M&F Worldwide: Delaware Supreme Court Upholds Business Judgment Review In Controlling Stockholder Transaction

by Perkins Coie
Contact

When a controlling stockholder’s buyout of a company has been challenged by minority stockholders, Delaware courts have generally subjected the transaction to entire fairness review, the most rigorous standard of review in corporate law.  The Delaware Supreme Court’s recent decision in Kahn v. M&F Worldwide Corp., 2014 WL 996270 (Del. Mar. 14, 2014) (“M&F Worldwide”), however, affirmed former Chancellor Strine’s finding in a Delaware Chancery Court decision that the more director-favorable business judgment standard of review can be applied to a controlling stockholder transaction conditioned from the outset on approval by both a properly empowered special committee of independent directors and an informed, uncoerced majority of the minority vote.

Our update summarizes the M&F Worldwide decision and discusses the court’s analysis in the case and its practical implications.

The Delaware Supreme Court Upholds Business Judgment Review if a Six-Factor Test Is Met

In M&F Worldwide, the Delaware Supreme Court upheld a Chancery Court decision by former Chancellor Strine that for the first time determined that a controlling stockholder buyout should be entitled to business judgment review if certain procedural protections were implemented at the outset of the transaction.  Prior to this case, controlling stockholder buyouts had traditionally been reviewed under an entire fairness standard, an exacting, fact-intensive review of the fairness of both the price and the process.  Generally, defendants in entire fairness cases bear the burden of proving that the transaction was entirely fair to minority stockholders.  However, since Kahn v. Lynch Communication Systems, Inc., 638 A.2d 1110 (Del. 1994) (“Lynch”), defendants in such cases can shift the burden of persuasion to the plaintiff by showing that the transaction was either approved by a properly empowered and functioning special committee of independent directors, or approved by an informed vote of a majority of the minority stockholders. 

In this case, however, the controlling stockholder had conditioned its offer on both procedural protections – a fully empowered special committee and a majority of the minority vote.  When the transaction was challenged, the defendants argued (and Chancellor Strine ultimately agreed) that, because of these dual protections, the transaction should be reviewed under the business judgment rule rather than the entire fairness standard.  In re MFW S’holders Litig., 67 A.3d 496 (Del. Ch. 2013) (“MFW Shareholders Litigation”), aff’d, M&F Worldwide, 2014 WL 996270.  On appeal, the Delaware Supreme Court acknowledged that the question of which standard of review should apply to controlling stockholder transactions that include both procedural protections was a novel one.

The Delaware Supreme Court’s decision provides that the business judgment standard of review will be applied to a controlling stockholder buyout if (and only if) the following six factors are satisfied:

  • the controlling stockholder conditions the transaction at the outset on the approval of both a special committee and a vote of a majority of the minority stockholders;
  • the special committee is independent;
  • the special committee is empowered to select its own advisors and definitively say no to the transaction;
  • the special committee exercises its duty of care in negotiating a fair price;
  • the minority stockholder vote is informed; and
  • the minority stockholder vote is uncoerced.

Background: An Empowered Special Committee Conducts Robust Negotiations

MacAndrews & Forbes Holdings, Inc. (M&F), owned by Ronald Perelman, was a 43% stockholder in M&F Worldwide Corp. (MFW).  M&F proposed to take MFW private through a merger at a price of $24 per share in cash for shares not already owned by M&F.  From the outset, M&F unambiguously conditioned its offer on approval by a special committee of independent directors and approval by a majority of stockholders unaffiliated with M&F.  In its proposal to the MFW board, M&F stated that it would not expect to support any alternative transaction in its capacity as a stockholder.

After M&F’s proposal was received, the MFW board established a special committee of independent directors, which among other things was empowered to retain its own advisors, evaluate and negotiate any element of the M&F proposal, and elect not to pursue the proposal .  The MFW special committee, which hired its own legal and financial advisors, followed a robust process in considering the proposal and negotiating with M&F.  The special committee eventually made a counterproposal of $30 per share, which M&F rejected, noting that MFW’s businesses had continued to decline in the interim between its initial proposal and the special committee’s counterproposal.  M&F’s best and final offer was $25 per share, which the special committee approved and recommended to the board.  When the merger was submitted to MFW’s stockholders for a vote, it was approved by holders of over 65% of the shares not owned by M&F.

The Court’s Analysis:  Business Judgment Rule Review Encourages Controllers to Employ the Two-Part Approval Process

The Delaware Supreme Court reasoned that a structure that implements these dual procedural protections from the beginning of negotiations duplicates the disinterested board and stockholder approval process involved in third party transactions.  By employing the dual procedural protections, the controlling stockholder cannot exercise control over either the board process or the stockholder approval process, and therefore the business judgment standard of review is appropriate. 

