Delaware Supreme Court Affirms Application of Business Judgment Review to Merger with Controlling Stockholder
March 17, 2014
In Kahn v. M&F Worldwide Corp,1 the Delaware Supreme Court unanimously affirmed the Court of Chancery's 2013 decision that a going-private merger with a controlling stockholder may be subject to the deferential business judgment rule, rather than an entire fairness standard of review. The Delaware Supreme Court held that business judgment review is applicable if the merger was conditioned prior to commencement of negotiations on both (1) approval by a committee of independent directors meeting certain requirements and (2) a non-waivable, informed, uncoerced majority-of-the-minority vote because "the simultaneous deployment" of these procedural protections results in the transaction "acquir[ing] the shareholder-protective characteristics of third-party, arm's-length mergers, which are reviewed under the business judgment standard."2
Although the opinion affirms the Court of Chancery's decision in In re MFW Shareholders Litigation,3 the Delaware Supreme Court's discussion of a special committee's "duty of care in negotiating a fair price"4 and related commentary in the decision could be read to add a new factor to the test the Court of Chancery announced that may narrow the factual circumstances in which deal litigation arising under this framework may terminate at an early stage.
The case arises out of the going-private merger of M&F Worldwide (MFW) with its 43 percent stockholder, MacAndrews & Forbes, a holding company solely owned by Ronald Perelman. MacAndrews & Forbes offered to purchase the remainder of MFW for $24 per share, and, at the outset, stated that it would not proceed with a transaction that was not approved by both an independent special committee and a majority-of-the-minority vote. It also explicitly promised upfront not to bypass the special committee by making a tender offer directly to the stockholders.
A special committee of independent members of the board was formed and retained its own independent legal and financial advisors. Through negotiations conducted over three months, the special committee convinced MacAndrews & Forbes to raise its offer to $25 per share. The special committee then recommended in favor of the merger and, ultimately, 65 percent of MFW's minority stockholders voted in favor of the merger. Plaintiff stockholders challenged the merger under the entire fairness standard. After 18 months of discovery (including depositions of all of the committee members and the production of 100,000 pages of documents), the Court of Chancery issued its decision on the defendants' motion for summary judgment.
Characterizing its holding as a matter of first impression, the Court of Chancery held that the business judgment rule will apply to a merger with a controlling stockholder if, but only if:
(i) [from the outset,] the controller conditions the procession of the transaction on the approval of both a special committee and a majority of the minority stockholders; (ii) the special committee is independent; (iii) the special committee is empowered to freely select its own advisors and to say no definitively; (iv) the special committee meets its duty of care; (v) the vote of the minority is informed; and (vi) there is no coercion of the minority.5
The Court of Chancery found that the plaintiffs had offered no evidence to create a triable issue of fact with regard to whether these conditions had been satisfied. The Court of Chancery therefore applied the business judgment rule to the merger and granted summary judgment to the defendants. The plaintiffs appealed.
The Delaware Supreme Court's Decision
The Delaware Supreme Court affirmed the decision that a merger with a controlling stockholder that is conditioned at the time the initial proposal is made on both (1) the approval of an independent special committee satisfying certain requirements and (2) the informed and uncoerced vote of a majority of the minority stockholders is governed by the business judgment standard of review.
The court explained that the proper use of both procedural protections removes a controller's influence from the merger, giving the merger the characteristics of a deal that was negotiated at arm's length. The court also stated that the use of both protections "optimally protects the minority stockholders in controller buyouts,"6 comports with Delaware's tradition of deferring to the decisions of disinterested directors, especially where those decisions are approved by an informed and uncoerced vote of disinterested stockholders, and incentivizes the use of the protections.7
The court's final reason for adopting its holding was that, in its view, both the entire fairness standard of review and the dual protection merger structure "converge and are fulfilled at the same critical point: price."8 The court's test would therefore require courts to make a "pretrial determination . . . that a fair price was achieved by an empowered, independent committee that acted with care" before applying the business judgment standard of review to a merger with a controlling stockholder.9
After explaining its reasoning, the Delaware Supreme Court, like the Court of Chancery, set forth a six-factor test that a merger with a controlling stockholder must satisfy to qualify for review under the business judgment rule. Specifically, the court held that "in controller buyouts, the business judgment standard of review will be applied if and only if: (i) the controller conditions the procession of the transaction on the approval of both a special committee and a majority of the minority stockholders; (ii) the Special Committee is independent; (iii) the Special Committee is empowered to freely select its own advisors and to say no definitively; (iv) the Special Committee meets its duty of care in negotiating a fair price; (v) the vote of the minority is informed; and (vi) there is no coercion in the minority."10 Significantly, the court immediately added that if a plaintiff "can plead a reasonably conceivable set of facts showing that any or all of those enumerated conditions did not exist, that complaint would state a claim for relief that would entitle the plaintiff to proceed and conduct discovery."11
