On March 14, 2014, the Delaware Supreme Court issued an opinion in In re MFW Shareholders Litigation, No. 334, 2013 (Del. 2014) which answers the fundamental question as to which standard of review applies to a majority stockholder led freeze-out merger of the minority.
Before MFW, the Delaware Supreme Court left unanswered what standard of review would apply to freeze-out mergers when a controlling stockholder agreed to two procedural protections, including: (i) appointing a special committee of independent directors to consider a merger proposal, and (ii) a majority-of-the-minority voting condition. In this instance, plaintiffs’ advocated that the entire fairness standard of review still applied and thus defendants would still hold the burden of proving fair price and fair process.
In Kahn v. Lynch Communications Systems, Inc., 638 A.2d 422, 428 (Del. 1997), the Delaware Supreme Court did not reach the ultimate question as to what standard of review applies when a controller consents to both procedural protections. The Court, however, did hold that in entire fairness cases, “the defendants may shift the burden of persuasion to the plaintiff if either (1) they show that the transaction was approved by a well-functioning committee of independent directors; or (2) they show that the transaction was approved by an informed vote of a majority of the minority stockholders.” MFW, at *11 (emphasis in original). If defendants satisfied either procedural protection, the burden of persuasion shifted from defendants to plaintiffs to prove unfair dealing and unfair price. Id.
In a very narrowly-tailored ruling, the Delaware Supreme Court in MFW held that the business judgment rule applies in controlling stockholder freeze-out mergers, if and only if: (i) the controller conditions the transaction on the approval of both a special committee and a majority of the minority of stockholders; (ii) the special committee is independent; (iii) the special committee is empowered to freely select its own advisors and to definitively say no; (iv) the special committee acts with care; (v) the minority vote is informed; and (vi) there is no coercion of the minority. MFW, at *18.
While at first glance the MFW opinion seems to change the standard of review in all controller led freeze-out mergers, from the entire fairness standard to the business judgment rule, the test actually adopted by the Delaware Supreme Court is much more nuanced and fact intensive than simply checking the proverbial boxes.
Moving forward, plaintiffs litigating a controlling stockholder freeze-out merger should pay special attention to establishing that the special committee is not “independent” or show that the special committee and/or the minority stockholders were not fully informed when voting to approve the freeze-out merger.