(Article from Securities Law Alert, December 2014)
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Delaware Supreme Court Holds Business Judgment Standard of Review Applies to Controlling Stockholder Transactions under Certain Circumstances
Last year, the Delaware Chancery Court addressed “[t]he 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.” In re MFW S’holders Litig., 67 A.3d 496 (Del. Ch. May 29, 2013) (Strine, C.). The court ruled that the business judgment rule standard of review, rather than the entire fairness standard, applies in such circumstances. On March 14, 2014, the Delaware Supreme Court affirmed the Delaware Chancery Court’s decision. Kahn v. M & F Worldwide Corp., 88 A.3d 635 (Del. 2014) (Holland, J.).
The Delaware Supreme Court offered several reasons for its decision. First, the court explained that “where the controller irrevocably and publicly disables itself from using its control to dictate the outcome of the negotiations and the shareholder vote, the controlled merger then acquires the shareholder-protective characteristics of third-party, arm’s-length mergers, which are reviewed under the business judgment standard.” Second, the court agreed with the Chancery Court’s determination that “the dual procedural protection merger structure optimally protects the minority stockholders in controller buyouts.” Third, the court concurred with the Chancery Court’s finding that “the adoption of this rule will … provide a strong incentive for controlling stockholders to accord minority investors” with “the benefits of independent, empowered negotiating agents to bargain for the best price” as well as “the critical ability to determine for themselves whether to accept any deal that their negotiating agents recommend to them.” Finally, the Delaware Supreme Court observed that “the underlying purposes of the dual protection merger structure utilized here and the entire fairness standard of review both converge and are fulfilled at the same critical point: price.”
New York Appellate Division, First Department, Applies Business Judgment Review to a Going-Private Transaction by a Controlling Stockholder
On November 20, 2014, the New York Appellate Division, First Department, found that “the motion court was not required to apply the ‘entire fairness’ standard” in a shareholder action challenging a transaction in which Kenneth Cole, the majority shareholder of Kenneth Cole Productions, took Kenneth Cole Productions private. In re Kenneth Cole Prods., Inc., S’holder Litig., 122 A.D. 3d 500 (N.Y. App. Div. 2014). The First Department found that “pre-discovery dismissal based on the business judgment rule was appropriate” because there were “no allegations sufficient to demonstrate that the members of the board or the special committee [established to evaluate Mr. Cole’s proposal] did not act in good faith or were otherwise interested.”
In reaching its decision, the First Department found it significant that “the merger … required the approval of the majority of the minority (
i.e., non-Cole) shareholders” and that Kenneth Cole “did not participate when the Company’s board of directors voted on the merger.” The First Department rejected plaintiffs’ contention that “members of the special committee … were controlled by Mr. Cole.” The court explained that “at least under Delaware law, which all parties urge[d] [the court] to consider, ‘it is not enough to charge that a director was nominated by or elected at the behest of those controlling the outcome of a corporate election.”
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