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Entire Fairness Standard Applies Where Controller Has Substantive Discussions with Minority Stockholders before Agreeing to MFW Protections

In re HomeFed Corporation Stockholder Litigation, C.A. 2019-0592-AGB (Del. Ch. July 13, 2020)
This case illustrates that the Court of Chancery will apply the entire fairness standard to review a squeeze-out merger by a controller, if the controller engages in substantive economic discussions before the company has enacted the procedural protections outlined in Kahn v. M & F Worldwide Corp, 88 A.3d 635 (Del. 2014) (“MFW”) that would permit business judgment review. In this case, Jefferies Financial Group Inc. (“Jefferies” or the “Controller”), which owned 70% of HomeFed Corporation (“HomeFed”), acquired the remaining shares of HomeFed in a share exchange in which each HomeFed minority shareholder received two Jefferies shares in exchange for one of its HomeFed shares (the “Transaction”). A HomeFed director originally proposed the 2:1 share exchange to Jefferies in September 2017, and Jefferies subsequently discussed the share exchange with HomeFed’s second largest shareholder Beck, Mack and Oliver, LLC (“BMO”). In December 2017, HomeFed’s board of directors (the “Board”) formed a special committee (the “Special Committee”) that had the exclusive power to evaluate and negotiate a potential transaction. When the parties were unable to agree to merger terms, the Special Committee “paused” its process in March 2018. Despite pausing the Special Committee, Jefferies continued to discuss a potential transaction with BMO for the next year. 

In early February 2019, BMO encouraged Jefferies to pursue the Transaction and indicated that it and another significant shareholder would vote for the Transaction. Jefferies announced the proposed 2:1 share exchange on February 19, 2019 (the “February 2019 Offer”) and the Board then reauthorized the Special Committee. During the Special Committee’s negotiations, Jefferies’ CEO reached out to BMO without the authorization of the Committee and implied that the 2:1 share exchange was a “take it or leave it” offer. The Special Committee and a majority of the minority shareholders approved the Transaction in May and June 2019, respectively.

The plaintiffs, who are former shareholders of HomeFed, claimed that the HomeFed directors and the Controller breached their fiduciary duties. In response, the defendants requested the Court of Chancery dismiss the case because the Transaction is subject to the business judgment rule under MFW. In MFW, the Delaware Supreme Court held that the business judgment rule applies to a squeeze-out merger by a controller “where the merger is conditioned ab initio upon both the approval of an independent, adequately- empowered Special Committee that fulfills its duty of care and the uncoerced, informed vote of a majority of the minority stockholders.” 

The Court of Chancery denied the motion to dismiss because it found that the plaintiffs adequately had pled that Jefferies did not impose the MFW conditions ab initio. This was because, among other things, the Board never dissolved the Special Committee, Jefferies had substantive economic discussions about a potential transaction when the Special Committee was paused, even though the Special Committee had the exclusive power to negotiate a transaction, and BMO consented to the Transaction before the Special Committee even began its negotiations. The Court held that it was reasonably conceivable that the February 2019 Offer was part of the same process that commenced in December 2017. The process failed to comply with MFW because Jefferies did not agree to the MFW protections before the December 2017 process began. Additionally, the Court explained that, even if the February 2019 Offer was part of a new process, the new process also failed to comply with MFW. This was because Jefferies had substantive economic discussions with BMO and obtained the support of BMO and another crucial shareholder in early February 2019, before the Special Committee was reauthorized near the end of February 2019 and before HomeFed publicly announced that any transaction would be subject to MFW’s requirements. Jefferies’ discussions were contrary to the ab initio requirement, which bars the controller from having substantive economic discussions with the minority shareholders, and instead requires that the controller negotiate exclusively with a special committee acting on behalf of the minority shareholders. The Court explained that a controller cannot satisfy the MFW conditions if it undermines the Special Committee by engaging in substantive discussions with minority stockholders before the Special Committee is authorized to act. The Court, therefore, denied the defendants’ motion to dismiss.

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