As a result of a recent decision of the Delaware Chancery Court, private equity buyers who partner with controlling stockholders may now be entitled to important new protections when acquiring publicly traded Delaware companies. If not overturned on appeal, the Delaware Chancery Court’s May 29 decision would permit such transactions to be reviewed under the business judgment rule so long as certain procedural safeguards are used. Obtaining the benefit of the business judgment rule can substantially reduce the risk that the transaction will be subject to a pre-closing injunction, and lower the cost (in terms of both legal expenses and settlement value) of the shareholder litigation that now accompanies nearly every going private deal.
The recent decision, by Chancellor Strine in a case entitled In re MFW Shareholders Litigation, held that a going private merger with a controlling stockholder will be subject to the business judgment rule, rather than the far more rigorous test of entire fairness, if the transaction is conditioned from its inception on approval by (1) a special committee of independent directors and (2) a majority of the shares held by persons unaffiliated with the controlling stockholder (a so-called majority-of-the-minority vote). The case arose from a transaction in which MacAndrews & Forbes, owner of 43% of M&F Worldwide (“MFW”), offered to buy the rest of MFW’s equity for $24 per share. In its initial proposal, MacAndrews & Forbes said it would not proceed with any going private transaction that was not approved by a special committee and by a majority-of-the-minority vote. The special committee negotiated a $1 per share price increase, and the merger was approved by holders of 65% of the shares not owned by MacAndrews & Forbes. Chancellor Strine, finding that the special committee was independent and functioned properly and that the unaffiliated stockholders were fully informed, granted defendants’ motion for summary judgment, applying business judgment review.
Although Chancellor Strine found that the case presented an unresolved question of Delaware law, it is a question that the deal community has discussed for many years: namely, whether all going private mergers with controlling stockholders must be subject to the test of entire fairness (which reviews fairness of process and fairness of price, and is a much tougher test for defendants to satisfy), or whether some combination of procedural protections could cause such a merger to be subject to business judgment review (which would respect a decision of independent and informed directors unless it was irrational). The Delaware Supreme Court had previously held that going private mergers with controlling stockholders were subject to entire fairness review, but that the burden would shift to the plaintiff to show that the merger was not entirely fair if the transaction was approved either by a special committee of independent directors or a majority-of-the-minority stockholder vote. That holding has invited the question of whether entire fairness should be the test where both procedural protections are present. Chancellor Strine found that despite broad language contained in previous Delaware Supreme Court rulings the issue had not been previously decided by the Delaware Supreme Court, because both protections were not present in those situations.
The logic underlying the Chancellor’s decision is persuasive, particularly the court’s focus on incentivizing transaction planners to include both protections by applying the business judgment standard, compared to the modest benefit resulting from merely shifting the burden of proof under the entire fairness standard. But it is not clear whether it will be embraced by the Delaware Supreme Court if the decision is appealed. As recently as last summer, that court, in its Southern Peru decision, called entire fairness “the only proper standard of review” for an interested cash-out merger and stated that because fair process usually results in fair price, it has “no doubt” that the use of special committees and majority-of-the-minority conditions will continue to be “integral parts of the best practices that are used to establish a fair dealing process.” However, as Chancellor Strine acknowledged, “rational minds can disagree about this question.”
While the MFW decision constitutes a potentially ground-breaking development in Delaware law relating to take-private transactions, given the tension between the Court of Chancery’s holding and prior rulings of the Delaware Supreme Court, private equity practitioners and controlling stockholders will need to consider carefully whether the potential for improved legal protection outweighs the additional conditionality that results from having both a special committee process and a majority-of-the-minority vote.