Thursday, May 30, 2013
Chancellor Strine broke some new ground with respect to the question of what is the approrpriate standard of review in a going provate transaction with a controller. This issue has been percolating around for for some years and has gone unresolved (In re Cox, In re CNX Gas Corp., among others). In an opinion just handed down in MFW Shareholders Litigation Strine explains why the Supreme Court's Kahn v Lynch jurisprudence with respect to standards of review in going private transactions with controllers is deficient:
The question of what standard of review should apply to a going private merger conditioned upfront by the controlling stockholder on approval by both a properly empowered, independent committee and an informed, uncoerced majority of the minority vote has been a subject of debate for decades now. For various reasons, the question has never been put directly to this court or, more important, to our Supreme Court.
This is in part due to uncertainty arising from a question that has been answered. Almost twenty years ago, in Kahn v. Lynch, our Supreme Court held that the approval by either a special committee or the majority of the noncontrolling stockholders of a merger with a buying controlling stockholder would shift the burden of proof under the entire fairness standard from the defendant to the plaintiff. …
Uncertainty about the answer to a question that had not been put to our Supreme Court thus left controllers with an incentive system all of us who were adolescents (or are now parents or grandparents of adolescents) can understand. Assume you have a teenager with math and English assignments due Monday morning. If you tell the teenager that she can go to the movies Saturday night if she completes her math or English homework Saturday morning, she is unlikely to do both assignments Saturday morning. She is likely to do only that which is necessary to get to go to the movies (i.e. complete one of the assignments) leaving her parents and siblings to endure her stressful last minute scramble to finish the other Sunday night.
For controlling stockholders who knew that they would get a burden shift if they did one of the procedural protections, but who did not know if they would get any additional benefit for taking the certain business risk of assenting to an additional and potent procedural protection for the minority stockholders, the incentive to use both procedural devices and thus replicate the key elements of the arm’s length merger process was therefore minimal to downright discouraging.
In MFW, the board conditioned the transaction on approval by a special committee and approval of a majority of the minority. The question for the court was whether by using both protective devices under these facts, does a board get the additional protection of business judgment review rather than simply a shifting of hte burden under entire fairness review. Granting BJR with additional protective devices would go some way to resolving the "homework" incentives described by Strine.
Strine provides the following guidance for transaction planners:
When a controlling stockholder merger has, from the time of the controller’s first overture, been subject to:
(i) negotiation and approval by a special committee of
independent directors fully empowered to say no, and
(ii) approval by an uncoerced, fully informed vote of a majority of the minority investors,
the business judgment rule standard of review applies.
This result makes sense. If transaction planners are able to replicate in form and substance an arm's length transaction, then they should get the benefit of BJR. To the extent minority shareholders are guaranteed through these procedural protections the right to a fully informed and uncoerced vote, then worries about controllers abusing their position to take companies private at the expense of minority shareholders should be mitigated. Now, we'll see if the Supreme Court decides to jump in and take a side on this question.