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Delaware Supreme Court Rejects MFW Defense Because of Delay in Safeguards

Posted In M&A

Olenik v. Lodzinksi, No. 392, 2018 (Del. Apr. 5, 2019).

Under Kahn v. M&F Worldwide Corp., 88 A.3d 635 (Del. 2014), deferential business judgment review governs mergers between a controlling stockholder and the controlled corporation when the deal is conditioned “ab initio” on two procedural safeguards. Those are approval by (i) a special committee of independent directors, and (ii) an uncoerced, informed majority-of-the-minority stockholders’ vote. The reasoning goes, with so-called “MFW conditions” in place at the outset, a controller cannot dictate the economic terms or unduly influence the stockholder vote, thus ameliorating the concerns otherwise justifying the more exacting “entire fairness” review.

Last year, in Flood v. Synutra, 195 A.3d 754 (2018), the Delaware Supreme Court expanded on what the MFW conditions’ “ab initio” timing requirement means. There, the Supreme Court rejected a bright-line test, finding “ab initio” does not necessarily equate to the first expression of interest. Rather, it means before any substantive economic negotiations occur. In Flood, the controller’s agreement to the MFW conditions shortly after its initial expression of interest but before further substantive economic negotiations had taken place was sufficiently early to invoke business judgment review.

The Olenik decision represents the latest word from the Delaware Supreme Court addressing the MFW conditions’ “ab initio” timing requirement. Here, however, the Supreme Court rejected the defendants’ MFW defense. According to the Supreme Court, and contrary to the Court of Chancery’s decision granting defendants’ motion to dismiss, the plaintiff’s complaint permitted a reasonable inference that the MFW conditions were not in place sufficiently early to afford deference. Intermittently, over a period of eight months before the controller’s agreement to the MFW conditions, the controller had met with company management about a potential transaction, the company began due diligence, management received initial valuation information from investment banks, and management also prepared equity valuations that were shared with the controller. The Supreme Court found the latter fact to be particularly significant, and cited social science literature concerning the “anchoring” effect, in which initial negotiations set expectations and therefore limit the range of potential outcomes. Because the controller and the controlled company “engaged in substantive economic discussions” before the MFW protections were in place, the transaction would remain subject to entire fairness review. The plaintiff’s complaint thus was sufficient to survive a motion to dismiss, requiring a reversal.

Tags: M&A


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