In a recent decision, the Delaware Court of Chancery for the first time applied the business judgment rule standard of review to a controlling stockholder (or freeze-out) merger. In re MFW Shareholders Litigation, C.A. No. 6566-CS (Del. Ch. May 29, 2013) arose when MacAndrews & Forbes Holdings, Inc. acquired the 57 percent of M&F Worldwide that it did not already own.
Under Delaware precedent, courts have evaluated freeze-out merger for "entire fairness." The burden of proving entire fairness shifts depending upon whether the controlling stockholder insists upon (and effectively employs) one of two procedural safeguards: (1) an independent negotiating committee; or (2) approval by a majority of the minority stockholders. If a merger takes place with neither safeguard being effectively employed, then the burden of proving entire fairness rests with the controlling stockholder. If, however, a controlling stockholder insists upon (and effectively employs) one procedural safeguard, then the dissenting shareholders bear the burden of proving unfairness. Previously, no court had directly addressed an alternative consequence for a merger that effectively employed both procedural safeguards.
In In re MFW, the Court of Chancery held that, when a freeze-out merger employs both procedural safeguards the dissenting shareholders, to survive summary judgment, must overcome the onerous presumption of the business judgment rule. The court reasoned that the entire fairness burden-shifting rule incentivizes using one, and only one, procedural safeguard. The court predicted that, because the business judgment rule is likely to reduce a controlling stockholder's exposure to post-merger litigation, the court's holding will incentivize a controlling stockholder to insist upon both procedural safeguards in future freeze-out mergers. Although the business judgment rule will shield many freeze-out mergers from the more scrutinizing entire fairness review, the court suggested that using both procedural safeguards in tandem will protect minority stockholder interests better than entire fairness review.
The court emphasized that the business judgment rule applies to freeze-out mergers only when the transaction strictly applies both procedural safeguards. A triable issue of fact on any of the following negates business judgment rule protection:
- whether the controlling stockholder conditioned the merger upon the approval of both a special committee and a majority of the minority stockholders
- whether the special committee was independent
- whether the special committee had the freedom to select its own advisors and disapprove the merger
- whether the special committee met its duty of care
- whether the minority vote was informed
- whether the minority was coerced
If upheld by the Delaware Supreme Court, In re MFW may shift the cost-benefit calculus such that controlling stockholders should insist that future freeze-out mergers take place with both a special committee and a minority shareholder vote. Although this likely would result in reduced litigation costs, this would also lead to increased uncertainty in the negotiation process, including whether the merger may be effected at all.
The full text of the opinion is available at: http://courts.delaware.gov/opinions/download.aspx?ID=189940