The New York Court of Appeals Adopts Delaware’s Standard for Evaluating Shareholder Class Actions Challenging Going-Private Mergers
 

On May 5, 2016, in In the Matter of Kenneth Cole Productions, Inc., Shareholder Litigation, No. 54, 2016 WL 2350133 (N.Y. May 5, 2016), the New York Court of Appeals adopted Delaware’s standard of review of shareholder class actions challenging going-private mergers.  Specifically, New York courts are now required to evaluate board approval of such mergers under the deferential “business judgment rule”—provided certain shareholder-protective conditions are present. 

In Kenneth Cole, New York’s highest court was confronted with claims of breach of fiduciary duty in connection with the Kenneth Cole Productions, Inc. board’s approval of an offer to take the company private from its majority shareholder, Kenneth Cole.  The plaintiff shareholder urged the court to apply the “entire fairness” standard, which the court described as “plac[ing] the burden on the corporation’s directors to demonstrate that they engaged in a fair process and obtained a fair price.”  By contrast, the defendant directors sought application of the “business judgment rule” under which—according to the court—“the substantive determination of a committee of disinterested directors is beyond judicial inquiry.”  Significantly, the offer was from the outset subject to approval by (a) a special committee of independent directors and (b) a majority vote of the minority shareholders.

The New York Court of Appeals determined to apply the standard set forth by the Delaware Supreme Court in Kahn v. M & F Worldwide Corp., 88 A.3d 635 (Del. 2014) (“MFW”), which generally provides for evaluation of a going-private merger under the deferential business judgment rule when certain shareholder-protective conditions are present and under the more exacting entire fairness standard when those protections are not present.   

More specifically, New York courts will apply the business judgment rule to challenged going-private mergers when all six of the following conditions—as quoted from MFW—are present:

(i) the controller conditions the procession of the transaction on the approval of both a Special Committee and a majority of the minority stockholders; (ii) the Special Committee is independent; (iii) the Special Committee is empowered to freely select its own advisors and to say no definitively; (iv) the Special Committee meets its duty of care in negotiating a fair price; (v) the vote of the minority is informed; and (vi) there is no coercion of the minority.

The New York Court of Appeals highlighted that the MFW approach creates a “strong incentive” to structure freeze-out mergers in a manner likely to protect minority shareholders.  In particular, the dual protection of “a properly empowered, independent committee and an informed, uncoerced majority-of-the-minority vote” has the effect of “replicat[ing] an arm’s-length transaction.”

Applying the MFW test, the court found that the plaintiff in Kenneth Cole did not sufficiently allege that any of these six conditions had not been satisfied.  As a result, the court upheld the dismissal of the complaint.