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In Kahn v M&F Worldwide Corp., 88 A.3d 635 (Del. 2014) (MFW), the Delaware Supreme Court held “business judgment is the standard of review that should govern mergers between a controlling stockholder and its corporate subsidiary, where the merger is conditioned ab initio upon both the approval of an independent, adequately-empowered [s]pecial [c]ommittee that fulfills its duty of care; and the uncoerced, informed vote of a majority of the minority stockholders.”[1]

On May 5, 2016, the New York Court of Appeals adopted the MFW standard for going-private mergers. In re Kenneth Cole Productions S’holder Litig., 2016 WL 2350133 (N.Y. 2016) (Stein, J.) (Kenneth Cole III). The Court of Appeals found “the MFW standard properly considers the rights of minority shareholders . . . and balances them against the interests of directors and controlling shareholders in avoiding frivolous litigation and protecting independently-made business decisions from unwarranted judicial interference.”

Background

In February 2012, Kenneth Cole proposed a going-private merger of Kenneth Cole Productions (“KCP”). At the time, Cole was KCP’s majority shareholder and controlled approximately 89% of the shareholders’ voting power. Cole made an initial offer of $15 per share, conditioned on approval by (1) a special committee of the board formed to consider Cole’s going-private offer; and (2) a majority of the company’s minority shareholders. Cole indicated that he would not approve any other type of merger, but stated that “his relationship with KCP would not be adversely affected” if either the special committee or the minority stockholders rejected the going-private merger offer.

The special committee retained independent counsel and its own financial advisor, but did not explore the possibility of any other transactions. After several months of negotiation, Cole increased his offer to $15.25 per share, which the special committee approved. Almost all of the minority stockholders also approved Cole’s offer.

Certain stockholders brought suit alleging that Cole and the directors had breached their fiduciary duties to the minority shareholders. The trial court dismissed plaintiffs’ complaint. In re Kenneth Cole Productions S’holder Litig., 2013 WL 4767369 (N.Y. Sup. Ct. 2013). The court determined it was “bound by the business judgment rule” because there were no allegations of “specific unfair conduct by the special committee.” The First Department affirmed, finding the trial court’s application of the business judgment rule “appropriate” because there were “no allegations sufficient to demonstrate that the members of the board or the special committee did not act in good faith or were otherwise interested.” In re Kenneth Cole Productions S’holder Litig., 122 A.D.3d 500 (N.Y. App. Div. 2014). Plaintiffs appealed.

Court of Appeals Holds the Business Judgment Rule Applies to Going-Private Mergers Provided “Certain Shareholder Protective Conditions Are Met” 

The New York Court of Appeals considered the question of “what standard should be applied by courts reviewing a going-private merger that is subject from the outset to approval by both a special committee of independent directors and a majority of the minority shareholders.” Kenneth Cole III, 2016 WL 2350133. The court held the business judgment rule applies “as long as the corporation’s directors establish that certain shareholder-protective conditions are met.”  

The Court of Appeals began its analysis by observing that it has “long adhered to the business judgment rule, which provides that, where corporate officers or directors exercise unbiased judgment in determining that certain actions will promote the corporation’s interests, courts will defer to those determinations if they were made in good faith.” The court noted it has previously “held that the substantive determination of a committee of disinterested directors is beyond judicial inquiry under the business judgment rule.” However, the Court of Appeals has also made it clear that courts may “inquire as to the disinterested independence of the members of that committee and as to the appropriateness and sufficiency of the investigative procedures chosen and pursued by the committee.” Id. (quoting Auerbach v. Bennett, 393 N.E. 2d 994 (1979)).

The Court of Appeals found the standard set forth in the Delaware Supreme Court’s MFW decision to be adequately “deferential to corporate boards” while still ensuring that “minority shareholders are sufficiently protected” in going-private mergers. Adopting the MFW standard, the Court of Appeals held the business judgment rule will apply to going-private mergers:

[I]f and only if: (i) the controller conditions the procession of the transaction on the approval of both a Special Committee and a majority of the minority stockholders; (ii) the Special Committee is independent; (iii) the Special Committee is empowered to freely select its own advisors and to say no definitively; (iv) the Special Committee meets its duty of care in negotiating a fair price; (v) the vote of the minority is informed; and (vi) there is no coercion of the minority. 

Id. (quoting MFW, 88 A.3d 635). Under this standard, the court explained that a plaintiff alleging breach of fiduciary duty claims in connection with a going-private merger may only “proceed to discovery” if the plaintiff “alleges a ‘reasonably conceivable set of facts’ showing that any of the six enumerated shareholder-protective conditions did not exist.” Id. (quoting MFW, 88 A.3d 635). In the event “the evidence demonstrates that any of the protections were not in place, then the business judgment rule is inapplicable and the entire fairness standard applies.”

Court of Appeals Applies the Business Judgment Rule and Dismisses Plaintiffs’ Claims  

Turning to the case at hand, the Court of Appeals affirmed dismissal of plaintiffs’ breach of fiduciary duty claims arising out of KCP’s going-private merger. The court found “[p]laintiffs did not sufficiently and specifically allege that any of MFW’s six enumerated conditions were absent from the merger here,” and therefore held the business judgment standard of review applied. “Pursuant to that standard,” the court “defer[red] to the determinations of the special committee and the KCP board of directors in recommending and approving the merger.” Because plaintiffs did not allege fraud or bad faith, the Court of Appeals held the complaint was “properly dismissed.”