On March 14 2014 the Delaware Supreme Court issued its much-anticipated opinion in Kahn v M&F Worldwide Corp,(1) affirming the Delaware Court of Chancery's holding in In re MFW Shareholders Litigation.(2) The decision provides guidance on steps that controlling stockholders and other deal participants can take to avail themselves of the more favourable business judgement standard of judicial review in stockholder litigation involving squeeze-out transactions where there is a controlling stockholder.
As a general proposition, unless there are unusual circumstances, the Delaware courts apply a deferential business judgement standard of review in challenges to corporate actions approved by a corporation's disinterested directors. Certain circumstances trigger the application of heightened standards of review, such as going-private transactions led by a controlling stockholder that are structured as a one-step merger. These squeeze-out transactions had been subject to a more demanding 'entire fairness' standard of review, with defendant directors bearing the burden of proof in establishing that the transaction was fair with respect to both price and process. Under the Delaware Supreme Court's Kahn v Lynch line of cases, the burden of proving entire fairness could be shifted to plaintiffs if the transaction with the controlling stockholder was approved either by:
- a special committee of independent directors; or
- an informed vote majority of the non-controlling disinterested stockholders.
In Kahn v M&F Worldwide Corp the Delaware Supreme Court affirmed the Delaware Court of Chancery's new rule that if a transaction between a corporation and its controlling stockholder is at the outset conditioned on both the approval of an independent, adequately empowered special committee that fulfils its duty of care and the uncoerced, informed vote of a majority of minority stockholders, then the more deferential business judgement standard of judicial review will apply.
The decision involved the 2011 acquisition by MacAndrews & Forbes Holdings, Inc (M&F), a 43% stockholder in M&F Worldwide Corp (MFW), of MFW. M&F's take-private of MFW was conditioned at the outset on the transaction being:
- negotiated and approved by a special committee of independent MFW directors; and
- approved by a majority of stockholders unaffiliated with M&F.
In its advances, M&F also made clear that it had "no interest" in participating in any alternative sale transaction. Ultimately, the transaction was approved by a vote of 65.4% of MFW's minority stockholders and closed in December 2011.
Various stockholder plaintiffs brought lawsuits asserting breach of fiduciary duty claims in the Delaware Court of Chancery against M&F and certain of MFW's directors, alleging that the transaction and related process was unfair to MFW's minority stockholders. Summary judgment was granted in the defendants' favour, and the Delaware Court of Chancery's conclusion that business judgement review was the appropriate judicial standard of review was appealed to the Delaware Supreme Court.
Standard of judicial review
The decision makes clear that the deferential business judgement standard of review will be applied to a squeeze-out transaction involving a controlling stockholder only if:
- from the outset, the controlling stockholder conditions the transaction on the approval of both a special committee and a majority of minority stockholders;
- the special committee is independent;
- the special committee is empowered to select its own advisers freely and say no definitively;
- the special committee fulfils its duty of care in negotiating a fair price;
- the vote of the minority stockholders is informed; and
- there is no coercion of the minority stockholders.
If any of these procedural protections are not established, the transaction will be reviewed under the more exacting 'entire fairness' standard.
Additionally, if any of these prerequisites are not satisfied, it remains that, under the Kahn v Lynch precedent, the burden of proving entire fairness may still be shifted to the plaintiffs if it can be shown that the transaction was approved either by a committee of independent directors or by an informed vote of a majority of the minority stockholders.
Under Delaware law, business judgement review is afforded to non-coercive squeeze-out transactions by controlling stockholders structured as tender offers that:
- are negotiated and recommended by a well-functioning and independent special committee;
- contain a majority of the minority tender condition; and
- contain a commitment from the controlling stockholder to consummate a short-form merger at the same price promptly after obtaining 90% of the outstanding shares of stock.
Any such tender offer that does not meet these conditions is subject to entire fairness review. However, before Kahn v M&F Worldwide Corp, squeeze-out transactions involving one-step mergers were evaluated under the entire fairness standard and never received business judgement level review. As a result of Kahn v M&F Worldwide Corp, the standards by which Delaware courts will evaluate a squeeze-out transaction by a controlling stockholder are now closely aligned, irrespective of whether the transaction is structured as a tender offer or a long-form merger.
Possibility of a new gold standard
Going forward, any failure to meet a Kahn v M&F Worldwide Corp prerequisite will likely be seized by plaintiffs challenging these types of transaction. Now that the roadmap for the 'optimal' protective devices has been identified by the Delaware courts, defendants in squeeze-out transactions not fully adhering to this standard may find the Delaware courts reluctant to conclude in the early stages of litigation that a transaction is entirely fair (irrespective of whether the burden of proving such fairness has shifted under Kahn v Lynch).(3)
Potential for prolonged litigation still exists for transactions between a company and its controlling stockholder
While implementing the procedural protections set forth in Kahn v M&F Worldwide Corp will ultimately lead to a controlling stockholder transaction being reviewed under the more deferential business judgement standard, it may not result in the dismissal of litigation challenging the transaction in the pre-discovery stage and, as a result, the benefits in following this framework should not be overstated. A plaintiff may still survive a motion to dismiss if its complaint adequately pleads facts challenging the independence, empowerment or effectiveness of the special committee, or coercion or lack of information affecting the majority-of-the-minority vote. This may not be a particularly high threshold. In a footnote to the opinion, the Delaware Supreme Court suggested that the plaintiffs in Kahn v M&F Worldwide Corp would have survived a motion to dismiss based on their allegations of inadequate price alone.
For further information on this topic please contact Jason Freedman at Ropes & Gray LLP's San Francisco office by telephone (+1 415 315 6300), fax (+1 415 315 6350) or email (firstname.lastname@example.org). Alternatively, contact Larissa R Smith at Ropes & Gray LLP's New York office by telephone (+1 212 596 9000), fax (+1 212 596 9090) or email (email@example.com). The Ropes & Gray website can be accessed at www.ropesgray.com.