October 7, 2015
Albert H. Manwaring, IV
Transaction Advisors and Delaware Business Court Insider

In a self-interested transaction between a company and its controlling stockholder, the operative standard of judicial review under Delaware law is the most rigorous: entire fairness standard of review. To obtain the least rigorous, business judgment standard of review, and reduce the risk of a minority stockholder challenge in a merger transaction between a company and its controlling stockholder, parties may condition the controlling stockholder merger on approval by: (1) a board committee composed of disinterested and independent directors and (2) the affirmative vote of a majority of the minority or unaffiliated stockholders (In re MFW Shareholders Litigation, 67 A.3d 496 (Del. Ch. 2013), aff'd sub nom., Kahn v. M&F Worldwide, 88 A.3d 635 (Del. 2014)). Similarly, parties may employ either one of these safeguards to shift the burden of proof to the plaintiff under the entire fairness standard of review (Emerald Partners v. Berlin, 787 A.2d 85, 98-99 (Del. 2001)). Moreover, a well-functioning special committee advised by its own independent financial and legal advisers, and/or an affirmative vote of a majority of the minority or unaffiliated stockholders makes a stronger case to support a finding of fair dealing or process, which in turn influences the fair price inquiry to satisfy entire fairness review.

Fraud by a corporate fiduciary in the merger transaction, however, vitiates these safeguards while undermining the fairness of the process and a fair price under entire fairness review. Indeed, as the Delaware Court of Chancery recently emphasized in In re Dole Food Stockholder Litigation, C.A. No. 8703-VCL (Del. Ch. August 27, 2015), "What [a special-committee process cannot] overcome, what [a] stockholder vote [cannot] cleanse, and what even an arguably fair price does not immunize, is fraud." In Dole, the Court of Chancery held that Dole Food Co.'s controlling stockholder, who was also a director and the CEO, and his right-hand man, who served as an officer and director, were liable for more than $148 million for their breach of the fiduciary duty of loyalty in a going-private merger of Dole with the controlling stockholder. The court ruled the merger did not satisfy the entire fairness test because the fraudulent conduct of the controlling stockholder's right-hand man deprived the special committee of the ability to negotiate with the controlling stockholder on a fully informed basis as the bargaining agent of the minority stockholders, and also deprived the minority stockholders of the ability to protect themselves by making a fully informed decision to vote against the merger.

Factual Background

Dole was one of the world's largest producers and marketers of fresh fruit and vegetables. In 2009, after the financial crisis, Dole conducted an initial public offering of approximately 41 percent of its shares. After the IPO, Dole's controlling stockholder, David Murdock, did not like sharing control with a board of directors of a public company.

In 2010, Dole's chief financial officer provided Murdock with a strategy to spin off Dole's higher-margin businesses to realize their value, and to subsequently have Murdock acquire the remaining lower-margin businesses in a going-private transaction. In 2012, ITOCHU acquired Dole Asia, which included Dole's higher-margin businesses. As part of the ITOCHU transaction, the Dole board agreed Murdock would start serving as Dole's CEO and that C. Michael Carter would start serving as Dole's president and chief operating officer. Carter also retained his position as Dole's general counsel and corporate secretary, he also joined the board, and became Murdock's only direct report.

Although Murdock was presented with a number of different options regarding a future Dole strategic transaction, Murdock wanted to take Dole private after the ITOCHU transaction. To depress Dole's stock price in anticipation of Murdock's effort, Carter announced publicly an anticipated $20 million in operational cost savings as a result of the sale of the high-margin businesses in the ITOCHU transaction. But, $20 million was significantly lower than the previously announced annual cost savings anticipated in internal and adviser-prepared analyses, which ranged from $50 million to $125 million. Dole's stock price dropped 13 percent after Carter's announcement, the court's opinion said. Further, although the board had unanimously approved open market repurchases in connection with a Dole share repurchase program, Carter announced publicly that the repurchase program was suspended. Carter falsely stated that another board directive to purchase new ships would instead require Dole's resources. But, the ship acquisition and share repurchase programs were both feasible concurrently. Upon Carter's announcement, Dole's stock price fell by 10 percent, the opinion said.

In June 2013, Murdock delivered his initial going-private proposal to the board and indicated that he was not willing to sell his shares to a third party as an alternative transaction for Dole. The board formed a special committee of its independent, disinterested directors to evaluate the proposed going-private transaction with its controlling stockholder. But, before the committee completed its analysis of the proposed transaction, Carter engineered the production of false revenue projections that were 20 percent lower than previous management projections. These new projections included only a fraction of the anticipated post-ITOCHU cost savings and did not include additional revenues from plans to purchase farms necessary to avoid Dole's continued reliance on independent growers. While the committee suspected that these new projections were inaccurate, and developed its own revenue projections from internal and publicly available information, the committee's projections did not include upward adjustments for the true anticipated operational cost savings from the ITOCHU transaction, or revenues from anticipated farm acquisitions. This information was never provided to the committee or the stockholders. Subsequently, the committee and Murdock agreed to the terms of a merger agreement, and the board subsequently approved the merger of Dole with Murdock, which a majority of the minority stockholders ultimately approved by a small margin.

Fraud Vitiates Special-Committee Process

The Court of Chancery first explained the applicable standard of review for a transaction involving self-dealing by a controlling stockholder was entire fairness, and that defendants would have the burden of persuasion at trial because the record did not permit a pretrial determination that the defendants were entitled to a lower standard of review under MFW, or a burden shift under Emerald Partners.

Turning to entire fairness review, the court found that the merger did not satisfy either the fair dealing or fair price components of entire fairness review. The court reasoned that fraud had vitiated the laudatory efforts of the special committee to negotiate a fair transaction. The court explained that for 18 months the controlling stockholder, Murdock, had orchestrated a plan to sell and realize the value of Dole's higher-margin businesses before taking Dole private. But, rather than make a merger proposal when Dole's stock was trading at high levels following the announcement of the ITOCHU transaction, which sold Dole's higher-margin businesses, Carter intentionally drove down the price of Dole stock by making false public statements about the amount of Dole's operational cost savings from the sale of these higher-margin businesses and Dole's ability to effect a stock repurchase plan. The court concluded that Carter had violated his duty of candor to the committee by manufacturing revenue projections that contained falsely low numbers, rather than providing projections that reflected Dole management's then-current best views about the prospects of Dole's business. The court emphasized that due to his fraud, the committee projections did not contain Dole management's true thinking about the cost savings Dole could achieve through the sale of its higher-margin businesses and the increase in revenues from its planned acquisition of farms. As to the issue of fair price, the court found the evidence at trial supported a per-share price that may have fallen within the lower end of a range of fairness—even after accounting for Carter's fraud. The court nevertheless concluded that the merger did not satisfy the entire fairness test.

The court then examined whether the defendants were liable for breach of their fiduciary duties. The court found that Murdock had breached his duty of loyalty as a controlling stockholder and as a director. As a self-dealing director, Murdock was subject to liability for breach of the duty of loyalty without an inquiry into his state of mind. For the other fiduciary defendants—Carter and former Dole CEO David DeLorenzo—the court examined whether they had breached their duty of loyalty by bad-faith conduct. The court found that Carter had engaged in a lengthy course of fraud and other bad-faith conduct, both as a Dole director and an officer. As to DeLorenzo, however, the court determined that he had a limited role after the ITOCHU transaction, did not personally participate in or know about the specific misconduct, in which Murdock and Carter engaged, and was entitled to rely in good faith on the committee's recommendation to approve the merger under Section 141(e) of the Delaware General Corporation Law, which immunized him from liability for breach of fiduciary duties.

Decision Impact

Fraud by a corporate fiduciary vitiates a special-committee process and a vote of the majority of the minority or unaffiliated stockholders under MFW, and negates fair dealing and price under entire fairness review. Even though a merger price falls within a range of fairness under the fair price component of entire fairness review, the Court of Chancery may still award damages reflecting a "fairer price" to prevent defendants from profiting from a breach of the fiduciary duty of loyalty, misconduct or fraud.

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