In 2014, hearing litigation over the fate of M&F Worldwide, the Delaware Supreme Court set out rules as to what a controlling shareholder has to do in order to keep his/its decisions within the safe domain of the “business judgment rule.”
Last month, in a decision that may be of interest to hedge funds pursuing activist equity-based strategies, the Chancery Court expanded the significance of those rules.
This may also be of interest to merger-arb oriented hedge funds, since the decision’s bottom line will ease the way for mergers in certain circumstances.
Without further ado, the two decisions and their facts.
The Facts Behind MFW
M&F Worldwide, a company headquartered in New York, printed bank checks, manufactured scanning equipment, and provided various services. It was controlled MacAndrews & Forbes, a holding company which in turn was controlled by Ronald Perlman, a high-visibility entrepreneur and philanthropist. Perlman decided that MacAndrew & Forbes should buy out the minority equity in MFW that it didn’t already own.
Some of the shareholders within that minority Perlman didn’t control objected to the terms of the buy-out and brought suit. These plaintiffs, including Alan Kahn, were as it turned out only a minority of that minority, but they contended that the transaction should be reviewed by the courts under the rigorous “entire fairness” standard. Entire fairness means that there is a party that is in a position to control the transaction and has an interest in its outcome not identical to that of other parties with interests at stake, and that party does in fact control the outcome. In such a case the courts review de novo all aspects of the deal, including timing, initiation, and structure of the deal.
But the courts in Delaware, up to and including its Supreme Court, determined that “entire fairness” did not apply to this case, because Perlman didn’t exercise control, he relinquished it, establishing critical procedural safeguards to simulate an arm’s length market transaction. Approving of those procedures, the courts said that they could review this case only under the more lenient “business judgment” standard, and there it passed muster.
Specifically, then, the rule that developed from the MFW precedent was and is that a going-private buy-out transaction will be evaluated within the safe harbor of business judgment if (a) it is negotiated and approved by a special committee of independent directors, and (b) it is then approved by a majority of the shareholders not affiliated with the controlling shareholders.
The Facts Behind MSLO
In 2017, Delaware’s Chancery Court has extended the scope of the MFW rule. In MFW, Perlman was on both sides of the transaction: since MFW was going private, Perlman was both a buyer and a seller. But what if he had only been controlling on one side – selling to an arm’s length buyer? Would dissidents have been entitled to “entire fairness” review from the courts in that somewhat different fact pattern, even if the intra-corporate decision-making standard had been the same?
The Chancery Court now says, “No.” It applied the business judgment rule in that situation as well, in the recent decision In re: Martha Stewart Living Omnimedia, decided on August 18.
MSLO sold itself to Sequential Brands Group, in a deal that closed in December 2015. As the Chancery Court puts the matter, the “gravamen of the claim against Stewart is that she leveraged her position as controller to secure greater consideration for herself than was paid to the other stockholders. In a motion to dismiss the Complaint, Stewart denies that she was paid disparate consideration but argues that even if the Complaint pleads that she engaged in a conflicted transaction, the Court should review the allegations under the business judgment rule standard since the transaction was structured in a manner that provided meaningful protections.”
Vice Chancellor Joseph R. Slights III found that the pleadings were defective: the plaintiffs failed to plead that controlling shareholder Martha Stewart even was conflicted. But even if they had pleaded that properly, and even if she were conflicted, Slights found that the key protections were in place. The independent special committee approved the transaction, and it won a majority-of-the-minority vote of the shareholders [their “informed, uncoerced approval”}. So Ms Stewart was within the safe harbor of the business judgment rule, and Slights dismissed the complaint.