On March 14, 2014, the Delaware Supreme Court, en banc, unanimously resolved a question of first impression by affirming a lower court’s holding¹ that the deferential business judgment rule standard of review, rather than the more burdensome entire fairness standard, applies to going-private mergers proposed by a controlling stockholder of a Delaware corporation when the transaction is conditioned from the outset on both of the following procedural protections (Dual Procedural Protections):

• the approval of an adequately empowered special committee of independent directors that fulfills its duty of care; and

• an uncoerced and informed vote of a majority-of-the-minority stockholders.²

The decision provides critical guidance for boards and in-house counsel when considering special committee actions and voting thresholds that are necessary to achieve business judgment rule review of the transaction and a pleadings-stage dismissal of transaction-related litigation. However, the Delaware Supreme Court emphasized that in order to avoid entire fairness review of a transaction, a defendant must establish that the challenged transaction qualifies for business judgment rule protection prior to trial by satisfying a six-pronged test related to the Dual Procedural Protections. 

The Delaware Supreme Court specified in great detail the following six-pronged test:

i. as noted above, from the outset, the controlling stockholder conditions the transaction on the approval of both a special committee and a majority-of-the-minority vote; 
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 minority stockholder vote is informed; and
vi. the minority stockholder vote is not coerced.³

As discussed below, the Delaware Supreme Court’s analysis focused greatly on factor (iv) - the actions taken by the special committee in negotiating a fair price.

The key takeaway of the ruling is cautionary - even if the controlling stockholder agrees at the outset to the Dual Procedural Protections, satisfaction of the six-pronged test to achieve business judgment rule protection will be highly fact specific, and dismissals of litigation prior to trial will be difficult to obtain.⁴

The Delaware Supreme Court did not address the issue of whether the six-pronged test necessary to receive the business judgment rule standard of review would also apply in the event of a tender offer by a controlling stockholder followed by a short-form merger.

Background

Going-private merger.  MacAndrews & Forbes Holdings, Inc. (M&F), a 43 percent stockholder of M&F Worldwide Corp. (MFW), proposed to take MFW private by acquiring the remaining shares of MFW it did not own for $24 per share in cash. From the beginning, M&F’s proposal was conditioned upon the approvals in the Dual Procedural Protections.⁵

In its initial proposal, M&F indicated that it was not interested in selling any of the MFW shares it owned nor would it vote in favor of any alternative transaction involving MFW. The proposal further indicated that M&F intended to remain a long-term MFW stockholder if the merger was not recommended by the special committee or approved by the minority stockholders.

After receiving M&F’s proposal, MFW’s board of directors formed a special committee of independent directors (Special Committee) and empowered it to, among other things:

• negotiate any element of the proposal and any resulting definitive agreement with M&F;

• say no to the proposal; and

• retain legal counsel, a financial advisor and other necessary agents.⁶

The MFW board also resolved that it would not approve M&F’s proposal without a favorable recommendation from the Special Committee.

Despite having financial projections at the outset, early in the process the Special Committee requested updated projections that “reflected management’s most up-to-date, and presumably most accurate, thinking”⁷ to be used by the Special Committee’s financial advisor in constructing its valuation analysis. The Special Committee explored alternative transactions (although not specifically empowered to do so), including investigating other possible buyers, that could generate more value for MFW stockholders. The Special Committee ultimately rejected M&F’s $24 per share proposal and countered at $30 per share despite declines in MFW’s business since the time of the initial proposal. M&F countered with a “best and final” offer of $25 per share. M&F’s proposal was determined by the Special Committee’s financial advisor to be fair to the minority stockholders from a financial point of view.  The Special Committee then approved and agreed to recommend the merger to the stockholders. 

After the M&F-affiliated directors recused themselves, the remaining MFW directors unanimously recommended the merger to stockholders. The merger closed after receiving the approval of over 65 percent of MFW’s minority stockholders.

