Going-Private Transaction With a Controlling Stockholder – What Standard of Review Applies?

Chairs Around a Table

We previously discussed how important a special negotiating committee of independent directors can be when defending against stockholder challenges to change-of-control transactions – particularly for going private transactions with controlling stockholders, which usually require boards to be able to prove the “entire fairness” of the transaction. This week, in an important decision that may reach the Delaware Supreme Court, In re MFW Shareholders Litigation, the Delaware Court of Chancery again affirmed the importance of special committees in those circumstances, and offered a road map to companies and controlling stockholders on how to structure going private transactions.

Nearly two decades ago, in Kahn v. Lynch, the Delaware Supreme Court held that where (1) a special committee of independent directors or (2) a majority of the non-controlling stockholders approves a merger with a controlling stockholder, it shifts the burden of proving the entire fairness of the transaction from the defendants to the stockholder challenging the transaction. Last year, in Americas Mining Corp. v. Theriault, the Delaware Supreme Court reiterated that the use of a properly functioning special committee of independent directors is an integral part of the best practices that are used to establish the entire fairness of a merger with a controlling stockholder.

But what if both a special committee of independent directors and a majority of the minority stockholders approve the merger? Does that afford the transaction even greater protection? According to the opinion in MFW, the answer is yes. As Chancellor Strine held, where the transaction has been negotiated by a properly functioning special committee of independent directors that is authorized to say “no” to the transaction and the controlling stockholder conditions the transaction on approval by an uncoerced, fully informed, majority-of-the-minority vote, the business judgment rule standard of judicial review applies. In other words, employing both procedural devices will insulate the transaction from substantive judicial review.

Whether a merger with a controlling stockholder will receive the protection of the business judgment rule if both procedural protections – special committee approval and majority-of-the-minority approval – are employed has never been squarely addressed by the Delaware Supreme Court, and it remains to be seen if Chancellor Strine’s ruling will withstand appellate review. Regardless, MFW reinforces that the use of a special committee of independent directors, coupled with other procedural mechanisms such as majority-of-the-minority approval, can be powerful evidence of a fair transaction when defending your deal.