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Going Private Mergers: More Lenient Standard of Judicial Review Now Available

Going Private Mergers: More Lenient Standard of Judicial Review Now Available

A recent Delaware Supreme Court decision has changed the rules for post-transaction litigation review for “going-private transactions.” The court described the conditions necessary for such a transaction to be judged by the business judgment rule, rather than the more demanding “entire fairness rule.” This decision has national implications because of Delaware’s status as the leading state in corporate governance matters. 65 Miss. L.J. 477 at n. 86.

Specifically, in Kahn v. M&F Worldwide Corp., the Delaware Supreme Court affirmed the Chancery Court’s granting of summary judgment to the 43% shareholder of the target company and several of that company’s officers and directors which were sued following the 43% shareholder acquisition of the remaining outstanding stock.See Alan Kahn, et al. vs M&F Worldwide Corp., et al.

The underlying transaction was noteworthy because it was conditioned upon the fulfillment of two conditions precedent: (a) the 43% shareholder required the transaction to be negotiated and approved by a special committee of independent corporate directors; and (b) the 43% shareholder required that the transaction be approved by a majority of the remaining unaffiliated shareholders (i.e., a majority of the minority).

The Delaware Supreme Court described the appeal as one of first impression because of the requirement of the approval of both conditions before consummation of the challenged transaction. In deciding the defendants’ summary judgment motion, the Chancery Court rejected the plaintiffs’ argument that the transaction should be evaluated under the “entire fairness” standard, and, instead, used the more lenient “business judgment rule.” When the entire fairness standard applies, the board of directors has the burden to present evidence sufficient to demonstrate that it discharged all of its fiduciary duties and that this culminated with both fair dealing and fair price. In contrast, the business judgment rule presumes that the board of directors made their decision on an informed basis, in good faith, and with an honest belief that their action was in the best interest of the corporation and the plaintiffs have the burden to prove otherwise.

The Delaware Supreme Court clearly stated that for the business judgment rule to apply in a challenged going private transaction that all of the following criteria must be met: “(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.”

Thus, the takeaway is that if one is considering a going-private transaction use the adage that “an ounce of prevention is worth a pound of cure.” Since litigation often follows such transactions, follow the roadmap provided by the Delaware Supreme Court in Kahn v. M&F Worldwide Corp. to structure your transaction for subsequent judicial review under the business judgment rule where the dissatisfied minority shareholders have the burden of proof instead of the entire fairness rule where your board of directors has the burden of proof. You will be much more likely to win a dispositive motion and avoid a run to the courthouse steps or even trial.

If you are interested in reading additional commentary about this sea change in corporate governance law, go to American Bar and the National Law Review.

Phillip S. Sykes