Frank Reynolds, who has been covering Delaware corporate decisions for various national publications for over 35 years, prepared this article.              

The full Delaware Supreme Court recently reversed the dismissal of a shareholder challenge to a private equity consortium’s acquisition of Inovalon HoldingsInc. after finding the cloud-based healthcare industry support provider’s directors did not fully reveal to investors the conflicted roles of the deal’s financial advisors, as the high court’s seminal MFW ruling requires, in City of Sarasota Firefighters Pension Fund et al. v. Inovalon Holdings Inc., Del. Supr., No. 305, 2023 (May 1, 2024).

The justices unanimously reversed the Court of Chancery’s decision that the transaction met the standard Khan v. M & F Worldwide Corp. 88 A.3d 635 (Del. 2014) demands of controller-dominated deals to qualify for review under the defendant-friendly business judgment standard. The high court said MFW required Inovalon’s special committee of directors that negotiated the merger terms to reveal the full extent of their financial advisors’ involvement with counterparties in this transaction.  Without that information, the Inovalon minority shareholders could not cast the informed merger vote that would justify business judgment review and dismissal of the suit, Justice Karen Valihura wrote.

The decision marked the second time in as many months that the high court overturned a Chancery Court merger ruling on grounds that, the justices found, too little was required of the challenged deal’s proponents under MFW.  In the case styled In re Match Group Inc. Derivative Litigation, Del. Supr., No. 368, 2022 (April 4, 2024), Chancery had allowed an asset reshuffle that allegedly dealt less value and more debt to pension fund investors compared to IAC insiders. The high court said, in a controller-dominated deal, all the directors of the negotiating committee—not just a majority—had to be independent to avoid review under the exacting entire fairness standard.

Background

Three pension funds challenged the Nordic-led acquisition of Inovalon claiming it was a controller transaction that failed to qualify for protection under MFW because the deal did not have the benefit of a fully independent review committee from the outset and did not get a completely informed approval vote from a majority of the minority shareholders.

The suit claimed that Inovalon CEO Kieth Dunleavy and director Andre Hoffmann controlled a majority of Inovalon’s stock through multiple vote shares but did not establish a functioning, fully-independent negotiating committee from the outset of bidding. And it charged that the minority knew only part of the conflicts involving Inovalon’s investment banker financial advisors.

The trial court ruling

In a bench ruling, the Chancery Court dismissed, finding that the deal and disclosures about it to investors met MFW’s requirements. Concerning the ab initio requirement for the special committee, it found that the alleged conflicts did not arise until Nordic “formally requested that Dunleavy participate in an equity rollover as part of its written offer on July 21, 2021,” which marked the official beginning of the negotiations.   The trial court found that the conflicted roles of the advisors was adequately revealed.

The appeal ruling

On appeal, the high court focused on the plaintiffs’ contention that “judicial cleansing under the MFW framework is unavailable because the Proxy omitted material information that rendered the minority stockholders’ vote to approve the Transaction uninformed.”  The full court agreed.

The justices noted that MFW requires of controller buyouts that 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.

Full disclosure required

The high court said, “the trial court’s due care analysis concerning the retention and management of the advisors did not sufficiently address all of the disclosure issues and “Delaware courts have required full disclosure of investment banker compensation and potential conflicts.”

Conclusion

It was not enough to simply disclose to investors that the advisors might have received fees from counterparties to the transaction, the high court  said, because, “when a board chooses to disclose a course of events or to discuss a specific subject, it has long been understood that it cannot do so in a materially misleading way, by disclosing only part of the story, and leaving the reader with a distorted impression.” Rather, “[d]isclosures must provide a balanced, truthful account of all matters they disclose.”

Frank Reynolds, who has been covering Delaware corporate decisions for various national publications for over 35 years, prepared this article.

The full Delaware Supreme Court recently revived part of an investor challenge to IAC/InterActive Corp’s spinoff of its internet dating subsidiary after finding that the deal that controller IAC imposed on minority shareholders did not meet the exacting standards of the high court’s seminal MFW ruling, in In re Match Group Inc. Derivative Litigation, Del. Supr., No. 368, 2022 (April 4, 2024).

