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To obtain business judgment deference, controllers must insist on MFWâ€™s minority
protections before engaging in any substantive economic or valuation discussions.
The Delaware Supreme Courtâ€™s 2014 decision in Kahn v. M&F Worldwide Corp.1 (MFW) altered the
landscape for suits challenging controlling stockholder take-private transactions. The decision provided
that if a controller conditions the deal on specific minority stockholder protections from the beginning, then
the transaction may be subject to the same deferential â€œbusiness judgmentâ€ review that applies to armâ€™s-
length, third-party transactions under Delaware General Corporation Law Â§ 251 (8 Del. C. Â§ 251), rather
than the more stringent â€œentire fairnessâ€ standard.2 Questions that have arisen since MFW include: when
exactly is the â€œbeginningâ€ of a transaction and when does the beginning end? Deal discussions often
begin informally or proceed in an on-again, off-again manner, and prior case law was unclear about the
precise point in the process when the controller needed to insist upon MFWâ€™s minority protections in order
for the transaction to obtain business judgment deference.
The Delaware Supreme Courtâ€™s April 5, 2019, decision in Olenik v. Lodzinski3 provides some much-
needed clarity to that timing issue. Earlier cases held that the MFW protections must be in place before
any â€œsubstantive economic negotiationsâ€ took place, but Lodzinski expands upon that standard and
explains that early exploratory discussions about ranges of value, or intentions to make future offers, may
trigger the need for the protections to be in place even if no firm offer is on the table at such time.
Controllers, target companies, and the targetsâ€™ special committees must be familiar with Lodzinski
because once substantive economic negotiations begin, it is probably too late to put the MFW protections
in place. Implementing the protections at the right time can be the difference between a pleadings stage
dismissal (under the business judgment standard) and a full trial (under the entire fairness standard that
otherwise applies to transactions with controllers).
Controlling Shareholder Buy-Out: The Road to MFW
Under Delaware law, a controlling stockholderâ€™s buy-out of the companyâ€™s minority interests was
historically reviewed under the rigorous entire fairness standard given that controllers, by definition,
control the company and can impose their will over the objection of the minority. Even if a special
committee of disinterested directors approved the deal, or if the deal was subject to a vote of the minority
stockholders, the burden of proof would, at most, shift from the defendant to the plaintiff â€” and the
standard would still be whether the deal was â€œentirely fairâ€ to the minority stockholders. Given the fact-
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specific nature of the fairness inquiry, if that standard applied, a pleadings-stage dismissal was very
unlikely. The law therefore provided little incentive for controllers to condition deals on minority
stockholder protections, because even if they did, they would likely either have to pay to settle claims
challenging the transactionâ€™s fairness, or undergo extensive litigation and potentially a full trial to prove
the fairness of the deal.4 The unfortunate consequences of this state of law were that (i) no matter how
favorable the deal was for minority stockholders, the deal would likely trigger litigation, and (ii) every such
suit carried automatic settlement value.
The law changed with MFW and its progeny. In MFW, the Delaware Supreme Court reasoned that a
controller could mirror a third-party, armâ€™s-length merger under 8 Del. C. Â§ 251 by irrevocably subjecting a
transaction to two specific minority protections from the outset of the negotiations: (i) an empowered,
independent special committee;5 and (ii) the informed, uncoerced consent of a majority-of-the-minority
stockholders.6 The Court reasoned that if these conditions were in place ab initio, the controller would
have sufficiently â€œdisabledâ€ itself from unfairly influencing the transaction. With the removal of the
controllerâ€™s thumb from the scale, minority stockholders would have the same general protections as
stockholders in a third-party merger offer. Thus, the Court saw no reason why a transaction with a
properly disabled controller should be treated any differently than a third-party deal, and therefore
concluded that, if MFWâ€™s conditions were satisfied, deferential business judgment review would apply.7
Initially it was unclear whether MFW could be applied at the pleadings stage, but subsequent Delaware
Supreme Court cases have confirmed that it can.8 MFW has become a powerful tool in deal structuring,
providing concrete incentives for controllers to disable themselves when negotiating with minority
stockholders (or disinterested special committees representing them) in return for gaining a reduced
likelihood of suit, and the potential early dismissal of any such action. Since MFW, Delaware courts have
repeatedly applied the MFW standard to deliver pleadings-stage dismissals.9
What Is Ab Initio and When Does It End?
