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The Delaware Supreme Court rules that the MFW doctrine applies to any transaction with controlling stockholders that results in a non-creditable benefit – disclosures

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LawFlash






April 5, 2024

In a case impacting corporations with controlling shareholders, the Delaware Supreme Court ruled that the MWF doctrine applies to any transaction in which a controlling shareholder receives a nontaxable benefit and that both MFW business judgment cleaning mechanisms must be satisfied is entirely fair to apply to such transactions.

As discussed in our December 2023 LawFlash, the Delaware Supreme Court considered two key questions: (1) whether the “MFW doctrine” applies all Control of shareholder transactions (not limited to squeeze-out mergers) and (2) whether both aspects of MFW The company must be content to make a business assessment of a transaction with a controlling shareholder in which it receives a non-taxable benefit.

Delaware's “MFW doctrine” generally provides that a transaction in which a controlling shareholder receives a nontaxable benefit – which is normally subject to the more stringent “entire fairness” test – is subject to the business judgment rule only if the transaction occurred from the outset subject to conditions, subject to approval by both (1) an independent, fully functioning special committee of independent directors and (2) a fully informed, unconstrained vote of the majority of disinterested shareholders. MFW is essentially designed to replicate arm's length negotiations by eliminating the inherent conflicts arising from the controlling shareholder's influence over the company and the board.

Whether a court applies the business judgment rule or the overall fairness standard of review may, but is not always, determine the outcome of litigation challenging the transaction.

EXPANSION OF THE MFW TEACHING

The MFW doctrine arose from Kahn v. M&F Worldwide Corp. (MFW), a case involving a “squeeze-out” merger in which the company's controlling shareholder attempted to forcibly pay out the company's remaining investors at a price determined by the controlling shareholder. However, since then MFWDelaware courts have applied the doctrine to a number of non-merger transactions, such as service agreements with a controlling shareholder and executive compensation for a controlling shareholder who was also the company's chairman.

IN RE MATCH GROUP INC. Derivative Litigation

The Match Group case involves minority shareholders' challenge to a reverse spinoff of the dating website Match.com by IAC/InterActiveCorp, the company's then majority shareholder, on the grounds that the transaction unfairly benefited the majority shareholder at the expense of the minority shareholders be.

Vice Chancellor Morgan T. Zurn of the Delaware Court of Chancery dismissed the challenge under the Business Judgment Rule and concluded that the company followed the procedures set forth in MFW. Vice Chancellor Zurn noted that while plaintiffs may have alleged that a member of the company's three-member special committee lacked independence, that did not negate the application of the business judgment rule because the majority of the company's special committee was independent. The plaintiffs appealed, arguing that the company failed to comply with the MFW doctrine because at least one of the directors on the special committee was not independent.

On appeal, the Delaware Supreme Court took an unusual step: It required the parties to provide supplemental notice as to whether the MFW doctrine should even apply outside the context of a freeze-out merger with a controlling shareholder, even though neither party did so had brought the matter before the Federal Chancellery.

On April 4, 2024, the Delaware Supreme Court issued its decision with the following ruling:

  • MFW Doesn't just apply to controller squeeze-outs: MFW applies to all transactions, not just squeeze-out mergers, in which “a controlling shareholder was on both sides of a transaction with the controlled entity and received a nontaxable benefit.”[1] This is where the court turned MFW to the reverse spin-off transaction, since the plaintiffs sufficiently asserted that the person responsible was on both sides of the transaction and received a non-creditable advantage.
  • Absolute fairness applies: Full fairness testing is the presumptive standard of review for all such controller transactions.
  • Just one of two MFW Tines can shift the load, but not the standard: A controlling shareholder can shift the burden of proof of complete fairness to the plaintiff by meeting only one of the two conditions MFW Prongs – through the proper use of either (1) a fully independent special committee or (2) an unaffiliated shareholder vote. However, using only one of these procedural tools does not change the standard of review – the entire fairness test applies, if not all MFWShareholder protection is fulfilled.
  • The price of reviewing the business judgment is both MFW Requirements: The court stated: “If the controlling shareholder wants to secure the benefits of review of the business judgment, he must follow all the rules.” MFW's requirements.” The court analyzed its precedent and found that a controlling shareholder generally exercises inherently coercive power over the board and other shareholders. To establish pre-trial evidence that negotiations are being conducted at arm's length and to obtain the protection of the business judgment rule, a controlling shareholder must be “irrevocably and publicly prevented from using its control to affect the outcome of the negotiations.” and to dictate the vote of shareholders.”[2]
  • There must be a special committee quite independent: To adequately replicate arm's length negotiations and eliminate the influence of a controlling shareholder, so the business judgment rule should apply, which is the underlying basis for the MFW Within this framework, each member of the special committee must be independent. It is not enough that the majority of committee members were independent or that the conflicting member(s) did not “infect” or “dominate” the committee process. The influence of a controlling shareholder cannot be “hindered” if a special committee is made up of even one member who is loyal to the controller. Here, the plaintiffs alleged that one of the committee members, who allegedly conducted the majority of the negotiations, had a long-standing close and intense personal and business relationship with the controller, based on admiration and gratitude, such that one could reasonably be expected to do so could assume that it was contradictory.

I'M LOOKING FORWARD TO

The decision provides a certain level of security in the market. While the exact boundaries of the MFW doctrine have been uncertain since the Delaware Supreme Court decision MFWTransactional lawyers have often advised companies to consider the MFW doctrine when considering a transaction with a controlling shareholder to limit the risk of subsequent litigation. Match group confirms that advice – any transaction in which a controlling shareholder is on both sides and receives a “non-taxable benefit” will enjoy the protection of the business judgment rule only if The company complies with both tenets of the MFW doctrine.

However, if a company cannot comply with all procedures (or cannot justify the time and cost of compliance). MFW, then it can still mitigate the litigation risks that arise from a majority shareholder transaction. The company may shift the burden of persuasion to future plaintiffs to prove that the transaction with the controlling shareholders was not entirely fair (not supported by a fair process or resulted in an unfair price) if the company adheres to any of these criteria MFW's dual procedural protections: either approval by a fully independent special committee or by a fully informed, non-coercive vote of a majority of shareholders unaffiliated with the person in charge.

The decision also contains some guidance regarding compliance with the MFW doctrine. The Chancellery had previously applied a test whereby a committee with a conflicting member could still be “independent” as long as the majority of members were independent or the conflicting member did not “infect” or “dominate” the committee process. However, the court is in To match rejected this test and decided that the special committee must be completely independent in order to exclude the influence of the controller. Therefore, if a company considering a majority shareholder transaction wishes to benefit from the protection of the Business Judgment Rule, it must pay close attention to ensuring the independence of all members of the special committee.