Updated Guidance (and Ground Rules) for Controlling Stockholder Deals

by Ropes & Gray LLP
Contact

Ropes & Gray LLP

The Delaware Supreme Court’s 2014 decision in Kahn v. M&F Worldwide Corp. (“MFW”)1 provided business judgment rule protection for controlling stockholder transactions that are conditioned from the outset on certain procedural protections being utilized, including approval by (1) a fully-empowered independent special committee that meets its duty of care and (2) a fully-informed, uncoerced vote of a majority of the target minority stockholders unaffiliated with the controller. While MFW provided helpful guideposts for avoiding entire fairness review in controlling stockholder transactions, as with any new doctrine, questions remained as to the application of MFW to different types of deals and negotiations, and the consequences of small deviations from strict adherence to MFW. Recent guidance from the Delaware Court of Chancery has given way to updated ground rules for controlling stockholder transactions: (i) MFW also applies to deals where the controller is only on the sell-side; (ii) other conflicted controller transactions besides mergers, such as recapitalizations, are eligible for MFW protection; and (iii) small, alleged foot faults will not cause the business judgment rule protection afforded by MFW to be lost.

MFW Also Applies to Deals Where the Controller Is Only on the Sell-Side

In In re Martha Stewart Living Omnimedia, Inc. Stockholder Litigation (“Martha Stewart”),2 the Chancery Court held that the business judgment rule protection afforded in a controlling stockholder buyout in MFW also applied to deals where the conflicted controlling stockholder was on the sell-side (as opposed to the buy-side). In Martha Stewart, the controller was not the buyer, which is the MFW paradigm; rather, the controller received the same merger consideration as the minority stockholders but was also alleged to have received certain “side deals” from the acquirer (agreements concerning employment and IP rights, and expense reimbursement) in the transaction. Notably, Vice Chancellor Slights held that in a so-called “single side” controller deal, the time by which the MFW procedural protections must be in place is before negotiations begin between the buyer and the controller on such side arrangements. In Martha Stewart, the procedural protections were instituted after the merger negotiations began between the target company and the buyer. Contrast that with the classic controlling stockholder buyout (where the controller is buying out the minority stockholders), where the procedural protections must be in place “ab initio” before the buyer begins negotiations with the target company. Moreover, the Court noted that the “side deals” the controller in Martha Stewart negotiated, which were claimed to divert consideration away from the minority stockholders, were not materially different than the pre-deal arrangements between the controlling stockholder and the company, and, therefore, did not amount to a material conflict such that entire fairness would have been triggered by those benefits alone. Without facts sufficient to plead a failure to comply with the MFW procedural framework or a conflict between the controller and the minority stockholders, the Chancery Court found the business judgment rule to be the appropriate standard of review.

Other Conflicted Controller Transactions Besides Mergers, Such as Recapitalizations, Are Eligible for MFW Protection

In IRA Trust FBO Bobbie Ahmed v. Crane (“NRG”),3 the Chancery Court held that a reclassification transaction that was undertaken with the procedural safeguards established in MFW was entitled to business judgment rule protection. In NRG, the controller implemented a pro rata recapitalization transaction designed to extend the controller’s control over the controlled company by issuing two classes of new low-vote stock, which could be used as currency in acquisitions, without significantly diluting the controller's voting control. In exchange, the controller agreed to add additional assets to a right of first offer agreement in favor of the controlled company. Chancellor Bouchard noted that the reasoning underpinning the MFW framework (as well as its doctrinal predecessor Kahn v. Lynch Communication Systems, Inc.4 and its progeny) was to protect minority stockholders and replicate an arm’s-length bargaining process in any conflicted controller transaction, not simply mergers. Accordingly, based on Chancellor Bouchard’s decision in NRG, business judgment protection should be available to any transaction (and not just mergers) with a conflicted controller that follows the safeguards in MFW.

Small, Alleged Foot Faults Will Not Cause the Business Judgment Rule Protection Afforded by MFW to Be Lost

Vice Chancellor Laster held in In re Synutra International, Inc. Stockholder Litigation (“Synutra”)5 that minor, alleged deviations from the MFW roadmap will not invalidate the protection afforded by MFW. The Synutra plaintiff alleged certain foot faults by the controller and the target. Notably, the controller’s original bid letter conditioned the deal on an independent special committee but not also on a majority of the minority stockholder vote. However, two weeks later, the controller sent an updated bid letter that provided for both MFW procedural protections. The target company’s long-time counsel originally advised the target company’s board in response to the controller’s proposal, but then represented the controller in the buyout. And just as negotiations got underway, an individual who was referred by a personal friend of the controller was nominated and elected as a director and special committee member. Vice Chancellor Laster rejected each of these allegations, addressing each of these in turn: substantive negotiations with the special committee only began after the updated bid letter was received; while the long-time counsel acted temporarily as counsel for both sides it was an “artless misstep”; and the fact that a director is nominated by the controller does not in and of itself rebut a presumption that a director is independent.

***

These decisions signal that the proper utilization of the procedural protections in MFW remains a potent shield against a plaintiff seeking to challenge a conflicted controller merger, and that this shield can also be used in other transactions involving a controller stockholder under Delaware law. While the precise contours of MFW protection are still being developed, these decisions provide the ground rules to controllers and boards of directors of controlled companies as to how to best structure any transaction with a controlling stockholder to protect it from challenge. Similarly, in May 2016, the New York Court of Appeals adopted the standard of review outlined in MFW in In the Matter of Kenneth Cole Productions, Inc., Shareholder Litigation.6 It remains to be seen to what extent, if at all, the New York courts will similarly extend the MFW burden-reducing framework to other conflicted controller transactions. 


1 Kahn v. M&F Worldwide Corp., 88 A.3d 635 (Del. 2014).
2 In re Martha Stewart Living Omnimedia, Inc. S’holder Litig., 2017 WL 3568089 (Del. Ch. Aug. 18, 2017).
3 IRA Trust FBO Bobbie Ahmed v. Crane, 2017 WL 6335912 (Del. Ch. Jan. 26, 2018).
4 Kahn v. Commc’n Sys., Inc., 638 A.2d 1110 (Del. 1994).
5 In re Synutra Int’l, Inc. S’holder Litig., C.A. No. 2017-0032-VCL (Del. Ch. Feb. 2, 2018) (order granting motion to dismiss).
6 In re Kenneth Cole Prods., Inc. S’holder Litig., 27 N.Y.3d 268 (2016).

Written by:

Ropes & Gray LLP
Contact
more
less

Ropes & Gray LLP 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.
Custom Email Digest
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.