|March 31, 2014|
Previously published on March 2014
In Kahn v. M&F Worldwide Corp., --- A.3d ---, No. 334, 2013 (Del. March 14, 2014), the Delaware Supreme Court upheld the finding of the Delaware Court of Chancery that, in certain circumstances, a transaction with a controlling stockholder may be protected by the business judgment rule, if the transaction is approved and recommended by a special committee of independent directors and is subject to the approval of a majority of the minority of stockholders.
It is a fundamental principle of Delaware law that where a fiduciary engages in a self-dealing transaction, the fiduciary will be required to show that the transaction is “entirely fair.” In the context of a merger of a Delaware corporation with a controlling stockholder, the principle requires that a controlling stockholder that effects a merger - for instance, a “going private” transaction where public stockholders are eliminated - must establish that the transaction is entirely fair to the corporation and the non-controlling stockholders. In contrast, a merger or other significant transaction with an unrelated third party is subject to the business judgment rule, and courts are loathe to second-guess the judgment of directors. “Entire fairness” encompasses components of “fair dealing” and “fair price” and can be a very demanding standard for a controlling stockholder to meet in litigation.
Two procedural devices are regularly used in interested stockholder transactions to establish the fairness of a deal. Corporations have appointed special committees of disinterested directors to negotiate with the controlling stockholder and pass upon deal terms. They also sometimes condition the deal on approval of a majority of stockholders not affiliated with a controlling stockholder (in shorthand, a “majority-of-the-minority” condition). When effectively used, either a special committee or a majority-of-the-minority condition has been held to shift the burden in litigation challenging the transaction. That is, a plaintiff challenging the transaction would need to prove it to be substantively unfair, instead of defendants being obliged to establish entire fairness.
While it had long been observed that either using a special negotiating committee or conditioning a transaction on a majority-of-the-minority approval could serve as evidence of procedural fairness, and might serve as a basis to shift the burden of persuasion to a plaintiff to establish that the transaction was substantively unfair, only recently have the Delaware courts confronted circumstances where a controlling stockholder transaction is conditioned at the outset on the use of both procedural devices. That is the issue decided in Kahn v. M&F Worldwide. The Supreme Court determined (as had the Court of Chancery) that effective use of both a special committee and majority-of-the-minority condition could justify the application of the business judgment rule. Stated differently, a transaction properly employing both procedural devices would be reviewed the same way that a third-party arm’s length transaction is reviewed.
The M&F Worldwide Transaction
Prior to the merger at issue, MacAndrews & Forbes, Inc. (MacAndrews) owned approximately 43% of the outstanding shares of M&F Worldwide Corp. (MFW), a public company. MacAndrews was controlled by Ronald Perelman. In June 2011, MacAndrews proposed to purchase the outstanding MFW shares it did not own for $24 per share. MacAndrews’ proposal expressly contemplated that a deal would be negotiated by a special committee of independent MFW directors and would be further conditioned upon the approval of a majority MFW stockholders not affiliated with MacAndrews.
The MFW board established a special committee of directors to negotiate a potential transaction. The special committee promptly retained independent legal counsel and an independent financial advisor to assist with the review and negotiation of the transaction and met eight times during the summer of 2011. The special committee’s financial advisor found that MFW’s shares had a value in the range of $15 to $45 per share, and thus MacAndrews’ initial proposal was in a range that the committee’s advisor deemed fair. In August 2011, the committee countered the MacAndrews’ $24 per share proposal with a proposed price of $30 per share, and MacAndrews responded with a “best and final offer” of $25 per share. The committee accepted the $25 per share proposal on September 10, 2011. The merger closed in December 2011, having been approved by 65.4% of MFW stockholders unaffiliated with MacAndrews.
The Court of Chancery Decision
Stockholders brought claims challenging the merger in the Delaware Court of Chancery. In re MFW S’holders Litig., 67 A.3d 496 (Del. Ch. 2013). Following discovery, defendants moved for summary judgment and then-Chancellor Strine granted their motion. The Court of Chancery’s decision focused on “a novel question of law” - “what standard of review should apply to a going private merger conditioned upfront by the controlling stockholder on approval by both a properly empowered, independent committee and an informed, uncoerced majority-of-the-minority vote....” The Court found that the business judgment rule should apply where both procedural devices are effectively used, subject to specific criteria. The Court of Chancery focused on the fact that allowing the possibility of business judgment review worked as a useful incentive for controlling stockholders to employ both procedural protections and effectively would give minority stockholders opportunities for transactions that closely resemble third party mergers. After exhaustively evaluating the record, the Court determined that the prerequisites for application of the business judgment rule were shown and granted summary judgment to defendants.
The Supreme Court’s Analysis
On appeal, an en banc panel of the Delaware Supreme Court unanimously affirmed the Court of Chancery’s grant of summary judgment, and explained the use of the “dual procedural protections” of an independent committee and majority-of-the-minority approval. Justice Holland rendered the Court’s opinion. The Court largely adopted the business judgment rule standard, but made clear that the standard could be invoked only where the use of the protections is clearly effective, to the point where the effectiveness can be established, as a matter of law, in advance of trial.
