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Delaware Supreme Court Holds that Controlling Stockholder Buyouts Effected by Negotiated Merger Can Receive Business Judgment Rule ReviewMarch 20, 2014
The Delaware Supreme Court, in Kahn, et al. v. M&F Worldwide Corp., et al. (Del. Mar. 14, 2014), recently issued a decision clarifying when courts will apply the business judgment rule, and not the entire fairness standard, to merger transactions involving controlling stockholders. In affirming the decision of the Delaware Chancery Court in In re MFW Shareholders Litigation (Del Ch. 2013), the court held that the business judgment rule is the proper standard of review for mergers between a target company and a controlling stockholder where the proposal is conditioned at the outset on both the approval of an independent and empowered special committee that fulfills its standard of care, and the uncoerced and informed majority approval of the minority stockholders of the target company.
The court’s decision in M&F Worldwide articulates a clear path to avoid entire fairness review in controlling stockholder buyouts effected by a negotiated merger. The decision explicitly provides that “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” will the court apply a business judgment rule standard of review. If there exist triable issues of fact as to whether one or both procedural protections of the special committee and majority of the minority vote were adhered to, the court will then conduct an entire fairness review.
The M&F Worldwide decision is a welcome development for M&A participants. The decision adds certainty to controlling stockholder transactions effected by a negotiated merger, and provides a clear framework for deal participants to avoid heightened judicial scrutiny. However, in a footnote to the decision, the Delaware Supreme Court noted that a complaint similar to the one filed in the case would survive a motion to dismiss. That potentially dilutes the value of the decision because it suggests that stockholder suits may still have to be litigated possibly up to or beyond the summary judgment phase even if the procedural protections in M&F Worldwide were followed.
M&F Worldwide effectively reconciles two lines of Delaware case law and presents a uniform standard of review applicable to controlling stockholder buyouts, regardless of their structure. In Kahn v. Lynch (Del. 1994), the Delaware courts held that controlling stockholder buyouts effected via a negotiated merger, regardless of whether a majority of the minority vote was required, were subject to entire fairness scrutiny. By contrast, pursuant to Solomon v. Pathe Communications Corp. (Del. 1996) and In re Siliconix Inc. Shareholders Litigation (Del. Ch. 2001), the Delaware courts held that a controlling stockholder buyout effected by way of a unilateral tender offer, a non-waivable majority of the minority tender condition and a promise to promptly effect a short-form merger on the same terms, would be subject to the business judgment rule. Indications of the Delaware Chancery Court seeking to reconcile the two standards surfaced in In re Pure Resources, Inc. Shareholders Litigation (Del. Ch. 2002), and continued in In re Cox Communications, Inc. Shareholders Litigation (Del. Ch. 2005) and In re CNX Gas Corporation Shareholders Litigation (Del. Ch. 2010). M&F Worldwide harmonizes these two divergent standards of review.
The M&F Worldwide decision does not appear to upset the holding in Glassman v. Unocal Exploration Corp. (Del. 2001), which held that short-form mergers pursuant to Section 253 of the Delaware General Corporation Law are not subject to entire fairness scrutiny.
Of course, with M&A being as nuanced a practice area as it is, decisions as to structure should never be made in a vacuum. Depending on the particular circumstances of the transaction, it may be advisable to not pursue the structure outlined in M&F Worldwide. One example would be a situation where a majority of the minority vote may provide “hold up” power to certain stockholders, such as activist stockholders, who might resist or vote down the transaction unless a higher price was offered. In that situation, utilizing a negotiated merger without a majority of the minority vote may provide greater deal certainty to completing the transaction, even though it will be subject to entire fairness scrutiny. As illustrated by the Delaware Chancery Court’s decision in In re John Q. Hammons Hotel Inc. S’holder Litig. (Del. Ch. 2011) in the not too distant past, entire fairness is not necessarily a “no win” situation in a public company transaction.
This memorandum is a summary for general information and discussion only and may be considered an advertisement for certain purposes. It is not a full analysis of the matters presented, may not be relied upon as legal advice, and does not purport to represent the views of our clients or the Firm. Paul Scrivano, an O'Melveny partner licensed to practice law in New York and California, Sarah Young, an O'Melveny associate licensed to practice law in New York, contributed to the content of this newsletter. The views expressed in this newsletter are the views of the authors except as otherwise noted.
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