In a much anticipated judicial development, the Delaware Supreme Court affirmed the holding of In re MFW Shareholders Litigation (Del. Ch. 2013) that if certain procedural protections are in place from the outset of a transaction, a controlling stockholder buyout otherwise subject to the entire fairness standard could be subject to the business judgment standard of review.
As the Court explains in its opinion, the entire fairness standard asks whether a transaction is “entirely fair,” requiring both “fair dealing” and a “fair price.” By marked contrast, the business judgment standard requires that the breach of fiduciary duty claim be dismissed unless “no rational person could have believed that the merger was favorable to [the] minority stockholders.” Prior cases had held that in controlling stockholder buyouts, if there is either a properly functioning Special Committee or the transaction is subject to a non-waivable condition that the approval of a majority of the minority stockholders is obtained, then the burden of proof as to entire fairness shifts to the plaintiffs. But the Court had not previously determined what standard applies if both protections are put in place from the outset of the transaction. Because the determination of the applicable standard of review can be determinative of the outcome of the case, this decision represents an important new step in the evolution of Delaware fiduciary law.
Summarizing the “new standard,” the court held that “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.” It is important to note that in this case, the buyer conditioned its initial offer on the MFW board agreeing to approval by a Special Committee and by a vote of a majority of the minority stockholders.
Tempering the practical utility of the new standard, the Court goes on to state that if a plaintiff “can plead a reasonably conceivable set of facts showing that any or all of those enumerated conditions did not exist,” then the claim would survive a motion to dismiss and, if discovery yields triable issues of fact as to these conditions, then “the case will proceed to a trial in which the court will conduct an entire fairness review.” The Court notes that in the particular case at hand, even under the new standard, the plaintiff’s claim in this case would have survived a motion to dismiss. However, in this case, the lower court’s decision followed review of what the Court describes as a “highly extensive record” in which both procedural protections had been “undisputedly established prior to trial” (emphasis in original). The Court concludes that the new standard warrants the application of the business judgment standard of review to this case and that the business judgment standard was, in fact, met.
Given the potential ease with which a plaintiff may plead facts to survive a motion to dismiss and the need to be able to demonstrate the independence and effectiveness of the special committee prior to trial, controlling stockholder buyers will need to consider whether the risks associated with meeting the new standard (such as not obtaining approval by a majority of the minority stockholders) are worth the potential benefit of possibly being able to achieve application of the business judgment standard and avoid a trial.