Controlling Stockholder Transactions: Delaware Supreme Court Clarifies When It Is Too Late for Business Judgment Review

In Olenik v. Lodzinski, the Delaware Supreme Court found that the conditions required for business judgment review of a controlling stockholder transaction under the MFW standard were not in place “at the outset” of the transaction and reversed the Chancery Court’s dismissal of the case.

In Kahn v. M&F Worldwide Corp., 88 A.3d 635 (Del. 2014) (“MFW”), the Delaware Supreme Court established the requirements for controlling stockholders to structure going-private and other interested transactions to receive the benefit of the business judgment standard of review and avoid the more rigorous entire fairness standard of review.  The requirements are: (i) a fully-functioning independent special committee of the board with full authority to select its advisers, negotiate the transaction and, if it chooses, say no, and (ii) conditioning the transaction on approval by a fully-informed and uncoerced majority of the minority stockholders.  It is key that these conditions be established by the controlling stockholder at the outset of its efforts to take the corporation private – sometimes referred to as the “ab initio” requirement.

Last October, in Flood v. Synutra, 195 A.3d 754, 763 (Del. 2018) (“Flood”), the Delaware Supreme Court clarified that MFW’s ab initio requirement would be satisfied if the controlling stockholder committed to the MFW protections before “substantive economic negotiations” commenced, even if the controlling stockholder did not include the requisite conditions in its initial written offer.  In Flood, the controlling stockholder made an initial offer that was not conditioned on either special committee approval or a vote of a majority of the minority.  However, shortly after the company formed a special committee, the controlling stockholder sent a second letter to the special committee that did contain the requisite MFW conditions.  The Delaware Supreme Court affirmed the Chancery Court’s dismissal of the case based on compliance with MFW stating that the second letter satisfied the ab initio requirement as it was delivered at the beginning of the process and the company had not commenced substantive negotiations with the controlling stockholder.

The complaint in Olenik challenged a business combination with another portfolio company of the controlling stockholder, alleging that merger negotiations started eight months before a special committee was formed to independently evaluate the deal.  The Chancery Court granted the defendant’s motion to dismiss on business judgment grounds stating that the parties’ early interactions were only exploratory in nature.  The Delaware Supreme Court disagreed and reversed the Chancery Court’s decision to dismiss the case.  The Supreme Court concluded that the parties’ preliminary discussions had transitioned to substantive economic negotiations during the eight months before the MFW protections were put into place, specifically noting, among other things, that company presentations made to the controlling stockholder during that time included valuations consistent with the controlling stockholder’s first formal offer and with the final agreed to deal value.

Even though the Delaware Supreme Court has provided for some flexibility in MFW’s ab initio requirement, if a controlling stockholder proposing a transaction wants the benefit of MFW to shift the standard of review to the business judgment rule, the Olenik decision underscores the importance of careful planning at the outset. This means avoiding any interactions or discussions that might be construed in hindsight as substantive economic negotiation until a special committee is formed and its advisers are retained.  The line between permissible preliminary discussions under Flood and impermissible negotiations under Olenik is not a bright line but any discussion of valuation or terms should be avoided until the MFW requirements are fully in place.

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