On Friday, the Delaware Supreme Court adopted the business judgment rule standard of review for some controlling stockholder freeze-out mergers and potentially other interested party transactions. In Kahn, et al. v. M&F Worldwide Corp., et al., MacAndrews & Forbes, then owner of 43 percent of the stock of M&F Worldwide Corp. (M&F), offered to purchase the remaining shares of M&F to take the company private. MacAndrews’ offer was expressly conditioned on (1) the approval of a special committee of independent directors of the M&F Board, and (2) the approval of the majority of the unaffiliated stockholders.
Before this case, Delaware law scrutinized controlling party merger transactions under the entire fairness standard of review. That standard requires the party seeking to conduct the transaction to establish that the transaction is entirely fair to the unrelated, minority stockholders in terms of both fair dealings and fair price. Earlier Delaware case law had adopted a test that would shift the burden under the entire fairness test to objecting stockholders if the transaction was approved by either a special committee of independent directors or by the majority of the minority stockholders.
In the M&F case, former Chancellor Leo Strine (now Chief Justice of the Delaware Supreme Court) ruled that where a controlling party freeze-out merger transaction was conditioned at the outset on both the approval of a special committee of independent directors and the approval of the majority of unaffiliated, minority stockholders, the transaction should be scrutinized under the business judgment rule, rather than the entire fairness standard. This approach was warranted, the court determined, because the two protective devices made the controlling stockholder merger more akin to a third-party arm’s length merger negotiation.
The Delaware Supreme Court’s ruling on Friday affirmed the lower court’s adoption of the business judgment rule standard on the specific conditions that (1) the controlling stockholder conditions the transaction on the approval of both a special committee and the majority of the minority stockholders, (2) the special committee is independent, (3) the special committee is empowered to 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 vote of the minority stockholders is informed, and (6) there is no coercion of the minority stockholders.
After adopting this new test, the Delaware Supreme Court then analyzed the prongs and affirmed the lower court’s ruling in favor of the defendants on summary judgment. In particular, the court analyzed the independence of the members of the special committee, and, despite various challenges based on prior business dealings or other personal relationships with MacAndrews or its owner, found that there was no evidence that any of the dealings were material to the specific committee members or would have altered their judgment, and that the challenging stockholders were required to present evidence that the connection or prior dealings would have had an effect on the specific committee member to avoid summary judgment.
The court also reviewed the mandate and work of the special committee and determined that its authority and negotiations were sufficient. Finally, the court concluded that the minority stockholders were adequately informed and not coerced. The court therefore concluded that the stockholders’ challenges to the controlling stockholder merger were properly rejected on summary judgment, without the need for a trial.
The court’s adoption of the business judgment rule for controlling stockholder freeze-out mergers will make challenges to those transactions far more difficult if the merger follows the M&F process from the outset and is conditioned on the procedural safeguards the court has established. In those situations, courts in Delaware, and likely many other jurisdictions that look to Delaware law for guidance on business transactions, will give far greater deference to the decision of the corporation to approve the merger. This may reduce stockholder merger challenges or, at a minimum, reduce the costs of that type of litigation as corporate boards will be more likely to obtain dismissal of challenges at earlier stages of the proceedings.