In a recent decision, the Delaware Supreme Court clarified the proper standard to apply to a non-freeze-out merger transaction involving a controlling stockholder.1 Litigators who practice in the Delaware Court of Chancery are well-versed in the standards of review that courts apply when evaluating transactions entered into by Delaware corporations. The business judgment rule and entire fairness doctrine are long-settled law in Delaware. The question of which standard of review applies to a challenged transaction in a given case is an important one, because the standard of review can be outcome-determinative.
In Match Group II, the Court held that entire fairness is the presumptive standard of review in any suit where a controlling stockholder stood on both sides of a transaction with the controlled corporation and received a non-ratable benefit.2 The Court further clarified that a controlling stockholder can “secure the benefits of business judgment review,” but only if it follows all of the requirements set forth in Kahn v. M & F Worldwide Corp. (“MFW”)—most notably the employment of an independent special committee and an unaffiliated stockholder vote.3
THE TRANSACTION
The plaintiffs bringing suit were shareholders who challenged the fairness of a reverse spinoff, through which the parent company—IAC/InterActiveCorp (“IAC”), an internet and media conglomerate—would separate from its controlled subsidiary, Match Group, Inc. (“Match Group”). Both IAC and Match Group were controlled by IAC’s chairman and largest individual stockholder, Barry Diller.
IAC acquired Match Group in 1999 and, in 2009, incorporated Match Group in Delaware as its subsidiary. The transaction in question involved the separation of Match Group, and some debt obligations, from the rest of IAC’s businesses. To complete the separation, IAC formed a subsidiary, “New IAC,” and spun off its other businesses into that new entity. This left “Old IAC” holding Match Group, as well as a considerable amount of debt. At the time of this reverse spinoff, Old IAC held 98.2% of Match Group’s voting power—a benefit conferred through its ownership of 24.9% of Match Group’s common stock and all of the Class B shares, which had disproportionately high voting rights. Old IAC reclassified three classes of stock into a single class of common stock and became known as “New Match.”
THE NEGOTIATION AND CONSUMMATION OF THE TRANSACTION
To complete the transaction, IAC established a “Separation Committee” composed of three of the ten Match Group directors: Thomas McInerney, Pamela Seymon, and Ann McDaniel. Importantly, McInerney was the former CFO of IAC and a director of several Diller-controlled companies. The Separation Committee was fully empowered to “oversee and consider potential separation transactions with Old IAC, and in its sole discretion to direct, negotiate, and approve or disapprove any separation transaction.”4 Led by McInerney, the Separation Committee negotiated and ultimately reached an agreement with IAC CEO Joey Levin to spin IAC off from Match Group. A majority of the unaffiliated shareholders of both IAC and Match Group voted to approve the transaction.
THE LITIGATION
Match Group stockholders filed suit against IAC and ten of its directors (the “Defendants”),5 alleging that they had breached their fiduciary duties to the company. Plaintiffs claimed that, through the conflicted transaction, IAC obtained non-ratable benefits to the detriment of Match Group’s minority stockholders, that the Separation Committee was conflicted, and that the proxy disclosures regarding the spinoff misled the Match Group stockholders who had voted in favor of the transaction.
Specifically, Plaintiffs alleged that “Old IAC, as Old Match’s controller, orchestrated the Separation to New IAC’s benefit but to the detriment of Old Match and New Match minority stockholders.”6 According to Plaintiffs, the transaction left New Match with Old IAC’s debt obligations and potential litigation liabilities, and forced New Match to purchase Old IAC’s real-estate and tax attributes, thereby providing New IAC with tax benefits.
THE DELAWARE COURT OF CHANCERY DECISION
In their motion to dismiss, Defendants argued that IAC had complied with the MFW framework and, thus, that the Court of Chancery should review the transaction under the business judgment rule. Alternatively, Defendants argued that the transaction was entirely fair—also a basis for dismissal. Plaintiffs argued that the Separation Committee lacked independence, that the minority stockholders were inadequately informed of the details of the transaction prior to their stockholder vote, and that the court should apply the entire fairness standard of review to this non-freeze-out merger.
