Back in the 1980s, Delaware courts occasionally pushed the law in a direction that was at least arguably favorable to shareholders. Van Gorkom placed renewed emphasis on the duty of care and the need for directors to be informed. Unocal adopted a stricter version of the business judgment rule in the takeover context, allowing shareholders to potentially overcome unreasonable defensive tactics.
Those days are over. Disney more or less represented a reversal of Van Gorkom. Air Products and other poison pill cases more or less showed that Delaware courts no longer really apply a standard that involves meaningful consideration of reasonableness but instead favor something approaching a "just say no" approach to takeovers. The Blasius doctrine, one that adds additional protections to shareholders by imposing higher standards of review on management practices that impair the franchise is under assault (with the apparent goal to replace it with the emasculated standard of reasonableness in Unocal).
Process has largely replaced substantive review in the fiduciary duty context yet the courts do not ensure that the process is in fact effective. When cases arise where the failings of a process standard are apparent (Americas Mining leaps to mind), the courts ignore the structural problems with the approach and apply a band aid.
One place where shareholders still have a favorable standard of review and meaningful protections is in connection with transactions between the company and controlling shareholder. These transactions often come up when the controlling shareholder seeks to buy out the minority shareholders. Under traditional Delaware law, these transactions are reviewed under the standard of entire fairness. The Delaware courts provide, however, that companies can obtain benefits on review if they have the transaction reviewed by a special committee of independent and disinterested directors (with independent advisors).
In those circumstances, the burden of showing fairness essentially shifts. Rather than placing the burden of showing fairness on the board, shareholders have the burden of showing that the transaction was unfair. Thus, procedural protections provide management with an advantage (shifting the burden) but they do not eliminate fairness from the analysis.
This can be contrasted with the standard that applies to other conflict of interest transactions not involving a controlling shareholder. In those cases, transactions approved by an independent board result in a shift not in the burden but in the legal standard. Although there is no requirement that the person with the conflict be excluded from the decision making process, courts will nonetheless apply the duty of care and business judgment rule when reviewing the transaction. For more discussion on this standard, see Returning Fairness to Executive Compensation.
The result in the change of the legal standard is that considerations of fairness are eliminated. Instead, the conflict of interest transaction is reviewed under a process standard. As long as the board was informed, the transaction will be upheld, irrespective of the terms. This is most apparent in the context of executive compensation. Although the CEO is typically a board member and part of the decision making process, the courts apply the business judgment rule to the determination so long as the board has a majority of independent directors. As long as the board was informed (the process standard), the amount paid (fairness) is hardly relevant to the analysis.
So, in transactions with controlling shareholders, shareholders have a fighting chance to challenge deals by arguing that the amount paid was unfair. In transactions with other interested parties, shareholders of a board with a majority of "independent" directors have no meaningful chance of challenging a transaction as unfair.
The latest evidence of this trend is In re MFW Shareholders Litigation. In that case, MacAndrews & Forbes (M&F), a company owned by Defendant Ronald Perelman, held 43% of M&F Worldwide (MFW). M&F sought to purchase the remaining shares of MFW at $24 per share. The transaction was, however, conditioned upon approval of an independent committee of the board and approval of a majority of the shareholders unaffiliated with the controlling shareholder. Ultimately, an agreement was reached on a $25 price and the matter submitted to shareholders. Approximately 65% of the unaffiliated shares voted to approve the transaction.
As a transaction with a controlling shareholders, the standard of review would ordinarily have been entire fairness. In this case, however, the court, despite several Supreme Court decisions to the contrary, opted, for the first time, to apply the duty of care. The Chancery Court essentially concluded that the double layer of protection (approval by a special committee of independent directors and approval by a majority of the unaffiliated shares) was sufficient to eliminate any consideration of fairness from analysis.
We intend to look more closely at the analysis in this case. As we will show (and the court addressed), the opinion arguably conflicts with a series of Supreme Court cases in Delaware setting out the standard of review for transactions with controlling shareholders. Yet the safe prediction is that this case, if appealed, will be affirmed and shareholders will find themselves yet again with reduced protections under fiduciary duty principles.
Primary materials in this case can be found at the DU Corporate Governance web site.