In In re HomeFed Corporation Stockholder Litigation, C.A. No. 2019-0592-AGB (Del. Ch. July 13, 2020), the Delaware Court of Chancery (the “Court”) found that the controlling stockholder of HomeFed Corporation undertook substantive economic negotiations with its minority stockholders in connection with a proposed squeeze-out merger transaction prior to implementing the procedural protections set forth in Kahn v. M&F Worldwide Corp. (“MFW”).   As a result, the Court ruled that the appropriate standard of review for the plaintiff’s claims of breach of fiduciary duty against the controlling stockholder and the board of directors was entire fairness, and not business judgment. The Court further found that two of the company’s directors were not independent and therefore could not avail themselves of exculpatory language in the company’s certificate of incorporation. The Court denied in full the defendants’ motion to dismiss under Rule 12(b)(6) for failure to state a claim for relief.

Plaintiffs in this case were prior stockholders of HomeFed Corporation, a developer of residential and mixed-use real estate projects in six states across the U.S. (the “Company”). Defendants were Jefferies Financial Group Inc., the 70% stockholder of the Company (“Jefferies”) together with the Company’s board of directors that approved the transaction (“Directors”). Jefferies and the Company had several close ties.  A holding company called Leucadia National Corporation had spun off the Company in 1998, and then merged with Jefferies in 2013. Three Directors of the Company simultaneously held senior positions at Jefferies at the time they voted to approve the squeeze-out merger transaction.

A merger of the Company and Jefferies was first proposed in September 2017. In response, the Company appointed two Directors to an independent Special Committee, granting them the “exclusive power and authority” to negotiate the terms and conditions of the potential transaction. In March 2018, however, Jefferies announced that it no longer wanted to pursue the transaction and the Special Committee put its work on “pause.” Nevertheless, for the next 11 months, despite having indicated a lack of interest in the transaction, Jefferies repeatedly discussed the transaction directly with the Company’s next two largest stockholders (the “Minority Stockholders”) whose support was essential to obtaining approval for the transaction.  In February 2019, Jefferies again proposed a merger with the Company – with the same 2:1 exchange ratio consideration as its initial proposal – communicating that it had the support of the Minority Stockholders and would now engage the Special Committee in negotiations. A majority of the Company’s minority stockholders then voted to approve the transaction in June 2019 and the complaint was filed in August 2019.

In reviewing the motion to dismiss, the Court first considered Defendants’ argument that the transaction was subject to business judgment review by virtue of having complied with the procedural protections set forth in MFW. Under MFW, business judgment review is appropriate for a controlled merger if a variety of stockholder protections are implemented, including that the merger must be conditioned ab initio upon the “dual protections” of (i) approval of an independent Special Committee that fulfills its duty of care and (ii) the uncoerced, informed vote of a majority of the minority stockholders. In the present case, Defendants contended that, because Jefferies had abandoned its initial proposal in March 2018, the beginning of the transaction for these purposes was the date on which Jefferies extended the “new” offer, in February 2019. Plaintiffs argued that substantive negotiations had begun in December 2017 and had never been meaningfully abandoned. The Court found Plaintiffs’ argument to be “reasonably conceivable” and determined that the pause in the Special Committee’s work was likely not sufficient to reset the offer process, particularly given that the final transaction had the same structure and exchange ratio as the initial proposal.

However, the Court ultimately stated that the question of whether Jefferies’ offer had reset was not determinative, because Jefferies had, in any case, engaged in substantive economic discussions with the Minority Stockholders prior to committing to MFW protections at the time of its second offer in February 2019. Jefferies said that its conversations with the Minority Stockholders prior to its second offer were merely “preliminary” and argued that the Minority Stockholders didn’t have the power to bind the Company in a transaction. The Court disagreed, stating that by agreeing on an exchange ratio prior to making its second offer, Jefferies had anchored the negotiations and undermined the Special Committee’s ability to bargain effectively as the minority stockholders’ agent. Under MFW, the Court stated, a controller must “self disable” prior to the start of substantive economic discussions by implementing MFW protections and must bargain with a Special Committee under the pressure thereof. Accordingly, the Court determined that Jefferies had not implemented MFW protections ab initio and denied the MFW defense.

Next, the Court considered whether an exculpatory provision in the Company’s certificate of incorporation protected two of the Director Defendants. The provision barred monetary damages for breaches of fiduciary duty by Directors, except in the case that a plaintiff could plead facts supporting a rational inference that a Director was not independent or acted in bad faith. Here, the Court found that each of the two Directors in question had meaningful ties to Jefferies, had their independence called into question by their fellow Directors, and were not listed as “independent” under the Nasdaq listing rules in the Company’s 2018 proxy. As such, the Court found the complaint to have supported the rational inference that such Directors acted to support Jefferies’s self-interest in approving the transaction. Such Directors were thus not protected by the provisions of the charter documents.