Since MFW, courts and litigants have grappled with how early the controller must disable itself by insisting
upon the MFW protections. The Delaware Supreme Court made clear that the controller cannot use those
protections as a bargaining chip in the negotiations: from inception, the controlling stockholder must know
that it cannot bypass the special committeeâ€™s ability to say no and cannot â€œhorse tradeâ€ by offering
minority protections later in the process in exchange for concessions.10
For example, in the first case to apply MFW at the pleadings stage, Swomley v. Schlecht, the Delaware
Court of Chancery noted that the controllerâ€™s initial proposal â€œhedgedâ€ on whether the majority-of-the-
minority condition would be waivable or not.11 However, the court nonetheless found the ab initio
requirement satisfied because the targetâ€™s board resolved, at its very first meeting after receiving the
offer, that any deal would require both a special committeeâ€™s approval and a majority-of-the-minority vote.
Thus, the court was satisfied that the MFW conditions were in place ab initio, noting â€œ[a]ll this went down
before any negotiations took place, even before anything really started.â€12 The Delaware Supreme Court
affirmed without opinion.13
The court in Flood v. Synutra Intâ€™l, Inc. subsequently elaborated upon the â€œbefore any negotiationsâ€
standard set out in Swomley.14 In Synutra, the initial letter of interest from the controlling stockholder did
not contain MFWâ€™s dual protections.15 However, once a special committee had been formed, a second
letter of interest issued two weeks later preconditioned the deal on the MFW protections.16 The Delaware
Supreme Court noted that the special committee declined to engage in any price negotiations until the
committeeâ€™s banker could perform due diligence, and no price negotiations took place until seven months
after the MFW conditions were in place.17 Chief Justice Strine, writing for the majority, found that the
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controlling stockholder had successfully conditioned his offer â€œat the germination stageâ€ and â€œself-
disable[d] before the start of substantive economic negotiations.â€18
In a dissent, however, Justice Valihura advocated for a more bright-line standard: controlling stockholders
must include the MFW conditions in the initial proposal itself.19 Justice Valihura opined that any doubt as
to whether the MFW protections were implemented in a timely fashion should be resolved against the
controller.20 She reasoned that a bright-line rule makes sense in the context of a controlling stockholder
take-private transaction, because the controller has the power to decide when to (i) begin negotiations,
and (ii) insist upon the MFW conditions.21 She posited that a bright-line rule serves the underlying purpose
of a speedy determination of the proper standard of review at the pleadings stage, while a vague
standard requiring the MFW protections to be in place before any negotiations occur invites a judicial
investigation into a â€œfactual morassâ€ that is inappropriate at the pleadings stage. 22
Olenik v. Lodzinski â€” Clarifying Timing Under MFW
This debate crystalized in the Delaware Supreme Courtâ€™s April 5, 2019 ruling in Lodzinski. In this case,
EnCap Investments L.P. (EnCap) owned 96% of one company, Bold Energy III LLC (Bold), and also a
majority stake in an entity that owned 41% of Earthstone Energy, Inc. (Earthstone).23 Earthstone, led by
its CEO and Chairman, Mr. Frank Lodzinski, was a mature-stage company operating in the upstream oil
and gas sector in Texas, but with limited undeveloped resources. Bold was an early-stage oil and gas
company with premium undeveloped acreage in Texasâ€™s oil rich Midland Basin, but with limited resources
to drill and extract its holdings. In addition, EnCap, Boldâ€™s financial sponsor, had reached the end of its
financial commitments in the summer of 2015 and was reluctant to invest more capital in the company.
The parties began discussing a combination transaction in the fall of 2015, and eventually consummated
a stock-for-stock deal in November 2016 that gave Earthstone stockholders 39% and Bold stockholders
61% of the equity of the combined entity.24 The combination offered a premium for Earthstone
stockholders based on the companyâ€™s trading price before the merger announcement, and Earthstoneâ€™s
stock jumped 27% on the day of the announcement. Ultimately, 99.7% of Earthstoneâ€™s minority
stockholders who voted on the transaction approved the deal. A group of dissenting stockholders brought
a class action suit in Delaware Chancery Court, claiming an unfair price. The Chancery Court dismissed
the case on the grounds that the MFW conditions had been satisfied and the transaction passed muster
under the business judgment standard of review.25 Plaintiffs appealed.