The Delaware Supreme Court's articulation of the test differs from the Court of Chancery's. Specifically, where the Court of Chancery had indicated that one of the requirements was that "the special committee meets its duty of care," the Delaware Supreme Court instead required that "the Special Committee meets its duty of care in negotiating a fair price."12 This change appears significant because, as the Delaware Supreme Court stated in a footnote with respect to the merger at issue in the case and this particular requirement, the plaintiffs' "allegations about the sufficiency of the price" of the merger would have allowed their complaint to survive a motion to dismiss because they "call[ed] into question the adequacy of the Special Committee's negotiations."13 The court specifically cited the following issues:
First, the complaint alleged that [the controlling stockholder's] offer "value[d] the company at just four times" MFW's profits per share and "five times 2010 pre-tax cash flow," and that these ratios were "well below" those calculated for recent similar transactions. Second, the complaint alleged that the final Merger price was two dollars per share lower than the trading price only about two months earlier. Third, the complaint alleged particularized facts indicating that [MFW's] share price was depressed at the times of [the controlling stockholder's] offer and the Merger announcement due to short-term factors such as MFW's acquisition of other entities and Standard & Poor's downgrading of the United States' creditworthiness. Fourth, the complaint alleged that commentators viewed both [the controlling stockholder's] initial $24 per share offer and the final $25 per share Merger price as being surprisingly low.14
The court also emphasized that "unless both procedural protections for minority stockholders are established prior to trial, the ultimate judicial scrutiny of controller buyouts will continue to be the entire fairness standard of review."15
Having so held, the Delaware Supreme Court examined the facts of the case and affirmed the Court of Chancery's determinations that MFW's special committee had been independent and had functioned effectively and that the merger had been approved by an informed and uncoerced majority of MFW's stockholders. The court therefore held that (1) business judgment review properly applied to the merger, and (2) under that standard, the Court of Chancery had properly granted summary judgment to the defendants because it could not be argued that a rational person could not have found the merger favorable to the minority.16
The Court of Chancery's opinion in MFW had been seen as potentially providing a road map for corporate practitioners to design mergers involving controlling stockholders in such a way as to avoid protracted litigation.17 The Delaware Supreme Court's opinion confirms that simultaneously deploying both procedural protections at the initial stage of any such transaction may result in business judgment review for controller transactions and, thus, may make it possible to terminate litigation arising out of such transactions before trial. But the Delaware Supreme Court's focus on a special committee's "duty of care in negotiating a fair price," as well as its related suggestion that the substantive results of those negotiations may affect the application of the business judgment standard of review, could continue to make it difficult to obtain a dismissal at the motion to dismiss stage in such litigation. That potential difficulty, together with the court's indication that a controlled merger will be reviewed under entire fairness unless both protections can be "established prior to trial," raises a question as to whether the test announced here will provide sufficient incentive for controlling stockholders to adopt the transactional structure that the Delaware Supreme Court states "optimally protects the minority stockholders in controller buyouts."
For more information about the Delaware Supreme Court's decision or any related matter, please contact William Chandler, David Berger, Steve Guggenheim, Amy Simmerman, Tamika Montgomery-Reeves, or any member of Wilson Sonsini Goodrich & Rosati's corporate law and governance or securities litigation practices.
5 MFW, 67 A.3d at 535. The Court of Chancery distinguished earlier decisions of the Delaware Supreme Court that had been read to suggest that even if a merger with a controlling stockholder were conditioned on the approval of both a special committee and a vote of minority stockholders, the transaction would have to be subject to review under the exacting entire fairness standard of review because none of those decisions involved a transaction in which both procedural protections had been employed. See Kahn v. Lynch Commc'n Sys., 638 A.2d 1110, 1117 (Del. 1994). ("[E]ven when an interested cash-out merger transaction receives the informed approval of a majority of minority stockholders or an independent committee of disinterested directors, an entire fairness analysis is the only proper standard of review.") (emphasis added). See also Kahn v. Tremont Corp., 694 A.2d 422 (Del. 1997); Emerald Partners v. Berlin, 726 A.2d 1215 (Del. 1999); Americas Mining Corp. v. Theriault, 51 A.3d 1213 (Del. 2012).
17 The opinion did not address the issue of whether tender offers made by controlling stockholders followed by short-form mergers would be subject to fiduciary review as part of a "unified standard," as the Court of Chancery has endorsed in several recent decisions. See, e.g., In re CNX Gas Corp. S'holders Litig., 4 A.3d 397 (Del. Ch. 2010); In re Cox Commc'ns, Inc. S'holders Litig., 879 A.2d 604, 607 (Del. Ch. 2005).