EBA HENDRICKSON—Against a backdrop of rising investor activism, controlling stockholders must now jump through more procedural hoops to obtain the deferential business judgment standard of review for transactions they take part in. In Kahn v. M&F Worldwide Corp. (“MFW”), the Delaware Supreme Court announced that the business judgment rule will only apply to “squeeze-out” mergers involving a controlling stockholder when the transaction is conditioned ab initio on: 1) approval from an independent and fully empowered committee that exercises due care in its negotiations and 2) approval from an informed, uncoerced majority of minority stockholders.
In a squeeze-out merger, the controlling stockholder seeks to acquire complete control of the corporation by essentially forcing the minority stockholders to sell their shares at an identified price. Failure to fulfill both of the requirements outlined in MFW would subject the transaction to the entire fairness standard of review, which entails a far greater level of judicial scrutiny.
This two-pronged “MFW Framework” is intended to “cleanse” potential conflicts of interest that may arise in “controller transactions” such as squeeze-out mergers and thereby mimic an arms-length transaction devoid of self-dealing tendencies. Since this case was decided in 2014, critics have argued that this dual-cleansing requirement for controller transactions has unjustifiably expanded beyond the squeeze-out merger context.
Those opposed to this expansion, commonly referred to as “MFW Creep,” argue that controller transactions outside the squeeze-out context should not be required to satisfy both cleansing mechanisms to obtain business judgment review. The rationale is that squeeze-out mergers present a uniquely grave threat to minority stockholders and are inherently coercive, so enhanced protections are justified in that particular context. Other controller transactions, like service agreements with a controlling stockholder, do not threaten the minority to the same extent. One prominent corporate law scholar, Professor Bainbridge, believes that the involvement of a controlling stockholder in a transaction is not enough to invoke the dual-cleansing requirement – the exclusion of and detriment to the minority must also be present.
In May 2023, the Delaware Supreme Court decided to address the debate surrounding MFW Creep. The case before the court, In re Match Group, Inc. Derivative Litigation, involves a spinoff of the dating site Match.com which was led by the corporation’s controlling stockholder. Minority stockholders challenged the transactions involved in the spinoff process, alleging that the controller unfairly benefitted at the minority’s expense.
The Delaware Court of Chancery ultimately granted the defendants’ motion to dismiss because the transaction satisfied the MFW dual-cleansing framework. The minority shareholders appealed, arguing that the MFW requirements were not met and that business judgment review was therefore improper.
The issue of whether the MFW framework should even apply to controller transactions outside the squeeze-out merger context was waived by the defendants in the Court of Chancery, but the Delaware Supreme Court made the unusual request of asking the parties to brief this issue in spite of the waiver. In its order, the Delaware Supreme Court expressed that it “is in the interests of justice to provide certainty to boards and their advisors who look to Delaware law to manage their business affairs.”
In response to the request, the Match Group defendants argued that the MFW framework should be restricted to squeeze-out mergers in their briefs and at oral argument. To support this position, the defendants asserted that Delaware courts have historically required that a conflicted transaction be cleansed by only one mechanism to acquire business judgment review. Therefore, the dual-cleansing requirement of the MFW framework should be an extreme rather than the norm. In opposition, the plaintiffs contended that MFW applies to all controller transactions, and any conclusion to the contrary would grant controlling stockholders dangerous levels of power.
Oral argument took place on December 13, 2023, so this monumental Delaware Supreme Court decision could be released in the near future. By clarifying the scope of MFW, this decision will significantly impact the power held by controlling stockholders and the protections afforded to minority stockholders. If the MFW dual-protection framework is limited to squeeze-out mergers, controlling stockholders will have to follow fewer steps to achieve business judgment review of other transactions they are involved in.
Some will find that this outcome invites greater potential for controllers to abuse their power, which could materially influence investor behavior. If, however, the Delaware Supreme Court decides to expand MFW to all controller transactions, this decision will mark a major victory for minority stockholders and critically alter the way corporations conduct transactions going forward.
