On March 14, 2014, the Delaware Supreme Court unanimously affirmed an important Delaware Court of Chancery decision issued in 2013 that offered a roadmap to companies and their directors on how to obtain the protections of the deferential business judgment rule when entering into a change-in-control transaction with a controlling stockholder. As we discussed previously, in In re MFW Shareholders Litigation, then-Chancellor (now Chief Justice) Strine held as a matter of first impression that the deferential business judgment rule – as opposed to the more onerous “entire fairness” – standard of review should apply to a merger with a controlling stockholder where (i) the controller conditions 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 acts with care; (v) the minority vote is informed; and (vi) there is no coercion of the minority.
As expected, the Delaware Supreme Court affirmed MFW, holding that the business judgment rule is the standard of review that should govern mergers between a controlling stockholder and its corporate subsidiary, where the merger is conditioned from the start upon both the approval of an independent, adequately-empowered Special Committee that fulfills its duty of care, and the uncoerced, informed vote of a majority of the minority stockholders. The Court reasoned that in these circumstances, “the controlled merger then acquires the shareholder-protective characteristics of third-party, arm’s-length mergers, which are reviewed under the business judgment standard.” The Delaware Supreme Court emphasized, however, that “if and only if” all six of the conditions enumerated by the Court of Chancery existed will the business judgment rule standard of review apply. If, instead, a plaintiff “can plead a reasonably conceivable set of facts showing that any or all of [the] enumerated conditions did not exist, that complaint would state claim for relief that would entitle the plaintiff to proceed and conduct discovery.” The Court further held that if “after discovery 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.” The Court also noted that the complaint in MFW would have survived a motion to dismiss based on allegations attacking the fairness of the price, which called into question the adequacy of the special committee’s negotiations, thereby necessitating discovery on all six of the enumerated conditions.
The Delaware Supreme Court’s decision reinforces that the use of a special committee of independent directors, coupled with other procedural mechanisms such as majority-of-the-minority approval, can provide a powerful shield when defending a merger with a controlling stockholder. It remains to be seen how future deals involving controlling stockholders and structured like the MFW deal will be scrutinized or whether other forms of minority protection will be sufficient to trigger the more deferential business judgment rule. Justice Ridgley of the Delaware Supreme Court noted last week at the Tulane Corporate Law Institute that whether a complaint pleads enough facts showing that any or all of the enumerated conditions did not exist will have to be decided on a “case-by-case basis.” Nevertheless, this decision provides boards with very clear guidance for controlling stockholder mergers: use a Special Committee of independent directors and subject your transaction to majority-of-the-minority approval, and the business judgment rule—not the more stringent “entire fairness” standard—will apply.