In a case with implications for companies with controlling stockholders, the Delaware Supreme Court held that the MWF Doctrine applies to any transaction involving a controlling shareholder receiving a non-ratable benefit, and both MFW cleansing mechanisms must be satisfied for business judgment review, rather than entire fairness, to apply to such transactions.
As discussed in our December 2023 LawFlash, the Delaware Supreme Court has been considering two key questions: (1) whether the “MFW Doctrine” applies to all controlling stockholder transactions (not limited to squeeze-out mergers), and (2) whether both prongs of MFW must be satisfied to invoke business judgment review of a transaction with a controlling stockholder in which it receives a non-ratable benefit.
Delaware’s “MFW Doctrine” generally provides that a transaction involving a controlling stockholder receiving a non-ratable benefit—typically subject to the more exacting “entire fairness” review—will be subject to the business judgment rule only if the transaction is conditioned, ab initio, on approval by both (1) an independent, fully functioning special committee of independent directors, and (2) a fully-informed, uncoerced vote of a majority of disinterested stockholders. MFW is essentially designed to replicate arm’s-length bargaining by removing the inherent conflicts that come from the controlling stockholder’s influence over the company and the board.
Whether a court applies the business judgment rule or the entire fairness standard of review can be, but is not always, outcome-determinative of litigation challenging the transaction.
EXPANSION OF THE MFW DOCTRINE
The MFW Doctrine arose out of Kahn v. M&F Worldwide Corp. (MFW), a case concerning a “squeeze-out” merger whereby the company’s controlling stockholder sought to forcibly cash out the company’s remaining investors at a price set by the controlling stockholder. However, since MFW, Delaware courts have applied the Doctrine to a variety of nonmerger controller transactions, such as service agreements with a controlling stockholder and executive compensation for a majority shareholder that was also the company’s chief executive officer.
IN RE MATCH GROUP INC. DERIVATIVE LITIGATION
The Match Group case concerns minority stockholders’ challenge to a reverse spinoff of dating website Match.com by IAC/InterActiveCorp, the company’s then-controlling stockholder, arguing that the transaction unfairly benefitted the controlling stockholder at the expense of the minority stockholders.
Vice Chancellor Morgan T. Zurn of the Delaware Court of Chancery dismissed the challenge under the business judgment rule, concluding that the company complied with the procedures set forth in MFW. Vice Chancellor Zurn found that while the plaintiffs conceivably alleged that one member of the company’s three-person special committee lacked independence, that did not negate the application of the business judgment rule because the majority of the company’s special committee was independent. The plaintiffs appealed, arguing that the company did not comply with the MFW Doctrine because at least one of the directors on the special committee was not independent.
In the course of the appeal, the Delaware Supreme Court took an unusual step: it asked the parties for supplemental briefing on whether the MFW Doctrine should even apply outside the context of a freeze out merger with a controlling stockholder, even though neither party raised the issue in the Court of Chancery.
On April 4, 2024, the Delaware Supreme Court handed down its decision, holding the following:
- MFW applies to more than controller squeeze outs: MFW applies to all transactions, not just squeeze-out mergers, where “a controlling stockholder stood on both sides of a transaction with the controlled corporation and received a non-ratable benefit.”[1] Here, the court applied MFW to the reverse spin off transaction because the plaintiffs adequately plead that the controller stood on both sides of the transaction and received a non-ratable benefit.
- Entire fairness applies: Entire fairness review is the presumptive standard of review for all such controller transactions.
- Only one out of two MFW prongs can shift the burden but not the standard: A controlling stockholder can shift the burden of proving entire fairness to the plaintiff by satisfying only one of the two MFW prongs—by properly employing either (1) an entirely independent special committee, or (2) an unaffiliated stockholder vote. However, the use of just one of these procedural devices does not change the standard of review—entire fairness review will apply unless all of MFW’’s stockholder protections are satisfied.
- The price of business judgement review is both MFW requirements: The court stated, “If the controlling stockholder wants to secure the benefits of business judgment review, it must follow all of MFW’s requirements.” The court analyzed its precedent in determining that a controlling stockholder generally has inherently coercive authority over the board and other stockholders. To make a pretrial showing of arm’s-length bargaining, and obtain the protections of the business judgment rule, a controlling stockholder must “irrevocably and publicly disable itself from using its control to dictate the outcome of the negotiations and the shareholder vote.”[2]
- A Special Committee must be wholly independent: To adequately replicate arm’s length bargaining and disable a controlling stockholder’s influence such that the business judgment rule should apply, which is the underlying basis for the MFW framework, each and every member of the special committee must be independent. It is not enough that a majority of the committee members were independent or that the conflicted member(s) did not “infect” or “dominate” the committee process. A controlling stockholder’s influence cannot be “disabled” when a special committee is staffed with even one member loyal to the controller. Here, plaintiffs pled that one of the committee members, who allegedly handled the bulk of the negotiation, had a longstanding close and pervasive personal and business relationship with the controller based on admiration and a debt of gratitude such that he could be reasonably deemed to be conflicted.
LOOKING FORWARD
The decision provides a measure of certainty in the marketplace. While the precise boundaries of the MFW Doctrine have been uncertain since the Delaware Supreme Court’s decision in MFW, transactional lawyers have often advised companies to observe the MFW Doctrine when considering any transaction with a controlling stockholder to limit subsequent litigation risk. Match Group confirms that advice—any transaction where a controlling stockholder stands on both sides and receives a “non-ratable benefit” will enjoy the protections of the business judgment rule only if the company complies with both prongs of the MFW Doctrine.
However, where a company cannot comply (or cannot justify incurring the time and expense to comply) with all of the procedures in MFW, then it can still mitigate the litigation risks arising from a controlling stockholder transaction. The company can shift the burden of persuasion to any future plaintiffs to prove that the controlling stockholder transaction was not entirely fair (not supported by a fair process or resulted in an unfair price) if the company observes one of MFW’s dual procedural protections: either approval by a wholly independent special committee or by a fully informed uncoerced vote of a majority of stockholders unaffiliated with the controller.
The decision also provides some guidance on complying with the MFW Doctrine. The Court of Chancery had previously applied a test where a committee with a conflicted member could still be “independent” as long as a majority of the members were independent or the conflicted member did not “infect” or “dominate” the committee process. However, the court in Match rejected that test and held that the special committee must be wholly independent to disable the controller’s influence. Thus, when a company considering a controlling stockholder transaction wants to invoke the protections of the business judgment rule, it must pay close attention to ensure the independence of all of the special committee members.
[1] The court noted that derivative claims against controlling stockholders remain subject to the Court of Chancery Rule 23.1 demand futility requirement.
[2] The court also distinguished Aronson and other precedent in the demand futility review context from the substantive standard of review in controlling stockholder transactions.
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