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It’s easy to see why a controlling shareholder contemplating a take-private transaction would want to reach out to obtain support from large minority shareholders before moving forward with a deal. The trouble is that – as Dell recently discovered – those contacts can create a big problem if the parties want to obtain business judgment review for the transaction under the MFW standard.

That point was brought home again by the Chancery Court’s decision last week in In re HomeFed Stockholder Litigation, (Del. Ch.; 7/20), which arose out of Jefferies Financial Group’s July 2019 acquisition of the 30% interest in HomeFed Corporation that it didn’t already own. A HomeFed director originally proposed a take-private deal to Jeffries in 2017, and the company put in place a special committee to negotiate with Jeffries in December of that year. The process was paused in March 2018, when Jeffries told the committee that it wasn’t interested in pursuing a deal.

Over the next 11 months, Jefferies discussed the potential deal with BMO, HomeFed’s largest minority stockholder.  BMO’s support was essential to get a deal done with the approval of the minority stockholders, and in February 2019, it told Jeffries that it would support a 2-for-1 share exchange. After it received the “thumbs up” from BMO, Jefferies formally proposed acquiring the rest of HomeFed’s shares on those terms, conditioned on the approval of a special committee & a majority of the minority shareholders.

The plaintiffs sued the HomeFed board & Jeffries for breach of fiduciary duty, and the defendants responded that MFW should apply and that the transaction should be evaluated under the business judgment standard of review.  Chancellor Bouchard disagreed, and declined to dismiss the plaintiffs’ claims. This excerpt from Steve Quinlivan’s recent blog on the case summarizes his reasoning:

Central to the case was whether Jefferies committed itself to the dual protections of MFW before engaging in substantive economic discussions concerning the transaction that anchored later negotiations and undermined the ability of the special committee to bargain effectively on behalf of the minority stockholders.

The court first considered whether the pause in negotiations in March 2018 put enough time and distance between subsequent negotiations around February 2019 so that the MFW protections were implemented in a timely manner. The court agreed with plaintiffs that the break in negotiations was not meaningful. The board never dissolved the special committee, negotiations were only paused, negotiations continued with BMO and BMO ultimately supported the exchange ratio.

The timing of the two sets of negotiations was not the fatal flaw however, but how the final negotiations progressed. Jefferies engaged in a series of discussions with BMO until Jefferies received an indication of support for a 2:1 share exchange from BMO—whose support was essential to get a deal done with minority stockholder approval—as well as from a financial advisor and key stockholder before Jefferies agreed to the dual MFW protections. To be more specific, Jefferies received these indications of support in early February 2019 but did not agree to the MFW protections until, at the earliest, February 20, 2019, when it amended its Schedule 13D.

The Court rejected defendants’ argument that Jefferies’ discussions with BMO before the February 2019 offer did not pass the point of no return for invoking MFW’s protections because those discussions were “preliminary” and only involved “an unaffiliated minority stockholder with no ability or authority to bind the corporation or any other stockholder.”

The Chancellor cited the recent Dell decision for the proposition that “MFW’s dual protections contemplate that the Special Committee will act as the bargaining agent for the minority stockholders, with the minority stockholders rendering an up-or-down verdict on the committee’s work.” He said that a special committee was “uniquely qualified to perform this task,” due to directors’ superior access to internal information, their ability to “deploy the board’s statutory authority” and to act as an “expert bargaining agent.”

Chancellor Bouchard also noted that directors also owe fiduciary duties & don’t suffer from the collective action problem of disaggregated stockholders. In contrast, minority stockholders are unencumbered by fiduciary duties and their individual interests may diverge from those of other shareholders – which makes negotiations with a large minority holder in a situation like this potentially problematic.

– John Jenkins