Strine makes new law on going-private deals in Ron Perelman case
Deference to the decisions of corporate boards is a bedrock principle of Delaware law, embodied in the business judgment rule that guides most Chancery Court analysis. But there are exceptions. In particular, the Delaware Supreme Court has made clear that deals in which a controlling shareholder wants to buy out minority stock owners must be evaluated very carefully, lest the controlling shareholder unduly influence the going-private process. In the landmark 1994 case Kahn v. Lynch, the state high court said that the appropriate standard of review for going-private deals is not business judgment but the entire fairness of the transaction, which gives courts discretion to second-guess the board’s decisions.
The Supreme Court did say in Lynch that the burden of showing whether deals are fair to minority shareholders can swing between plaintiffs and defendants depending on whether the company built protections for minority shareholders into the sale process. (Pay attention to this quote; as you’ll see, it’s crucial.) “The initial burden of establishing entire fairness rests upon the party who stands on both sides of the transaction,” the court said. “However, an approval of the transaction by an independent committee of directors or an informed majority of minority shareholders shifts the burden of proof on the issue of fairness from the controlling or dominating shareholder to the challenging shareholder plaintiff.”
Note the court’s use of the word “or” in describing the protections: Since Lynch, corporate directors and controlling shareholders have known that they could stick plaintiffs with the burden of establishing the unfairness of going-private deals either by vesting approval of the transaction with a legitimately independent committee or by winning the approval of minority shareholders. Their incentive, therefore, was to build in one of those safeguards – but not both. Why take the risk that the deal wouldn’t pass both tests if you only need to pass one?
On Wednesday, Chancellor Leo Strine of Chancery Court gave companies a powerful incentive to build both independent board review and minority shareholder approval into the going-private process, writing new law that should boost shareholder protections. Strine granted summary judgment to M&F Worldwide, finding that the board did not breach its duty to shareholders when it approved a $25 per share offer by MFW’s controlling shareholder, MacAndrews & Forbes (which, in turn, is wholly owned by Ron Perelman). Of much broader significance, the chancellor also said, in a scholarly opinion devoid of the usual Strinian flourishes of rhetoric, that because MFW structured the deal process so that an independent board committee negotiated the transaction and minority shareholders subsequently approved it, the deal should be evaluated under the deferential business judgment standard, not the more rigorous entire fairness standard.
“This conclusion is consistent with the central tradition of Delaware law, which defers to the informed decisions of impartial directors, especially when those decisions have been approved by the disinterested stockholders on full information and without coercion,” Strine wrote. “Not only that, the adoption of this rule will be of benefit to minority stockholders because it will provide a strong incentive for controlling stockholders to accord minority investors the transactional structure that respected scholars believe will provide them the best protection.” And as an added benefit, Strine said, companies that subject going-private deals to the scrutiny of both an independent board committee and a vote of minority shareholders will have an easier time fending off litigation challenges to their transactions by minority shareholders.
The question of applying the business judgment rule to deals with double-barreled protection for minority shareholders has been kicked around for a while in academic circles, but Strine determined that the Delaware Supreme Court has never addressed it squarely, rejecting arguments by MFW shareholders that high court dicta stands for the proposition that all controlling shareholder deals are subject to the entire fairness standard. It’s interesting that Ron Perelman – whose hostile bid for Revlon back in 1985 led the Delaware Supreme Court to establish the duties of a corporate board in a takeover process – finally put the issue before Chancery Court.
Perelman and the board of MFW, along with counsel from Skadden, Arps, Slate, Meagher & Flom, set up a process that, from the beginning, was designed to satisfy both the independent board consideration and minority shareholder vote prongs of Lynch. The company said, in fact, that it would not proceed with the buyout unless it had approval from both the independent committee and shareholders. Plaintiffs later questioned the independence of three of the four purportedly conflict-free members of the board committee that negotiated with MacAndrews, but in a lengthy discussion, Strine concluded not only that committee members were independent but also that the committee, represented by independent counsel from Willkie Farr & Gallagher, had actual authority to reject the offer from MacAndrews, which owned 42 percent of MFW’s shares. After negotiations with the committee led MacAndrews to raise its bid by one dollar, from $24 to $25 per share, 65 percent of the minority shareholders approved the deal. “The process was meant to insure shareholders had appropriate opportunity to evaluate the offer,” a MacAndrews representative told me via email.
Despite those shareholder protections, plaintiffs’ lawyers from Wolf Popper, Faruqi & Faruqi, Gardy & Notisand Rosenthal Monheit sued to block the buyout. They ended up dropping their preliminary injunction case but continued litigating for post-closing damages based on the MFW board’s supposed breach of duty. Carl Stine, who argued for shareholders at the summary judgment hearing before Strine, was in depositions and unavailable for comment, but plaintiffs were presumably counting on the deal to be evaluated under the entire fairness standard, which would permit them to argue that the $25 per share price was too low.
Strine determined that fairness was not the right standard, distinguishing the MacAndrews process from those the Supreme Court has previously evaluated. “Although admitting that there is language in prior Supreme Court decisions that can be read as indicating that there are no circumstances when a merger with a controlling stockholder can escape fairness review,” he wrote, “the court concludes that this language does not constitute a holding of our Supreme Court as to a question it was never afforded the opportunity to answer.”
Even the chancellor seems sure that his is not the last word on structuring buyouts to receive business judgment deference. He noted several times that he is offering his interpretation of Supreme Court precedent and invited the justices to set him straight if he’s wrong. But in the meantime, corporate lawyers advising on going-private deals will have to think hard about the sale process. And shareholder lawyers will have to think just as hard about whether it makes economic sense to challenge transactions that will be evaluated under the business judgment standard.
Thomas Allingham of Skadden, who argued for MacAndrews at the summary judgment hearing, referred me to the company for comment. Tariq Mundiya, who argued for the MFW independent committee, sent an email statement: “The Special Committee is pleased that Chancellor Strine recognized the tireless and thorough efforts by the independent Special Committee.”
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