The Court noted that the entire fairness standard is intentionally the highest standard of review in corporate law, and found that such a high standard is not required where a controlling stockholder “irrevocably and publicly disables itself from using its control to dictate the outcome of the negotiations and the shareholder vote...” Echoing the public policy incentives discussed at length by the Court of Chancery, the Supreme Court stated that the “dual procedural protection” structure optimally protects minority stockholders in controller buyouts.” The Court recognized that the “ability to say no” both at the special committee level and at the stockholder level renders the transaction “fundamentally different” from a controlled transaction. The Court also observed that a dual protection structure would achieve a fair transaction price, inasmuch as an independent committee and the minority stockholders would review and pass upon the fairness of price.
The Court adopted a six-part test for invoking the business judgment rule for a transaction with a controlling stockholder:
To summarize our holding, in controller buyouts, the business judgment standard of review will be applied 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.
(emphasis in original). Most notably, the Supreme Court left open the possibility that a court could accept evidence that the price is substantively unfair as a ground not to apply business judgment rule review.
The Supreme Court made clear that, even if a controlling stockholder is not irrevocably bound to establish the entire fairness of the transaction, it will be difficult for a controlling stockholder transaction to be judged under the lenient business judgment rule standard of review. If a plaintiff can allege “a reasonably conceivable set of facts showing that any or all of those [six] enumerated conditions did not exist,” then the plaintiff’s complaint will state a claim and the case will proceed to discovery. Further, if after discovery there remain triable issues concerning whether the factors required under the six-part analysis are demonstrated, the case will proceed to trial on an entire fairness review. Functionally, even where a controlling stockholder conditions a deal on both special committee approval and majority-of-the-minority approval, it may be difficult to prevail on a motion to dismiss. Moreover, where a claim can survive a motion to dismiss, the controlling stockholder and other defendants will be required to establish each of the six prerequisite elements (including that the special committee negotiated a “fair price”) to avoid a trial under the entire fairness test. The Court observed that plaintiffs’ complaint in MFW S’holders Litig. would have been sufficient to survive a motion to dismiss had it been brought. Among other things, plaintiffs alleged that: (i) the MacAndrews’ offer was below metrics against which the deal should be judged, such as multiples of five times cash flow; (ii) commentators viewed MacAndrews’ offer as “surprisingly low;” and (iii) MFW’s stock was temporarily depressed due to specific market conditions.
Having explained the test for business judgment protection, the Court considered whether it had been satisfied on the record before the Court of Chancery. The Court affirmed the Court of Chancery’s holding that the directors who served on MFW’s special committee were independent, despite allegations that they had prior business relationships with MacAndrews or other Perelman affiliates.
The Court also affirmed that the MFW special committee was properly empowered. The committee had authority to, and did, engage its own legal and financial advisors to assist it with the transaction. Further, the committee was empowered to consider, negotiate and recommend a deal that was fair. It was not simply a committee formed to “evaluate” the deal. Most importantly, the committee had the power to “say no” to a MacAndrews-proposed transaction. Indeed, the authority to “say no” was underscored by MacAndrews’ initial approach, wherein MacAndrews emphasized that it would only proceed with a transaction recommended by a special committee and if no transaction were recommended, MacAndrews would continue on as a long term investor in MFW.
The Court emphasized the fact that the deal approved was one that the directors deemed fair and one that was within the committee’s financial advisor’s suggested range of fair value. While the committee process increased the value of the proposed deal by only $1 per share (from $24 to $25) and the committee’s advisor posited a fairness range including values well above $25, the Court recognized that the committee carefully considered MFW’s business and prospects, including significant declines and projected declines in some key business units. The Court also held that the majority of stockholders unaffiliated with MacAndrews approved the deal in a fair vote. Among other things, the proxy statement on the merger fully disclosed the negotiating history and the committee’s $30 counter offer.
The Court concluded that defendants established that the merger transaction had been approved by an independent and empowered special committee and an uncoerced informed vote of MFW’s minority stockholders; the Court further concluded that those conditions had been “undisputably established prior to trial.” (emphasis in original). Therefore, the Court held it was appropriate for the Court of Chancery to apply the business judgment rule and affirmed the grant of summary judgment to defendants.
The Supreme Court’s affirmance in Kahn v. M&F Worldwide Corp. is a useful decision for any corporation considering a major transaction with a controlling stockholder. The Court has sanctioned the availability of a business judgment rule test in certain types of transactions with controlling stockholders. The Supreme Court’s formulation of the six-part standard, however, leaves open a judge’s ability to review a transaction for substantive (and arguably subjective) notions of fairness in determining what standard of review will be used. Its decision also emphasizes that high standards will be applied and suggests that business judgment rule review will be difficult to achieve. Regardless of whether a transaction can meet the demanding requirements for business judgment rule review, the case illustrates the types of procedural devices that can establish the fairness of a transaction with a controlling stockholder.