The Delaware Supreme Court’s MFW decision provides a safe harbor for controlling stockholder buyouts that are conditioned upon approval of a special committee of independent directors and a majority-of-the-minority vote, provided, inter alia, “there is no coercion of the minority.” Kahn v. M & F Worldwide Corp. (MFW), 88 A.3d 635, 645 (Del. 2014). The Court of Chancery’s recent decision in In re Dell Tech. Inc. Class V. S’holders Litig., 2020 WL 3096748 (Del. Ch. Jun. 11, 2020), held that a redemption of minority stockholders’ shares failed to satisfy MFW due to the company’s decisions to give the special committee an impermissibly narrow mandate and then bypass it to negotiate directly with minority stockholders. The court also found that, in light of the looming threat of undesirable alternative transaction, the company’s offer was impermissibly coercive.
The Transaction: Dell’s Class V Stock Redemption
Following a 2013 going-private transaction, a majority of the voting power of Dell Technology Inc. (Dell) was controlled by Michael Dell and his affiliates. He also controlled board votes via a director seat with super-voting rights.
In 2016, Dell acquired EMC Corporation, which owned an 81.9% interest in VMWare, Inc. (VMWare), a publicly traded company. As part of the consideration, Dell issued shares of new publicly traded Class V common stock intended to track the value of Dell’s ownership interest in VMWare. Under Dell’s certificate of incorporation, the Class V stock could be converted into Class C common shares at Dell’s election if the Class C shares also became publicly traded (the Conversion Right). The conversion ratio was based on each stock’s market price in the ten trading days leading up to Dell’s decision to convert. The plaintiffs alleged that, due to the Conversion Right, as well as concern that Dell might behave opportunistically toward minority stockholders, the Class V stock traded at a roughly 30% discount to VMWare’s publicly traded common stock. Market participants referred to this as the “Dell discount.”
To consolidate the value of Dell’s ownership of VMWare, Dell explored a redemption of the Class V stock. At the same time, Dell allegedly explored an initial public offering of the Class C shares – a step toward exercising the Conversion Right. To satisfy MFW, Dell formed a special committee and conditioned any redemption on its recommendation and a majority-of-the-minority vote. The special committee was granted authority only over the redemption, however, not the exercise of the Conversion Right.
After negotiations, the special committee recommended accepting Dell’s supposed best and final offer. Class V stockholders opposed it, however. Over the ensuing months, Dell negotiated directly with large Class V holders while the special committee was largely inactive, allegedly due to its belief that it could not revisit its past recommendation. Dell and the large Class V holders reached an agreement. Without knowledge of that agreement, the special committee then finally proposed a transaction at a higher per share price. After the special committee was informed of the agreement with the large Class V holders, however, the committee met for an hour and then recommended in favor of a redemption at the lower price Dell negotiated with them.
The Court’s Decision
Vice Chancellor J. Travis Laster found the MFW standard was not satisfied for a number of reasons. the court’s rulings concerning the special committee process and the concept of “coercion” are of particular interest.
Regarding the process, the court explained that the committee’s mandate was too narrow because it failed to include authority over Dell’s exercise of the Conversion Right. The court explained that, under MFW, a special committee must have power to prevent the controller from acting unilaterally via “alternative means for the controller’s desired end” or, stated somewhat differently, the “functional equivalent” thereof. Here, Dell allegedly had prepared for and threatened exercising the Conversion Right – an unattractive outcome for the Class V holders – as an alternative to the redemption.
Similarly, Dell’s decision to engage in direct negotiations with the large Class V holders failed to comply with MFW, which the court explained requires “dual protections.” That is, the special committee “will act as the bargaining agent for the minority stockholders, with the minority stockholders rendering an up-or-down verdict on the committee’s work.” The court reasoned, “[t]hose roles are complements, not substitutes. A set of motivated stockholder volunteers cannot take over for the committee and serve both roles.” Under MFW, if a committee’s proposal is rejected by the minority stockholders, then “the committee must return to the bargaining table, continue to act in its fiduciary capacity, and seek to extract the best transaction available.”
The court also reviewed in detail Delaware case law concerning impermissible “coercion,” and held that Dell’s offer was impermissibly coercive. After observing that there are “[a]t least five” different “strands” of law on this subject, the court reasoned that cases involving coercion by a fiduciary look to whether “the fiduciary has taken action which causes stockholders to act – whether by voting or making an investment decision like tendering shares – for some reason other than the merits of the proposed transaction.” Similarly, in analogous cases under Corwin considering the cleansing effect of a stockholder vote, deference is unwarranted where the vote is “situationally” or “structurally” coercive. Situational coercion was found in In re Saba Software, Inc. S’holder Litig., 2017 WL 1201108 (Del. Ch. Apr. 11, 2017), where past malfeasance caused the company’s shares to be delisted, and stockholders were forced to choose between that status quo and an unattractive buyout. Structural coercion was found in Sciabacucchi v. Liberty Broadband Corp., 2017 WL 2352152 (Del. Ch. May 31, 2017), where a vote unnecessarily conditioned certain transactions beneficial to minority stockholders upon distinct proposals ratifying alleged conflict-of-interest transactions. Reviewing such decisions, the court reasoned that “[a]s a matter of policy, giving cleansing effect to a stockholder vote avoids judicial second guessing where stockholders inferably made a decision that the transaction was in their own best interests. If a plaintiff can identify a reasonably conceivable basis to doubt that the stockholders made that determination, then the vote should not be given cleansing effect.” Finally, with respect to coercion of a special committee, pre-MFW case law supported that a controller’s threat to force a transaction at a lower price if a committee rejected a proposal could be coercive.
Applying these concepts, the court found that the plaintiffs adequately alleged the potential exercise of the Conversion Right – and Dell’s alleged statements to the committee and the public suggesting an intent to exercise it in the absence of a redemption – created impermissible coercion. The court reasoned that the fear of a forced conversion could induce Class V stockholders to approve a proposed redemption for reasons other than the merits of the transaction. The situation, with a status quo freighted with so-called “Dell discount,” also supported a finding of coercion. Finally, Dell’s decisions to retain control over the Conversion Right undermined the committee’s bargaining power and ultimate recommendation. The circumstances supported an inference that the Committee approved the redemption not because it was fair, but because it was better than the alternative of a forced conversion.
The court accordingly concluded that MFW deference was unwarranted, and the redemption would be reviewed under the entire fairness standard of review. Accordingly, the court denied the defendants’ motions to dismiss.
This opinion builds upon a series of recent Delaware decisions examining the standards for the process leading up to a transaction that must be satisfied under MFW. A reviewing court will examine allegations concerning a special committee process to assess whether a committee functioned appropriately. Parties to transactions who hope for MFW deference must ensure that a committee has an appropriately broad mandate, and that it work actively on behalf of the minority. The controller also must not bypass the committee to negotiate directly with the minority, regardless of whether the minority holders concur with the committee’s initial recommendation. The court’s comprehensive discussion of “coercion” also is instructive and may help litigants and judicial officers consider that concept going-forward. In explaining the different strands of case law, the court clarified, among other things, that coercion should have a similar meaning in the MFW context as it does in the analogous Corwin context.