Eight years ago, the Delaware Supreme Court in Kahn v. M&F Worldwide Corp. (“MFW”), affirmed then-Chancellor Strine’s decision holding that the business judgment rule could apply to controlling stockholder mergers if certain necessary conditions were met. In articulating the new standard that the Supreme Court would ultimately adopt, the Chancellor expressed optimism that controlling stockholders would be more likely to start embracing the ab initio conditions if the presumption of the business judgment rule would be available.
While the lure of the business judgment rule is unquestionably appealing to many controlling stockholders, others remain unwilling to face the execution risks that can arise from a non-waivable majority-of-the-minority condition or to limit their flexibility at the outset of negotiations for an undefined period of time. Recent Court of Chancery decisions demonstrate that the Court will carefully review compliance with the MFW conditions and apply entire fairness if those conditions are not met. At the same time, the Court has also shown its willingness, most recently in In re BGC Partners, Inc. Derivative Litigation, to find transactions entirely fair after trial where the evidence establishes a robust special committee process, and where the defendants have presented a strong record to support a fair price.
MFW and Application of the Business Judgment Rule
Where a controlling stockholder stands on both sides of a transaction, an agency problem arises, and under Delaware law, entire fairness review of the transaction is the default standard. As the Court of Chancery reminded us last year, however, “the common law of corporations recognizes that conflicted controller transactions may enhance firm value, and that the risk of litigation under the high bar of entire fairness may discourage such value-enhancing deals.” Acknowledgement of this risk led the Delaware Supreme Court in MFW to extend the business judgment rule to conflicted controlling stockholder transactions so long as the controlling stockholder commits ab initio to proceed only if the transaction is subject to both (1) the approval of an independent, adequately-empowered special committee that fulfills its duty of care, and (2) the uncoerced, informed vote of a majority of the minority stockholders.
The last few years have seen several decisions denying motions to dismiss where the Court found these two MFW requirements not met. These include instances where (i) a special committee had paused negotiations then reactivated and approved the transaction, but the controlling stockholder had substantive negotiations with a minority shareholder in the interim; (ii) minority shareholders objected to a special committee’s terms, and the controlling stockholder negotiated better terms directly with the minority; and (iii) there were inadequate disclosures to the minority before they approved the transaction. These recent decisions make clear that conditioning a transaction on compliance with MFW is no guarantee that the business judgment rule will end up applying in a subsequent litigation.
In re BGC Partners
Given this uncertainty, should a controlling stockholder retain flexibility in the process and aim to satisfy entire fairness? As the Court of Chancery reinforced last month in BGC Partners, defendants can prevail at trial, even under the more exacting entire fairness standard. To do so, however, it is critical that the evidence at trial reflect a robust special committee process and a strong record supporting fair price.
After trial, the Court found for the defendants in an action challenging the fairness of BGC Partners’ acquisition of Berkeley Point Financial from an affiliate of Cantor Fitzgerald. BGC purchased the entity for $875 million and simultaneously invested $100 million in a Cantor affiliate’s mortgage-backed securities business. Plaintiffs alleged that Howard Lutnick— controlling stockholder of both BGC and Cantor—caused BGC to undertake a deal that benefitted him at the expense of BGC’s stockholders, and that the transaction was not entirely fair.
While the evidence showed that Lutnick initiated the deal, had a financial incentive to cause BGC to overpay, and overstepped in identifying advisors for the special committee, the Court nonetheless found that defendants’ trial evidence “carried the day.” In particular, the Court found that the special committee and its advisors were independent and that Lutnick sufficiently extracted himself from the committee deliberations after it was fully empowered. The Court also found that the one special committee member whose claims were not dismissed on summary judgment had pushed back when needed and “worked tirelessly” on the committee’s behalf. The Court further found that Berkeley Point was “a unique asset particularly appealing to BGC,” that the price the committee agreed to pay was in line with its financial advisor’s recommendation, and that the price fell within what the Court concluded to be in the range of fairness.
The Court noted “some defects in the process,” including Lutnick’s hand in selecting committee members and advisors, as well as the slow roll of information and the compressed time period for negotiations. It concluded, however, that the deal was not timed to benefit Cantor, and, in fact, the committee had ignored Lutnick’s efforts to drive the timeline, declining to complete the deal on any of the timelines he proposed. Also, at least a majority of the committee members were independent throughout the negotiations, and the committee spent substantial time poring over information, meeting at least nine times, and reviewing multiple presentations about Berkeley Point and Cantor’s CMBS business. The Court also found that the committee’s advisors were independent, its multiple diligence requests were met, and a deal was ultimately agreed to, following an arm’s length process, where the committee obtained its desired structure, a favorable price, and had extracted “consequential concessions.” The Court also concluded that the prices for both the Berkeley Point acquisition and the Cantor investment were fair, relying heavily on a fairness opinion, along with expert opinions and testimony from both sides.
