August 22, 2017

Delaware: MFW Cleanses Controller Conflict in 3rd Party Sale

In its 2014 MFW decision, the Delaware Supreme Court set a path to business judgment rule review for controller squeeze-outs.  Last week, Vice Chancellor Slights’ decision in In re Martha Stewart Living Omnimedia S’holders Litig. applied MFW to the sale of a company to a 3rd party that was alleged to involve a controller conflict.  Here’s an excerpt from this Wachtell memo summarizing the decision:

While MFW provided a clear path for controllers pursuing “squeeze out” transactions, its more general application to controller conflicts has not been addressed until now. The Court of Chancery has just issued an opinion holding that the presence of the three cleansing mechanisms identified in MFW will provide business judgment protection to controllers in contexts outside of squeeze-outs. In re Martha Stewart Living Omnimedia, Inc. Shareholders Lit., C.A. No. 11202-VCS (Del. Ch. Aug. 18, 2017) (“MSLO”).

In the MSLO case, stockholder plaintiffs contended that Delaware law required the application of the stringent entire fairness standard to employment and intellectual property rights agreements that the third-party buyer of MSLO negotiated with Martha Stewart, who controlled MSLO. The plaintiffs alleged that these personal arrangements “diverted” merger consideration to the controller from the public, even though Ms. Stewart received the same stated price per share as the public stockholders.

Ms. Stewart had agreed to structure a sale process for MSLO that included the three MFW features. Accordingly, the Court held that claims that she had breached any duties to stockholders were unfounded, and that the stockholder claims should be dismissed under the business judgment rule. Describing the fact pattern as a “one-sided conflict transaction” because the buyer was unaffiliated, the Court applied the reasoning of MFW, thereby rewarding Ms. Stewart’s disavowal of her control power with dismissal of the stockholder challenge.

The MSLO case is consistent with prior decisions holding that the business judgment rule could apply to disparate consideration claims arising out of a transaction in which a controller “rolled over” its equity stake.  However, MSLO addressed head-on the issue of whether MFW’s procedural protections had to apply from the outset of a proposed transaction in order to achieve that result.

Vice Chancellor Slights held that compliance with MFW’s procedural protections was required from the outset of a transaction, but he distinguished between controller squeeze-outs – which involve a “two-sided conflict” – and the one-sided conflicts potentially involved in disparate consideration claims arising in connection with 3rd party sales.  In a 3rd party sale initiated by an unaffiliated buyer, Slights said that the “outset” of the transaction occurs when the controller & the potential buyer begin negotiations for disparate treatment – not when the initial approach by the buyer is made.

John Jenkins