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On April 11, 2019, the Delaware Supreme Court reversed the dismissal of a shareholder derivative suit alleging that the directors breached their fiduciary duties in approving a controlling stockholder transaction. Olenik v. Lodzinski, 2019 WL 1497167 (Del. 2019) (Seitz, J.) (Olenik II). The Delaware Supreme Court held that the Chancery Court erred in applying the business judgment standard of review because plaintiffs alleged that the company and its controlling stockholder “substantially negotiated the financial state of play” before the transaction was conditioned on the procedural protections set forth in Kahn v. M&F Worldwide Corp., 88 A.3d 635 (Del. 2014) (MFW).[1]

Background

Over the course of more than eight months in late 2015 and 2016, the company engaged in discussions with its controlling shareholder concerning the possibility of acquiring an entity controlled by the same shareholder. These discussions included a “joint exercise” by the acquiring company and its controlling shareholder to value the target company. This “joint exercise” yielded a valuation of $305 million in the acquiring company’s first presentation to its controlling shareholder, and $335 million in the second presentation. On August 19, 2016, the acquiring company’s CEO submitted a letter to the target company (the “Offer Letter”) proposing the acquisition and conditioning the transaction on MFW’s procedural protections, namely, approval by the acquiring company’s special committee and approval by a majority of the acquiring company’s minority stockholders. The “first formal offer” submitted in the Offer Letter “reflected an equity valuation for [the target company] of about $300 million, and the final deal reflected an equity valuation for [the target company] of around $333 million.”

One of the acquiring company’s minority stockholders subsequently filed a shareholder derivative suit; defendants moved to dismiss. In a decision dated July 20, 2018, the Delaware Chancery Court held that the submission of the Offer Letter “marked the appropriate time at which to announce the MFW ab initio conditions.” Olenik v. Lodzinski, 2018 WL 3493092 (Del. Ch. July 20, 2018). The court reasoned that although the discussions preceding the Offer Letter were “extensive,” they “never rose to the level of bargaining” but were instead “entirely exploratory in nature.”[2] The court applied the business judgment rule and dismissed plaintiffs’ complaint; plaintiffs appealed.

While the appeal was pending, the Delaware Supreme Court issued its decision in Flood v. Synutra Int’l, 195 A.3d 754 (Del. 2018), in which it held that MFW’s ab initio requirement is satisfied “so long as the controller conditions its offer on the key protections” before the commencement of “substantive economic negotiations with the controller.”[3]

The Business Judgment Rule Did Not Apply Because the Purchase Price Parameters Were Allegedly Set Before the Transaction Was Conditioned on MFW’s Procedural Protections

The Delaware Supreme Court relied on Synutra to hold that the Chancery Court “erred when it found that MFW’s dual protections had been agreed to from the deal’s inception.” The court determined that the Chancery Court “failed to credit reasonable inferences from well-pled facts that the MFW procedural protections were not put in place until after almost eight months of substantive economic dealings among the parties.” The Delaware Supreme Court acknowledged that “some of the early interactions between [the acquiring company and its controlling shareholder] could fairly be described as preliminary discussions outside of MFW’s ‘from the beginning’ requirement.” However, the court found plaintiffs adequately alleged that “the preliminary discussions transitioned to substantive economic negotiations when the parties engaged in a joint exercise to value” the target company. The Delaware Supreme Court found that “these valuations set the field of play for the economic negotiations to come by fixing the range in which offers and counteroffers might be made.” The court observed that the final deal reflected an equity valuation for the target company of $333 million—just shy of the $335 million valuation presented in the acquiring company’s second presentation to the controlling stockholder.

The Delaware Supreme Court rejected defendants’ contention that the Chancery Court’s decision should nevertheless be affirmed because the alleged controlling stockholder “shed its controller status” through a reduction in stock ownership before the submission of the Offer Letter. The Delaware Supreme Court found that MFW still governed the transaction because the stockholder “controlled [the company] . . . and also held a majority of [the company’s] stock while substantive economic negotiations took place that fixed the field of play for the eventual transaction price.” 

The court reversed the Chancery Court’s decision, and remanded for further proceedings consistent with its opinion.