Delaware Standard for Controlled Company Mergers

Delaware courts have long been
considering disputes pertaining to mergers between companies and their
controlling shareholders. Not only do such mergers involve related party
transactions but they are also used as a means to squeeze out the minority
shareholders of the target who are cashed out as part of the merger. In one of
the first decisions that permitted minority shareholders to bring fiduciary
duty class actions in such transactions, the Delaware Supreme Court applied the
“entire fairness” standard that is quite onerous on the controlling
shareholders (see Weinberger v. UOP, Inc.,
457 A. 2d 701 (Del. 1983)). Subsequently, the court adopted a more nuanced
approach in Kahn v. Lynch Communication Systems Inc., 638 A. 2d 1110
(Del. 1994).
After some lapse of time, the issue
was reconsidered by the Delaware Chancery Court last year in In Re MFW Shareholders Litigation, 67 A.
3d 496 (Del. Ch. 2013), which applied the more deferential “business judgment
rule” standard so long as the transaction was subject to certain precautionary
measures that ensured sufficient protection to the minority shareholders. Last
month, this ruling of the Chancery Court was upheld by the Delaware Supreme
Court in Kahn v.
M&F Worldwide Corp.
, which represents the settled legal position on
the issue.
In this case, through a merger,
MacAndrews & Forbes Holdings, Inc. (“M&F”), a 43% shareholder of
M&F Worldwide Corp. (“MFW”) sought to acquire the remaining shares of MFW
thereby effectively taking the company private. Two protective conditions were
included as part of the transaction process, i.e. that (i) the merger be
negotiated and approved by a special committee of independent MFW directors
(the “Special Committee”), and (ii) the merger be approved by a majority of
shareholder not affiliated with M&F (i.e. non-controlling shareholders).
The importance of the question
presented before the Delaware Supreme Court is evident from the following
passage:
This appeal
presents a question of first impression: what should be the standard of review
for a merger between a controlling stockholder and its subsidiary, where the
merger is conditioned ab initio upon the approval of both an independent, adequately-empowered Special Committee that
fulfills its duty of care, and the uncoerced, informed vote of a majority of
the minority stockholders. The question has never been put directly to this
Court.
After considering the legal
position in these circumstances, the court affirmed the availability of the
business judgment standard of review. This standard is summarised as follows:
To summarize our
holding, 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. [footnote omitted]
Although this standard appears
deferential to boards and controlling shareholders, it is available only if the
precautions set forth above are exercised carefully (which is subject to
scrutiny by the courts). In establishing this standard, the court appears to
have introduced a fair amount of certainty that corporations and their advisors
can rely upon while structuring controlled company mergers and squeeze out
transactions. As noted on the Delaware
Corporate & Legal Services Blog
, the decision “is an important
milestone in Delaware corporate jurisprudence, providing definitive guidance on
how a company can structure a going-private merger so that, in the event of a
lawsuit brought by shareholders against the board of directors, the court
applies the deferential business judgment rule to the board’s decision and not
the more stringent entire fairness standard.”

Although the Delaware position represents a significant
contrast to the manner in which squeeze out transactions are regulated in
India, some lessons may be useful. The use of a committee of independent
directors, which has hitherto been rare in India, is beginning to gain some
prominence and may be utilised effectively for squeeze out transactions.
Similarly, a “majority of the minority” (MoM) vote is now recognised for
related party transactions under section 188 of the Companies Act, 2013. Although
a plain vanilla squeeze out transaction may not necessarily fall within the
definition of a related party transaction for that purpose, the use of an MoM
vote will certainly enhance minority shareholder protection. The regulation of
squeeze outs in India has received limited attention under the Companies Act,
2013, and is likely to continue to vex the companies, shareholders, regulators
and courts alike.

About the author

Umakanth Varottil

Umakanth Varottil is an Associate Professor at the Faculty of Law, National University of Singapore. He specializes in corporate law and governance, mergers and acquisitions and cross-border investments. Prior to his foray into academia, Umakanth was a partner at a pre-eminent law firm in India.

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