Delaware Court of Chancery Applies Business Judgment Standard of Review to Going Private Merger Involving Controlling Stockholder
In a recent decision, the Delaware Court of Chancery held that "when a 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, the business judgment rule standard of review applies." In Re MFW Shareholders Litigation, C.A. No. 6566-CS (Del. Ch. May 29, 2013).
The case concerned a going private merger involving MacAndrews & Forbes and its 43 percent controlled subsidiary, M&F Worldwide. MacAndrews & Forbes made clear at the outset that it would not proceed with any going private transaction that was not approved by an independent special committee and a vote of the majority of the stockholders unaffiliated with the controlling stockholder. The court held that the business judgment rule applied to the transaction, and entered summary judgment for the defendants.
In reaching his decision, Chancellor Strine first reviewed the procedural protections used by the controlling stockholder to ensure that those procedures were sufficient to qualify for "cleansing credit" under the business judgment rule. Among other factors, the court considered whether the members of the special committee were independent and satisfied their duty of care, and whether the majority-of-the-minority stockholder vote was fully informed and uncoerced. The court concluded that the procedures, as applied in this case, were adequate.
Chancellor Strine then reviewed existing case law to determine whether the Delaware Supreme Court had directly addressed the applicable standard of review for assessing actions on going private mergers involving controlling stockholders where approval by both a special committee and a majority-of-the-minority vote of stockholders was made a condition for going forward. The court noted that the Kahn v. Lynch line of cases,1 which held that approval by either a special committee or majority-of-the-minority stockholder vote can shift the burden of proof under the entire fairness test in going private mergers involving controlling stockholders, did not assess whether a different standard applies when both of those procedural protections are adopted. Chancellor Strine further noted that broad language in the cases suggesting that entire fairness should apply was mere dictum.
Finding that the Delaware Supreme Court had not ruled on the issue of the applicable test where both procedural protections were used, Chancellor Strine noted that the standard posited in Kahn v. Lynch created a disincentive to use both devices because the controlling stockholder would "receive no extra legal credit for doing so." Chancellor Strine noted that the two forms of procedural protections serve different purposes. A special committee solves the stockholder collective action problem by ensuring there is an independent bargaining agent who can negotiate price, whereas a majority-of-the-minority vote provides stockholders with the chance to determine for themselves whether to support the merger. Chancellor Strine concluded that the business judgment test should govern assessment of the transaction. He noted that applying the more deferential business judgment standard when both procedural protections are used will benefit minority stockholders by providing a strong incentive for controlling stockholders to use both procedures.
Assuming the case does not get overturned by the Delaware Supreme Court on appeal, it provides important structuring guidance for going private mergers involving controlling stockholders, including introducing a framework that will enable nuisance litigation challenging controlling stockholders to be dismissed on the pleadings.
1 Kahn v. Lynch Comm'ns Sys., 638 A.2d 1110 (Del. 1994)
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