(Article from Securities Law Alert, September 2017)
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On August 18, 2017, the Delaware Chancery Court held that “conflicted one-side controller transactions” in which the controller negotiated for disparate consideration must comport with the requirements adopted in Kahn v M&F Worldwide Corp., 88 A.3d 635 (Del. 2014) (MFW)[1] “to secure pleadings-stage business judgment rule review.” In re Martha Stewart Living Omnimedia Stockholder Litig., 2017 WL 3568089 (Del. Ch. 2017) (Slights, V.C.) (MLO). The court further ruled that “the correct time at which to determine if the [MFW] ab initio requirement has been met is the point where the controlling stockholder actually sits down with an acquiror to negotiate for additional consideration.”
One-Sided Controller Transactions Involving Disparate Consideration Must Satisfy MFW’s Prerequisites to Merit Business Judgment Review
The Delaware Chancery Court explained that MFW established a “road map by which a controlling stockholder’s buyout of its subsidiary in a negotiated merger will earn the controller” the benefit of the business judgment standard of review, “even at the pleading stage.”[2] MLO, 2017 WL 3568089.
In considering whether the MFW test applies to transactions in which the controlling stockholder is the seller only, the Delaware Chancery found that “the risks and incentives [do not] differ significantly as between two-sided controller transactions and one-sided controller transactions where the controller is alleged to have competed with the minority for consideration.” The court further determined that “[t]he need to incentivize fiduciaries to act in the best interests of minority stockholders, likewise, is equally important in one-sided and two-sided conflicted controller transactions.” The court stated that “[i]n both instances, the key is to ensure that all involved in the transaction, on both sides, appreciate from the outset that the terms of the deal will be negotiated and approved by a special committee free of the controller’s influence and that a majority of the minority stockholders will have the final say on whether the deal will go forward.”
Based on its finding that “[t]he potential for conflict is omnipresent in both scenarios,” the Delaware Chancery Court held that “strict compliance with [MFW’s] transactional road map . . . is required for the controlling stockholder to earn pleadings-stage business judgment deference when it is well-pled that the controller, as seller, engaged in a conflicted transaction by wrongfully diverting to herself merger consideration that otherwise would have been paid to all stockholders.”
A Controlling Stockholder Must Implement MFW’s Procedural Protections Before Negotiating for Disparate Consideration
The court then considered when MFW’s procedural protections must be in place in order for a one-sided controller transaction involving disparate consideration to qualify for deferential business judgment review. The court declined “to adopt a rule that would require the procedural protections to be implemented at the outset of discussions between the target and the third party even if the controller and third party have not even hinted that they might engage in separate negotiations.” The court reasoned that “[s]uch a rule would make no sense for the simple reason that the [MFW] protections serve no purpose at the outset of discussions between a target and third party when the only proposal from the putative buyer is that all shareholders receive the same price for their shares.”
Rather, the court found that “the ‘get go’ of the process in the disparate consideration case is the moment the controller and third party begin to negotiate the controller’s side deals.” The court held that the controller must “ensure that the third party and the target have agreed to both [MFW] procedural protections before she begins to negotiate separately with the third party for disparate or non-ratable consideration” since “[t]hat is when the potential conflict with the minority surfaces.”
[1] Please click here to read our prior discussion of the MFW decision.
[2] The MFW court held that the business judgment standard of review governs “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.” 88 A.3d 635.