The en banc high court partially reversed a Court of Chancery decision that the derivative suit must be dismissed because IAC met the requirements of independence set by the milestone opinion in Kahn v. M & F Worldwide Corp., 88 A.3d 635 (Del. 2014).  The asset reshuffle allegedly dealt less value and more debt to pension fund investors compared to IAC insiders.  MFW famously said a controller-engineered deal could get business judgment protection if the negotiating committee was independent and disinterested–and the properly-disclosed transaction was endorsed by a majority of the minority shareholders.

The ruling’s importance

But the pivotal issue in this high court appeal concerned the proper standard to determine whether this unique corporate transaction was the product of fully independent, disinterested fiduciaries.  At one extreme, in the case of a freeze-out merger–where the corporate machinery is allegedly used to deprive investors of their shares and/or voting rights–all deal negotiators must be completely independent and disinterested. The high court said the key question in the appeal was: since the Match spinoff did not involve a freeze-out, could the IAC defendants qualify for the protection of the deferential business judgement standard even though one of three deal negotiators was not independent? 

The Court of Chancery said “yes”, agreeing with defendants that a majority of independent directors was enough to trigger the business judgment standard.  The high court said, ‘no“  and reversed. “If the controlling stockholder wants to secure the benefits of business judgment review, it must follow all MFW’s requirements,” the justices said.  In the MFW setting, to replicate arm’s length bargaining, all separation committee members must be independent of the controlling stockholder.

 Background

 The challenged 2020 transaction involved the creation of two new corporations out of the former IAC and Match.com businesses and a reshuffling of the assets and liabilities of those two entities that was engineered by a “separation committee” composed of three IAC directors.  The old Match was later dissolved into the new ICA.

Three pension funds that owned that eliminated stock sued alleging that the separation was a conflicted transaction in which Old IAC, as Old Match’s controlling stockholder, stood on both sides of the transaction. The plaintiffs claimed that Old IAC obtained significant “non-ratable” benefits in the Separation to the detriment of Match and its minority stockholders, and argued that the Separation Committee was conflicted and the proxy disclosures misled the Old Match minority stockholders.

The trial court ruling

Although the Court of Chancery found that the plaintiffs successfully pleaded facts creating a reasonable inference that one director was not independent of Old IAC, it ruled that a plaintiff must nonetheless show that “either (i) 50% or more of the special committee was not disinterested and independent,” or “(ii) the minority of the special committee ‘somehow infect[ed]’ or ‘dominate[ed]’ the special committee’s decision-making process.“  Finding that plaintiffs failed to do that, the vice chancellor dismissed.

The appellate ruling

Defendants argued that the vice chancellor correctly applied a less exacting standard than the one used in MFW and other freeze-out merger cases.  But the Supreme Court  said, in those key cases, “the common thread running through our decisions: a heightened concern for self- dealing when a controlling stockholder stands on both sides of a transaction.’”

In addition, the high court noted that, longstanding business affiliations, particularly those based on mutual respect, are of the sort that can undermine a director’s independence. Directors who owe their success to another will conceivably feel as though they owe a “debt of gratitude” to the individual. The plaintiffs have adequately pleaded that Director Thomas McInerney may have such a relationship with IAC.

The justices said, a controlling stockholder’s influence is not “disabled” when the special committee is staffed with members loyal to the controlling stockholder. “We stated in MFW that the special committee must be independent, not that only a majority of the committee must be independent,” the high court said’,  “A special committee created to secure the protections of MFW should function “in a manner which indicates that the controlling stockholder did not dictate the terms of the transaction and that the committee exercised real bargaining power at an arm’s length.

The unanimous Supreme Court reversed the dismissal, finding the plaintiffs’ claims of an unfair deal by non-independent directors are supported by the facts that:

1) the minority stockholders received a slightly higher percentage of ownership of New Match;

(2) Old Match was capitalized in a vastly different way, with limited cash, much higher debt, and restrictive governance provisions; and

(3) the boards were different

Supplement: One of Delaware’s favorite corporate law scholars, Professor Stephen Bainbridge, provides additional insights about this case on his eponymous blog here and here.

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

Delaware’s Court of Chancery recently dismissed a shareholder challenge to The Trade Desk Inc. (TTD) charter amendment that extended the advertising software company’s dual stock class structure and its CEO’s control, finding TTD met all six qualifications of the Delaware high court’s seminal MFW ruling, entitling it to deferential business judgment review in City Fund for Firefighters and Police Officers in the City of Miami v. The Trade Desk Inc.,et al. opinion issued, (Del. Ch. July 29, 2022).

