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In an opinion that could substantially affect future controlling-shareholder buyouts, the Delaware Supreme Court on Friday affirmed the Chancery Court’s decision that the business judgment standard of review, rather than entire fairness, should apply to controlling-party takeovers where it is established before trial that certain protections exist.

Background

The suit stemmed from Ronald Perelman’s going-private buyout of M&F Worldwide Corp. (“MFW”), a company he controlled. Investors sued directors including Perelman in Delaware Chancery Court, arguing that Perelman improperly took advantage of a temporary drop in share prices to take MFW private.

The Court of Chancery held that, though Perelman’s MacAndrews & Forbes Holdings, Inc. (“M&F”) owned 43.4 percent of MFW’s stock at the time of the buyout, Perelman and his co-defendants did not violate their fiduciary duty to shareholders. The dual procedural protections of the transaction required both the approval of an independent and empowered special committee of MFW directors acting with care and an uncoerced, informed vote of a majority of stockholders unaffiliated with M&F. The court determined in a summary judgment ruling that there were no fact issues to be tried regarding whether MFW followed these procedures, which the court concluded occurred. Therefore, the Court of Chancery applied the business judgment standard rather than the entire fairness standard and granted summary judgment in favor of the defendants – because the deal was structured as if Perelman was an outside buyer.

Supreme Court Adopts New Standard

Delaware’s high court affirmed, stating that existence of the dual procedural protections was undisputedly established before trial. Moreover, the court agreed that where the controlling party effectively relinquishes its control, the transaction is treated as a third-party, arm’s-length merger and reviewed under the more deferential business judgment standard. More specifically, the court held that “in 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.” Importantly, the court concluded that the business judgment standard only applies where presence of these protections is established pretrial. If fact issues remain to be resolved at trial regarding existence of one or both of the protections, the court will apply the entire fairness standard at trial to the breach of fiduciary duty claims.

Impact

The lower court’s holding was significant because under Delaware law, Perelman would typically have had to show that both the price and the process were entirely fair due to the conflicted nature of the transaction. Application of the business judgment standard instead defers to the informed decision of impartial directors. Friday’s decision means that Delaware’s highest court now extends the benefit of the board-friendly business judgment standard to controlling-party takeovers that use both a special committee of independent directors and a majority-of-the-minority voting provision if it is established before trial that the required protections exist.

The Delaware Supreme Court’s ruling incentivizes those who structure similar transactions to ensure the required protections are present so they may invoke the deferential business judgment standard. Where a controlling shareholder transaction is conditioned on approval of a special committee and a majority of the minority stockholders, the burden will now be on plaintiffs challenging the transaction to plead a reasonably conceivable set of facts showing that one or more of the required elements did not exist. And even if the case survives a motion to dismiss, plaintiffs will need to create a triable issue of fact on the required elements in order to avoid application of the business judgment rule. Boards approving well-structured transactions may be less likely to face lawsuits and will be better positioned to defend any ensuing litigation.

If you have questions about the case discussed above, securities litigation or fiduciary litigation in general, please contact one of the Securities Class Action Defense and Fiduciary Litigation attorneys listed below: