholders. He recognized that there is empirical evidence showing that in the absence of a legally recognized transaction structure that can invoke the business judgment rule, there has been no practical way of getting cases dismissed at the pleading stage and the costs of discovery and entanglement in multiyear litigation exceed the cost of paying attorneys’ fees. The ability to implement both protections and thereby invoke the business judgment rule makes cost-saving motions to dismiss feasible. However, Chancellor Strine acknowledged that “rational minds can disagree” with the new rule and the Delaware Supreme Court “will be able to bring its own judgment to bear if the plaintiffs appeal” or if the question arises again. Given MFW’s pronounced effect on the ability of litigation to impose settlement leverage, one can expect that the plaintiffs’ bar will look for an opportunity to ask the Delaware Supreme Court to scrutinize this decision.