Saturday, June 1, 2013

Delaware Court on Going Private Transactions

Transactions such as mergers between a company and its controlling shareholders are subject to close scrutiny by courts. Such transactions give rise to conflict of interest as they are carried out between related parties and therefore require close supervision. Moreover, mergers with controlling shareholders may also be utilised to force out minority shareholders of a company if the non-controlling shareholders are paid the consideration in cash. These are generally referred to as freezeout mergers in the US context. Historically, such mergers have been subjected to a high standard of scrutiny where courts have applied the “entire fairness” standard commencing from the landmark case of Weinberger v. UOP.

This position was revisited earlier this week by the Delaware Chancery Court in Re MFW Shareholders Litigation where the court applied the less onerous business judgment rule to the merger of a company with its controlling shareholder in which an offer was made to buy out the minority shareholders. The court adopted a deferential approach because the transaction was structured in a manner that took into account minority interests. Two protections specifically found relevance. First, an independent special committee of directors approved the transaction. Second, a majority of the shareholders unaffiliated with the controlling shareholder approved it as well. In other words, it was an independent shareholder approval or a “majority of the minority” vote. This decision indicates the key protections that transaction planners must offer minority shareholders if they are to be sustainable if challenged in a court of law.

A commentary of the decision and its background can be found on Reuters, and it is not intended to discuss the merits of the decision in any detail.

In juxtaposition, the law in India arguably confers lesser protection on minority shareholders both in related party transactions generally as well as in squeeze outs. As discussed extensively on this Blog, related party transactions are subject to greater disclosures but not to approval by either an independent committee of directors or independent shareholders, although the position is likely to change drastically if and when the Companies Bill, 2012 is enacted (e.g. section 188, although a merger is not expressly covered in that provision).

As regards squeeze outs, the legal position continues to be unsettled where companies have the option of following either schemes of arrangement (where minority shareholders have some protection due to classification of shareholders) or reduction of capital (where no independent shareholder approval is required). Previous discussion on squeeze outs is contained here and here


Ashutosh Kumar said...

Are these minority protection measures provided in the takeover entirely voluntary on the part of the offeror? Are there any specific safeguards of a similar nature under Delaware law?


Umakanth Varottil said...

In this case, the measures were introduced voluntarily by the parties to the transaction, but this was based on guidance previously provided by the Delaware courts. This seems to be the case in jurisdictions such as Delaware where the courts play an important role in setting standards against which transactions are evaluated.

Anonymous said...

Mangesh Patwardhan
This judgment is in classic `law and economics’ tradition, in line with Chancellor Strine’s reputation. Legal issues are analyzed in terms of their economic incentives to act or not act in a particular way, and locating the optimal set of incentives. Here, Strine advocates a sliding scale of judicial review standard –greater the protections built into the process by the controlling shareholder, less intrusive is the standard of judicial scrutiny. The reasoning is that an independent board committee AND majority of minority would ensure bargaining power for the minority shareholders, and also afford them a voice in the final decision (added to that is the non-negotiable nature of the arrangement). This eliminates any need for judicial second guessing, and therefore the business judgment rule is sufficient. Also, in future cases, the controlling shareholders will be incentivized to have both protections in place, to reap the benefit of easier judicial scrutiny. To use economics lingo, Strine considers both `ex post’ and `ex ante’ effects of this ratio.
I doubt whether this carries over to India. With its strong community and familial loyalties, it is indeed difficult to ensure de facto independence of the board committee. Also, with more dispersed retail shareholding and the relatively non-activist institutional shareholders, the majority of minority rule also may have limited impact in practice (though this may be changing). Any views?

Mandar Kagade said...

As a case of first instance, his reasoning is convincing that application of BJR would incentivize future "going private through merger" transactions.

I would go a step further tho and contend that where the controller uses BOTH these protections, the transaction itself ceases to be self dealing, because if the controller is waiving its voting rights and the Special Comm. satisfies the tailored Delaware test of independence, then in effect the transaction is just like any other third-party merger as the controller no longer now stands on the sell-side of the transaction (Which it would, were it to retain its rights to vote the merger proxy, or have the powers to bypass the Board by going to the Shareholders directly, if the Comm. voted a no). Thus, since the transaction structured with these protections is akin to a third-party merger transaction, it falls to reason that both enjoy the same standard of review. Strine stops short of making this point however, and it would be interesting to see if the Delaware Supreme Court has a chance to comment on this parity.

@ Mangesh, I agree with the latter limb of your argument as to why lessons for India could be limited- dispersed shareholding and lack of robust institutional shareholder voting policies foreclose any meaningful application of the majority-of-the-minority rule here.

But there are lessons to be drawn from the independence tests espoused by Delaware law- the granular detail the Courts in Delaware subject any "conflicted-out" claim by the Plaintiff's bar is precisely antithetical to the family loyalties/Social ties and out" rule.