New York Court Finds Failure to Meet MFW Standard in Controlling Stockholder Merger
May 31, 2018
In another significant M&A decision from the New York Supreme Court, the controlling stockholder of a Delaware corporation failed to obtain judicial deference under the so-called "MFW" framework for its merger with the corporation. The MFW framework allows a controlling stockholder transaction that would otherwise be subject to the difficult entire fairness standard of judicial review in litigation to regain the protection of the deferential business judgment rule if the transaction is properly subjected to approval by an independent committee of the board of directors and the company's minority stockholders.1
This new case, In re Handy & Harman Ltd. Stockholder Litigation,2 was decided by the same judge who recently enjoined Fujifilm's acquisition of Xerox3 and is important reading in the context of deals that might benefit from use of the MFW framework and for related litigation over Delaware corporations outside of the Delaware Court of Chancery. The case also reflects the ongoing stream of corporate litigation occurring outside of Delaware.
Before the merger at issue in the case, the Handy & Harman controller and its affiliates owned approximately 70 percent of the company's outstanding common stock. In March 2017, the controller, itself a publicly traded holding company, submitted a proposal to the company's board of directors, including a statement that it would not move forward with the merger unless it was approved by a special committee of independent directors and a non-waivable condition that a majority of the non-controller shares approve the merger. The board responded by forming and empowering a three-director special committee, and the special committee engaged separate legal and financial advisors. The parties negotiated a two-step merger under Section 251(h) of the Delaware General Corporation Law in which the controller would exchange preferred units of itself for all of the company shares that it did not already own. The special committee's financial advisor gave a fairness opinion, and in June 2017, the merger agreement was approved by the special committee and the board, subject to acceptance by a majority of the minority. In July and December 2017, stockholders commenced litigation alleging that the special committee was not independent, that the special committee had not fulfilled its duty of care, and that the minority stockholders were not fully informed. In October 2017, the conditions to the merger were fulfilled, and the merger was consummated.
On the defendants' motion to dismiss, the court found a number of potential problems calling into question the target company's compliance with the MFW framework. The court first found that the chair of the special committee had a longstanding personal and professional relationship with the founder, chair, and CEO of the controlling stockholder. This relationship included having been college roommates, roommates after college, and business partners with the founder-CEO of the controlling stockholder for several years. The court held that these findings called into question the independence of the special committee and the fairness of the process.
The court next found facts sufficient to raise issues regarding the special committee's exercise of its duty of care in negotiating a fair price: in addition to allowing the potentially conflicted chair to lead deal negotiations; the chair had also been allowed to select the special committee's financial advisor; and the financial advisor's previous work for the controller may have created a conflict. The court further held that, at least at the motion to dismiss stage, the financial advisor allegedly conducted a flawed valuation analysis that favored the proposed merger. Finally, the court held that the stockholders may not have been fully informed regarding the special committee chair's relationship with the controller's founder-CEO and the financial advisor's analysis and fairness opinion.
Because the transaction failed to meet the requirements for shifting the standard of review from entire fairness to business judgment, the court denied the controller's motion to dismiss. However, the court granted the special committee chair's motion to dismiss. The court stated that "best practices" suggested the chair should have disclosed his relationship with the founder-CEO of the controller but held that the claims did not amount to alleged disloyalty or bad faith and, therefore, the customary exculpatory provision in the company's certificate of incorporation, permitted under Delaware law, barred any personal liability on his part.
We note that this new case follows on the heels of yet another New York decision from April 2018 that also relied on Delaware law and addressed the MFW framework: In re Baltic Trading Stockholders Litigation,4 a short decision that involved claims regarding the merger of two Marshall Islands corporations under a merger agreement governed by New York law. In that case, the New York Appellate Division affirmed a 2016 decision by the New York Supreme Court, dismissing a number of the plaintiff's challenges to a target company's compliance with MFW. The plaintiff questioned whether the controller had conditioned its procession with the merger on approval by a majority of the minority, but the court held that the plaintiff had not raised that argument before the trial court. The court also concluded that the four directors on the target board special committee were independent despite allegations that: one director had done a "business deal" with the chairman of the controller seven years before; three of the directors sat on the controller's board for approximately nine years until shortly before formation of the special committee; one director's company was considered (though ultimately not used) for a business arrangement with the controller and that director joined the controller's board after the merger; and one director was negotiating a "multi-million-dollar, non-merger-related deal" with the same director of the controller who was negotiating the merger. The court next affirmed that, although the target's MFW minority vote included large stockholders that also had significant holdings in the controller, the vote had not been coerced. After finding that the transaction met the other MFW requirements, the court affirmed dismissal of the claims for breach of fiduciary duty.
In light of the continuing consolidation of controlled companies and other potential conflict transactions involving controlling stockholders, the MFW framework presents an important option for curtailing litigation. That standard and its specific requirements are not, however, the subject of extensive precedent. Thus, these recent developments from New York are useful guidance for understanding how courts—both in and outside of Delaware—may apply that framework, especially as litigation outside of Delaware continues to arise with some frequency.
For more information on the New York decisions, the MFW framework, or any related matter, please contact David Berger, William Chandler, Randy Holland, Amy Simmerman, Brad Sorrels, or any member of the corporate governance or securities and governance litigation practices at Wilson Sonsini Goodrich & Rosati.
Nate Emeritz contributed to the preparation of this WSGR Alert.