In mid-March, the Delaware Supreme Court issued what is being described as a landmark ruling in the case Kahn v. M&F Worldwide Corp., which involved a shareholder challenge to the buyout of M&F by its controlling shareholder — MacAndrews & Forbes Holdings, Inc., an investment vehicle owned by Ronald Perelman. The court affirmed then-Chancellor Leo Strine’s use of the more deferential “business judgment” standard of review in granting a motion for summary judgment filed by the controlling shareholder. Until this decision, Delaware courts had typically applied the more stringent “entire fairness” standard in such cases.
According to the trial court, the use of the “business judgment” standard of review was appropriate in this instance because, from the outset, the controlling shareholder had agreed to make approval of the transaction contingent upon the review and recommendation of a “capable” special committee of independent directors, and approval by a majority of the minority or non-controlling shareholders. In the trial court’s view, these mechanisms gave the buyout the characteristics of an arm’s-length transaction with an actual third-party purchaser and, thus, warranted the more deferential standard of review typically applied in such cases. The Delaware Supreme Court unanimously affirmed this approach. Specifically, the high court held that:
[I]n 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.
Importantly, the decision makes clear that these conditions are absolute prerequisites. If any one of these conditions is absent or deemed ineffective, then the “entire fairness” standard will be used in evaluating any challenge. That also will be true if “triable issues of fact” exist regarding the true effectiveness of any of these conditions.
No doubt this is an important decision of first impression by the nation’s premiere business court. And, while the decision is certain to inform the way transaction counsel and other deal principals structure controlling shareholder buyouts in the future, its lasting impact on shareholder litigation — if any — is harder to discern at this time. Indeed, nothing in the decision can or should be seen to provide a checklist that controlling shareholders or directors can use to insulate themselves from challenges or liability in transactions with controlling parties. Transactions of that type necessarily raise serious questions related to self-dealing, conflicts of interest and the extent and adequacy of informed consent. If anything, the decision may well give helpful guidance to plaintiff’s counsel regarding the way in which to frame their allegations in order to survive any motion to dismiss and obtain discovery. In other words, this decision it not likely to curtail litigation but, instead, may affect how it gets conducted.
It also remains to be seen whether and how this decision gets applied by other courts across the country in evaluating controlling party transactions. In discussing the decision in this case, several commentators have remarked on the “management friendly” approach of the Delaware courts. Whether one agrees with that characterization or not, it is clear that it does not apply equally to all trial and appellate courts throughout the United States. One has to assume that, to the extent defendants try to make use of this decision in other courts, they will encounter at least some judicial skepticism over the elimination of the duty of loyalty that is inherent in the shift away from a traditional “entire fairness” review. Likewise, it is not hard to imagine a less business-oriented court being open to the argument that approval by a majority of the minority shareholders — which is likely to include any number of short-term investors or arbitrageurs — is not an especially meaningful measure of price fairness. After all, even the Delaware courts acknowledge that short-term investors have unique interests that often make them less concerned about the true fairness of a particular share price so long as they are able to obtain some premium.
In the short-term, however, it is clear that the Kahn v. M&F Worldwide Corp. decision will have a significant influence on transactional practice. As to the long-term impact on litigation, we will continue to wait and see.