Plaintiffs alleged that, during the negotiations, Boldâ€™s parent, EnCap, had sought to take Bold public or
sell the company or its assets, as early as June 2015, but a market check at the time came up empty.
Upon hearing of Boldâ€™s unsuccessful efforts, Mr. Lodzinski initiated discussions with EnCap for an
acquisition of Boldâ€™s assets in the fall of 2015. Between November 2015 and January 2016, Earthstone
engaged in an extensive review of Boldâ€™s assets, and even sought valuation parameters from three
separate investment banking firms. By April 27, 2016, Mr. Lodzinski felt confident enough to send a letter
to the Earthstone Board of Directors stating that he was â€œupdating [his] analysisâ€ on Bold and that he
â€œintend[ed] to make an offer.â€26 This letter did not mention the MFW minority protections. The Supreme
Courtâ€™s unanimous opinion noted this omission, stating that â€œEnCap, Earthstone, and Bold were engaged
in substantive economic discussions â€¦ eight months before the MFW protections were put [in] place.â€27
In May 2016, without engaging an independent financial advisor, Earthstone made two presentations to
EnCap regarding a potential combination between Earthstone and Bold. Earthstoneâ€™s first presentation
valued Bold at US$305 million. When EnCap apparently did not respond to this presentation after a week,
Earthstone made a second presentation that valued Bold at US$355 million. Once again, neither
presentation mentioned the MFW minority protections. The Court identified these valuations as the
discernible dividing line at which discussions transitioned from â€œpreliminary discussions ... to substantive
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economic negotiations when the parties engaged in a joint exercise to value Earthstone and Bold.â€28 The
valuations were particularly probative because â€œ[b]ased on these facts, it is reasonable to infer that these
valuations set the field of play for the economic negotiations to come by fixing the range in which offers
and counteroffers might be made.â€29
On July 8, 2016 â€” more than two months after Mr. Lodzinskiâ€™s initial letter to the Earthstone Board, and
more than eight months after his initial discussions with EnCap â€” Earthstoneâ€™s two independent directors
began taking steps to form a special committee to oversee the transaction. Earthstoneâ€™s Board did not
actually form the special committee until July 29, 2016. When Earthstone made its first formal proposal to
Bold on August 19, 2016, the proposal conditioned the transaction on the MFW protections for the first
time. The offer was for an all-stock transaction valuing Bold at US$325 million â€” well within the range set
out in the May valuations.
The Appellees contended that they satisfied MFW because the first binding offer was conditioned on the
MFW protections, and they discounted the prior discussions as merely exploratory discussions that did
not rise to the level of the substantive economic negotiations standard enunciated in earlier Delaware
case law. The Delaware Supreme Court disagreed, given the advanced nature of the economic
discussions that occurred. The Court instead concluded that the Appellant â€œha[d] pled facts that
support[ed] a reasonable inference that the two procedural protections were not put in place early and
before substantive economic negotiation took place.â€30 The Chancery Courtâ€™s dismissal on MFW grounds
Best Practices for Controllers Engaging in Take-Private Transactions
If a controlling stockholder engages in a take-private merger (or other transaction over which the
stockholder can exert substantial influence), and wants to have the transaction reviewed under the
deferential business judgment standard rather than the much more stringent entire fairness standard, the
controller should condition the transaction on the MFW protections from the very first discussion or initial
offer. As Justice Valihura observed, the controller has total authority over when the merger discussions
commence and is uniquely empowered to condition any negotiations on these protections. If pre-
negotiation disablement is, for whatever reason, not feasible, Lodzinski requires a controller to insist on
the MFW protections before the controller commences substantive negotiations in order to obtain the
benefit of the business judgment standard.
Lodzinski, like Synutra before it, seems to indicate that, to obtain the benefit of the business judgment
standard, a controller only need insist that the transaction be subject to the MFW protections, not that the
protections actually be in place before the start of negotiations. However, the logical interpretation of
these decisions is that a controller wishing to have the benefit of the protections cannot commence
substantive negotiations until the party charged with protecting minority stockholdersâ€™ interests (usually a
committee of the target companyâ€™s board composed of disinterested directors) have agreed to and
implemented the protections. Courts look at substance rather than form in determining what constitutes
substantive discussions. Thus, even if a controller does not make a binding, written offer that the other
party can accept, if the controller engages in exploratory talks about economic value, terms, or the
structure of a transaction that arguably have the effect of narrowing the negotiating range, the controller
runs the risk that the court will find that MFW protections should have been in place before those
discussions began. Lodzinski indicates that valuation discussions can be tantamount to substantive
economic negotiations, particularly if they set the parameters for subsequent economic negotiations.
