It seems fair to say that companies have gotten comfortable with the Corwin cleansing process over the past several years. If you provide your shareholders with full & fair disclosure, and obtain approval of the deal from a majority of the shares held by disinterested stockholders in an uncoerced vote, then Delaware courts will review the board’s decision under the deferential business judgment standard.
The Chancery Court’s recent decision in Salladay v. Lev, (Del. Ch.; 2/20), may ultimately change that familiar recipe – at least for companies with majority conflicted boards. Here’s an excerpt from Fried Frank’s recent memo on the decision:
In Salladay v. Lev (Feb. 25, 2020), the Delaware Court of Chancery held, at the pleading stage, that the merger (the “Merger”) of InterSections, Inc. (the “Company”) with an acquisition vehicle formed by the iSubscribed Investor Group would be subject to “entire fairness” review even though it had been approved by both a special committee (the “Committee”) and the stockholders.
The court ruled that (i) the Committee, although comprised of independent, unconflicted directors, was not formed early enough in the process to counteract the influence of the “interested” directors; and (ii) the disclosure was insufficient, thus the approval by a majority of the stockholders not affiliated with the interested directors did not “cleanse” the transaction under Corwin.
The problem, from Vice Chancellor Glasscock’s perspective, was that while the seller didn’t have a controlling shareholder, a majority of its directors did have a conflict of interest. In these situations, the memo notes that the efficacy of a special committee has traditionally been assessed by reference to whether it was “fully empowered” and “functioned effectively.” Here, however, the Vice Chancellor borrowed from another doctrine that hasn’t been applied to transactions not involving a controller – MFW’s “ab initio” requirement:
A corporate transaction entered by a conflicted board is subject to entire fairness, but our case law contemplates that if there is no controller present, then a fully constituted, adequately authorized, and independent special committee can cleanse such a transaction. This is because the true empowerment of a committee of independent, unconflicted directors removes the malign influence of the self interested directors, and thus should result in business judgement review.
Whether such a committee is truly empowered is a necessary question, to be reviewed practically to determine if the transaction, in fact, is untainted by fiduciary self-interest. The issue before me in this regard involves the timing of the formation of the committee. Must the committee be sufficiently constituted and authorized ab initio; consistent, that is, with the requirements set forth in MFW for cleansing a transaction in a control situation? The answer, I perceive, is yes.
VC Glasscock said that the rationale for MFW’s “ab initio” requirement was to remove the ability of a controller to use its procedural protections as a “bargaining chip” to obtain pricing concessions from a special committee – and that, in his judgment, the same rationale applied to situations involving a majority conflicted board.
He wrote that “[t]he acquirer—as well as any interested directors—must know from the transaction’s inception that they cannot bypass the special committee,” and concluded that starting negotiations before forming an independent special committee “may begin to shape the transaction in a way that even a fully-empowered committee will later struggle to overcome.”
– John Jenkins