Tuesday, March 18, 2014
On Friday last week, the Delaware Supreme Court handed down an opinion affirming the Chancery Court's opinion in MFW. In the Chancery opinion, (then) Chancellor Strine was attempting to reconcile the frayed strands of jurisprudence around controlling shareholder transactions and - at the same time - trying to reduce incentives to pursue meritless claims in order to seek a settlement. In Cox Communications, a case where he took teh oopportunity to describe the problem with controlling shareholder cases, Strine described the present incentive structure created by the legal rules in the following manner:
Unlike any other transaction one can imagine — even a Revlon deal — it was impossible after Lynch to structure a merger with a controlling stockholder in a way that permitted the defendants to obtain a dismissal of the case on the pleadings. Imagine, for example, a controlled company on the board of which sat Bill Gates and Warren Buffett. Each owned 5% of the company and had no other business dealings with the controller. The controller announced that it was offering a 25% premium to market to buy the rest of the shares. The controlled company's board meets and appoints Gates and Buffett as a special committee. The board also resolves that it will not agree to a merger unless the special committee recommends it and unless the merger is conditioned on approval by two-thirds of the disinterested stockholders. The special committee hires a top five investment bank and top five law firm and negotiates the price up to a 38% premium. The special committee then votes to approve the deal and the full board accepts their recommendation. The disinterested stockholders vote to approve the deal by a huge margin that satisfies the two-thirds Minority Approval Condition.
After that occurs, a lawsuit is filed alleging that the price paid is unfair. The filing party can satisfy Rule 11 as to that allegation because financial fairness is a debatable issue and the plaintiff has at least a colorable position. The controller and the special committee go to their respective legal advisors and ask them to get this frivolous lawsuit dismissed. What they will be told is this, "We cannot get the case dismissed. We can attempt to show the plaintiffs that we are willing to beat them on this and persuade them to drop it voluntarily because they will, after great expense, lose. But if they want to fight a motion to dismiss, they will win, see Lynch. At the very least, therefore, if the plaintiffs are willing to fight, it would be rational for you to pay an amount to settle the case that reflects not only the actual out-of-pocket costs of defense to get the case to the summary judgment stage, but the (real but harder to quantify) costs of managerial and directorial time in responding to discovery over a past transaction."
Given the inability to settle on the pleadings - no matter how good the process - meant that any merger with a controlling shareholder became an immediate payday for attorneys. Of course, that's frustrating for everyone involved. It's especially frustrating for the judges who have to oversee the settlement processes.
No surprise, then, that when Strine was given an opportunity to address the issue in MFW that he took a swing. Strine held that in a merger with a controlling stockholder conditioned upfront on a promise that no transaction will proceed without (i) special committee approval, and (ii) the affirmative vote of a majority of the minority stockholders that business judgment and not entire fairness will be the standard of review. This structure is important because by empowering the minority, it attempts to replicate as much as possible an arm's length transaction.
On appeal, the Delaware Supremes upheld the Chancery opinion and gave us the following standard for dealing with controlling shareholder transactions (Kahn v. M F Worldwide Corp.):
[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.
Ok, so far so good.
But here's a wrinkle...footnote 14. In footnote 14, the Supreme Court notes that MFW could not have decided on the pleadings and would have survived a motion to dismiss even under the new standard. The pleadings, the court noted were sufficient to require discovery on all the new prerequisiting in the application of the standard...
Ultimately we'll see to what degree footnote 14 matters. But, it does seem a little disconcerting that Strine's project to provide a pathway to early dismissal of these kinds of cases might just move the locus of the argument to the functioning of the special committee.
Sure, that's obviously better, but it's not yet clear that MFW and footnote 14 will dramatically reduce incentives to bring these cases. Perhaps we will just be battling the same fight on new ground. Of course, the Chancery Court is likely to want to find ways to rule on the pleadings and my guess is that now that Chief Justice Strine is in a place to influence how the MFW standard is going to roll out that he won't be looking to increase incentives for plaintiffs to bring these cases.