In his July 29 memorandum opinion, Vice Chancellor Paul Fioravanti threw out the breach of duty charges that the City Fund for Firefighters and Police Officers in the City of Miami had brought against TTD officers and directors for allegedly helping CEO and controlling shareholder Jeff Green trick common shareholders into approving Green’s self-interested stock scheme.  He said the plaintiffs failed to show that investors were duped into voting for an amendment to delay the end of a dual stock class or were uninformed about Green’s supposed hidden urgency to dispose of his many Class B shares that carried ten votes per share.

The ruling called on the Chancery Court to apply the Delaware Supreme Court’s milestone MFW opinion, which set out the six conditions that could exempt a controller’s transaction from the heightened scrutiny of review under the exacting entire fairness standard announced in Kahn v. M & F Worldwide Corp., 88 A.3d 635 (Del. 2014) (commonly referred to as MFW.)  Since the TTD amendment fit the MFW framework, it only faced examination under the more lenient business judgment rule, the vice chancellor said.

Background

According to the court record, Jeff Green co-founded TTD, a Ventura, California, technology company that markets “a software platform to provide data-driven digital advertising campaigns” and has served as its President, Chief Executive Officer, and as chairman of the Delaware-chartered company’s board of directors.  Green controlled a majority of TTD’s stock through his ownership of most of its Class B stock but that was due to change when the number of those non-public shares shrank.

After lengthy negotiations and the creation of a three-director special review committee, the TTD board company endorsed an extension of the projected sunset of the Class B shares and their conversion into the common Class A stock and that continued Green’s control at a crucial juncture.

After the pension fund filed its complaint, defendants moved to dismiss based on failure to plead a claim and the case focused on whether the disputed transaction fit the MFW framework by complying with six elements:

  • the controller conditions the procession of the transaction on the approval of both a Special Committee and a majority of the minority stockholders;
  • the Special Committee is independent;
  • the Special Committee is empowered to freely select its own advisors and to say no definitively;
  • the Special Committee meets its duty of care in negotiating a fair price;
  • the vote of the minority is informed; and
  • there is no coercion of the minority.

Plaintiffs focused on elements two and five, arguing that the independence of the special committee was tainted by director Lisa Buyer and the vote was uninformed because shareholders were kept in the dark about the scheduled end of the Class B stock and Green’s need to unload his shares.

The Special Committee’s independence

Plaintiff charged that the Chair of the committee, Buyer, had been a consultant for  Green during TTD’s initial public offering and received a large compensation for her services that compromised her neutrality.

But the vice chancellor noted that the MFW opinion requires an inquiry before such a determination. “This court is hesitant to infer materiality of compensation absent well-pleaded facts. The determination of whether a director’s compensation from the Company is sufficient to raise a reason to doubt her independence is a fact intensive inquiry. See In re MFW S’holders Litig., 67 A.3d at 510–13.

Plaintiff contended that Buyer caused the other two independent directors to function under a “control mindset” that skewed the committee’s decisions.

The decision

The court determined that, “Even assuming that Buyer’s TTD compensation creates a reasonable inference that her director compensation was material to her and that she was, therefore, not independent, the Plaintiff has not alleged facts that create a reason to doubt that a majority of the committee lacked independence or that Buyer so dominated the committee process that it undermined its integrity as a whole.”

“Plaintiff has not pleaded sufficient facts alleging that Buyer’s conduct dominated or subverted the Special Committee process so as render the entire committee defective, even if she was determined to be lacking in independence,” Vice Chancellor Fioravanti added, noting that the controlled mindset theory is not part of the MFW analysis.

Was the vote uninformed?

The court concluded that none of six alleged material non-disclosures altered the “total mix of information” available to the investors who needed to consider whether to vote for the extension amendment.

  • Green’s desire to sell Class B stock;
  • the Company’s expectations as to when the Dilution Trigger would likely be tripped;
  • advice that Centerview provided to the Special Committee;
  • Green’s counsel’s acknowledgement that a business rationale would be needed to justify any amendment to the Dilution Trigger;
  • the Special Committee’s efforts to obtain stockholder support for the Dilution Trigger Amendment; and
  • the Compensation Committee’s consideration of an equity grant to Green in December 2020

The court concluded that as Defendants aptly put it, “anyone reading the Proxy would understand both that Green desired to retain control through the Trigger Amendment and that the amendment would enable him to continue his (disclosed) historical practice of selling shares without losing that control.”

