On May 29, 2013, Chancellor Leo E. Strine, Jr. of the Delaware Court of Chancery issued a decision that could potentially impact the structure of future going-private mergers by controlling stockholders. Ruling on a case of first impression, Chancellor Strine held that the business judgment rule—rather than the more arduous entire fairness standard—applies in cases where a going-private merger involving a controlling stockholder has been conditioned on the approval of both a “properly empowered, independent committee” and an “informed and uncoerced” majority-of-the-minority stockholder vote. In re MFW Shareholders Litigation, No. 6566-CS, 2013 WL 2326879, at *1 (Del. Ch. May 29, 2013). On June 25, 2013, the decision was appealed to the Delaware Supreme Court.
Factual and Procedural Background
In June 2011, MacAndrews & Forbes—a holding company owning 43 percent of M&F Worldwide (“MFW”)—made a public offer to purchase the remaining shares of MFW’s equity in a going-private merger. MacAndrews & Forbes proposed to acquire MFW for $24 per share, but made this offer contingent on the approval of an independent special committee and the affirmative vote of a majority of the minority stockholders.
In response to MacAndrews & Forbes’ offer, the MFW board formed a special committee. The special committee employed its own legal and financial advisors, and had the ability to negotiate the merger and definitively accept or reject MacAndrews & Forbes’ proposal. The special committee met eight times during the course of three months to negotiate with MacAndrews & Forbes. Eventually, MacAndrews & Forbes raised its price by $1 per share, to $25 per share.
After the special committee approved the $25 per-share price, the minority stockholders voted on the merger, with 65 percent of that minority approving the transaction. Certain MFW stockholders challenged the merger, however, suing MacAndrews & Forbes and the MFW directors. The plaintiffs initially sought a preliminary injunction, but later dropped their injunction request in favor of a post-closing-damages remedy for breach of fiduciary duty. The defendants moved for summary judgment, arguing that the business judgment rule should apply.
The Court's Holding and Analysis
In its decision, the Delaware Court of Chancery noted that since 1994 it has been well established that the entire fairness standard applies even where the approval of a going-private merger involving a controlling stockholder is provided by either a special committee, or the majority of the minority stockholders. However, when one of these two constituencies approves the transaction, the burden of proof shifts from the defendant to the plaintiff to show “fair dealing” and a “fair price.” Weinberger v. UOP, Inc., 457 A.2d 701 (1983).
However, the question of what the correct standard of review should be when there is approval by both an independent committee and an informed majority-of-the-minority vote had not been resolved. To make this determination, the court considered whether minority stockholders would be better protected by the application of the entire fairness standard in all cases, or by encouraging controlling stockholders to use both a special committee and a majority-of-the-minority vote.
In discussing special committees and minority stockholder voting, Chancellor Strine emphasized that “a special committee alone ensures only that there is a bargaining agent who can negotiate price and address the collective action problem facing stockholders…and it does not provide stockholders any chance to protect themselves.” Chancellor Strine added, “a majority-of-the-minority vote provides stockholders a chance to vote on a merger proposed…but with no chance to have an independent bargaining agent work on their behalf to negotiate the merger price, and determine whether it is a favorable one….” The court concluded that each of these two protections is “incomplete and not substitutes, but are complementary and effective in tandem.”
The court further explained that when both protections are launched from the merger’s inception, the controlling stockholder knows that it cannot bypass the special committee’s ability to reject the proposal, and it “cannot dangle a majority-of-the-minority vote before the special committee late in the process as a deal closer” in an effort to avoid paying a higher price. Consequently, the court reasoned that the special committee will be incentivized to negotiate more stridently on behalf of the minority stockholders since these stockholders will vote on any deal approved by the special committee, and can express whether they think the special committee did a sufficient job.
Overall, the court reasoned that “[b]y 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.” Thus, the Delaware Court of Chancery held that the business judgment rule will apply “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 court stressed, however, that the presumptions of the business judgment rule are only available if each of the following conditions is met:
The controlling stockholder from the outset makes the merger contingent on the approval of both a special committee and a majority-of-the-minority stockholder vote
The special committee is comprised of independent directors
The special committee is empowered to definitively reject the proposal, and to freely employ its own legal and financial advisors
The special committee meets its duty of care, and
The minority is fully informed and uncoerced
Failure to satisfy any one of these conditions would subject the transaction to an entire fairness standard.
Although the Court of Chancery’s decision was recently appealed, if In re MFW Shareholders Litigation is upheld, the case will be a guide to obtaining the more advantageous business judgment standard.