April 9, 2019

MFW: “And It’s Too Late, Baby Now, It’s Too Late. . .”

In order for a board’s decision to enter into a deal with a controller to qualify for business judgment review, MFW’s procedural protections must in place at the outset of the transaction – or “ab initio.” Last October, in Flood v. Synutra, the Delaware Supreme Court clarified that MFW’s ab initio requirement would be satisfied if the controller committed to those protections before “substantive economic negotiations” commenced.

Last week, In Olenik v. Lodzinski,  the Delaware Supreme Court added more interpretive gloss to the ab initio requirement when it overruled the Chancery Court & held that safeguards were put in place too late to permit reliance on MFW’s path to the business judgment rule.  Here’s an excerpt from this recent Steve Quinlivan blog summarizing the Court’s decision:

The complaint challenged a business combination between Earthstone Energy Inc. and Bold Energy III LLC and alleged EnCap Investments L.P. controlled Earthstone and Bold. The Supreme Court held, based on its review of the complaint, the well pled facts support a reasonable inference that the MFW requirements were not put in place early and before substantive economic negotiation took place.

According to the Court, presentations made by Earthstone to EnCap, Earthstone management valued Bold at $305 million in an initial presentation and $335 million in a second presentation. Based on these facts, the Court found it was reasonable to infer that these valuations set the field of play for the economic negotiations to come by fixing the range in which offers and counteroffers might be made.  According to the complaint, that generally turned out to be the case. Earthstone’s first formal offer—the one in which the MFW conditions were finally mentioned—reflected an equity valuation for Bold of about $300 million, and the final deal reflected an equity valuation for Bold of around $333 million.

There were also a number of fairly extensive contacts between the parties in advance of formal negotiations. The Court pointed out that these included, among other things, providing the buyer with access to a corporate data room containing valuation materials, as well as preliminary discussions about a potential action plan for a deal involving corporate officers and lawyers for the parties.

The Chancery Court was aware of these contacts as well, but apparently found them less troubling than did the Supreme Court. While acknowledging that the contacts between the parties were “extensive,” the Chancery Court believed that they were “exploratory,” and not aimed at “bargain[ing] toward a desired contractual end.”  Ultimately, it concluded that these contacts did not cross the line into substantive economic negotiations.  At least for purposes of ruling on a motion to dismiss, the Supreme Court disagreed:

While some of the early interactions between Earthstone and EnCap could be fairly described as preliminary discussions outside of MFW’s “from the beginning” requirement, the well-pled facts in the complaint support a pleading stage inference that the preliminary discussions transitioned to substantive economic negotiations when the parties engaged in a joint exercise to value Earthstone and Bold.

John Jenkins