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.

Delaware’s Court of Chancery recently threw out an attempt to undermine activist investor Carl Icahn’s claim of business judgment protection under the seminal MFW ruling for his buyout of Voltari Corp.’s minority, finding plaintiffs failed to prove a special director committee lacked independence or that a shareholder vote was uninformed or coerced in Franchi, et al. v. Firestone, et al., No. 2020-0503 KSJM, order issued (Del. Ch. May 10, 2021). 

Newly-appointed Chancellor Kathaleen St. J. McCormick’s May 10 order dismissing a combined shareholders’ breach-of-duty lawsuit provides an updated application of a key Delaware Supreme Court opinion on the requirements shareholder plaintiffs must meet to force an interested majority shareholder like Icahn to show that a deal’s price and negotiation were entirely fair to investors.   Kahn v. M & F Worldwide Corp. 88 A.3d 635 (Del. 2014)(“MFW“), overruled on other grounds by Flood v. Synutra Int’l, Inc., 195 A.3d 754 (Del. 2018).

The crux of that touchstone high court ruling was that in a challenged controller-backed deal the defendants could get benefit-of-the doubt deference – and a much-improved chance of winning — only if the controller insured that the minority’s interests were protected by:

(i) conditioning the transaction on the approval of both a special committee and a majority of the minority stockholders; 

(ii) making the special committee independent; 

(iii) empowering the special committee to freely select its own advisors and to say no definitively; 

(iv) allowing the special committee to meet its duty of care in negotiating a fair price; 

(v) ensuring that the vote of the minority is informed; and

(vi) barring any coercion of the minority vote.

Background

Plaintiffs’ suit claimed the $7.7 million Icahn and his allies paid in 2019 for the 48 percent of Voltari they did not yet own undervalued the commercial real estate investment company and resulted in a “windfall” to Icahn in the form of $78.7 million in tax savings from Voltari’s past losses called “net operating loss carryforwards”

The combined complaints of former shareholders Adam Franchi and David Pill charged that: Icahn was unjustly enriched by coercing a deep discount price for the NOL’s, the Voltari directors breached their duties by wrongly approving the merger and that along with Icahn and his companies, they comprised an improper control group.

They claimed that:

(i) the Special Committee lacked independence;

(ii) the Special Committee failed to exercise its duty of care; and

(iii) the vote of the minority was not informed

No unreasonable, reckless actions

The Chancellor ruled in favor of dismissal of the challenge to the special committee’s independence because, “To plead that a director is not independent “in a manner sufficient to challenge the MFW framework, a plaintiff must allege facts supporting a reasonable inference that a director is sufficiently loyal to, beholden to, or otherwise influenced by an interested party so as to undermine the director’s ability to judge the matter on its merits.”

She said, “If the complaint supports a reasonable inference that [any] member [of the special committee] was not disinterested and independent, then the plaintiffs have called into question this aspect of the MFW requirements.” 

But the complaint here fails to show “conduct that constitutes reckless indifference or actions that are without the bounds of reason.”  Disagreeing with a special committee’s strategy is not a duty of care violation, nor is a “windfall“ allegation that amounts to “questioning the sufficiency of the price,” the Chancellor noted.

No controlled mindset

The fact that the special committee “met seven times, engaged and consulted with independent advisors, came to a reasoned decision to negotiate a transaction with Icahn, and successfully bid the deal price up by 48% percent” does not support the allegation that it fell under a “controlled mindset,” the court held.

No material disclosure left behind

Under MFW, the board’s consideration and rejection of a special committee candidate who had been an employee of an Icahn company did not need to be disclosed in the buyout proxy because it would not have been material to the average investor, the Chancellor ruled, finding that, “This alleged omission does not render the vote of the minority stockholders uninformed.”

Only gross negligence claims survive

Finally, the chancellor dismissed the unjust enrichment charge because it only involves ordinary negligence and since it has been determined that the business judgment standard applies, under MFW, only claims of gross negligence could survive the motion to dismiss.

                                                                                                                                                 

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.

The issue presented to the Delaware Supreme Court in Flood v. Synutra International, Inc., Del. Supr., No. 101, 2018 (Oct. 9, 2018), was whether it was proper for the Court of Chancery to apply the MFW standard by: “(i) allowing for the application of the business judgment rule if the controlling stockholder conditions its bid on both of the key procedural protections at the beginning stages of the process of considering a going private proposal and before any economic negotiations commence; and (ii) requiring the Court of Chancery to apply traditional principles of due care and to hold that no litigable question of due care exists if the complaint fails to allege that an independent special committee acted with gross negligence.” See page 1.

The “MFW standard” was announced by the Delaware Supreme Court in Kahn v. M&F Worldwide Corp., 88 A.3d 635 (Del. 2014), which was highlighted on these pages.  That standard allowed for the deferential business judgment review that be applied to a merger “proposed by controlling stockholder conditioned before the start of negotiations on ‘both the approval of an independent, adequately-empowered Special Committee that fulfils its duty of care; and the uncoerced, informed vote of the majority of the minority stockholders.’” Id. at 644.

The high court concluded, in its majority opinion, that the interpretation of MFW standard based on the foregoing principles was correct, and cited with approval, for support of its conclusion, the high court’s previous affirmance in Swomley v. Schlecht, 128 A.3d 992 (Del. 2015) (Table).

Highlights:

Although this majority decision could be the subject of a lengthy analysis, especially in light of the vigorous dissenting opinion–which is an indication that reasonable people could easily differ on the conclusions in this case–I will provide highlights only in this short post, via bullet points, to allow a quick reference to key parts of the ruling. Those interested may read the whole opinion for a complete understanding of this important decision:

  • One of the issues in the case was whether or not the prerequisites that must be satisfied in order for the MFW standard to apply must be imposed as a condition of the deal at the absolute beginning of the negotiations–or if the imposition of those conditions at the “beginning” of negotiations can be more flexibly determined as a matter of chronology, as opposed to a “bright line test” requiring a specific point in time. See pages 9 to 21.
  • This issue arose because of the description in the Supreme Court’s initial announcement of the MFW decision that the prerequisites that must be a condition of the deal need to be announced “ab initio” which can be translated as “at inception” or “at the beginning.”
  • The court used several descriptions to explain why a more flexible approach should be used for exactly when in the chronology of a deal the conditions must be imposed, by referring to many situations where the word “beginning” does not refer to a specific point in time, such as the “beginning of a book” that extends beyond just the first word in a novel, and may at least include the first few pages of a novel, for example.
  • The court reasoned that a more flexible approach is sensible in terms of focusing on the more meaningful point in a deal when “substantive economic negotiations take place,” as in this case when a second offer letter was sent and no prior economic substantive negotiations had taken place after the first letter, but before the second offer letter was sent.
  • The second issue addressed was whether due care violations were pled in the complaint.
  • This ambiguity was raised by footnote 14 in the original MFW opinion of the Supreme Court, but which was clarified by this case which essentially nullified the dicta in footnote 14 of the original MFW opinion of the court. See pages 23 to 25, where the majority opinion in this case explains why that footnote 14 should not be relied on, and why no due care violation was adequately pled in this case.

A recent post on the Harvard Law School Corporate Law Blog, (on which I have published several articles as a contributing author), reviewed the Court of Chancery’s decision in Olenik v. Lozinski, C.A. 2017-0414-JRS (Del. Ch. July 20, 2018), in which a modification of the “ab initio” requirement of the MFW framework was applied in order for the challenged transaction to enjoy the benefit of the business judgment rule’s presumption. The MFW framework, and the cases that explain it, have been discussed in several posts on these pages. As the above-linked post describes it:

MFW provides for judicial review of a merger between a controller and the controlled company under the deferential business judgment rule standard (rather than “entire fairness”) if, among other things, “from the outset of negotiations” (the so-called “ab initio requirement”), the controller conditioned the transaction on approval by both an independent special committee and a majority of the minority stockholders

A recent Delaware Court of Chancery opinion addressed the not infrequent situation where a distressed company is sold or merged but only the preferred stockholders receive consideration—and the common stockholders receive nothing. In Jacobs v. Akademos, Inc., Del. Ch., C.A. No. 2021-0346-JTL (Del. Ch. Oct. 30, 2024), a scholarly work of art, the court conducts an analysis of the fiduciary duties of the directors who approved the deal.

Brief Factual Background

The first 3-pages of the decision provide a pithy overview of the key factual circumstances including that the challenged transaction was not conditioned on the twin MFW requirements—approval from both an independent special committee and a majority of the unaffiliated stockholders—because the company was in such a distressed financial situation that it lacked the funds to support a full-blown MFW process.

