In Kahn, et al. v. M & F Worldwide Corp., et al., 2014 WL 996270 (Del. Mar. 14, 2014), the Delaware Supreme Court unanimously affirmed that, when certain procedural safeguards are implemented at the outset of negotiations, a controller’s buyout of its subsidiary is entitled to judicial review under the deferential “business judgment” standard—instead of the exacting “entire fairness” standard.
This litigation stems from a going-private transaction whereby the 43.4 percent owner, MacAndrews & Forbes (“M&F”), sought to buy out the minority interest of a Delaware holding company, M & F Worldwide Corp. (“MFW”). M&F sent the MFW board a letter proposal to purchase the remaining MFW shares for $24 in cash. In the proposal, M&F stated, in relevant part,
It is our expectation that the Board of Directors will appoint a special committee of independent directors to consider our proposal and make a recommendation to the Board of Directors. We will not move forward with the transaction unless it is approved by such a special committee. In addition, the transaction will be subject to a non-waivable condition requiring the approval of a majority of the shares of the Company not owned by M & F or its affiliates.
Initially, the special committee consisted of five members. The day after the special committee was created, however, one member recused himself because although the board determined he qualified as an independent director under the rules of the New York Stock Exchange, he had current relationships that could raise questions about his independence.
The special committee retained independent counsel and negotiated the transaction with M&F. Ultimately, a deal was reached for $25 per share, which was also approved by a majority of the minority shareholders.
Ruling of the Court
The Supreme Court began its analysis by reciting familiar Delaware law: “Where a transaction involving self-dealing by a controlling stockholder is challenged, the applicable judicial review is ‘entire fairness,’ with the defendants having the burden of persuasion.” The Court continued, reaffirming its holding in Kahn v. Lynch Comc’n Sys., Inc., 638 A.2d 1110 (Del. 1994), that the burden of proof is shifted to the plaintiff to prove the transaction was not entirely fair where the transaction included either an independent special committee or required the approval of fully informed, majority-of-the-minority shareholders.
The Court noted that the question here, however, was the impact of a transaction predicated upon both procedural safeguards, “where the controller voluntarily relinquishes its control—such that the negotiation and approval process replicate those that characterize a third-party merger.” The Supreme Court affirmed the Court of Chancery’s decision, which held that where both procedural safeguards are in place from the start of negotiations and are not perfunctory, the appropriate judicial standard of review is the business judgment rule.
Specifically, the Supreme Court held that in controller buyouts, the business judgment standard of review will be applied if and only if: (i) the controller conditions the procession of the transaction on the approval of both a special committee and a majority of the minority stockholders; (ii) the special committee is independent; (iii) the special committee is empowered to freely select its own advisors and to say no definitively; (iv) the special committee meets its duty of care in negotiating a fair price; (v) the vote of the minority is informed; and (vi) there is no coercion of the minority.
The Supreme Court cited to the Court of Chancery’s analysis below regarding the benefits of implementing the deferential business judgment standard under these circumstances:
By giving controlling stockholders the opportunity to have a going private transaction reviewed under the business judgment rule, a strong incentive is created to give minority stockholders much broader access to the transactional structure that is most likely to effectively protect their interests…. That structure, it is important to note, is critically different than a structure that uses only one of the procedural protections. The “or” structure does not replicate the protections of a third-party merger under the DGCL approval process, because it only requires that one, and not both, of the statutory requirements of director and stockholder approval be accomplished by impartial decisionmakers. The “both” structure, by contrast, replicates the arm’s-length merger steps of the DGCL by “requir[ing] two independent approvals, which it is fair to say serve independent integrity-enforcing functions. Kahn, 2014 WL 996270, at *5.
The Plaintiffs did not challenge whether the minority vote was fully informed. It should be noted that where the court determines that a shareholder vote is tainted by faulty or incomplete information having been provided to shareholders, such claims are not typically accorded business judgment rule protection. See, e.g., In re Rural/Metro Corporation Stockholders Litigation, 2014 WL 971718 (Del. Ch., March 7, 2014) (applying enhanced scrutiny to find board breached duty of disclosure) [for more information, see Reed Smith's Rural/Metro Client Alert]; Frank v. Elgamal¸ 2014 WL 957550 (Del. Ch. Mar. 10, 2014) (refusing to dismiss disclosure claims where entire fairness standard might apply).
The Plaintiffs argued that the record evidence revealed that the special committee was not independent. The Supreme Court rejected that argument and affirmed the Court of Chancery’s analysis and conclusion that none of the purported allegations revealed any material professional or personal relationships. The Court stated that “bare allegations that directors are friendly with, travel in the same social circles as, or have past business relationships with the proponent of a transaction or the person they are investigating are not enough to rebut the presumption of independence.” Kahn, 2014 WL 996270, at *10. Finally, the Court held that, where the non-moving party failed to establish any triable material issue of fact regarding the independence of any of the special committee members, ruling on a director’s independence at the summary judgment stage was appropriate.
Accordingly, the Court held that the applicable standard for judicial review of this transaction was the business judgment rule. The Court held that, because “it cannot be credibly argued (let alone concluded) that no rational person would find the Merger favorable to MFW’s minority stockholders,” summary judgment was appropriate in favor of the Defendants.