(Article from Securities Law Alert, November 2016)
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On October 10, 2016, the Delaware Chancery Court rejected allegations that the directors of Books-a-Million had acted in bad faith by approving a controlling stockholder’s going-private offer instead of pursuing a higher third-party offer. In re Books a Million, 2016 WL 5874974 (Del. Ch. 2016) (Laster, V.C.). The court found that even when parties follow the Delaware Supreme Court’s framework in Kahn v. M&F Worldwide, 88 A.3d 635 (Del. 2014) (MFW), plaintiffs can still challenge the transaction on bad faith grounds.[1] However, the court determined that approving a controlling stockholder’s offer over a higher third-party offer is not sufficient, standing alone, to support an inference of bad faith because third-party offers incorporate a control premium and are therefore not “fairly comparable” to controlling stockholder offers.
Background
In January 2015, the Anderson Family, the controlling stockholder of Books-a-Million, proposed to acquire all outstanding shares of Books-a-Million that it did not already own at a premium over the trading price. The Anderson Family conditioned the proposal on compliance with the MFW framework, including approval by a special committee of independent directors and approval by a majority of the minority shareholders. A third party subsequently offered to purchase all shares of Books-a-Million, including the Anderson Family’s shares, at a higher price than the Anderson Family’s offer (“Party Y’s offer”). The special committee did not pursue Party Y’s offer, but instead decided to negotiate with the Anderson Family. The special committee ultimately approved the Anderson Family’s offer, and a majority of the minority stockholders approved the transaction.
Certain Books-a-Million stockholders subsequently brought the instant action claiming that the company’s directors, together with the Anderson Family and several of the company’s officers, breached their fiduciary duties in connection with the merger.
Plaintiffs Can Challenge Transactions Subject to the MFW Framework on Bad Faith Grounds
One of the requirements of the MFW framework is that the members of the special committee formed to review the transaction are independent and disinterested. Plaintiffs claimed that even though the members of the special committee formed to review the transaction “appeared to be independent,” their purported independence and disinterestedness was “belied by their bad faith actions” in “recommending the Anderson Family’s offer.”
The Chancery Court observed that it was “not immediately clear how an argument regarding bad faith fits within the [MFW] framework.” The court noted that in MFW, the Delaware Supreme Court “did not discuss whether a plaintiff could seek to call into question the independence of a director by contending that although appearing independent, the director did not in fact act independently for the benefit of the stockholders.” However, the Books-a-Million court found the Chancery Court’s opinion in the MFW case left open the possibility of such an argument.[2]
The Books-a-Million court determined that “the difficult route of pleading subjective bad faith is [a] theoretically viable means of attacking the [MFW] framework.” The court reasoned that “[t]his makes sense, because pleading facts sufficient to support an inference of subjective bad faith is one of the traditional ways that a plaintiff can establish disloyalty sufficient to rebut the business judgment rule.”
Special Committee’s Failure to Pursue a Higher Third-Party Offer Did Not Support an Inference of Bad Faith
Plaintiffs contended that the independent directors’ “failure to pursue Party Y’s offer support[ed] an inference that the independent directors disloyally favored the interests of the Anderson Family” over those of the minority stockholders.
In considering plaintiffs’ bad faith claims, the Chancery Court relied on its prior decision in Mendel v. Carroll, 651 A.3d 297 (Del. Ch. 1994), which involved an analogous fact pattern. The Mendel court explained that “it is widely understood that buyers of corporate control will be required to pay a premium above the market price for the company’s traded securities.” The court found that the third-party offer at issue was “an offer, in effect, to the controlling shareholder to purchase corporate control, and to all public shareholders, to purchase the remaining part of the company’s shares, all at a single price.” The third party’s offer “distributed the control premium evenly over all the shares.” The Mendel court determined that the third-party offer on the table was “not fairly comparable to the per-share price proposed” by the controlling stockholder because the controlling stockholder was “not buying corporate control.”
The Mendel court also outlined the scope of directors’ duties when weighing a controlling stockholder’s offer against a third-party offer. The court stated that the board must “respect the rights” of the controlling stockholders, including the right not to sell their shares, while at the same time ensuring that any transaction “would be accomplished only on terms that were fair to the public stockholders.” The court explained that directors may “take extraordinary steps to protect the minority from plain overreaching” by the majority stockholder, but they may not “deploy corporate power against the majority stockholder[], in the absence of a threatened serious breach of fiduciary duty by the controlling stock[holder].”
Applying the reasoning set forth in Mendel, the Books-a-Million court stated that it could “reasonably infer that Party Y’s offer was higher because Party Y was seeking to acquire control and that the Anderson Family’s offer was lower because it took into account the family’s existing control over the [c]ompany.” Books-a-Million, 2016 WL 5874974. Although the court noted that that it was “not possible to infer the exact amount of the premium or discount” of control, the court determined that the Anderson Family’s “bargained-for consideration” fell “within a rational range of discounts and premiums.” The court reasoned that the “difference” between the two offers was “not so facially large as to suggest that the [special committee] was attempting to facilitate a sweetheart deal for the Anderson Family.”
The court also observed that the Anderson Family’s insistence on “[a]ppraisal [rights] act[ed] as a further check on expropriation by the Anderson Family,” because a court would “exclude any minority discount” when appraising the shares. In addition, the court found it significant that the Anderson Family’s offer represented a sizable premium over the trading price. The court reasoned that the special committee “rationally could [have] believe[d] that stockholders might prefer liquidity at a premium to market.”
The court concluded that plaintiffs’ allegations did “not support a reasonable inference that the [special committee had] acted in bad faith” in approving the Anderson Family’s offer.
[1] Please click here to read our prior discussion of the Delaware Supreme Court’s decision in MFW. [2] The Chancery Court in MFW stated that there was “no basis to infer” that the special committee “did not attempt in good faith to obtain the most favorable price they could secure for the minority or believe they had done so.” In re MFW S’holdrs. Litig., 67 A.3d 496 (Del. Ch. 2013).