Transaction litigation. Initially, stockholder plaintiffs sought to enjoin the merger. After taking expedited discovery, the plaintiffs withdrew that request and instead sought post-closing relief against M&F, its owner and MFW’s directors for breach of fiduciary duty.

The Delaware Chancery Court held that business judgment rule standard of review, rather than entire fairness review, should apply only if six specified conditions are met. After finding these conditions satisfied and that the plaintiffs had not raised any triable issue of material fact to the contrary, the Chancery Court reviewed the merger under the business judgment rule standard and granted summary judgment for the defendants. The plaintiffs appealed to the Delaware Supreme Court. 

Delaware Supreme Court Decision

Affirming newly articulated standard of review for controlling stockholder going-private mergers. As discussed above, challenge to a controlling stockholder buyout would typically be reviewed under the entire fairness standard, which is the “highest standard of review in corporate law”⁸ and involves a fact-specific review of the fairness of the price and the process. Under an entire fairness review, a defendant must prove that the transaction was entirely fair to the minority stockholders. However, a defendant may shift the burden of persuasion to the plaintiff by showing that the transaction was either approved by (1) a well-functioning special committee of independent directors or (2) an informed majority-of-the-minority vote.⁹

The Delaware Supreme Court affirmed the Chancery Court’s decision¹⁰ and its use of a six-pronged test to determine if the business judgment rule should apply to the controlling stockholder going-private transaction. The test discussed by the Delaware Supreme Court is the same as the one articulated by the Chancery Court with one significant exception - the Delaware Supreme Court required that the Special Committee meet its duty of care in negotiating a fair price, whereas the Chancery Court had only required that the Special Committee meet its duty of care.

The Delaware Supreme Court reasoned that employing the Dual Procedural Protections from the outset of the transaction ultimately fulfills the same critical point as the entire fairness standard of review - achieving a fair price.¹¹

To drive the significance of this point home, the Delaware Supreme Court indicated in a lengthy footnote that the MFW case would have survived a motion to dismiss under the new standard due to allegations questioning the fairness of the price. The Court noted that the allegations “call into question the adequacy of the Special Committee’s negotiations, thereby necessitating discovery on all of the new prerequisites to the application of the business judgment rule.”¹² Specifically, the Court called out the following points: (1) that the price was $2 per share lower than the trading prices only about two months earlier, (2) that the complaint alleged that the share price was depressed because of short-term factors such as MFW’s acquisition of other entities and Standard & Poor’s downgrading of the U.S.’ creditworthiness and (3) that the proposed purchase price valued the company at “at just four times” MFW’s profits per share and “five times 2010 pre-tax cash flow,” which were alleged to be “well below” those calculated for recent similar transactions.¹³

New standard is not a fail safe against discovery or protracted litigation.Immediately following its articulation of the six conditions necessary for the application of the business judgment rule standard of review, the Delaware Supreme Court noted that “[i]f a plaintiff…can plead a reasonably conceivable set of facts showing that any or all of [the six] enumerated conditions did not exist, [its] complaint would state a claim for relief that would entitle the plaintiff to proceed and conduct discovery.”¹⁴ Thus, if plaintiffs plead facts casting doubt on one of the six enumerated conditions, plaintiffs can survive a motion to dismiss and be entitled to conduct costly discovery.

Following discovery, if “triable issues of fact remain about whether either or both of the dual procedural protections were established, or if established were effective, the case will proceed to a trial in which the court will conduct an entire fairness review.”¹⁵ Thus, entire fairness review will apply unless, prior to trial, both Dual Procedural Protections are established.¹⁶  In the event of a trial, the Delaware Supreme Court confirmed that the proper use of only one of the Dual Procedural Protections would still entitle the defendants to burden-shifting under the entire fairness standard.¹⁷

Decision.  The Delaware Supreme Court found that the business judgment rule standard of review applied to the transaction and affirmed the Chancery Court’s holding because “it cannot be credibly argued (let alone concluded) that no rational person would find the Merger favorable to MFW’s minority stockholders.”¹⁸

