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Gibson Dunn on Controlling Shareholders and the Business Judgment Rule in Going Private Merger Transactions

On May 29, 2013, Chancellor Leo E. Strine, Jr. of the Delaware Court of Chancery issued an important decision that lays the foundation for controlling stockholders to pursue going-private merger transactions with the comfort that, if certain conditions are met, such transactions will be reviewed under the deferential business judgment rule standard, rather than the exacting entire fairness standard.   

In In re MFW Shareholders Litigation, C.A. No. 6566-CS (Del. Ch. May 29, 2013), Chancellor Strine considered a question of law that had long vexed the deal community: whether a controlling stockholder that expressly conditions a going-private merger transaction on the approval of both a committee of independent directors and a majority-of-the-minority stockholders is entitled to the protections of the business judgment rule, or whether such transactions—because they involve a controlling stockholder—are necessarily evaluated under the entire fairness standard, which requires the controlling stockholder to demonstrate (usually at trial) that the transaction was the result of a fair process and resulted in a fair price to minority stockholders.

In MFW, a 43% holder of MFW sought to take the company private.  At the outset of the proposed transaction, the controlling stockholder made clear to the target board that it would only agree to the transaction if it were approved by both an independent committee of MFW’s Board of Directors and by a majority of the non-controlling stockholders of MFW.  In response to the acquisition proposal, MFW formed a special committee of independent directors, which hired its own financial and legal advisors and was empowered to negotiate the terms of and to veto the transaction.  After negotiations with the controlling stockholder and due consideration, the special committee voted to recommend the transaction to MFW’s stockholders.  65% of MFW’s non-controlling stockholders then voted to approve the transaction.  

In the stockholder litigation that followed, the plaintiff sought, and then dropped, a request to enjoin a vote on the transaction, and instead alleged post-closing that the MFW Board breached its fiduciary duties by approving the transaction.  Defendants moved for summary judgment, arguing that because the merger was conditioned on “two key procedural protections that, together, replicate an arm’s-length merger,” the transaction was analogous to a third-party merger, which is traditionally reviewed under the business judgment rule.

Chancellor Strine granted the motion for summary judgment, finding no disputed facts as to the independence of the special committee and the approval by a majority of the minority stockholders.  On the critical question of what standard applied for review of the transaction, the Chancellor concluded that the particular issue before the Court—whether a controlling stockholder merger transaction that is conditioned on approval of both an independent committee of the board and a majority of the minority stockholders is subject to entire fairness review or the business judgment rule—had never been squarely presented to or considered by any Delaware court.  Instead, Delaware decisional law had been limited to cases where one of the two “independent integrity-enforcing functions” had been applied.  After careful consideration of relevant Delaware Supreme Court precedent, the Chancellor concluded that the application of the “potent combination of procedural protections” was a “transactional structure that is most likely to protect” the interests of minority stockholders.  Accordingly, the Chancellor concluded that these “fairness enhancing” protections should be encouraged by providing controlling stockholders that utilize both protections the benefit of the deferential business judgment rule, rather than the entire fairness standard of review.

This decision, from one of the leading voices in deal litigation, provides a clear path for controlling stockholders to effect going-private merger transactions with the highest degree of certainty that the transaction will be immune from attack by plaintiffs’ firms.  After MFW, controlling stockholders in going-private merger transactions should seek, where possible, to implement the “both” structure, as Chancellor Strine called it—by insisting up front that the transaction will not go forward unless approved by both a truly independent committee of the board that is fully informed and with real negotiating power (including the power to reject a proposed transaction) and by a majority of the minority stockholders that are fully informed as to the deal terms.  With these conditions in place, controlling stockholders may proceed with added confidence that going-private transactions will escape the costly and lengthy process of demonstrating, at trial, that the transaction was entirely fair to the minority stockholders.

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