The In re MFW case establishes that the deferential business judgment standard of review will apply to going-private one-step mergers with controlling stockholders if such transactions are, from the outset, subject to both (i) negotiation and approval by a fully empowered special committee of independent directors and (ii) approval by an uncoerced, fully informed vote of a majority of the minority of target stockholders.
The In re MFW case seeks to converge the “unified standard” of review recently applied by the Delaware Court of Chancery in the context of controlling stockholder-backed two-step going-private mergers, creating an across-the board incentive for controlling stockholders to provide minority stockholders with dual procedural protections in all going-private transactions regardless of whether structured as a one- or two-step merger.
One of the key benefits of the holding of the In re MFW case is that, going forward, use of both procedural protections will facilitate dismissal of inevitable M&A litigation at the motion to dismiss stage without a trial. Until now, this was not possible in one-step going-private transactions.
Addressing an unsettled area of Delaware law, the Delaware Court of Chancery (the “Chancery Court”) revisited the appropriate standard of review for a going-private merger with a controlling stockholder. Writing for the Court in In re MFW Shareholders Litigation, C.A. No. 6566-CS (Del. Ch. May 29, 2013), Chancellor Strine concluded that, “when a controlling stockholder merger has, from the time of the controller’s first overture, been subject to (i) negotiation and approval by a special committee of independent directors fully empowered to say no, and (ii) approval by an uncoerced, fully informed vote of a majority of the minority investors, the business judgment rule standard of review applies.”
Going-private transactions are routinely challenged by plaintiffs in the Chancery Court based on claims that the board of directors of the target company breached its fiduciary duties to its stockholders. As a result, the likely standard of review to be applied by a court in evaluating the conduct of the board is a key factor to be considered when structuring such transactions.
Background of the Case
MacAndrews & Forbes (“MacAndrews”), a holding company wholly owned by Ronald Perelman, owned 43% of M&F Worldwide (“MFW”). MacAndrews offered to purchase the rest of MFW’s equity in a going-private merger. But upfront, MacAndrews said it would not proceed with any going-private transaction that was not approved by both: (i) an independent special committee of the MFW board; and (ii) a vote of a majority of the stockholders unaffiliated with MacAndrews, or a “majority of the minority.” A special committee of the MFW board was formed, and the merger was eventually approved by both the special committee and an affirmative vote of the majority of the minority of MFW stockholders, with 65% of the shares held by the minority stockholders approving the merger.
The defendants argued that because the merger was conditioned up front on two key procedural protections that, together, replicated an arm’s-length merger, the judicial standard of review should be the business judgment rule. Under that rule, the court is precluded from inquiring into the substantive fairness of the merger, and must dismiss the challenge to the transaction unless its terms were so disparate that no rational person acting in good faith could have thought the merger was fair to the minority.1
In Re MFW Adresses a Novel Question of Law
In re MFW addressed a novel question of law, which has been a hotly debated issue for decades: which standard of review should apply in a going-private one-step merger with a controlling stockholder that is conditioned upfront by the controlling stockholder on the approval by both a properly empowered, independent committee of the board and an informed, uncoerced majority of the minority vote?
Historically, Delaware courts have applied different standards of review to going-private transactions depending on whether the transaction is structured as a one- or two-step merger and, depending on structure, the use of certain procedural protections aimed at replicating an arm’s length transaction. The Chancery Court’s holding in In re MFW sought to create an across-the board incentive to provide minority stockholders with the best procedural protections in all going-private transactions regardless of structure.
Historical Standards of Review in One- and Two-Step Going-Private Transactions
In one-step mergers involving controlling stockholders, Delaware courts have applied the “entire fairness” standard (a heightened standard that requires the controlling stockholder’s demonstration of both fair price and a fair process). However, as originally held by the Delaware Supreme Court nearly twenty years ago in Kahn v. Lynch2, controlling stockholders who structure going-private transactions as one-step mergers conditioned on the approval by either a special committee of independent directors or a majority of the non-controlling stockholders are normally able to shift the burden of proving entire fairness from the controlling stockholder to the plaintiff(s) challenging the merger. For decades many commentators and lawyers assumed that, notwithstanding the ability to add procedural protections that would result in a shift in the burden of proof, a controlling stockholder could not escape entire fairness review in a transaction structured as a one-step merger. The question, however, had remained unanswered in any definitive way.