The Delaware Court of Chancery granted Defendants’ motion to dismiss.7 Because Plaintiffs failed to plead facts sufficient to call into question any of the procedural protections that form the MFW framework for conflicted controller transactions, the Court held, the transaction was entitled to the deference of the business judgment rule.
In analyzing the MFW prong requiring the independence of a special committee, the Court looked to whether “the pleadings support[ed] a reasonable inference that either (i) 50% or more of the special committee was not disinterested and independent, or (ii) the minority of the special committee somehow infected or dominated the special committee’s decisionmaking process.”8 Although the Court concluded that the complaint adequately alleged that McInerney was not independent of the controlling stockholder, the Court ultimately held that he neither infected nor dominated the Separation Committee or its evaluation process. Therefore, Plaintiffs failed to plead a breach of fiduciary duty based on a conflicted special committee. In essence, the Chancery Court held that the independence prong of MFW does not require complete independence of a special committee in order for business judgment to apply to the evaluation of a conflicted transaction.
The Chancery Court also held that the Separation Committee was sufficiently empowered to evaluate the conflicted transaction because it “was empowered to freely select its own advisors, and empowered to say no definitively.”9 The Separation Committee selected financial and legal advisors who were sufficiently independent to objectively evaluate the merits of the conflicted transaction. “In this context, ‘independent’ means that the advisors work for the special committee and have the committee’s interests in mind. Independence requires not being chosen by the controller, being co-opted by the controller, or harboring powerfully conflicting incentives.”10 To maintain independence for purposes of MFW, the special committee (and its advisors) must have accurate information, cannot be facing an ultimatum from the controller or otherwise be threatened, and must have the authority to reject a proposed transaction, if that is in the best interests of minority stockholders.11
Plaintiffs appealed all aspects of the Court of Chancery’s decision.
THE DELAWARE SUPREME COURT DECISION: CLARIFYING ENTIRE FAIRNESS
In considering the appeal, the Delaware Supreme Court requested supplemental briefing on the previously unresolved issue of whether the MFW doctrine should apply outside the context of a freeze-out merger, or whether a less burdensome “cleansing mechanism” would suffice to trigger business judgment review in non-merger transactions with a controlling stockholder. The Supreme Court’s decision thus addressed both (1) the threshold issue of whether, in a non-freeze-out merger, the entire fairness standard of review changes to business judgment if a defendant shows either approval by an independent special committee or approval by an uncoerced, fully informed, unaffiliated stockholder vote, and (2) the specific issue of whether IAC satisfied all MFW’s requirements to invoke business judgment review.12
Plaintiffs argued that MFW applies to all transactions with a controlling stockholder. Plaintiffs also argued that the Court of Chancery erred in applying the business-judgment standard of review, because (1) in order to satisfy MFW’s requirement of an independent special committee, each member must be independent of the controlling stockholder; (2) McInerney dominated the Separation Committee’s process and improperly influenced the negotiations; and (3) the stockholder vote was not fully informed, because the proxy materials published by IAC did not adequately disclose material information about McInerney’s conflicts.
Defendants responded that, in the context of non-freeze-out transactions, the business judgment rule should apply if a company employs either of the independent committee or minority vote procedural devices.13 Further, defendants argued that Delaware law requires only a majority of a special committee be independent to satisfy MFW. Finally, they claimed, McInerney was independent of the controlling stockholder.
