In a stockholder challenge to a going-private merger by a controlling stockholder to buy out minority stockholders, the operative standard of review is ordinarily the most rigorous judicial review, entire fairness. To obtain the most deferential judicial review, business judgment, in a challenge to a squeeze-out merger, the controlling stockholder may, however, structure the merger to satisfy the MFW framework approved by the Delaware Supreme Court in Kahn v. M&F Worldwide, 88 A.3d 635 (Del. 2014). The MFW framework requires that the controlling stockholder condition the merger on both approval of an independent, adequately empowered special committee of the board that fulfills its duty of care in negotiating a fair merger price, and the uncoerced, informed vote of a majority of the minority disinterested, independent stockholders. If the MFW requirements are satisfied, the business judgment rule applies, and the Delaware Court of Chancery will dismiss the stockholder challenge to the squeeze-out merger unless the merger somehow constitutes waste—which is logically impossible to prove after the fully informed, uncoerced, independent stockholders ratify the merger by their vote.
In its most-recent decision, applying the MFW framework, in In re Books-A-Million Stockholder Litigation, C.A. No. 11343-VCL (Del. Ch. Oct. 10, 2016), (Laster, V.C.), the Court of Chancery held that a squeeze-out merger of the minority stockholders by the controlling stockholder of Books-A-Million, Inc. satisfied the MFW requirements, and therefore, applied the business judgment rule to dismiss the plaintiff minority stockholders’ complaint under Court of Chancery Rule 12(b)(6). In finding that the special committee was independent and exercised due care in negotiating a fair merger price under MFW, the court reasoned that a controlling stockholder does not breach a fiduciary duty merely by offering to buy out minority stockholders at a lower price than a price offered by a third party to buy the entire company, since the third-party price would typically be higher to account for the premium to purchase control of a company.
The Anderson family, the controlling stockholder of Books-A-Million, Inc., sought to buy out the company’s minority stockholders in a going-private merger. With the goal of obtaining business judgment review of any challenge to the controlling stockholder merger, the Anderson family structured the merger to satisfy the MFW requirements. The Anderson family also conditioned the merger on its right to terminate the merger if more than 10 percent of the minority stockholders sought appraisal. A third-party offered to buy the entire company at a price 30 percent higher than the price offered by the Anderson family to buy out the minority stockholders.
In their challenge to the merger, the plaintiff minority stockholders claimed that the MFWrequirements were not satisfied. The plaintiff minority stockholders asserted that the special committee was not independent and did not exercise due care in negotiating a fair merger price with the controlling stockholder under MFW. Their primary contention was that a higher price offered by a third party for the company as a whole was available, but the special committee nevertheless had pursued and recommended that minority stockholders accept a lower price offered by the Anderson family to buy out the minority stockholders. The Anderson family was unwilling to sell its controlling stockholder interest in the company.
CONTROLLING STOCKHOLDER MERGER MET 'MFW' REQUIREMENTS
The Court of Chancery found that the squeeze-out merger of the minority stockholders by the controlling stockholder met the MFW requirements, and applied business judgment review to dismiss the action. The plaintiff minority stockholders principal claim was that the special committee’s recommendation to minority stockholders to accept a lower price offered by the controller to buy out their shares, when a third-party bidder was offering a higher price to buy the entire Company, was in bad faith and irrational. While systematically addressing each of the MFWrequirements to reject the plaintiffs’ claim, the court focused its analysis on whether the special committee was independent and exercised due care in negotiating a fair merger price.
In its analysis, the court explained the obligations of a controlling stockholder and board in connection with a proposed squeeze-out merger to buy out the minority stockholders when faced with a third-party, offering a higher price than the controller, to buy the entire company. First, the court found that the controlling stockholder did not have a fiduciary duty to sell its shares or controlling interest to facilitate a sale of the company to the third party. In short, a controlling stockholder does not have any fiduciary duty to sacrifice its own financial interest in a company for the sake of minority stockholders. Thus, the controlling stockholder’s unwillingness to sell its shares was well within its rights. In turn, absent an abuse of power or exploitation of the minority stockholders by the controlling stockholder, the Court found that the board would have violated its fiduciary duty of loyalty to the controller by diluting its interest to facilitate a sale of the company (over the controller’s objection) to the third party.
Based on the board’s inability to pursue the third-party offer, the court concluded that a controlling stockholder’s mere offer to buy out minority stockholders at substantial premium to the market price of the company, but at a lower price than the price offered by the third party to buy the entire company, did not breach its fiduciary duties. The court reasoned that a third-party’s price to buy the entire company would typically be higher to account for the premium to purchase control of the company. The court further explained that because the controlling stockholder had followed the MFW framework, which required the vote of a majority of the minority stockholders, the controller had ensured up front that minority stockholders would have the right to determine for themselves whether to accept the controlling stockholder’s offer to buy them out. This made for an even stronger case that the controlling stockholder did not overreach or exploit the minority stockholders by making its lower offer to buy them out. Finally, further militating against any finding of exploitation, minority stockholders aggrieved over the controller’s lower price that implied a minority discount for their buy out could still seek appraisal, which would exclude any minority discount, to value the Company as a “going concern” as required in an appraisal under Delaware law.
The In re Books-A-Million decision confirms the ability of a controlling stockholder to obtain early dismissal of a challenge to a squeeze-out merger by structuring the merger to satisfy the MFWrequirements, which results in business judgment review of the merger. To ensure that a challenge to a squeeze-out merger may be tested under MFW at the pleadings stage, practitioners should be careful to describe compliance with the MFW requirements “in a public way suitable for judicial notice, such as board resolutions and a proxy statement.”
Delaware Business Court Insider | November 2, 2016
Transaction Advisors l November 2016 (reprinted with permission)