The standard of review for two-step going-private transactions (a tender offer followed by a back-end merger) involving controlling stockholders has also lacked clarity; however, what has been clear for more than a decade is that application of the business judgment rule is achievable through the use of a two-step structure (as opposed to a one-step structure). Under the Pure Resources3 line of cases, which culminated with Vice Chancellor Parsons’ May 6, 2010 opinion in In Re Cox Radio4, the Chancery Court held that the deferential business judgment rule would apply to tender offers so long as the tender offer was “non-coercive.” The test for demonstrating a non-coercive offer involved showing each of the following: that (i) the tender offer was subject to a non-waivable majority of the minority condition; (ii) the controlling stockholder promised to complete a prompt back-end short-form merger at the same price as was offered in the tender offer if it obtained more than 90% of the target’s shares in the tender offer; (iii) the controlling stockholder made no threats of retribution to the minority stockholders if they were to choose not to tender into the offer; and (iv) the independent directors had both "free rein and adequate time" to consider the tender offer and provide the minority stockholders with a recommendation and adequate information with which to make a decision. A few weeks later in In Re CNX5, in an opinion written by Vice Chancellor Laster, the Chancery Court decided not to apply the Pure Resources non-coercive standard and instead applied a “unified standard” of review in which the business judgment rule is only applicable if such a transaction is conditioned on both the affirmative recommendation of a special committee and approval of a majority of the unaffiliated stockholders.
The Chancery Court’s Application of the Business Judgment Rule in In Re MFW
A threshold issue before the Court in In re MFW was whether it was bound by prior decisions of either the Delaware Supreme Court or the Chancery Court. While Chancellor Strine conceded that language in Kahn v. Lynch and other Delaware Supreme Court decisions can be (and has been) read as indicating that there are no circumstances when a merger with a controlling stockholder can escape fairness review in a one-step merger, he concluded that the language in Lynch does not constitute a holding of Delaware’s Supreme Court and that the question at hand had never been squarely decided by Delaware courts. As Chancellor Strine noted “[i]n no prior case was the [Delaware] Supreme Court given the chance to determine whether a controlling stockholder merger conditioned on both independent committee approval and a majority-of-the-minority vote should receive the protection of the business judgment rule.” Once the Chancery Court determined that there was no binding precedent applicable to the case at hand, it was then able to examine whether the MFW special committee and the majority of the minority provision qualify as cleansing devices under Delaware’s approach to the business judgment rule. For example, if the MFW special committee was not comprised of directors who qualify as independent under Delaware law, the defendants would not be entitled to summary judgment under their own argument. Likewise, if the majority of the minority vote were tainted by a disclosure violation or coercion, the defendants’ motion would fail.
As to the special committee, the Chancery Court concluded that the special committee qualified because there was no triable issue of fact regarding: (i) the independence of the special committee; (ii) its ability to employ financial and legal advisors and its exercise of that ability; and (iii) its empowerment to negotiate the merger and to definitively say no to the transaction. The Chancery Court noted that the special committee met on eight occasions and there were no grounds for the plaintiffs to allege that the committee did not fulfill its duty of care. As to the majority of the minority vote, the plaintiffs conceded that it was a fully informed vote, and they did not point to any failure of disclosure. The Chancery Court also found that there was no evidence of any stockholder coercion. As a result, seemingly in a step towards convergence with the standard of review recently applied in In re CNX and, on its face, seeking to create an across-the board incentive for controlling stockholders to provide minority stockholders with the best procedural protections in all going-private transactions regardless of whether such a transaction is structured as a one-step or two-step merger, the Chancery Court held that, “when a controlling stockholder merger has, from the time of the controller’s first overture, been subject to [both] (i) negotiation and approval by a special committee of independent directors fully empowered to say no, and (ii) approval by an uncoerced, fully informed vote of a majority of the minority investors, the business judgment rule standard of review applies.”
