The Delaware Supreme Court heard oral argument on December 13, 2023 in a case that will decide whether transactions involving controlling stockholders outside of the merger context may be subject to deferential business judgment review with fewer stockholder protections implemented than would be required to invoke business judgment review in the merger context. The decision will potentially have far-reaching consequences for all Delaware corporations that have a controlling stockholder.

The “MFW Doctrine”—originally decided and applied in a squeeze-out merger—provides that a controlling stockholder transaction—typically subject to entire fairness review—will be subject to the business judgment rule only if the transaction is conditioned, ab initio, on approval by both (1) an independent, fully functioning special committee of independent directors and (2) a majority of disinterested stockholders.

In essence, the MFW Doctrine is intended to replicate an arm’s-length transaction by removing the conflicts of the controlling stockholder and the controller’s influence on the rest of the board. If the company fails to comply with the MFW Doctrine in any respect, the court will assess the controlling stockholder transaction under the “entire fairness” standard rather than the more forgiving “business judgment rule.”

Whether a court determines to review the transaction under the business judgment rule or the entire fairness standard can be, practically speaking, outcome-determinative of litigation challenging the transaction.

EXPANSION OF THE MFW DOCTRINE

The MFW Doctrine came to be in Kahn v. M&F Worldwide Corp. (MFW), a case that concerned a “squeeze-out” merger whereby the company’s controlling stockholder sought to forcibly cash out the company’s remaining investors at a price set by the controlling stockholder.

Since MFW, the doctrine has subsequently been applied by the Delaware Court of Chancery to a variety of corporate transactions with controlling investors other than mergers, including service agreements with a controlling stockholder and executive compensation for a majority shareholder that also served as the company’s CEO. 

IN RE MATCH GROUP, INC. DERIVATIVE LITIGATION

The Match Group case concerns a challenge to a spinoff of dating website Match.com by IAC/InterActiveCorp, the company’s then-controlling stockholder. Vice Chancellor Morgan T. Zurn of the Court of Chancery ultimately dismissed the challenge under the business judgment rule, concluding that the company complied with the procedures set forth in MFW.

In the course of the appeal, the Delaware Supreme Court took the unusual step of asking the parties for supplemental briefing (including accepting additional briefing from numerous amici curiae) on an issue not raised in the Court of Chancery: whether MFW should apply outside the context of a parent-subsidiary merger, or whether a less-cumbersome “cleansing mechanism” may be employed in nonmerger transactions with a controlling stockholder for the company to enjoy the protections of the business judgment rule. 

In its briefing and at oral argument, the company argued against “MFW creep,” or the expansion of the MFW Doctrine outside of the squeeze-out merger context. Specifically, the company reasoned that Delaware courts have historically required companies to use only one of three so-called “cleansing mechanisms” to invoke the protections of the business judgment rule for a conflicted transaction: (1) approval by a majority of independent directors, (2) approval by a special committee of independent directors, or (3) approval by a majority of disinterested stockholders.

Accordingly, the company argued that MFW’s holding should be cabined to apply only to squeeze-out mergers, and other controlling stockholder transactions should be entitled to deference under the business judgment rule so long as the company meets one of the three traditional cleansing mechanisms.

The plaintiffs responded that the company’s argument relied on a “revisionist narrative of Delaware law” and that it is well settled that MFW applies to all transactions with a controlling stockholder. To hold otherwise here, in the plaintiffs’ view, would “administer a coup de grace by rendering entire fairness inapplicable to all controller transactions except freeze-out mergers.”

The court also accepted briefing from a group of law professors supporting the plaintiffs. The self-titled “Academics” cautioned that limiting the application of MFW would allow controlling stockholders “to smuggle in squeeze-outs under alternative packaging” and that MFW is a necessary and effective minority shareholder protection. The company responded that the Court of Chancery is well equipped to protect against the Academics’ concern about “subterfuge.”

LOOKING AHEAD

The Delaware Supreme Court could be expected to hand down its decision in the Match Group case at any time over the next three months. While the merits of its decision remain to be seen, any following decision that sets forth the metes and bounds of the MFW doctrine is guaranteed to have a long-lasting impact on corporate transactional practice.

A decision in the company’s favor would likely result in a decision that allows for more streamlined (nonmerger) transactions with controlling stockholders. Meanwhile, a decision in the plaintiffs’ favor would likely provide certainty in the market concerning the exact type of procedures a company should implement when considering a transaction with a controlling stockholder if the company wants to invoke the benefits of the business judgment rule.

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