Wednesday, October 10, 2018
Since Kahn v. M&F Worldwide there have been a series of challenges to the application of the business judgment presumption in the context of controller squeezeout transactions. The crux of these challenges was M&F's ab initio requirement.
You'll remember that in M&F, the court tried to iron out the problems associated with the Kahn v. Lynch standard that were essentially flypaper for litigation in controller squeezeout transactions. It didn't matter how good a job you might have done in structuring a transaction to look like an arm's length deal, under Lynch your deal was still going to be subject to entire fairness review and you were going to get sued. Although entire fairness was the standard of review for a controller squeezeout with robust procedural protections (approval by disinterested special committee or stockholders), Lynch shifted the pleading burden to plaintiffs rather than the board. That was a mistake by the Del. Supreme Court. Rather than reward boards and give controllers an incentive to do the right thing, shifting the burden of proving entire fairness to plaintiffs simply ensured plaintiffs would sue and demand their day in court - guaranteeing that even meritless litigation had settlement value.
M&F sought to address this problem adopting the following standard:
[B]usiness judgment is the standard of review that should govern mergers between a controlling stockholder and its corporate subsidiary, where the merger is conditioned ab initio upon both the approval of an independent, adequately-empowered Special Committee that fulfills its duty of care; and the uncoerced, informed vote of a majority of the minority stockholders.
Of course, no good deed goes unpunished. What does ab initio mean anyway? Does it mean that if the controller's first proposal to the board doesn't stipulate the M&F conditions that the transaction must be subject to entire fairness review under Lynch? Or is it more forgiving than that? The Chancery Court has taken the position in a series of cases that ab initio should not be read so rigidly. Now, the Delaware Supreme Court has agreed. In Flood v. Synutra, the Court yesterday clarified what it meant by ab initio:
Admittedly, our opinion and the Court of Chancery’s opinion in MFW uses what can be read as ambiguous language to express the requirement that the key dual procedural protections must be in place before economic negotiations so the protections are not used as a bargaining tool in substitution for economic concessions by the controller. In describing this prerequisite to the invocation of the business judgment rule standard of review, we and the Court of Chancery have said the conditions must be in place “ab initio,” before the “procession of the transaction,” “from inception,” “from the time of the controller’s first overture,” and “upfront.”
From these uses, the plaintiff argues that MFW strictly hinges the application of the business judgment rule on the controller including the two key procedural protections in the first offer. A controller gets one chance, as the master of its offer, to take advantage of MFW, and if it fails to do so, that is it. But in an earlier case, the Court of Chancery and we did not embrace this rigid reading of MFW. In the case of Swomley v. Schlecht, the Court of Chancery held that MFW’s “ab initio” requirement was satisfied even though “the controller’s initial proposal hedged on whether the majority-of-the-minority condition would be waivable or not” because the controller conditioned the merger on both of MFW’s dual requirements “before any negotiations took place.” We affirmed that well reasoned conclusion, and adhere to that approach[.]
Rather than read ab initio literally and rigidly, the Court wants controllers and boards and, most especially potential plaintiffs to have a more flexible reading of ab initio:
A goal scored in the fifth minute of a 90-minute game would be referred to as a goal at the beginning of the match. Enjoying the beginning of fall refers to those few weeks in late September and early October when the weather gets chilly and the leaves start to change color, not just the autumnal equinox. The beginning of a novel is not the first word, but the first few chapters that introduce the reader to the characters, setting, and plot. Indeed, three years after Britain entered World War II, Winston Churchill famously declared that the War had reached “the end of the beginning.”
So, perhaps this is the beginning of the end of litigation in properly structured controlling shareholder transactions.