BGC Partners fits neatly within a continuing line of cases, both before and after MFW, where the Court of Chancery found for defendants after trial when applying entire fairness. For example, in In re Cysive, Inc. Shareholders Litigation, then-Vice Chancellor Strine found a controlling stockholder’s buyout of the company’s public float to be entirely fair. The Court noted that the decision to enter into the agreement was preceded by an active, aggressive search for a third-party buyer and included extensive market checks before and after execution. The Court also credited the work of the special committee, which was independent, devoted substantial time to its work, selected qualified, independent advisors, and bargained hard throughout the process. The Court further noted that the controlling stockholder had given the committee the leeway to fulfill its duties without any influence or coercion. Similarly, then-Chancellor Chandler in In re John Q. Hammons Hotels Inc. Shareholder Litigation, another pre-MFW decision, found a merger to be entirely fair even where the controlling stockholder allegedly used his position to negotiate an array of private benefits for himself that were not shared with the minority stockholders. In so doing, the Court found that the special committee was not coerced but, rather, its members were undisputedly independent, highly qualified, and had extensive experience in the hotel industry. The trial record also showed that the committee members understood their authority and duty to reject any unfair offer—which they exercised—and that they were thorough, deliberate, and negotiated at arm’s length over a nine-month period with two active bidders. The Court also considered extensive expert evidence presented by the parties and found that the defendants’ evidence of fair value was more convincing, persuasive, and thorough.
Even after MFW was decided, with the business judgment rule formally on the table, companies have still occasionally chosen to forgo that option and take their chances at trial with entire fairness review. On several occasions, defendants have prevailed. In 2017, Vice Chancellor Laster found that Sprint had engaged in “multiple instances of unfair dealing” in the first phase of the Sprint/Clearwire merger process. But after DISH intervened and a bidding war caused the price to increase from $2.97 to $5.00 per share, Vice Chancellor Laster found that the circumstances “changed the landscape so substantially as to render [those prior instances of unfair dealing] immaterial.” Earlier this year, former Vice Chancellor Slights found the Tesla/SolarCity transaction to be entirely fair after trial. There, the Tesla Board elected not to form a special committee but did condition the acquisition on a majority-of-the-minority vote. The Court acknowledged that the process was “far from perfect,” Musk was “more involved in the process than a conflicted fiduciary should be,” and certain Board members’ conflicts “were not completely neutralized.” The Court nonetheless found for the defendants because the Board had “meaningfully vetted the Acquisition,” Musk “did not stand in the way,” and, critically, the preponderance of the evidence established that Tesla paid a fair price.
While the business judgment rule undoubtedly remains appealing to many controlling stockholders, there may be reasons why some may choose not to go down the MFW path and instead embrace entire fairness review:
- The risks of a majority-of-the-minority vote may be high. Subjecting a buyout to a non-waivable majority-of-the-minority condition ab initio presents significant execution risks that could make the transaction simply unappealing.
- Controlling stockholders may want to retain a level of flexibility in the negotiation process that is simply unavailable under the MFW approach. To satisfy MFW, the Court has made clear that, when a special committee is formed and empowered, the committee is to be the exclusive bargaining agent for the minority early on. But a controlling stockholder may prefer to have some flexibility in terms of the negotiation process. The process in Dell provides an example of a controlling stockholder’s election to engage in direct negotiations with the minority.
For those controlling shareholders who elect not to adhere to MFW and therefore choose to go the “entire fairness” route, the following lessons for the controlling shareholder and independent directors of the controlled company are important both during the negotiation process and during preparation for litigation:
- A good special committee process is critical. The BGC Partners decision, as well as other entire fairness decisions, underscore the importance of a qualified, independent special committee that is diligent, retains its own independent advisors, and is fully empowered to negotiate without influence from the controlling stockholder. The committee’s process should be thorough, including meetings with and presentations from advisors, and should operate on its own timeline. The committee should be authorized to negotiate the best terms, extract meaningful concessions, reject offers that are unfair to the minority stockholders, and, if the controlling stockholder is open to being a seller and not just a buyer, entertain multiple bids. (The Tesla/Solar City transaction is likely an outlier for satisfying entire fairness without a special committee (although there was majority-of-the-minority approval).
- Powerful evidence on price is invaluable. One of the two prongs of the entire fairness test is “fair price.” Although courts look to the other prong—“fair process” (typically satisfied by a good special committee process)—as an indicator of fair price, courts often rely significantly on traditional forms of valuation analysis when determining whether the transaction had a fair price. Thus, while it is not typical for a controlling stockholder to obtain a fairness opinion when buying out the minority holders, it is advisable for any controlling stockholder that is anticipating having to satisfy entire fairness to have internally done the math up front to determine that the price likely will fall within the range of financial fairness. Even more importantly, any special committee that is approving or recommending a transaction will first need to have adopted, after proper deliberations and receipt of advice from management and advisors, a reasonable set of internal forecasts and obtained a fairness opinion premised on a financial analysis that uses those forecasts. Moreover, when preparing for an entire fairness trial, amassing supporting evidence of fairness of price, including expert evidence, will be critical.
- The supporting evidence must be memorialized by the special committee. There should be a comprehensive record, including minutes and meeting materials, that memorialize details of the committee’s process. Each of the committee’s diligence requests should be documented, along with the information provided in response. The record should reflect that the committee’s work was fully independent and unimpeded by any influence from the controlling stockholder. Any analyses regarding price, throughout the negotiations and continuing through closing, should be memorialized and consistent with the ultimate fair price evidence presented at trial.
- Prevailing at trial or reaching a settlement remains a viable option. BGC Partners and several other decisions underscore that entire fairness can and has been demonstrated, particularly where the trial record shows a robust, independent process and a fair price. And, short of trial, numerous transactions that have not embraced MFW have settled for amounts that controlling stockholders and their insurers have found reasonable.
 See, e.g., In re HomeFed Corp. Stockholder Litig., 2020 WL 3960335 (Del. Ch. July 13, 2020); In re Dell Techs. Inc. Class V Stockholders Litig., 2020 WL 3096748 (Del. Ch. June 11, 2020); Ligos v. Isramco, Inc., 2021 WL 3870679.