In In re Orchard Enterprises, Inc. Stockholder Litigation, the Delaware Court of Chancery held that the entire fairness standard of review applied to a going-private transaction with a controlling stockholder, even though the transaction was negotiated by a special committee of independent directors and approved by a majority of the minority stockholders.
Dimensional Associates, LLC, which held 42 percent of the common stock of Orchard Enterprises, Inc. and 99 percent of Orchard’s senior convertible preferred stock, proposed to acquire all of the outstanding shares of Orchard’s capital stock held by the minority stockholders for $2.05 per share. Orchard’s board of directors formed a special committee of independent directors to evaluate the proposal. The special committee had the exclusive power and authority to negotiate with Dimensional, terminate consideration of Dimensional’s proposal, solicit interest from third parties and retain independent advisors. After several rounds of negotiations, Dimensional and the special committee agreed that the transaction would be subject to a non-waivable condition that the majority of the minority stockholders approve the transaction.
The court held that, even though the transaction was subject to the approval of Orchard’s special committee and a majority of the minority stockholders, the transaction would be subject to review under the entire fairness standard rather than the business judgment rule. In distinguishing the court’s decision in In re MFW Shareholders Litigation (as summarized in the Corporate & Financial Weekly Digest edition of June 7, 2013) and the Delaware Supreme Court’s decision in Kahn v. M&F Worldwide Corp.(as summarized in the Corporate & Financial Weekly Digest edition of March 21, 2014), which affirmed the court’s decision in In re MFW Shareholders Litigation, the court explained that, in order to avoid entire fairness review, a controlling stockholder must agree “up front, before any negotiations begin” that the transaction will be subject to (i) the affirmative recommendation of a special committee composed of independent and disinterested directors that is empowered to freely select its own advisors and to say no definitively and (ii) the affirmative vote of an informed majority of the minority stockholders. If none or only one of the protections is agreed to up front, the transaction will be subject to entire fairness review. If the controlling stockholder can show that at least one of the protections was in place, the controlling stockholder can shift the burden of proof to the plaintiffs to show that the transaction was unfair, even if such protections are not agreed to up front. If the controlling stockholder is unable to shift the burden of proof such that the plaintiff challenging the transaction must prove unfairness, the controlling stockholder will bear the burden at trial of proving that the transaction was the product of a fair process and that the price paid was fair.
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