Controlling shareholders cannot circumvent the procedural safeguards of MFW by nominally offering the
MFW conditions after negotiations are well under way, or after the economic goalposts have effectively
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1 88 A.3d 635 (Del. 2014).
2 Kahn v. Lynch Commcâ€™n Sys., 638 A.2d 1110, 1117 (Del. 1994) (â€œ[T]he exclusive standard of judicial review in examining the
propriety of an interested cash-out merger transaction by a controlling or dominating shareholder is entire fairness.â€).
3 No. 392, 2018, 2019 WL 1497167 (Del. Apr. 5, 2019).
4 Weinberger v. UOP, Inc., 457 A.2d 701 (Del. 1983); Kahn v. Lynch Commcâ€™n Sys., 638 A.2d 1110 (Del. 1994). Kahn v. Lynch
established that steps to protect minority interests could, at best, result in burden shifting at trial.
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5 The Court listed requirements to ensure that the special committee was properly empowered, such as being able to hire its own
advisors, negotiate with the controller, and definitively reject any offer from the controller and end the negotiations. MFW, 88
A.3d at 645.
6 88 A.3d at 645.
7 Id. at 644-45.
8 See, e.g., Daniel Gold and Scott Ewing, New Guidance on How MFW Operates at Pleading Stage, LAW360 (Sept. 10, 2014, 10:55
9 See, e.g., In re Books-A-Million, Inc. Sâ€™holders Litig., C.A. No. 11343-VCL, 2016 WL 5874974 (Del. Ch. Oct. 10, 2016), affâ€™d, 164
A.3d 56 (Del. 2017) (Table); Swomley v. Schlecht, C.A. No. 9355-VCL (Aug. 27, 2014) (Transcript Ruling), affâ€™d, 128 A.3d 992
(Del. 2015) (Table).
10 In re MFW Sâ€™holders Litig., 67 A.3d 496, 528 (Del. Ch. 2013); Flood v. Synutra Int'l, Inc., 195 A.3d 754, 756 (Del. 2018).
11 C.A. No. 9355-VCL (Aug. 27, 2014) (Transcript Ruling), affâ€™d, 128 A.3d 992 (Del. 2015).
13 Id. Similarly, in In re Books-A-Million, Inc. Sâ€™holders Litig., the controller conditioned any transaction on the MFW dual protections
in the initial proposal, leading the court to commend that the controller did not â€œdelay establishing the conditions, waver from
them, or â€¦ [seek] to circumvent them.â€ 2016 WL 5874974, at *8.
14 195 A.3d 754 (majority opinion).
15 Id. at 757.
16 Id. at 758.
18 Id. at 763.
19 Id. at 768 (Valihura, J., dissenting)
20 Id. at 779-80.
22 Id. at 776, 779-80.
23 Appellees argued that EnCapâ€™s 41% stake did not qualify it as a controlling stockholder, but the Delaware Supreme Court rejected
this argument due to facts pleaded in the complaint that supported the Appellantsâ€™ control theory. Lodzinski, 2019 WL 1497167,
24 The deal structure in the Earthstone/Bold transaction was not a classic take-private by a controlling stockholder. The two principal
parties to the business combination (Earthstone and Bold) were directly or indirectly controlled by the same parent entity
(EnCap), and the MFW issue arose in the context of the fairness of the transaction to Earthstoneâ€™s minority stockholders. The
Court noted that â€œ[a]lthough the Earthstone/Bold transaction is not a transaction between the controlling stockholder and a
controlled company, the same principles apply whether the controller is directly or indirectly exerting its influence over the
transaction.â€ Lodzinski, 2019 WL 1497167, at *7 n.50.
25 Olenik v. Lodzinski, No. CV 2017-0414-JRS, 2018 WL 3493092 (Del. Ch. July 20, 2018).
26 Lodzinski, 2019 WL 1497167, at *3.
27 Id. at *10.
28 Id. at *9.
29 Id. The Court noted that this is what essentially transpired under the facts as alleged.
30 Id. at *10.