In addition, the court stated that the structure employed in the M&F Worldwide case provides optimal protection to minority stockholders in a controlling stockholder buyout.  In support of the benefits of the structure, the court cited Chancellor Strine’s decision in MFW Shareholders Litigation, which noted that if a controlling stockholder commits at the outset to a transaction conditioned upon both protections, the controller cannot later circumvent the special committee by shifting to a more coercive tender offer structure and cannot “dangle” a majority of the minority vote late in the process as a bargaining chip to avoid having to give on price.  This structure permits the special committee to bargain for the best price and reject the proposed transaction and allows the minority stockholders to determine for themselves whether to accept the deal.  These protections work together to achieve a fair price.

The defendants in M&F Worldwide argued that affording transactions that employ the dual procedural protections the benefit of the business judgment rule encourages controlling stockholders to use the structure.  Following Lynch, controlling stockholders had an incentive to provide some procedural protections, but as Chancellor Strine pointed out in MFW Shareholder Litigation, an “either/or” structure does not replicate an arm’s length third party transaction.  In M&F Worldwide, the Delaware Supreme Court endorsed the view that a structure that effectively employs both protections replicates that arm’s length process, and the benefit of business judgment - instead of entire fairness - review creates a powerful incentive for controlling stockholders to use this structure.

A Note of Caution: The Fact-Specific Inquiry Means Plaintiffs Will Likely Be Permitted Discovery

Although the M&F Worldwide decision is generally salutary from the perspective of controlling stockholders and the boards of controlled companies, it is not an unqualified win.  The six-factor inquiry into the procedural protections is very fact specific.  The Delaware Supreme Court emphasized that, “[i]f a plaintiff . . . can plead a reasonably conceivable set of facts showing that any or all of [the six factors] did not exist,” its complaint should survive a motion to dismiss and it should be permitted to conduct discovery.  If, following discovery, “triable issues of fact remain” about whether the dual protections were properly established, the case would proceed to trial under an entire fairness standard of review (with burden shifting available if one of the procedural protections was effective).  This part of the opinion raises questions about whether judicial scrutiny of controlling stockholder buyouts that employ the dual protections structure may in fact be a more active process than the business judgment standard of review would normally imply.

In M&F Worldwide, the court noted that this case would have survived a motion to dismiss under the newly articulated standard because of facts relating to the price negotiated by the special committee.  The proposal from M&F came at a time when MFW’s market price had recently declined, and the complaint alleged that the price was depressed due to short-term factors, including recent acquisitions by MFW and Standard & Poor’s downgrading of the United States’ credit rating.  The court stated that these allegations would call into question the adequacy of the special committee’s negotiations at the motion to dismiss stage.

Establishing Dual Procedural Protections: Some Helpful Guidance

In articulating the six-factor test for obtaining business judgment rule review in controlling stockholder transactions, the Delaware Supreme Court provided helpful guidance on many of the individual factors.

Material Relationships Required to Undermine Director Independence.  The Delaware Supreme Court first rejected arguments by the plaintiffs that three of the independent directors on the special committee were not independent.  Although the plaintiffs established some business, social and/or financial connections between M&F or Mr. Perelman, on the one hand, and the members of the special committee, on the other, the court emphasized settled Delaware law that a materiality standard applies in deciding whether a director’s ties to the person whose proposal or actions the director is evaluating disqualifies that director from being considered independent.  Specifically, for a director to be considered not independent, the ties in question must be so substantial as to make the director not capable of objectively discharging his or her fiduciary duties. 

Empower the Special Committee; Allow It to Exercise Its Power.  The court also looked carefully at the power of the special committee and its exercise of that power.  In this review, the court focused on the special committee’s strong mandate, which included the power to negotiate with the controlling stockholder, recommend whether the transaction was fair and in the best interests of MFW’s minority stockholders, and elect not to proceed with the transaction.  Although M&F stated in its initial proposal that it would not be willing to sell its block of shares to another buyer in an alternative transaction, the special committee explored alternative strategic options, including the potential interest of other buyers if M&F had been willing to sell and asset divestitures that might provide more value to minority stockholders.  In addition, because M&F had conditioned the transaction on approval by the special committee, the committee knew that M&F could not circumvent the process with a tender offer directly to stockholders if the committee bargained too hard. 

The Special Committee Must Use Available Resources and Negotiate Actively.  Finally, the court found that the special committee had exercised due care through screening M&F-related employees from the special committee’s process, obtaining up-to-date management projections for the company’s businesses, and reviewing a range of valuations prepared by the committee’s financial advisor.  The committee also made a counterproposal, although the effect of which was only to raise the final offer price by $1 per share.  Based on this review, the court determined that the price was effectively negotiated by an empowered independent committee that acted with due care. 

Inform the Stockholders with Full Disclosure.  With respect to the stockholder vote, the court easily found that the majority of the minority vote was fully informed and uncoerced because the proxy statement disclosed the background of the special committee’s work and included the five separate price ranges for the company’s stock prepared by the committee’s financial advisor. 

