Kahn v. M&F Worldwide Corp.: Delaware Supreme Court Affirms In Re MFW Court of Chancery Ruling that Business Judgment Review Can Apply to Squeeze-Out Mergers Conditioned Up Front on Both Approval by Special Committee and Majority-of-the-Minority VoteSullivan & Cromwell LLP - March 17, 2014
In an opinion issued last Friday, a unanimous Delaware Supreme Court sitting en banc affirmed then Chancellor (now Delaware Supreme Court Chief Justice) Strine’s decision in In re MFW Shareholders Litigation, holding that the business judgment rule standard of review applies to squeeze-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 (i) negotiation and approval by a special committee of independent directors free to select its advisors and empowered to say no definitively that fulfills its duty of care and (ii) approval by an uncoerced, fully informed vote of a majority of the minority. The Court further indicated that if triable issues of fact remain after discovery about whether either procedural protection was established or effective, then a squeeze-out merger will be subject to entire fairness review at trial.
Noting that the appeal presented a question of first impression, the Delaware Supreme Court adopted the new standard articulated by the Court of Chancery, holding that business judgment review would only apply if all the following elements were present: (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 empowered to freely select its own advisors and to say no definitively; (4) the special committee meets its duty of care in negotiating a fair price; (5) the minority vote is informed; and (6) the minority is not coerced.
Distinguishing prior cases involving squeeze-out mergers in which it had held that the most either a well-functioning special committee or an informed majority of the minority stockholder vote could effect was a shifting of the burden to the plaintiffs to prove that the transaction was not entirely fair, a burden-shifting it continued to endorse, the Court noted the distinguishing characteristic of In Re MFW was the controller’s agreement up front to forgo exercising its voting power on a non-waivable basis – something the Chancery Court indicated would limit the potential for any retributive going private effort by the controller.
The Court reasoned that the dual procedural protections required by In Re MFW optimally protect minority stockholders in squeeze-out mergers because the controller “irrevocably and publicly disables itself” from being able to dictate the outcome of the negotiations and the minority stockholder vote (the minority stockholders are given the ability to decide whether to accept a deal recommended by an independent negotiating agent that cannot be bypassed and that is empowered to bargain for the best price and reject any inadvisable deal), simulating third-party, arm’s-length mergers that are subject to business judgment review in the first instance. Moreover, the Court agreed with the Court of Chancery that applying the business judgment rule was consistent with Delaware law’s tradition of deferring to informed decisions of impartial directors approved by uncoerced, fully-informed disinterested stockholders. The Court also agreed with the Court of Chancery that employing both safeguards replicates the arm’s length merger steps statutorily prescribed by the DGCL (in which the controlling stockholder first negotiates with independent directors and then obtains approval from a majority of unaffiliated stockholders) and greatly enhances the minority stockholders’ voice – the special committee, aware that it will be judged by the minority stockholders at the ballot box, may bargain harder, while the controlling stockholder, wanting a favorable vote, may be willing to concede more.
Finally, the Court reasoned that so long as plaintiffs can plead a reasonably conceivable set of facts showing that any of the elements needed to obtain the business judgment standard did not exist, the plaintiffs would be entitled to discovery and the issue of fair price in controller buyouts will continue to be subject to pretrial scrutiny because a trial court will only be able to determine if business judgment review applies to a controller buyout after the court has made a pretrial assessment, following discovery, of whether an independent, adequately-empowered special committee that acted with due care achieved a fair price that was approved by an uncoerced, fully-informed majority of the minority.
After affirming the Chancery Court’s analysis, the Court went on to confirm the Court of Chancery’s findings that in the instant case, the dual procedural prongs had been established and business judgment review properly applied at summary judgment, noting that the Chancery Court had concluded at that stage that the plaintiffs had failed to raise any genuine issue of material fact; the Court found that it could not be “credibly argued (let alone concluded)” that no rational person would have found the M&F Worldwide Corp. merger favorable to its minority stockholders on the facts presented. However, the Court noted that the plaintiffs’ claims would have survived a motion to dismiss under this new standard had such a motion been brought, permitting them to obtain discovery, based on the specific allegations in the plaintiffs’ complaint challenging the sufficiency of the merger price that implicated the adequacy of the special committee’s negotiations.
The Kahn v. M&F Worldwide decision harmonizes the standard of judicial review of freeze-out mergers with that of freeze-out tender offers, thereby addressing the doctrinal inconsistency that had been commented on unfavorably in dicta in previous Chancery Court decisions. And it preserves existing Delaware precedent permitting a burden shift in entire fairness review for transactions that have the benefit of either an independent committee recommendation or a majority-of-the-minority condition; some transactions may continue to be structured in this manner, particularly if there is uncertainty about obtaining majority of the minority approval.
Controllers and special committees seeking business judgment review should be prepared for the fullest range of possible plaintiff challenges to the independence and efficacy of the special committee and to the accuracy and completeness of disclosures since they will form the basis for plaintiffs’ only path to avoid an outcome determinative finding that a committee’s actions are entitled to business judgment review.