Tuesday, April 8, 2014

Delaware Standard for Controlled Company Mergers

Delaware courts have long been considering disputes pertaining to mergers between companies and their controlling shareholders. Not only do such mergers involve related party transactions but they are also used as a means to squeeze out the minority shareholders of the target who are cashed out as part of the merger. In one of the first decisions that permitted minority shareholders to bring fiduciary duty class actions in such transactions, the Delaware Supreme Court applied the “entire fairness” standard that is quite onerous on the controlling shareholders (see Weinberger v. UOP, Inc., 457 A. 2d 701 (Del. 1983)). Subsequently, the court adopted a more nuanced approach in Kahn v. Lynch Communication Systems Inc., 638 A. 2d 1110 (Del. 1994).

After some lapse of time, the issue was reconsidered by the Delaware Chancery Court last year in In Re MFW Shareholders Litigation, 67 A. 3d 496 (Del. Ch. 2013), which applied the more deferential “business judgment rule” standard so long as the transaction was subject to certain precautionary measures that ensured sufficient protection to the minority shareholders. Last month, this ruling of the Chancery Court was upheld by the Delaware Supreme Court in Kahn v. M&F Worldwide Corp., which represents the settled legal position on the issue.

In this case, through a merger, MacAndrews & Forbes Holdings, Inc. (“M&F”), a 43% shareholder of M&F Worldwide Corp. (“MFW”) sought to acquire the remaining shares of MFW thereby effectively taking the company private. Two protective conditions were included as part of the transaction process, i.e. that (i) the merger be negotiated and approved by a special committee of independent MFW directors (the “Special Committee”), and (ii) the merger be approved by a majority of shareholder not affiliated with M&F (i.e. non-controlling shareholders).

The importance of the question presented before the Delaware Supreme Court is evident from the following passage:

This appeal presents a question of first impression: what should be the standard of review for a merger between a controlling stockholder and its subsidiary, where the merger is conditioned ab initio upon the approval of both an independent, adequately-empowered Special Committee that fulfills its duty of care, and the uncoerced, informed vote of a majority of the minority stockholders. The question has never been put directly to this Court.

After considering the legal position in these circumstances, the court affirmed the availability of the business judgment standard of review. This standard is summarised as follows:

To summarize our holding, in controller buyouts, the business judgment standard of review will be applied if 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. [footnote omitted]

Although this standard appears deferential to boards and controlling shareholders, it is available only if the precautions set forth above are exercised carefully (which is subject to scrutiny by the courts). In establishing this standard, the court appears to have introduced a fair amount of certainty that corporations and their advisors can rely upon while structuring controlled company mergers and squeeze out transactions. As noted on the Delaware Corporate & Legal Services Blog, the decision “is an important milestone in Delaware corporate jurisprudence, providing definitive guidance on how a company can structure a going-private merger so that, in the event of a lawsuit brought by shareholders against the board of directors, the court applies the deferential business judgment rule to the board’s decision and not the more stringent entire fairness standard.”

Although the Delaware position represents a significant contrast to the manner in which squeeze out transactions are regulated in India, some lessons may be useful. The use of a committee of independent directors, which has hitherto been rare in India, is beginning to gain some prominence and may be utilised effectively for squeeze out transactions. Similarly, a “majority of the minority” (MoM) vote is now recognised for related party transactions under section 188 of the Companies Act, 2013. Although a plain vanilla squeeze out transaction may not necessarily fall within the definition of a related party transaction for that purpose, the use of an MoM vote will certainly enhance minority shareholder protection. The regulation of squeeze outs in India has received limited attention under the Companies Act, 2013, and is likely to continue to vex the companies, shareholders, regulators and courts alike.

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