In Kahn v. M&F Worldwide, 88 A.3d 635 (Del. 2014) (MFW), the Delaware Supreme Court ruled that a controlling stockholder transaction involving a freeze-out merger, which is structured to include approval by a well-functioning independent special committee and the affirmative vote of the majority of the fully-informed and uncoerced minority stockholders, is subject to the business judgment standard of review. Since MFW, the Court of Chancery has applied the MFW framework to assess the standard of review of controlling stockholder transactions that did not involve a freeze-out merger, which commentators have referred to as “MFW creep.”

In re Match Group Derivative Litigation, C.A. No. 368, 2022 (Del. April 4, 2024), the Supreme Court clarified that controlling stockholder transactions that do not involve a freeze-out merger may also be structured under the MFW framework to obtain business judgement review dismissal at the pleadings stage. In Match Group, plaintiff minority stockholders challenged the fairness of a controlling stockholder’s reverse spinoff of its internet and media lines of business from its subsidiary, Match Group. The reverse spin off was a controlling stockholder transaction because the controlling stockholder received benefits in the transaction allegedly at the expense of minority stockholders, but the transaction did not constitute a freeze-out merger. Defendants argued that other than a freeze-out merger, if a controlling stockholder transaction employs either a special committee of independent directors, or an affirmative vote of the majority of the unaffiliated minority stockholders, the presumptive most-rigorous entire fairness review changes to the most-deferential business judgment review. Under long-standing Delaware corporate law precedent, the Supreme Court rejected this argument. The Supreme Court held that while a controlling stockholder may shift the burden of proof on the entire fairness standard of review of a controlling stockholder transaction by properly employing a well-functioning special committee, or a majority of the unaffiliated minority stockholder vote, the use of just one of these procedural devices in a transaction is insufficient to secure business judgment review. Instead, the Supreme Court held that if a “controlling stockholder wants to secure the benefits of business judgment review, it must follow all MFW’s requirements.” But, importantly, by this holding, the Supreme Court clarified that controlling stockholder transactions, like the reverse spin off in Match Group, which do not involve a freeze-out merger, may also be structured to meet the MFW requirements to secure business judgment review.

Turing to the application of MFW, the Court of Chancery ruled that business judgment review applied to the controlling stockholder transaction because it was conditioned on the approvals of a fully empowered, well-functioning special committee of independent directors, and the uncoerced, fully informed vote of unaffiliated minority stockholders. The Court of Chancery reasoned that to meet the MFW requirements, only a majority of the special committee must be independent, and that any interested minority of the special committee did not infect or dominate the special committee’s decision-making process. Accordingly, while one of the members of the special committee lacked independence from the controlling stockholder, the Court of Chancery nevertheless determined that the committee’s approval of the transaction was effective under MFW. The Court of Chancery also found that the minority stockholder vote was fully informed because the defendants disclosed the interested committee member’s ties to the controller in a public filing.

The Supreme Court disagreed with the Court of Chancery that only a majority of the special committee had to be independent. Instead, the Supreme Court held that “MFW requires full independence of the special committee.” The Supreme Court explained that to obtain business judgment review when a controlling stockholder transacts with the corporation and receives a non-ratable benefit apart from the consideration received by minority stockholders, “the inherently coercive presence of the controlling stockholder requires it to ‘irrevocably and publicly disable[ ] itself from using its control to dictate the outcome of the negotiations’ to ensure an ‘arm’s-length’ outcome.” The Supreme Court reasoned, however, that a “controlling stockholder’s influence is not ‘disabled’ when the special committee is staffed with members loyal to the controlling stockholder.” Therefore, to satisfy MFW’s requirements, all members of the special committee must be independent.

In sum, because one of the members of the special committee lacked independence, the Supreme Court held that entire fairness remained the standard of review of the controlling stockholder’s reverse spinoff of its lines of business from its subsidiary, Match Group.

Accordingly, the Supreme Court reversed the Court of Chancery’s decision to apply the business judgment rule and dismiss the plaintiffs’ complaint.

Delaware Business Court Insider | July 24, 2024