In the recent Delaware Court of Chancery decision in In re MFW Shareholders Litigation (MFW), Chancellor Strine applied the deferential business judgment rule standard – as opposed to the more burdensome entire fairness review – to a going-private transaction with a controlling stockholder. Although the decision is appealable, if affirmed by the Delaware Supreme Court, the decision could both provide certainty in an important area of unsettled Delaware corporate law and guide future going-private transactions.
In MFW, the defendant directors’ conduct was reviewed under the business judgment rule because the controlling stockholder made the going-private transaction conditional on both (1) negotiation and approval by a special committee of independent, disinterested directors fully empowered to say no, and (2) approval by an uncoerced, fully informed vote of the majority of the shares not owned by the controlling stockholder or its affiliates. By giving the defendants the benefit of the more deferential standard of review, Chancellor Strine intended to encourage future going-private transactions to be pursued in this manner for the protection of minority stockholders. The process endorsed by Chancellor Strine is similar in most respects to the process that Canadian securities law mandates for going-private transactions involving significant shareholders.
Since the Delaware Supreme Court’s 1994 decision in Kahn v. Lynch, it had been established that negotiated mergers with controlling stockholders would generally be reviewed under the entire fairness standard. If the transaction and the directors’ conduct were challenged by stockholders, the defendants would have the burden of demonstrating the procedural and substantive fairness of the transaction. However, the burden of proving the lack of fairness could be shifted to the plaintiff if one of the following two procedural protections were in place: the transaction’s approval by a special committee of independent, disinterested directors; or its approval by an informed vote of the majority of minority stockholders. The MFW decision takes these protections one step further.
In MFW, the controlling stockholder, MacAndrews & Forbes Holdings, Inc., proposed to take private M&F Worldwide – of which it owned approximately 43% of the common stock – at a purchase price of $24 per share. From the outset, M&F Worldwide conditioned the merger on (1) negotiation and approval of the transaction by a special committee and (2) a non-waivable approval by a majority-of-the-minority. The M&F Worldwide board formed a special committee of independent directors which in turn hired independent legal and financial advisors. Following negotiation, the special committee recommended a transaction at $25 per share (a 47% premium to the pre-announcement closing price), subject to approval by a majority-of-the-minority. Ultimately, 65% of the shares not owned by MacAndrews voted to approve the merger.
MFW stockholders filed suit, alleging that the merger was not entirely fair, and sought damages for breach of fiduciary duty. The defendants moved for summary judgment arguing that the business judgment rule applied and the court should not interfere with the decisions taken by the board.
Implications for Going-Private Transactions
The Court found that there was no dispute that the special committee was, from the beginning of the process, composed of independent, empowered directors fully authorized to evaluate, negotiate and reject the transaction. It also found that a majority of the company’s minority stockholders approved the transaction and that the vote was fully informed and uncoerced. As such, the Court held that by employing both procedural protections, a going-private transaction with a controlling stockholder should be subject to the deferential business judgment rule standard as opposed to the more onerous entire fairness standard, and the Court granted the defendant’s motion for summary judgment.
In determining that the business judgment rule standard applied in this case, Chancellor Strine intended to incentivize companies and their directors to implement similar procedural protections in future related-party transactions. The Court was also aware of the costs associated with unmeritorious deal litigation. The more deferential standard allows defendants to obtain early dismissal of litigation, thus potentially reducing legal fees and avoiding fee awards to plaintiff’s counsel as part of settling these claims.
The process of special committee and minority stockholder approval endorsed in Chancellor Strine’s decision is similar in most respects to the requirements for going-private transactions involving significant shareholders under Canada’s Multilateral Instrument 61-101. Whereas the ruling in MFW is intended to create an incentive for transaction participants to use the procedural protections, in Canada, similar protections must be provided to comply with legal requirements.
Although the Delaware Supreme Court has yet to weigh in, the MFW decision presents a number of takeaways and practical implications for going-private transactions:
- By creating a strong incentive for controlling stockholders to form a fully empowered special committee and permit a majority-of-the-minority condition, both special committees and minority stockholders are likely to have increased leverage throughout the course of a going-private transaction.
- Whereas the entire fairness standard effectively precludes a defendant’s ability to succeed with dispositive motions, the business judgment rule review gives defendants an opportunity to prevail at the motion to dismiss stage, thereby potentially reducing the costs of deal litigation.
- Although the MFW decision encourages controlling stockholders to condition takeover proposals at the outset on the two procedural devices described above in order to obtain the business judgment rule, they will have to weigh the commercial risks of committing to these procedures, including their ability to achieve a majority-of-the-minority stockholder vote if there are uncooperative or activist investors willing to fight for greater value.
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