December 14, 2017

Controlling Shareholders: Recapitalization Passes Muster under MFW

This Wilson Sonsini memo reviews the Delaware Chancery Court’s recent decision in IRA Trust FBO Bobbi Ahmed v. Crane (Del. Ch.; 12/17), in which the Chancellor Bouchard dismissed fiduciary duty claims arising out of a corporate recapitalization specifically designed to benefit the company’s controlling shareholder. Notwithstanding the conflicts of interest involved in the transaction, the Chancellor held that the process by which it was implemented satisfied the MFW framework – and that the business judgment rule applied to board’s decision.

The recapitalization involved NRG Yield, Inc., a company with a dual-class capital structure & a controlling shareholder.  The company had issued stock to finance several acquisitions following its IPO, and as a result the controlling shareholder’s stake had declined from 65% to 55%.  In order to prevent further erosion of the controller’s interest, the board authorized the issuance of a new class of low-vote common shares as a dividend to all of the company’s shareholders.  Those new shares each had 1/100th of a vote, and the company planned to issue them to finance future acquisitions.

This excerpt from the memo summarizes Chancellor Bouchard’s decision:

Despite finding that the entire fairness standard applied to the transaction, the court still granted the defendants’ motion to dismiss the case. In particular, the court held that the Company had properly followed the “MFW” framework, named after the 2014 Delaware Supreme Court decision in Kahn v. M&F Worldwide Corp., which provides a roadmap for avoiding the entire fairness standard of review in, at least, certain types of controlling stockholder transactions.

Specifically, the Company’s board of directors – unlike some companies that have pursued similar types of recapitalizations – conditioned the recapitalization from the outset of negotiations on approval by a fully empowered independent committee of the board of directors and by a fully informed, uncoerced majority of the minority vote. Because the Company had followed MFW, the court applied the business judgment rule to the recapitalization. The court also rejected the typical panoply of disclosure allegations that plaintiffs bring in these types of claims in an effort to discredit approval by minority stockholders, which must be fully informed under MFW.

The memo touches on several other potentially significant aspects of the Chancellor’s decision – including his statement that even if MFW had not been properly followed, the company’s independent directors would have been dismissed from the lawsuit because the plaintiff didn’t meaningfully allege that they lacked independence or failed to discharge their fiduciary duties.

John Jenkins