Controlling Shareholder Buyout: Entire Fairness Standard or Business Judgment Rule?

By: Mark Tarallo

In the past, the Delaware Chancery Court has applied the “entire fairness” standard when evaluating claims made by minority shareholders in the context of a buyout by a controlling shareholder.  The entire fairness standard is generally considered the most rigorous standard of review, incorporating a detailed review of the specific facts surrounding both the price and process of a controlling shareholder buyout.  In an entire fairness review, the burden is on the controlling shareholder to prove fairness.  The Delaware Supreme Court recently upheld a Chancery Court decision applying the much less rigorous business judgment rule instead of the entire fairness standard.

On May 29, 2013, former Chancellor Strine, sitting in the Chancery Court, granted summary judgment in favor of MacAndrews & Forbes Holdings Inc., and indicated that the business judgment rule should be applied to evaluate the transaction (In re MFW Shareholders Litigation, May 29, 2013).  In Kahn v. M&F Worldwide Corp., 2014 WL 996270 (Del. Mar. 14, 2014), the Delaware Supreme Court upheld this ruling and confirmed that a buyout by a controlling shareholder should be reviewed under the business judgment standard,  if certain procedural protections were implemented at the outset of the transaction.

MacAndrews & Forbes Holdings, Inc. (“MacAndrews”) owned 43% of M&F Worldwide Corp. (“MFW”). In June 2011, MacAndrews offered to take MFW private. MacAndrews’ offer contained, among other items, two specific requirements for the transaction: (1) negotiation and approval by a special committee of independent MFW directors and (2) approval of the acquisition by a majority of the minority stockholders who were unaffiliated with MacAndrews.  The MFW board then formed a special committee, and the special committee retained its own separate advisors.  The special committee negotiated and approved transaction terms, and the transaction was then approved by over 65% of the minority stockholders of MFW.

The plaintiffs brought several claims against various parties alleging breaches of fiduciary duty, arguing that the transaction should be evaluated under the entire fairness standard.  The Chancery Court found that the business judgment rule should apply, “if, but only if:

(i)   the controller conditions 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 acts with care;

(v)  the minority vote is informed; and

(vi) there is no coercion of the minority.”

The Delaware Supreme Court upheld this ruling, and recently upheld a ruling in a similar case where there was a controlling stockholder, who was not on both sides of the transaction but was alleged to have used his position to compete with the minority for merger consideration that the business judgment rule should be the applicable standard of review (Southern Pennsylvania Transportation Authority v. Volgenau, C.A. No. 461, 2013 (Del. May 13, 2014)).  These cases provide clear guidance to controlling stockholders as to the steps they should incorporate in the M&A process to ensure a business judgment standard of review.

For more information on this topic, please contact Mark Tarallo.

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