A group of common stockholders led by the company’s founder sought appraisal rights and also asserted plenary claims for breach of fiduciary duty against the directors, challenging the deal on the basis that the common stockholders did not receive any consideration. The first 33-pages or so of the decision provide an exhaustive recitation of the factual details and credibility determinations.

The company involved had not made a profit in its 20-year history. An investor continued to provide necessary working capital and in exchange received preferred stock and other preferential rights upon sale or liquidation.

Summary of Holding

The court determined that the plaintiffs did not present a credible valuation, and the defendants at trial presented a convincing case that the fair value of the common shares at the time of the merger was zero. Regarding the plenary claims, the defendants bore the burden of proving that the challenged transactions were entirely fair, and they carried that burden. The court also noted, as an aside, that the net loss from the transaction to the primary investor with the preferred stock was $18 million.

Highlights

  • The court provides a primer on principles of Delaware appraisal law, as well as a critique of competing reports of valuation experts. The court explained: (i) why the court gave no weight to a Rule 409A valuation, and (ii) why it did not rely on deal price. Slip op. at 35 to 56.
  • The court addressed the analysis of the fair value of the minority interest by assessing the value attributable to the shares as a going-concern. Slip op. at 56 to 66. Notably, the court observed that in appraisal actions in Delaware, there is no minority discount imposed. Slip op. at 58 to 59.
  • The court described the two elements of a breach of fiduciary duty as: first, establishing that a fiduciary duty existed, and then, establishing that the defendant breached that duty. Slip op. at 67. The court observed that establishing the first element was easily satisfied in this matter, but the second element in this case was more complex.
  • The court distinguished between the standard of conduct and the standard of review when determining whether corporate fiduciaries breached their duties when approving a transaction.
  • The standard of conduct describes what those with fiduciary duties are expected to do, and is defined by the content of the duties of loyalty and care. Slip op. at 68.
  • The standard of review arises in the context of litigation when instead of using the standard of conduct, the courts in Delaware use three tiers of review for evaluating director decision-making: (i) the business judgment rule; (ii) enhanced scrutiny; and (iii) entire fairness. Slip op. at 68.
  • The entire fairness standard of review applied in this case and the two dimensions include: (1) substantive fairness (fair price); and (2) procedural fairness (fair dealing). Id.
  • The court underscored the distinction between “fair price” for purposes of appraisal, as compared to satisfying the entire fairness standard in connection with a breach of fiduciary duty claim: (i) the appraisal statute requires that the court determine an estimate for fair value using the special valuation standards in the statute. (ii) by contrast the fair price aspect of the entire fairness test is the standard of review to identify a fiduciary breach, and instead of picking a single number, the task of the court is to determine whether the transaction price falls within a range of fairness. Slip op. at 69 to 70 and 72 to 73.
  • The court elaborated on the fair price and fair dealing components of the entire fairness test. Slip op. at 69 to 72.
  • My favorite quote from the case is the following:
    • “Ultimately, fairness is not a technical concept. ‘No litmus paper can be found or Geiger-counter invented that will make determinations of fairness objective.’ A judgment concerning fairness ‘will inevitably constitute a judicial judgment that in some respects is reflective of subjective reactions to the facts of a case.’” Slip op. at 72.
  • The court also observed that in an appraisal proceeding the going-concern standard looks to the value of the corporation without considering issues of control, by contrast a claim for breach of fiduciary duty that challenges the fairness of a squeeze-out transaction must account for the implications of control. Slip op. at 72-73.
  • The court provided a detailed analysis to apply the standards of fair price and fair dealing to the facts of this case. Slip op. at 72-85.
  • The court concluded that the preferred stockholders proved that the fair value of the common stock for purposes of appraisal was zero, and they proved that the other challenges to the transaction satisfy the entire fairness test, and therefore, did not breach any fiduciary duty.

Frank Reynolds, who has been covering Delaware corporate decisions for various national publications for over 35 years, prepared this article

The Delaware Court of Chancery recently reconsidered most of its earlier dismissal of an investor challenge to IAC/InterActive Corp’s spinoff of its Match.com internet dating subsidiary after the state high court ruled that dual-position Match/IAC fiduciaries may have been too conflicted to get the protection of the business judgment rule in In re Match Group, Inc. Derivative Litigation, No. 2020-0505-MTZ (Del. Ch. Oct, 2, 2024).

