Delaware court advances unified standard for controlling shareholder buy-outs

In one of the most important decisions it has issued this year, the Delaware Court of Chancery held that the business judgement rule, rather than the more searching entire fairness standard, will apply to controlling shareholder transactions if, from the outset, the merger is subject to both negotiation and approval by a special committee of independent directors fully empowered to say no and approval by an uncoerced, fully informed vote of a majority of the minority investors.

In re MFW(1) arose out of a takeover proposal from the company's controlling stockholder, MacAndrews & Forbes Holdings, Inc (M&F). M&F's initial proposal to the MFW board conditioned its offer on both the approval of a disinterested, fully empowered special committee and a non-waivable majority-of-the-minority vote in favour of the deal. M&F also informed the MFW board that if the board did not accept its offer, M&F would remain a long-term stockholder of MFW and would not sell into any third-party transaction or initiate an alternative attempt at a takeover, including through a tender offer. Shareholders filed suit against MFW and M&F alleging that the deal was unfair and should be enjoined.

The Delaware Chancery Court granted summary judgment for MFW and M&F, rejecting the plaintiff's claim that the Delaware Supreme Court's decision in Kahn v Lynch Communication Systems required that the deal be closely scrutinised by the court to decide whether it was "entirely fair" to minority shareholders. Instead, Chancellor Strine held that the business judgement rule should apply where a controlling shareholder initially conditions a takeover on both the support of an empowered and independent special committee and a non-waivable majority-of-the-minority vote provision. Under this deferential standard, the court will not second-guess decisions of independent directors, as long as they can be attributed to some rational business purpose. If In re MFW survives appeal, the standard of review for freeze-out tender offers (set forth in Pure Resources and CNS Gas) will now mirror that of a freeze-out merger.

This decision maps a promising path to reduce significantly the litigation risk to controlling shareholders in take-private transactions.

The chancellor's suggested process is now being used in controlling party buy-out transactions. David Murdoch, Dole Food's chief executive and controlling shareholder, has proposed to take the company private in a process that adheres closely to the chancellor's suggested In re MFW framework.

For further information on this topic please contact James Lidbury at Ropes & Gray LLP's Chicago office by telephone (+1 312 845 1200), fax (+1 312 845 5500) or email ([email protected]). Alternatively, contact Jason Freedman at Ropes & Gray's San Francisco office by telephone (+1 415 315 6300), fax (+1 415 315 6350) or email ([email protected]). The Ropes & Gray website can be accessed at www.ropesgray.com.

Endnotes

(1) In re MFW S'holders Litig, CA No 6566-CS (Del Ch May 29 2013).