Over time, Delaware case law has analyzed the application of entire fairness to several transactions in which a controlled stockholder stood on both sides of the transaction. In Weinberger v. UOP, Inc., the Delaware Supreme Court reiterated that the entire fairness doctrine applies to a freeze-out merger when a controlling stockholder stands on both sides of the transaction and receives a non-ratable benefit.14 But where that “corporate action has been approved by an informed vote of a majority of the minority shareholders,” it held, “the burden entirely shifts to the plaintiff to show that the transaction was unfair to the minority.”15 The Supreme Court later clarified in Kahn v. Lynch that, if the defendants established that the transaction was either negotiated by a special committee of independent directors or subject to the approval of the majority of the minority shareholders—like in Weinberger—the burden would shift to the plaintiff to demonstrate that the transaction was not fair to the minority shareholders.16
After Kahn v. Lynch, the Delaware Supreme Court was left to clarify how courts should evaluate freeze-out mergers involving a controlling shareholder on both sides of the transaction where the transaction was both evaluated by a well-functioning special committee and approved by a vote of fully informed, uncoerced minority stockholders. In MFW, the Court held that, where both procedural protections were implemented, the transaction should be evaluated under the business judgment rule.17 “Where the controller irrevocably and publicly disables itself from using its control to dictate the outcome of the negotiations and the shareholder vote, the controlled merger then acquires the shareholder-protective characteristics of third-party, arm’s-length mergers, which are reviewed under the business judgment standard.”18
Through its recent decision in Match Group II, the Delaware Supreme Court filled two important gaps in conflicted-transaction jurisprudence. First, the Court grappled with the previously unresolved issue of whether the MFW framework should be applied to non-freeze-out mergers involving a controlling stockholder. The Court held that the MFW framework applies to all transactions in which a controlling stockholder stands on both sides of the deal because Delaware precedents indicate that “the standard of review did not depend on the nature of the transaction.”19 Rather, what matters is that the “specter of impropriety can never be completely eradicated and still require[s] careful judicial scrutiny.”20
Second, the Court held that “[a] controlling stockholder’s influence is not ‘disabled’ when the special committee is staffed with members loyal to the controlling stockholder.”21 The Court reiterated the holding of MFW “that the special committee must be independent, not that only a majority of the committee must be independent. And, as we stated in Weinberger, fairness can be equated to conduct by a theoretical, wholly independent, board of directors acting upon the matter before them.”22
Finally, the Court held, in order to secure the benefits of the deferential business judgment review of a conflicted transaction, defendants must strictly adhere to all aspects of the MFW framework. A controlling stockholder–defendant “can shift the burden of proof to the plaintiff by properly employing a special committee or an unaffiliated stockholder vote. But the use of just one of these procedural devices does not change the standard of review. If the controlling stockholder wants to secure the benefits of business judgment review, it must follow all MFW’s requirements.”23 In other words, Delaware courts cannot evaluate a conflicted transaction under the business judgment rule, unless the transaction was negotiated and evaluated by a completely independent special committee and approved by a fully informed majority of the minority stockholders.
1 In re Match Grp., Inc. Deriv. Litig. (Match Group II), __ A.3d __, 2024 WL 1449815 (Del. Apr. 4, 2024).
2 Id. at *1.
3 Id. In MFW, the Delaware 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. 88 A.3d 635, 645 (Del. 2014).
4 Match Group II, 2024 WL 1449815, at *2.
5 The full suite of defendants, as named in the Amended Complaint, included Diller, IAC’s chairman, and IAC’s chief executive; it also named Match Group as a nominal defendant.
6 In re Match Grp., Inc. Deriv. Litig. (Match Group I), 2022 WL 3970159, at *3 (Del. Ch. Sept. 1, 2022).
7 Match Group I, 2022 WL 3970159.
8 Id. at *16 (alterations omitted).
9 Id. at *21.
10 Id. (alterations omitted).
11 See id. at *21.
12 Match Group II, 2024 WL 1449815, at *1.
13 Id. at *6.
14 457 A.2d 701 (Del. 1983).
15 Id. at 703.
16 See Kahn v. Lynch Commc’ns Sys., Inc., 638 A.2d 1110, 1115 (Del. 1994).
17 MFW, 88 A.3d at 645.
18 Id. at 644.
19 Match Group II, 2024 WL 1449815, at *11.
20 Id. at *12.
21 Id. at *19.
22 Id. at *19 (quoting Weinberger, 457 A.2d at 711 n.7).
23 Id. at *1.
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