Overview

In 2014, the Delaware Supreme Court held in Kahn v. M&F Worldwide Corp. (“MFW”) that a court will apply the entire fairness standard of review to freeze-out merger transactions between a controlled corporation and its controlling stockholder when the controlling stockholder receives a non-ratable benefit unless the controller conditions the transaction on (1) negotiation by an independent committee and (2) approval by a fully informed vote of a majority of minority stockholders (the “MFW framework”). For the past decade, the applicability of the MFW framework to controlling stockholder transactions outside of the freeze-out context has been uncertain.

On April 4, 2024, the Delaware Supreme Court resolved this uncertainty in In re Match Group Inc., Derivative Litigation. The central question before the Delaware Supreme Court was whether courts should apply the more deferential business judgment rule standard of review, rather than the more stringent entire fairness standard, to non-freeze-out controlling stockholder transactions, if a defendant puts in place just one prong of the MFW framework. In other words, is it sufficient for a controlled company to show “either approval by an independent special committee or approval by an uncoerced, fully informed, unaffiliated stockholder vote” to get business judgment rule deference?

The Match court evaluated a reverse spinoff, and held that “in a suit claiming that a controlling stockholder stood on both sides of a transaction with the controlled corporation and received a non-ratable benefit, entire fairness is the presumptive standard of review,” and “[i]f the controlling stockholder wants to secure the benefits of business judgment review, it must follow all [of] MFW’s requirements.” The Court further reaffirmed that the elements of MFW would not be met unless all members of the independent committee charged with negotiating the transaction satisfied independence requirements under Delaware law.

Background

In 2019, IAC/InterActiveCorp (“Old IAC”) announced that it was considering a reverse spinoff from its controlled subsidiary Match Group, Inc. (“Old Match”) (the “Separation”). At the time of the Separation, Old IAC held 98.2% of Old Match’s voting power through its ownership of 24.9% of Old Match’s common stock and all of its Class B high-vote common stock.

The Old IAC board appointed three directors to an independent committee (the “Separation Committee”) to assess the transaction; the board also empowered the Separation Committee to retain its own financial and legal advisors, oversee and consider potential separation transactions, and direct, negotiate, and approve any separation transaction. One member of the Separation Committee, Thomas McInerney, played a central role in the negotiations. McInerney had previously worked for Old IAC from 1999 to 2012 (seven years of which he served as the CFO) and earned more than $55 million in compensation from Old IAC. When announcing his departure from Old IAC, he expressed gratitude for Old IAC and Barry Diller, Old IAC’s chairman, senior executive, and large stakeholder; likewise, Diller expressed his “total respect for [McInerney’s] ability, trustworthiness, and decency.” Additionally, during and after his time at Old IAC, McInerney served on boards of various IAC-affiliated companies, earning more than $4.5 million in director compensation.

The Separation Committee retained legal counsel and a financial advisor and received an initial proposal from Old IAC. In the ensuing months, McInerney met several times with Old IAC’s CEO, reported back to the Separation Committee, and conveyed a counterproposal. McInerney and Old IAC’s CEO eventually reached an agreement.

The agreement, as described in the proxy statement, created two separate public companies and eliminated Old Match’s dual-class capital structure. All Old Match and Old IAC stockholders would receive stock in New Match. New Match would retain and guarantee debt in the form of exchangeable notes from subsidiaries of Old IAC and would issue a dividend to its stockholders, most of which would go to Old IAC. New Match would also be subject to certain governance restrictions, giving New IAC certain control over New Match, and New IAC would have the right to engage in an equity offering. The stockholders of both Old IAC and Old Match voted in favor of the agreement, with approximately 75% of Old Match’s minority stockholders approving the Separation.

Old Match stockholders challenged the fairness of the Separation. Specifically, the plaintiffs alleged that the transaction resulted from a conflicted process because Old IAC, Old Match’s controlling stockholder, stood on both sides of the transaction; McInerney lacked independence, resulting in a Separation Committee that was not fully independent; and the proxy statement was misleading. The defendants moved to dismiss.

The Delaware Court of Chancery granted the motion to dismiss. Among other things, the court concluded that the defendants satisfied the requirements of the MFW framework. Although the Court of Chancery found that McInerney lacked independence, that fact alone was not fatal because the plaintiffs did not show that (1) more than 50% of the Separation Committee was not independent or (2) the minority of the Separation Committee infected or dominated the decision-making process.

On appeal, the plaintiffs asked the Delaware Supreme Court to decide whether the MFW framework applied to non-freeze-out transactions involving a controlling stockholder and whether McInerney’s former relationships with IAC meant that the Separation Committee was not independent.

The Delaware Supreme Court Affirmatively Expands the Scope of MFW

The defendants argued that outside the freeze-out context, the business judgment rule should apply if the challenged controller transaction receives approval by either (1) a board with an independent director majority, (2) a special committee of independent directors, or (3) a majority of unaffiliated stockholders. The Delaware Supreme Court disagreed. The Match court concluded that the impetus behind the MFW framework was not the nature of the transaction. Rather, the MFW framework’s purpose is to avoid the “specter of impropriety,” mimic arm’s-length negotiation, and prevent potential conflicts, which arise when a controlling stockholder stands on both sides of the transaction and receives a non-ratable benefit. A non-ratable benefit is a unique benefit given to the controlling stockholder and may exist even if the controller receives nominally the same consideration as other stockholders.

The Court held that entire fairness—Delaware’s most stringent standard of review—applies to all transactions involving a controlling stockholder that receives a non-ratable benefit. When entire fairness applies, the controlling stockholder bears the heavy burden of demonstrating that the transaction was entirely fair to the corporation and its minority stockholders. The controlling stockholder can shift the burden of proof to the plaintiff to show that the transaction was not entirely fair by either (i) relying on a special committee to negotiate the transaction or (ii) putting the transaction to a vote by the unaffiliated stockholders. But the controlling stockholder cannot change the standard of review to the more deferential business judgment standard absent satisfaction of the full MFW framework: (1) negotiation of the transaction by an independent committee and (2) approval of the transaction by a fully informed vote of the majority of minority stockholders.

The Delaware Supreme Court Confirms That One Conflicted Director Can Undermine an Independent Committee

The Delaware Supreme Court also concluded that the defendants had not met the requirements of the MFW framework in Match because one of the three directors on the Separation Committee lacked independence. Specifically, the Delaware Supreme Court affirmed the Court of Chancery’s conclusion that McInerney was not independent, but it rejected the lower court’s view that only a majority of the Separation Committee had to be independent under MFW. Rather, the Delaware Supreme Court held that to meet the first prong of the MFW framework, all members of a special committee must be independent. Thus, the Court held that because the defendants failed to satisfy the MFW framework, entire fairness remained the standard of review, and it reversed the Court of Chancery’s decision granting the defendants’ motion to dismiss.

Key Takeaways

• To obtain review under the deferential business judgment rule for all controlling stockholder transactions—freeze-out or not—the utilization of the full MFW framework (i.e., the transaction is (1) negotiated by an independent committee and (2) approved by a fully informed vote of the majority of minority stockholders) from the outset of the transaction is the best path. 
• Deploying only one prong of the MFW framework is insufficient to secure business judgment review. However, to shift the burden to the plaintiff under entire fairness in controlling stockholder transactions, a company can use approval by either an independent committee or a fully informed vote of the minority stockholders.  
• The MFW framework requires a special committee of a board of directors that consists entirely of independent directors, not a committee consisting of merely a simple majority of independent directors.

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