Thursday, December 19, 2013
I took advantage of the brief time between exams and the holidays to hop down to Delaware to sit in on the appellate arguments in MFW Shareholder Litigation. You'll remember that in MFW Chancellor Strine was presented with a question - in a controlling shareholder transaction which is conditioned on both negotiation and approval by an independent, special committee and a fully-informed, uncoerced vote of the majority of the minority what is the proper standard of review. Chancellor Strine held that the proper strandard of review for a transaction in which the controller essentially disables itself is business judgment.
[If you don't need any of this background and just want a quick summary of the argument, feel free to skip down.]
Since Weinberger, entire fairness has been the standard for transactions involving controlling shareholders. In Kahn v Lynch, the Supreme Court provided a gloss on Weinberger's entire fairness standard for controlling shareholder transaction. Where the controller does the transaction in reliance on either a special committee or a vote of the majority of the minority, the burden shifts from the controller to plaintiff to prove that the transaction was not entirely fair. But, as Chancellor Strine noted in Cox Communications, the decision by the Supreme Court to keep the entire fairness standard in play made it impossible to get even weak complaints dismissed at an early stage. In no small part, Kahn v Lynch was a contributor to the 'litigation industrial complex' - generating almost guaranteed valuable settlement opportunities at the mere announcement of a controlling shareholder transaction no matter how valuable the underlying transaction for minority shareholders.
In MFW, Chancellor Strine had an opportunity to directly address the question of the proper standard of review in a controlling shareholder transaction where the controller conditioned the deal on robust procedural protections that essentially disabled the controller. The question for the corut was whether additional protections should give the board any credit - perhaps even sufficient credit to get weak claims dismissed early. Chancellor Strine put the 'credit' problem this way:
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.
Plaintiffs in MFW improvidently decided not to settle, rather seeking the option of going for post-closing damages. Their mistake. That gave Chancellor Strine the opportunity to address the question that eluded him in Cox. In MFW, Chancellor Strine announced that where a transaction with a controller is conditioned on both negotiation and approval by an independent, special committee and a fully-informed, uncoerced vote of the majority of the minority that business judgment is the proper standard of review.
[Appeal before Delaware Supreme Court]
OK. So that brings us to today in Dover where the Supreme Court met en banc to hear the plaintiff's appeal. I went down to watch the arguments and seem the wheels of corporate justice turn. Justice Holland sat as acting chief. Judge Jan Jurden sat by designation (Someone trying her out? Just sayin'...).
Justice Holland noted for the plaintiffs benefit that the court decided to hear the case en banc because, well, maybe the court wanted to write a new rule... Was that big enough of a hint that the court is looking to make some new law here? Justice Jacobs made the issue more explicit for the plaintiffs - forget about the particular facts of this case, what is the policy reason why the Supreme Court should accept or reject the Chancellor's reasoning.
Unfortunately, the plaintiffs weren't really up to the task of articulating a good reason why the procedural protections in MFW aren't robust enough to generate the business judgment presumption for a special committee. Plaintiffs asserted that special committees are structurally biased in favor of controllers in almost all circumstances. OK, so I am generally pretty cynical, but I still believe in the court's presumptions. Near as I can tell, special committees still get the presumption of independence until plaintiffs present facts that they aren't. Plaintiffs, it seemed, wanted the court to toss the presumption of independence of special committees altoghether in controlling shareholder transactions. Why? Not sure exactly why. But, if you are proposing to the court that directors shouldn't have the presumption of independence, then one really should have a strong articulated reason why. In any event, it didn't seem like the court was entertaining that notion.
Rather, the court quickly turned to the power of the fully-informed, uncoerced vote of a majority of the minority. Why isn't that powerful enough - together with the special committee - to get the business judgment presumption Justice Jacobs wondered? Well, well, because arbs! Oh, wait. Aren't arbs stockholders? Yes, but they just want to make money. So, shareholder votes shouldn't get credit? Again...the plaintiffs failed to clearly articulate a policy reason why a fully-informed, uncoerced vote of the majority of the minority isn't going to work. In general the plaintiffs struggled to provide the court with any reasons to overturn Chancellor Strine's reasoning.
When counsel for the special committee got their chance, they did a much better job of articulating reasons to uphold Chancellor Strine ruling. Justice Berger asked whether with the procedural safeguards the result of the special committee/majority of minority process was equivalent to an arm's length deal? No, was the response, but for the purposes of judicial review the precedural protections that disable the controller put the special committee in the same place as an independent board that would otherwise get the protection of business judgment. There was some push-back from Justice Berger on that point - particularly that even though the controller disabled itself, it's the controller who is the impetus for the transaction, not the special committee.
If the plaintiffs manage to get the Supreme Court to overturn the Chancery Court's opinion in MFW Justice Berger's point will likely be the reason. While, the special committee and the unaffiliated shareholders can still say no, it's the controller (and only the controller) who always gets the ball rolling. Because only the controller is permitted to 'set the scene' for the sale, the special committee process and the following shareholder votes are irretrievably infected by a structural bias that requires entire fairness to be the standard rather than business judgment. There, I made the plaintiff's argument for them.
As in previous cases, I won't hazard a guess on the actual outcome of this argument. However, I will note the old saying that 'you can't win an appeal at oral argument, but you can lose one.'