Vice Chancellor Morgan Zurn’s September 1, 2022 opinion had dismissed investors’ derivative breach of duty charges over the Match separation for failure to show that the defendant directors lacked the independence to fairly decide whether the suit had enough merit to go forward.  In re Match Gp., Inc. Deriv. Litig. (“Match I”), 2022 WL 3970159 (Del.  Ch. Sept. 1, 2022).

But the Delaware Supreme Court partially reversed, finding that under its seminal MFW decision, no matter what procedure the defendant board used to ensure that the deal was fair in price and method, it would still be questionable if the directors who negotiated and approved it were conflicted. In re Match Gp., Inc. Deriv. Litig. (“Match II”), 315 A.3d 446 (Del. 2024).

Then, the vice chancellor’s Oct 2 opinion deciding that director independence question on remand from the state Supreme Court applied the requirements of the high court’s seminal MFW decision to the actions of the Match/IAC directors and officers and decided the shareholder plaintiffs have grounds to continue their charges against the defendants—except parent company controller Barry Diller.  Kahn v. M & F Worldwide Corp., 88 A.3d 635 (Del. 2014).

That Chancery opinion will be closely examined by corporate law specialists nationwide because it applies the state high court’s September 1 interpretation of MFW to the question of when and why allegedly disloyal inside directors and officers must face derivative charges if they purportedly manipulate transactions for their advantage in a non-freeze-out situation.

 Background

The challenged 2020 transaction involved the creation of two new corporations out of the former IAC and Match.com businesses and a reshuffling of the assets and liabilities of those two entities that was engineered by a “separation committee” composed of IAC directors who also held positions at the Old Match.  Old Match was later dissolved into the new IAC.

Three pension funds that owned that eliminated stock sued, alleging that the separation was a conflicted transaction in which Old IAC, as Old Match’s controlling stockholder, stood on both sides of the transaction. The plaintiffs claimed that Old IAC obtained significant “non-ratable” benefits in the Separation to the detriment of Match and its minority stockholders, and argued that the Separation Committee was conflicted and the proxy disclosures misled the Old Match minority stockholders.

The initial trial court ruling

Although the Court of Chancery initially found that the plaintiffs successfully pleaded facts creating a reasonable inference that one deal approving director was not independent of Old IAC, it ruled that a plaintiff must nonetheless show that “either:

(i) 50% or more of the special committee was not disinterested and independent,” or (ii) the minority of the special committee ‘somehow infect[ed]’ or ‘dominate[ed]’ the special committee’s decision-making process.“

 Finding that plaintiffs failed to do that, the vice chancellor dismissed.

Diller different than directors

But after the state high court’s reversal, on remand, Vice Chancellor Zurn then examined the independence of Diller and each defendant in turn.  First she found, that just because Old IAC held a controlling interest in Old Match and Diller owned a majority of Match through multiple- vote stock, that doesn’t mean he personally controlled Match’s merger decisions directly.  Therefore he should be dismissed for lack of proof that he suffered from a conflict of interest regarding the separation, the court ruled.

The remaining directors argued that they are exculpated from all of the fiduciary charges that the plaintiffs say disables them from deciding whether the suit has enough merit to continue. But the vice chancellor said they all fail the key rule in this area because, “Where a corporate charter contains an exculpatory provision, claims against a director will survive a motion to dismiss if the plaintiff pleads that the director

(1)“harbored self-interest adverse to the stockholders’ interests”;

(2) “acted to advance the self-interest of an interested party from whom they could not be presumed to act independently”; or

(3) “acted in bad faith

The vice chancellor held that the motion to dismiss failed because “The Dual Fiduciary Defendants each face such a conflict, so the claims against them are not exculpated.”

The Delaware Court of Chancery recently published an opinion that provides guidance on the latest iteration of the standard that will be applied when the court considers an application for mootness fees in the context of stockholder litigation. In Anderson v. Magellan Health Inc., C.A.No. 2021-0202-KSJM (Del. Ch. July 6, 2023), Chancellor McCormick granted a fee award of $75,000 in response to a fee request of $1.1 million in connection with a stockholder class action challenging a merger agreement between Centene Corporation and Magellan Health, Inc. After suit was filed, Magellan took certain actions that included supplemental disclosures which mooted the action and a stipulation of dismissal was filed.