After determining that the special committee and majority of the minority vote procedures met the six-factor test, the court applied the business judgment rule and upheld the dismissal of the claims because it could not be credibly argued that no rational person would find the transaction favorable to the minority stockholders.  Under the new structure set out in M&F Worldwide, a controlling stockholder buyout transaction that effectively implements the six factors described above can avoid an entire fairness inquiry, although the facts surrounding a particular transaction may survive a motion to dismiss and require defendants to proceed through discovery.

Written by:

Perkins Coie
Contact
more
less

Perkins Coie on:

Readers' Choice 2017
Reporters on Deadline

"My best business intelligence, in one easy email…"

Your first step to building a free, personalized, morning email brief covering pertinent authors and topics on JD Supra:
Sign up using*

Already signed up? Log in here

*By using the service, you signify your acceptance of JD Supra's Privacy Policy.
Privacy Policy (Updated: October 8, 2015):
hide

JD Supra provides users with access to its legal industry publishing services (the "Service") through its website (the "Website") as well as through other sources. Our policies with regard to data collection and use of personal information of users of the Service, regardless of the manner in which users access the Service, and visitors to the Website are set forth in this statement ("Policy"). By using the Service, you signify your acceptance of this Policy.

Information Collection and Use by JD Supra

JD Supra collects users' names, companies, titles, e-mail address and industry. JD Supra also tracks the pages that users visit, logs IP addresses and aggregates non-personally identifiable user data and browser type. This data is gathered using cookies and other technologies.

The information and data collected is used to authenticate users and to send notifications relating to the Service, including email alerts to which users have subscribed; to manage the Service and Website, to improve the Service and to customize the user's experience. This information is also provided to the authors of the content to give them insight into their readership and help them to improve their content, so that it is most useful for our users.

JD Supra does not sell, rent or otherwise provide your details to third parties, other than to the authors of the content on JD Supra.

If you prefer not to enable cookies, you may change your browser settings to disable cookies; however, please note that rejecting cookies while visiting the Website may result in certain parts of the Website not operating correctly or as efficiently as if cookies were allowed.

Email Choice/Opt-out

Users who opt in to receive emails may choose to no longer receive e-mail updates and newsletters by selecting the "opt-out of future email" option in the email they receive from JD Supra or in their JD Supra account management screen.

Security

JD Supra takes reasonable precautions to insure that user information is kept private. We restrict access to user information to those individuals who reasonably need access to perform their job functions, such as our third party email service, customer service personnel and technical staff. However, please note that no method of transmitting or storing data is completely secure and we cannot guarantee the security of user information. Unauthorized entry or use, hardware or software failure, and other factors may compromise the security of user information at any time.

If you have reason to believe that your interaction with us is no longer secure, you must immediately notify us of the problem by contacting us at info@jdsupra.com. In the unlikely event that we believe that the security of your user information in our possession or control may have been compromised, we may seek to notify you of that development and, if so, will endeavor to do so as promptly as practicable under the circumstances.

Sharing and Disclosure of Information JD Supra Collects

Except as otherwise described in this privacy statement, JD Supra will not disclose personal information to any third party unless we believe that disclosure is necessary to: (1) comply with applicable laws; (2) respond to governmental inquiries or requests; (3) comply with valid legal process; (4) protect the rights, privacy, safety or property of JD Supra, users of the Service, Website visitors or the public; (5) permit us to pursue available remedies or limit the damages that we may sustain; and (6) enforce our Terms & Conditions of Use.

In the event there is a change in the corporate structure of JD Supra such as, but not limited to, merger, consolidation, sale, liquidation or transfer of substantial assets, JD Supra may, in its sole discretion, transfer, sell or assign information collected on and through the Service to one or more affiliated or unaffiliated third parties.

Links to Other Websites

This Website and the Service may contain links to other websites. The operator of such other websites may collect information about you, including through cookies or other technologies. If you are using the Service through the Website and link to another site, you will leave the Website and this Policy will not apply to your use of and activity on those other sites. We encourage you to read the legal notices posted on those sites, including their privacy policies. We shall have no responsibility or liability for your visitation to, and the data collection and use practices of, such other sites. This Policy applies solely to the information collected in connection with your use of this Website and does not apply to any practices conducted offline or in connection with any other websites.

Changes in Our Privacy Policy

We reserve the right to change this Policy at any time. Please refer to the date at the top of this page to determine when this Policy was last revised. Any changes to our privacy policy will become effective upon posting of the revised policy on the Website. By continuing to use the Service or Website following such changes, you will be deemed to have agreed to such changes. If you do not agree with the terms of this Policy, as it may be amended from time to time, in whole or part, please do not continue using the Service or the Website.

Contacting JD Supra

If you have any questions about this privacy statement, the practices of this site, your dealings with this Web site, or if you would like to change any of the information you have provided to us, please contact us at: info@jdsupra.com.

- hide
*With LinkedIn, you don't need to create a separate login to manage your free JD Supra account, and we can make suggestions based on your needs and interests. We will not post anything on LinkedIn in your name. Or, sign up using your email address.
Feedback? Tell us what you think of the new jdsupra.com!