Business judgment rule applicable to freeze-out mergers with built-in protections for minority shareholders
September 2013 | EXPERT BRIEFING | MERGERS & ACQUISITIONS
On 29 May 2013, the landmark decision of In re MFW Shareholders Litigation (‘MFW’), issued by Chancellor Strine of the Delaware Chancery Court, held the business judgment rule standard of review to be applicable to freeze-out mergers involving a controlling shareholder when, from the inception of merger negotiations, the controlling shareholder predicates that it will only proceed with the transaction if it is subject to both: (i) approval by a fully empowered special committee of independent directors; and (ii) ratification by a fully-informed, uncoerced vote of the majority of the minority of outstanding shares. If the MFW decision is not overturned by the Delaware Supreme Court (to which the case was appealed on 25 June 2013), controlling shareholders hoping to carry out a freeze-out merger are likely to be able to rely on the actions taken by the parties in MFW as a method for ensuring a transaction is reviewed under the business judgment rule.
Chancellor Strine’s opinion emphasises the protections of the business judgment rule will be available only when: “(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; (v) the vote of the minority is informed; and (vi) there is no coercion of the minority”.
In MFW, the initial merger proposal went so far as to stipulate that no adverse action would be taken in the event the committee or the minority shareholders did not vote to approve the merger and that the controlling shareholder intended to remain a long-term shareholder of MFW regardless of the result of the merger negotiations. With a guarantee that no adverse action would be taken and without fear of a coercive tender offer, the committee was empowered to vote against the offer if it so decided. Similarly, the minority shareholders were able to vote on the proposal without the concern that the controlling shareholder would later force their hand with a threat to destroy share value.
From the very outset of merger negotiations, a controlling shareholder must explicitly state it will only proceed with the transaction if it is approved by both a special committee and a majority-of-the-minority vote. Accordingly, future shareholder suits are likely to focus on any lack of independence of the special committee, a violation of the duty of care by the special committee, coercion of the shareholder vote, or inadequate disclosures to the minority shareholders.
Director independence should be a primary concern when selecting members for a special committee to evaluate and negotiate the proposed merger. Delaware law presumes directors to be independent and this presumption can only be rebutted by a plaintiff able to show “material” ties between a director and the controlling shareholder which make the director so “beholden” or “under the controller’s influence that the director’s discretion would be sterilized”. Personal relationships rarely meet this standard and the inquiry is almost always into a director’s individual economic circumstances. In MFW, the court rejected the plaintiff’s claims of director interestedness based on past business relationships, casual friendship, and consulting fees paid to the directors in the past because they had not been shown to be material with respect to the personal circumstances of each director.
Furthermore, to meet their duty of care, committees must act in an “informed and deliberate manner in determining whether to approve an agreement of merger” (Smith v. Van Gorkom). Directors elected to special committees should spend sufficient time meeting to consider a merger proposal, base their decision on material facts rather than mere representations, and adequately consider alternative courses of action. The MFWcommittee was found to have satisfied its duty of care by meeting eight times over the course of three months, choosing its own legal and financial advisers after interviewing several, considering other options for sale and whether it could solicit a higher outside bid, and negotiating with the acquirer to raise its offer price by a dollar (from $24 to $25 – a 47 percent premium over the share price at the time just prior to the merger), which was within all five ranges of stock value provided by the committee’s financial advisers.
Lastly, a shareholder vote will be deemed ‘fully informed’ when all material information necessary to acquaint shareholders with each party’s bargaining position has been disclosed. MFW’s proxy statement included a complete history of the merger and the independent committee’s recommendation, details of the negotiations that resulted in the final offer, notes on management’s current business projections, and all five ranges of stock value that had been provided by the financial advisers. The minority shareholders were fully empowered to check the power of both the controlling shareholder and the independent committee and nonetheless approved the merger.
The underlying premise of Chancellor Strine’s decision is that the controlling shareholder and the board of directors engaged in a process that replicated an arm’s length merger that procedurally protected the interests of the minority shareholders. Accordingly, the deal was fair and the board of directors and the controlling shareholder did not breach any duties to the minority shareholders. However, the merger procedures used by MFW not only protected minority shareholders, they made it more difficult for dissenting shareholders to attack the transaction.
In a matter of months, the MFW decision has become a basis for structuring deals and shielding transactions from judicial interference. On 7 August 2013, the Delaware Chancery Court applied MFW and the business judgment rule to the sale of SRA International, Inc. to Providence Equity Partners Inc., protecting the transaction from interference by dissenting shareholders because the takeover was authorised by an independent special committee and the majority of minority shareholders. Also in accordance with MFW, David Murdock, the chairman and chief executive of Delaware-incorporated Dole Food Company, Inc., subjected his bid to take over Dole to approval by a special committee of the board of directors and a majority of the outstanding shares he does not own. Mr Murdock holds almost 40 percent of Dole’s outstanding shares and his 11 June 2013 bid for the remaining shares of the company was accepted by the special committee on 12 August 2013. After a 30-day go-shop period, Mr Murdock’s bid for Dole will then be subject to a shareholder vote. Despite the possibilities of MFW’s merger procedures yielding higher premium payments to minority shareholders, because independent committees are empowered to decline initial offers, and opening any controlling shareholder who bypasses the special committee or the majority-of-the-minority vote in its takeover efforts to liability for breaching its duty of loyalty, controlling shareholders have already been incentivised to offer the procedural protections outlined in MFW in merger proposals.
Steven Goldberg is a partner and Jason Cabico is an associate at BakerHostetler. Mr Goldberg can be contacted on +1 (212) 589 4219 or by email: firstname.lastname@example.org. Mr Cabico can be contacted on +1 (212) 589 4687 or by email: email@example.com. The authors would like to thank Justin Sommerkamp, a summer associate, for his contribution to this article.
© Financier Worldwide
Steven Goldberg and Jason Cabico