On May 29, 2013, in the case of In Re MFW Shareholders Litigation, Chancellor Leo Strine of the Delaware Court of Chancery held that controlling stockholder going-private transactions may be protected by the deferential business judgment rule, rather than the more stringent entire fairness standard, if the "controlling stockholder merger has, from the time of the controller’s first overture, been subject to (i) negotiation and approval by a special committee of independent directors fully empowered to say no, and (ii) approval by an uncoerced, fully informed vote of a majority of the minority investors."1 If affirmed by the Delaware Supreme Court, this decision may trigger a fundamental change in the way controlling stockholders structure going-private proposals, providing tangible litigation benefits that may engender a greater willingness on the part of controlling stockholders to agree to majority-of-the-minority conditions despite their potential drawbacks.
In a nutshell, MacAndrews & Forbes, which held 43% of the stock of M&F Worldwide ("MFW"), offered to acquire the remaining shares for $24 per share. When it made its proposal, MacAndrews agreed not to proceed with any going-private transaction that was not approved by a special committee and a vote of the majority of the remaining stockholders. In particular, MacAndrews agreed to not make a tender offer for the remaining shares if it could not come to terms with the committee. A special committee was formed and negotiated with MacAndrews, ultimately getting it to raise its bid to $25 per share, a premium of 47% over MFW’s historical market price. 65% of MFW’s public stockholders voted to approve the deal.
Following consolidation and expedited discovery, the plaintiffs dropped their motion for a preliminary injunction, choosing instead to pursue a post-closing damages remedy for breach of fiduciary duty against the MFW board. The defendants moved for summary judgment, arguing that the business judgment rule, rather than the entire fairness standard, applied to the transaction.
Chancellor Strine, in a careful and well-reasoned opinion, began by examining the existing precedent, including Kahn v. Lynch,2 and concluded that, while a broad reading of those cases might point to entire fairness review, the precise circumstances before the Court—i.e., a transaction conditioned from the outset on both the approval of a well-constituted special committee and a majority-of-the-minority vote—had not been previously addressed by the Delaware Supreme Court. The Court then determined that plaintiffs’ breach of fiduciary duty claim should be evaluated under the business judgment rule in light of the formation of a fully-empowered independent special committee and the majority-of-the-minority condition—procedural protections that, together, effectively mirror those in an arms-length third party merger process.3 Upon reviewing the transaction under the business judgment standard, the Court concluded that the board had acted with due care and granted summary judgment for defendants. It is interesting to observe that Chancellor Strine’s holding in MFW reflects his long-held view that, with the right protections, controlling stockholder takeovers could be subject to review under the business judgment rule.4
In reaching this result, the Court carefully analyzed the formation, composition and empowerment of the special committee. In so doing, it reviewed the independence of each member (rejecting various challenges based on personal and past business relationships) and observed that the committee had retained its own independent legal and financial advisors (having interviewed four different candidates to serve as financial advisor during its first meeting). The Court placed particular emphasis on the committee’s broad mandate to negotiate and approve the transaction, as well as the enhanced bargaining power it obtained to "just say no" to MacAndrews in light of MacAndrews’ agreement at the outset (rather than at the last minute) to a majority-of-the-minority condition, and to refrain from "end-running" the special committee by making a tender offer directly to the stockholders.
Moreover, while the Court approved the thoroughness of the special committee’s deliberations and negotiations from a duty of care standpoint (noting, for example, that the committee met eight times, demanded and received updated financial projections and had sought and obtained a price increase), it deliberately stopped short of inquiring into whether the committee was substantively "effective" in representing the minority stockholders, as such a "precondition is fundamentally inconsistent with the application of the business judgment rule."5
The MFW opinion dramatically lowers the legal standard for review of controlling stockholder going-private transactions if the controller agrees at the outset to the twin procedural protections for minority stockholders of special committee negotiation and approval and a majority-of-the-minority vote. This is no small advantage: the business judgment rule is far more lenient than the entire fairness test traditionally applied to those transactions. Under the business judgment rule, a court is precluded from inquiring into the substantive fairness of the merger "unless the merger’s terms were so disparate that no rational person acting in good faith could have thought the merger was fair to the minority."6 In contrast, the entire fairness standard traditionally applied to controlling stockholder transactions requires the court to inquire into and determine the "financial fairness"7 of the deal and its terms, such as the merger price, which in turn requires separate fact-specific determinations with respect to "fair dealing and fair price."8 This typically involves extensive discovery and expert testimony with respect to valuation, investing even non-meritorious cases with settlement value because the case is not susceptible to dismissal on the pleadings.
A bidder that elects to structure its transaction to meet the MFW test may benefit economically, but there may be drawbacks as well. It will gain the assurance that the price it negotiates with the special committee will not be subject to re-negotiation with plaintiffs’ lawyers as the result of litigation under the entire fairness standard. In addition, post-deal litigation should be less protracted, expensive and distracting. Perhaps most importantly, the path to an early dismissal is much easier.9
On the other hand, the bidder may enter the negotiation with less leverage than it would have otherwise and the price it agrees to pay may be higher as a result. A controlling stockholder following MFW must give up its option to take its bid directly to the other stockholders by launching a tender offer for the shares it does not already own. Moreover, by agreeing to a majority-of-the-minority vote, the bidder may empower smaller, but recalcitrant stockholders, such as hedge funds, to demand that the special committee extract a higher price or to crater the deal struck by the special committee by voting against it. And these concessions maybe for naught if the special committee, over which the controlling stockholder necessarily has no control, was improperly formed, mandated, or advised, or if the committee otherwise failed to meet applicable requirements. As a result, there can be no assurance that a controlling stockholder willing to comply with MFW’s requirements will not end up litigating substantial fairness requirements.
If not overturned on appeal, MFW establishes a new application for the business judgment rule in a previously unsettled area of corporate law. The MFW opinion provides an important opportunity for future transactional structuring and, if the procedural protections described are implemented correctly, has the potential to diminish costly and drawn-out litigation in the controlling stockholder going-private context.