This post was prepared by Frank Reynolds, who has been following Delaware corporate law, and writing about it for various legal publications, for over 30 years.

The Delaware Court of Chancery recently ruled that AmTrust, Inc.’s controlling shareholders’ go-private buyout of the insurer must be reviewed under the harsh light of the entire fairness standard because three of its four special committee directors who negotiated the deal may have had a material self-interest in the transaction, in the matter styled In re AmTrust Financial Services Inc. Litigation, No. 2018-0396-AGB (Del. Ch., Feb. 26, 2020).

Chancellor Andre G. Bouchard’s February 26 opinion denied motions by three controlling shareholders and three members of AmTrust’s special committee to dismiss consolidated shareholder suits that accused the directors of disloyally approving an underpriced squeeze-out because it would squelch a previous suit against them.

Five out of six won’t do

The Chancellor found that the possible conflict of interest prevented the 2018 buyout from getting the benefit of the doubt under the deferential business judgment rule because it could not pass the six-part MFW test the Delaware Supreme Court prescribed for controlling stockholder squeeze-outs in Kahn v. M & F Worldwide Corp., 88 A.3d 635 (Del. 2014)(MFW case).

He allowed plaintiffs’ breach of duty claims against the three controlling shareholders and three directors who were on the negotiating committee to survive, but dismissed a fourth committee member director who faced no liability in a previous action, and tossed aiding and abetting charges against a private equity buyout partner.

The challenged transaction was the second step in a two-step squeeze-out merger in which the controlling shareholders and their private equity company backer initially proposed to acquire the remaining shares of AmTrust for $12.25 with the approval of a special director committee and a majority of the minority shareholders.

CEO and Chairman of the Board Barry D. Zyskind and directors George and Leah Karfunkel collectively controlled 55% of AmTrust’s shares, which meant the deal would be subject to increased scrutiny under Delaware General Corporation Law if it didn’t meet those two conditions.

Those two conditions could, under the right circumstances, cleanse the deal of the taint of controlling shareholder self-interest but the $13.50 a-share offer the special committee approved drew criticism from major shareholders such as financier Carl Icahn, and a scheduled shareholder vote was cancelled.

Icahn’s deal sparks suit

However, one day after the cancelled meeting, Icahn met with two of the controlling shareholders – but without the special committee –and he agreed to support a $14.75 per share bid, which the special committee and 67.4% of the minority shareholders approved, the court said.

Numerous stockholders who had been forced to give up their shares in the squeeze-out filed later-combined lawsuits; and the defendants, including special committee members Donald T. DeCarlo, Abraham Gulkowitz, Susan C. Fisch and Raul Rivera, moved to dismiss.

The court said DeCarlo, Gulkowitz and Fisch were also defendants in a previous shareholder action by AmTrust shareholder Cambridge Retirement System for allegedly usurping a corporate opportunity in dealing with Tower Group International, Ltd.   Cambridge Retirement System v. DeCarlo, et al., No. 10879 complaint (Del. Ch. April 2015).  He noted that the three did not move to dismiss that suit, which is still pending.

If the company that Cambridge sued was merged out of existence in the buyout, Cambridge would lack derivative standing and face a tough challenge to continue its litigation against the three directors in the previous action.

Six criteria for business judgment shield

In response to the controlling shareholders’ motion to dismiss, the Chancellor said to qualify for business judgment review, a controller buyout must meet six conditions:

  • Special committee of directors and majority of the minority shareholder approval
  • A fully-independent special committee
  • The special committee must be empowered to freely select its own advisors and to say “no” definitively
  • The special committee must meet its duty of care in negotiating a fair price
  • The minority vote must be fully informed
  • There is no coercion of the minority.

The Chancellor said he only needed to address a single condition to defeat reliance on the MFW standard because “plaintiffs have pled a reasonably conceivable set of facts that the second condition has not been satisfied based on the complaint’s allegations that three of the four members of the special committee had material self-interest in the transaction.”

Further, he said the MFW framework “was intended to ensure not only that members of a special committee must be independent in the sense of not being beholden to a controlling stockholder but also that the committee members must have no disabling personal interest in the transaction at issue.”

Liability on their minds?

Here the plaintiffs have pled that the three directors were aware that they faced the derivative claim when they were considering the transaction and that potential liability was material to them, the court said, because they faced a possible settlement claim of between $15 and $25 million.

Since the controlling shareholders – who collectively held 55% of AmTrust – would not be likely to take up the Cambridge action after the go-private move, the squeeze-out would likely end the director’s liability, the Chancellor concluded.

He dismissed aiding and abetting a breach of duty charges against Stone Point Capital LLC, finding it was not enough to allege that the private equity company knew the special committee directors faced liability if the buyout was not approved.