In re MFW Shareholders Litigation: Controlling Stockholder’s Upfront Commitment to Both Approval by Special Committee and Majority-of-the-Minority Vote Warrants Business Judgment Rule Standard of Review For Freeze-Out MergersSullivan & Cromwell LLP - June 3, 2013
In an opinion issued on May 29, 2013, the Delaware Court of Chancery (Strine, C.) held that the business judgment rule standard of review applies to freeze-out mergers with controlling stockholders so long as from the outset of the merger negotiations the controlling stockholder commits to proceed with the merger only if it is subject to both (1) negotiation and approval by a special committee of independent directors free to select its advisors and empowered to say no definitively and (2) approval by an uncoerced, fully informed vote of a majority of the minority.
MFW is the first Delaware opinion holding that entire fairness is not always the appropriate standard of review for a freeze-out merger. Until MFW, the only variable in judicial review of a freeze-out merger was whether the controlling stockholder had employed sufficient procedural safeguards to shift to the plaintiff the burden of proof on entire fairness—which it could do if the target company created a well-functioning special committee to evaluate and negotiate the bid or the transaction was subject to a non-waivable majority-of-the-minority stockholder vote.
Finding that the Delaware Supreme Court’s precedents arguably left open what the effect of employing both safeguards would be, Chancellor Strine held that freeze-out mergers with both safeguards do more than simply shift the burden of proof on the substantive issue of entire fairness; they shift the standard of review itself. In so holding, Chancellor Strine conceded that his holding is not free from doubt and, in any event, subject to confirmation or rejection by the Delaware Supreme Court, if appealed.
The MFW opinion, Chancellor Strine noted, provides controlling stockholders with an incentive to effect going private transactions through a merger instead of the “inherently more coercive” tender offer by allowing them to benefit from the less rigorous standard of review, and thereby giving them a strong basis to dismiss at the pleading stage the inevitable shareholder litigation challenging the merger. Presently, settling litigation over freeze-out mergers is an almost foregone conclusion because of the high costs of discovery and inherent unpredictability of the outcome resulting from entire fairness review.
As the Court itself emphasized, however, the presumptions of the business judgment rule now provided under MFW are available only if (1) the controller from the outset conditions the transaction on the approval of both a special committee and a majority of the minority stockholders; (2) the special committee is independent; (3) the special committee is broadly empowered, including to freely select its own advisors and to say no definitively; (4) the special committee meets its duty of care; (5) the minority vote is informed; and (6) the minority is not coerced. Failure to satisfy any one of these conditions would subject the defendants to entire fairness review.
It is not clear whether all controlling stockholders will attempt to take advantage of the application of business judgment rule review given the attendant risks that the stockholder vote might fail or that a process defect might trigger post-closing entire fairness review anyway. Some controllers may continue to prefer the certainty of merger approval and the attendant litigation settlement costs invariably required by entire fairness cases. Nevertheless, MFW reinforces the importance of ensuring that a special committee adheres to the procedural strictures it would follow if entire fairness were being applied.