Delaware Supreme Court Holds That Business Judgment Rule Applies To Controller Transactions As Long As MFW Conditions Are In Place Prior To Economic Negotiation
10/16/2018On October 9, 2018, the Delaware Supreme Court affirmed a decision of the Delaware Court of Chancery dismissing a lawsuit brought by stockholders of Synutra International Inc. (the “Company”) challenging a controlling stockholder’s takeover of the Company. Flood v. Synutra Int’l, Inc., No. 101, 2018 (Del. Oct. 9, 2018). Plaintiffs asserted breach of fiduciary duty claims and argued that the transaction did not meet the requirements of Kahn v. M&F Worldwide Corp., 88 A.3d 635 (Del. 2014) (“MFW”) for business judgment review because the controller group’s initial proposal did not contain the MFW conditions—recommendation by a special committee and approval by a majority of the disinterested stockholders—although they were added later. As discussed in our prior post on this case, the Court of Chancery applied business judgment review (rather than entire fairness review) and dismissed the complaint because the controller announced the conditions before any negotiations took place. Affirming, the Delaware Supreme Court confirmed that MFW does not require that the conditions be included in the controller’s first offer, but instead that the controller condition its offer on the two key procedural protections “early in the process—i.e., before any substantive economic negotiations begin.” The Court also clarified that the sufficiency of the price is not subject to evaluation under the business judgment standard and affirmed the Court of Chancery’s finding that plaintiffs failed to allege that the Company’s special committee acted with gross negligence with respect to the negotiations.
Under MFW, the business judgment rule applies to a controller take-private transaction if it is “conditioned ab initio upon both the approval of an independent, adequately-empowered Special Committee that fulfills its duty of care; and the uncoerced, informed vote of a majority of the minority stockholders.” Plaintiffs argued that because the controller, which held 63.5% of the Company’s stock, failed to invoke the conditions in its first offer (even though it did so shortly thereafter, before negotiations commenced), the transaction did not comply with MFW. Rejecting this narrow reading of MFW, the Court clarified that the conditions need not be included in the initial overture, but must be in place “at the beginning stage of the process of considering a going private proposal and before any negotiations commence between the Special Committee and the controller over the economic terms of the offer.” The Court reasoned that this approach served the central aim of MFW—replication of the protective characteristics of an arm’s-length, third-party merger. The purpose of the timing requirement, according to the Court, is to preclude the use of agreement to the conditions “as a chit” in economic negotiations. Thus, “what is critical for the application of the business judgment rule is that the controller accept that no transaction goes forward without special committee and disinterested stockholder approval early in the process and before there has been any economic horse trading.”
Plaintiffs also contended that the special committee failed to obtain a more favorable price and thus violated its duty of care. The Court found that the Court of Chancery appropriately decided that the application of MFW precludes a substantive review of the economic fairness of the deal and, therefore, the special committee’s process must be assessed under a gross negligence standard. The Court thus affirmed the dismissal because the special committee employed qualified legal and financial advisors and “indisputably engaged in a deliberative process that cannot rationally be characterized as grossly negligent.” In doing so, the Court overruled footnote 14 of the MFW decision, on which plaintiffs’ relied, and thus made clear that business judgment review is available at the pleading stage.