May 30, 2013

Delaware Chancery’s Latest on Business Judgment Rule Unification: In Re MFW Shareholders

Here’s news from Greenberg Traurig’s Cliff Neimeth:

In by far the most direct statement on the subject to date, Delaware Chancellor Strine held yesterday – in In Re MFW Shareholders – that, in the context of a controlled company’s take private by its parent (controller), the business judgment rule standard of judicial review will apply, and not “entire fairness” review , where at the outset of the transaction: (i) the controller conditions the transaction on approval by an uncoerced, fully informed, majority-of-the-minority vote and (ii) the transaction has been negotiated (on the target side) by a properly established, properly authorized (with the power to just say “no”) and well-functioning special committee of independent directors.

The Delaware Court of Chancery in a series of decisions starting with Aquila, Siliconix, Pure Resources, Cox Communications and others over the years has espoused in dicta ( and has encouraged the use of) the two-pronged procedural template for remediating the dichotomy inherent in the application of the business judgment rule for parent take-privates effected by means of tender offer vis-a-vis the application of entire fairness review (and at best “burden shifting”) for parent take-privates effected by means of single-step merger where neither or only one of the structural protections are used.

Chancellor Strine, in recognizing the Delaware Supreme Court’s lack of direct precedent on this issue (the higher court never squarely addressed the issue in Kahn v. Lynch because both procedural protections were not used in that controller take-private transaction), stated that this enabled him to fill the void and answer the question definitively.

The decision is not surprising in terms of its substantive holding and doctrinal analysis – as aforementioned – the Delaware Court of Chancery has been moving the needle (to harmonize Kahn v. Lynch and its progeny with Pure Resources and its progeny). The Delaware Court of Chancery has been trying to encourage the use of both mechanisms in controller take-privates, however effected, and not so quietly urging litigants to brief the issue more extensively and prodding the Delaware Supreme Court to break it’s silence.

The use of an uncoerced, unwaivable, fully informed majority-of-minority voting condition coupled with a properly formed, authorized and well-functioning special committee indeeds replicates arms-length bargaining power of a target board in a third-party merger transaction negotiated under Section 251 of the DGCL. The use, ab initio, of both procedural protections in the context of a controller’s squeeze out transaction effectively eliminates the tensions , conflicts and unequal bargaining power otherwise inherent in such a transaction which requires entire fairness judicial review.

The disjunctive use of either a special committee or a majority-of-the-minority voting condition merely shifts the burden of disproving entire fairness to the plaintiff. Moreover, because of the lack of any direct Delaware Supreme Court precedent on the subject to date, there has been continuing uncertainty over the years whether the use of both mechanisms in a controller take-private does, in fact, alter the standard of judicial review and result in application of the business judgment rule. This was a disincentive for controllers to use both mechanisms.

Yesterday’s decision at a minimum puts the “ball” quite squarely in the hands of the Delaware Supreme Court (whether on appeal of this decision or on a separate future litigation). In the meantime, this decision may further encourage the use of both mechanisms.

Strine’s analysis and this decision is – in my view – correct. That said, there are always practical considerations that need to be analyzed when structuring, strategizing and implementing any public M&A deal and the use of a majority-of-the-minority voting condition (which can cede veto power to the public, non-affiliates) is not always a closing risk that a controller wants to take. Litigation risk vs deal execution risk is always something to consider carefully. Of course, a very robust premium is a powerful elixir.