Basic Background Facts

The suit claimed that confidentiality agreements that contained “don’t-ask, don’t-waive” provisions impeded the process that led to the Centene deal and, because the provisions were not fully described in the proxy, rendered stockholder provisions materially deficient. Shortly after suit was filed, Magellan issued supplemental disclosures on the don’t-ask-don’t-waive provisions and waived its rights under three of the four confidentiality agreements. On the theory that the supplemental disclosures and waivers were corporate benefits, plaintiff’s counsel petitioned the court for an award of fees and expenses.

Key Aspects of Ruling

This decision was provided as a public service to non-Delaware courts applying Delaware law who may not have “access to the this court’s bench rulings” that reflect a doctrinal shift that resulted in an “overall decline in settlements and fee awards” for strike suits challenging M&A transactions in Delaware. Slip op. at 15.

The Chancellor described this opinion as a clarification “for their sake”. Id. Specifically, the Court explained that: “Often, pre-Trulia precedent pricing corporate benefits reflect inflated valuations and warrant careful review.” Id.

The Court’s analysis emphasized that precedent prior to the seminal decision in the matter of In Re Trulia S’holder Litig.,129 A.3d 884 (Del. Ch. 2016), was “less useful”. In particular, the Court added that: “Post-Trulia decisions awarding attorneys’ fees in suits challenging don’t-ask-don’t-waive provisions reflect the decline in fees awarded for non-monetary benefits in merger litigation.’ Id.

Supplemental Disclosures

After explaining why the waivers did not deserve a fee award, the Court focused on the value of the supplemental disclosures. Although such disclosures have been recognized as a benefit, the Court observed that: “… the standard for pricing that benefit for the purpose of awarding mootness fees warrants reexamination in view of developments in deal litigation since Trulia.” Slip op. at 16.

In response to excessive deal litigation, Delaware courts responded in several ways, including a change in substantive law. In MFW and Corwin, the Supreme Court allowed deal lawyers to invoke the business judgment rule to avoid a merits-based review under the entire fairness or enhanced scrutiny standards. See Kahn v. M & F Worldwide Corp., 88 A.3d 635 (Del. 2014) and Corwin v. KKR Fin. Hldngs LLC, 125 A.3d 304 (Del. 2015). In addition, C & J Energy Servs. Inc. v. City of Miami Gen. Empls. and Sanitation Empls. Ret. Trust, 107 A.3d 1039 (Del. 2014), “denounced the use of preliminary injunctions as a means of challenging third-party acquisitions and rerouted stockholders to ‘after-the-fact monetary damages.'” Slip op. at 17.

Importantly, moreover, “Delaware courts … began to clamp down on disclosure-only settlements.” Id. See footnote 49 and 51 collecting cases that document this change.

Delaware Public Policy

For the avoidance of doubt, the Court underscored that Delaware public policy does not encourage plaintiffs’ counsel to: “pursue weak disclosure claims with the expectation that defendants would rationally issue supplemental disclosures and pay a modest mootness fee as a cheaper alternative to defending the litigation.” Slip op. at 22.

Delaware courts have not had much opportunity to clarify Delaware policy and law on mootness fees based on supplemental disclosures because in the wake of Trulia, the “… deal-litigation diaspora spread mainly to federal courts, where plaintiffs’ attorneys repackaged their claims for breach of the fiduciary duty of disclosure as federal securities claims.” Id.

After careful reasoning and citation to scholarship on the topic and the case law developments, the Chancellor clarified that: ” At a minimum, mootness fees should be granted for the issuance of supplemental disclosures only where the additional information was legally required.” Slip op. at 23.

Going forward, the Court gave notice that it: “… will award mootness fees based on supplemental disclosures only when the information is material”. Slip op. at 24.

The Court engaged in a thorough analysis of the precise details and impact of the supplemental disclosures in this case, and what amounts have been awarded in relevant Delaware decisions. See, e.g., footnotes 81 to 84.

Money Quote and Takeaway

After an extensive review of the facts of this case and reasoning based on the applicable cases as well as public policy considerations, including the submissions by several professors who filed amici curiae briefs, my vote for the best concluding quote of the case, that also serves as a takeaway for future guidance, follows:

Where lawsuits are not worth much, plaintiffs’ counsel should not be paid much. In this case, the award represents less than the Movants’ lodestar, which should send a signal that these sorts of cases are not worth the attorneys’ time. Moreover, had Movants been required to meet the materiality standard, it seems unlikely that there would have been any award at all.

Slip op. at 35 (emphasis added).