Practical Implications

Controlling stockholder going-private mergers are still likely to be the subject of litigation regardless of the procedural protections for the minority stockholders that are employed.  Because of the execution risks involved with implementing the Dual Procedural Protections required by M&F Worldwide Corp. and the related six-pronged test, transaction participants will need to consider the particular facts and circumstances of their transaction to determine if the benefits of a lesser standard of judicial review outweigh the time and expense associated with employing both protections. For example, last year’s going-private transaction for Dell Inc. was delayed due to issues in obtaining the required majority-of-the-minority vote.

In addition, although M&F Worldwide Corp. was dismissed at the motion for summary judgment stage, the Delaware Supreme Court noted that discovery had been conducted for 18 months and included over 100,000 pages of documents and depositions of all four Special Committee members, their financial advisors and senior executives of both MFW and M&F.¹⁹  The Delaware Supreme Court also in great specificity discussed factors that would be considered in determining if a special committee had negotiated a fair price.  These two points demonstrate the difficulties of satisfying the six-pronged test to be entitled to the protection of the business judgment rule in a going-private merger proposed by a controlling stockholder.

The above also demonstrates that even if the Dual Procedural Protections are used, the risk remains that dismissal of transaction-related litigation prior to trial will be difficult to obtain, resulting in the onerous entire fairness standard review at trial. Participants should anticipate that plaintiffs will construct their pleadings in response to this decision to raise issues about, for example, special committee independence, the process employed by the special committee or the fairness of the price in order to get to discovery and a possible trial.

_{1. See In re MFW Shareholders Litigation, 67 A.3d 496 (Del. Ch. 2013), available at http://courts.delaware.gov/opinions/download.aspx?ID=189940.}

_{2. See Kahn v. M&F Worldwide Corp., No. 334, 2013, 2014 WL 996270, at *6 (Del. Mar. 14,  2014), available at http://courts.delaware.gov/opinions/download.aspx?ID=202790.}

_{3. Id. at *7.}

_{4. A recent Delaware Chancery Court decision on summary judgment that preceded the Delaware Supreme Court’s M&F Worldwide Corp. decision, but relied on the Chancery Court’s In re MFW Shareholders Litigation decision, illustrates that a controlling stockholder’s failure to agree that it would not proceed with a squeeze-out merger without the Dual Procedural Protections before the commencement of negotiations will result in the entire fairness standard of review, rather than the business judgment rule, being applied. See In re Orchard Enterprises, Inc. Stockholder Litigation, C.A. No. 7840-VCL, 2014 WL 1007589 (Del. Ch. Feb. 28, 2014).}

_{5. M&F’s initial letter proposal noted, in part: “It is our expectation that the Board of Directors will appoint a special committee of independent directors to consider our proposal and make a recommendation to the Board of Directors. We will not move forward with the transaction unless it is approved by such a special committee. In addition, the transaction will be subject to a non-waivable condition requiring the approval of a majority of the shares of the Company not owned by M & F or its affiliates. ...”  Id. at *3.} 

_{6. Id. at *3 - *4.}

_{7. Id. at *12.}

_{8. Id. at *6.}

_{9. M&F Worldwide Corp., 2014 WL 996270,  at *4 (citing Kahn v. Lynch Comc’n Sys., Inc., 638 A.2d 1110, 1117 (Del. 1994) (citation omitted)).}

_{10. Id. at *6.}

_{11. Id. at *7.}

_{12. Id. at *7 n.14.}

_{13. Id. at *7 n.14.}

_{14. Id. at *7 (footnotes and citations omitted).}

_{15. M&F Worldwide Corp., 2014 WL 996270, at *7 (footnotes and citations omitted).}

_{16 Id. at *8.}

_{17. Id. at *8.}

_{18. Id. at *15.}

_{19. Id. at *15 n.40.}