October 15, 2018

Delaware Supreme Court Clarifies MFW’s “Ab Initio” Requirement

In order to rely on MFW’s path to business judgment review of transactions with a controlling shareholder, the deal must be conditioned on independent committee & majority of the minority shareholder approval “ab initio.” In Flood v. Synutra, (Del.; 10/18), the Delaware Supreme Court affirmed an earlier Chancery Court decision & held that MFW’s ab initio requirement doesn’t necessarily require those conditions to be spelled out in the buyer’s first overture. Here’s an excerpt from this Potter Anderson memo that explains the Court’s reasoning:

The Synutra International case involved a proposal by Liang Zhang to acquire the approximately 36.5% of the stock of Synutra International that he did not already own. Zhang’s initial offer to Synutra was not conditioned on either special committee approval or a vote of a majority of the minority stockholders. Shortly after the formation of a special committee, however, Zhang sent a second letter to the newly-formed special committee that did contain these requisite conditions.

As the Supreme Court explained in affirming the Court of Chancery’s dismissal of the action based on compliance with MFW, this second letter satisfied the ab initio formulation, coming as it did in the “beginning” of the process and before economic negotiations commenced. As the Court stated, “so long as the controller conditions its offer on the key protections at the germination stage of the Special Committee process, . . .and has not commenced substantive economic negotiations with the controller, the purpose of the pre-condition requirement of MFW is satisfied.”

Justice Karen Valihura issued a lengthy dissent from the Court’s opinion. In her view, the intent to comply with MFW’s key procedural protections must be contained in the controlling shareholder’s initial formal written proposal. We’re posting memos in our “Controlling Shareholders” Practice Area.

The memo also points out that the Court overruled dicta in its MFW opinion suggesting that a plaintiff asserting a due care claim could avoid application of the business judgment rule by challenging the deal’s pricing. The Court said that “a plaintiff can plead a duty of care violation only by showing that the Special Committee acted with gross negligence, not by questioning the sufficiency of the price.”

John Jenkins