Delaware Court Of Chancery Declines To Apply Business Judgment Deference To Take-Private Merger Because Of “Deficiencies” In MFW Protections, Including That The Conditions Were Not Irrevocable
On July 23, 2021, Chancellor Kathaleen St. J. McCormick of the Delaware Court of Chancery denied defendants’ motion to dismiss breach of fiduciary duty claims brought by a putative class of minority stockholders of Empire Resorts, Inc. (the “Company”) challenging the Company’s take-private acquisition by the Company’s majority shareholder. The MH Haberkorn 2006 Trust v. Empire Resorts, Inc., C.A. No. 2020-0619 (Del. Ch. Jul. 23, 2021) (Transcript). Plaintiffs alleged that a special committee approved the deal even though it undervalued the Company and asserted claims against officers, directors, the controlling shareholder and certain of their affiliates. Defendants argued that the transaction complied with the procedural protections necessary for deferential review—under the business judgment standard—of a merger process involving a controller pursuant to Kahn v. M & F Worldwide Corp., 88 A.3d 635 (Del. 2014) (“MFW ”). But the Court found the complaint adequately pleaded “deficiencies” in the MFW conditions, including that they were not “irrevocable.” Therefore, the Court applied the entire fairness standard and found that defendants did not show “conclusively” at the pleading stage that the transaction was entirely fair.
For a squeeze-out merger to be entitled to business judgment deference under MFW, “a controller must, ab initio, condition the transaction on approval by a special committee and a majority of the minority stockholders.” As the Court explained, the MFW framework “aims to replicate a third-party bargaining process free from a controller's coercive influence.”
Here, the controller and the Company entered into a letter agreement in 2016, which provided that the controller would not engage in a going-private transaction unless the transaction was subject to approval of both (i) a majority of disinterested board members or a special committee and (ii) a majority of shares entitled to vote that were unaffiliated with the controller. At the time the Company agreed to the transaction in August 2019, the term of the letter agreement was set to expire in February 2020.
The Court held that this impending expiration constituted a deficiency as to the timing requirements of MFW, even though the conditions were in place prior to the commencement of negotiations. The Court also noted that, according to the complaint, the controller signaled to the special committee that it would not commit to the MFW conditions beyond the contractual term. The Court explained that “for the ab initio requirement to mean anything and to accomplish the goal of eliminating otherwise-present bargaining pressures, the condition must be irrevocable.”
The Court also held that the complaint adequately pleaded that the majority-of-the-minority vote requirement had not been satisfied. Specifically, the merger was approved with only 53% of the minority shares voting in favor. But that “majority” would not have been achieved without the shares held by a joint venture partner to the Company. Moreover, the complaint alleged that the controller provided this partner information on the deal—without authorization of the special committee—as well as on the consequences for its relationship with the Company. The Court thus found that it was reasonably conceivable that the partner was “not an unaffiliated minority stockholder for the purposes of this MFW condition.”
The Court further found that the complaint adequately alleged an unfair process. The Court pointed to, among other things, alleged threats by the controller to cut off financing for the Company and acceleration of the merger’s timeline. The Court also noted that the complaint alleged leaks that may have been evidence of “back-channeling communications.” Additionally, the Court held that plaintiffs adequately alleged unfair price because, among other reasons, the company’s valuation analysis was based on projections that excluded “the impact of plans and issues that were allegedly lucrative,” as “discussed by the board in prior meetings.”