In applying the business judgment rule in a summary judgment decision, the court in In re MFW addressed both (i) the incentive structure created by the Delaware Supreme Court’s and the Chancery Court’s prior holdings and the incentive structure that is expected to be created by the holding in this case and (ii) the lack of precedent directly applicable to the question at hand, while expressly noting that the Delaware Supreme Court is ultimately the final arbiter of the matter.
In reaching his conclusion, Chancellor Strine stated that “whether proceeding by a merger or a tender offer, a controlling stockholder would recognize that it would face entire fairness review unless it agreed not to proceed without the approval of an independent negotiator with the power to say no, and without the uncoerced, fully informed consent of the majority of the minority.” This is consistent with Kahn v. Lynch and its progeny, as a controlling stockholder would continue to get burden-shifting relief if it employed only one of the procedural protections discussed, but could not escape an ultimate judicial scrutiny into substantive fairness, without employing both procedural protections. Furthermore, the Chancery Court’s holding seeks to close the gap on a distinction between transaction structures that many have argued is artificial.
Moreover, Chancellor Strine’s analysis focused on, and his conclusion is consistent with, the central tradition of Delaware law, which defers to the informed decisions of impartial directors, especially when those decisions have been approved by the disinterested stockholders on a fully informed basis and without coercion. Additionally, the Chancery Court asserted that adoption of In Re MFW’s holding will be of benefit to minority stockholders because it will “provide a strong incentive for controlling stockholders to accord minority investors the transactional structure that respected scholars believe will provide them the best protection, a structure where stockholders get the benefits of independent, empowered negotiating agents to bargain for the best price and say no if the agents believe the deal is not advisable for any proper reason, plus the critical ability to determine for themselves whether to accept any deal that their negotiating agents recommend to them.” The Court’s decision to apply the business judgment rule stemmed from the fact that such standard of review would only apply to a transactional structure having both of the procedural protections noted above, which structure is “fundamentally different from [a transaction] with only one protection.” The use of both protective devices is what completes the replication of an arm’s length transaction; they are not substitutes for one another, but are complementary and only truly effective in tandem. As Chancellor Strine elucidated, a special committee alone only ensures that there is a bargaining agent who can negotiate price; it does not, however, provide stockholders the ability to protect themselves. A majority of the minority vote alone only ensures that stockholders have a chance to vote on a merger proposed by a controller-dominated board, but it does not give them a chance to have an independent bargaining agent negotiate price on their behalf.
As alluded to above, Chancellor Strine concluded that it is “[obvious that] rational minds can disagree about [the question presented], and [the Delaware Supreme Court] will be able to bring its own judgment to bear if plaintiffs appeal.” In a similar vein, in In re CNX, Vice Chancellor Laster wrote that “the choice among Lynch and [certain cases addressing which standard of review to apply in two-step going-private transactions] implicates fundamental issues of Delaware law and public policy that only the Delaware Supreme Court can resolve.” Practitioners, controlling stockholders and boards should keep this in mind.
The decision in In re MFW provides controlling stockholders and their advisors with a basis to structure transactions from the beginning in a manner that, if properly implemented, qualifies for deferential scrutiny under the business judgment rule, thereby reducing the settlement value of suits challenging going-private transactions with controlling stockholders. Although there will be greater closing uncertainty associated with completing transactions that are subject to both of these procedural protections, that risk may be offset in whole or in part by the diminished likelihood of success of lawsuits challenging transactions that are structured with both of the procedural protections described (as well as targets’ ability to get such lawsuits dismissed at the motion to dismiss stage without having to go to trial).