Delaware's Top Five Worst Shareholder Decisions for 2014 (#5: Kahn v. M & F Worldwide Corp. and the Elimination of Fairness in Controlling Shareholder Cases)
Beware anytime the Delaware courts claim they are making decisions because the result are good for shareholders. This is one of them.
Shareholders have few advantages in challenging board behavior. One of the few had been in connection with transactions involving controlling shareholders. For reasons best explained as a matter of historical accident, the Delaware courts provided benefits to boards that used what they deemed to be appropriate process when approving a transaction with a controlling shareholder.
Boards relying on a special committee consisting of independent directors did not have to establish the "entire fairness" of the transaction. Instead, the burden shifted to shareholders to establish the unfairness of the transaction. The burden shift could be constrasted with the law with respect to the approval of a conflict of interest transaction between the company and a director (often the CEO). In those circumstances, a board with a majority of independent directors received the protection of the business judgment rule. All of this is discussed in Disloyalty Without Limits: 'Independent' Directors and the Elimination of the Duty of Loyalty.
The differences in the two standards are stark. In the case of the shift of the burden, the substantive terms of the transaction matter. In the case of the application of the BJR, only process matters. It is enough that the board was independent and informed; for the most part, the substantive terms are irrelevant.
In Kahn, however, the Delaware Supreme Court began the process of eliminating this vestige of shareholder protection. In a case involving a controlling shareholder, the Court gave the board the benefit of the business judgment rule
- if: (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.
With process on top of process, the business judgment rule applied. And the value of the new process, particularly the addition of the requirement that approval be by a majority of disinterested shareholders? Without citation, the Court had this to say:
- The simultaneous deployment of the procedural protections employed here create a countervailing, offsetting influence of equal—if not greater—force. That is, where the controller irrevocably and publicly disables itself from using its control to dictate the outcome of the negotiations and the shareholder vote, the controlled merger then acquires the shareholder-protective characteristics of third-party, arm’s-length mergers, which are reviewed under the business judgment standard.
In fact, that is not likely to be true. The assumption is that disinterested shareholder approval is another method of determining fairness. The Court, however, did not discuss the shift in ownership configuration that takes place after a transaction has been announced. Risk averse shareholders sell; risk taking shareholders (hedge funds and arbitrageurs) buy. The buyers have every incentive to see the transaction close. As a result, they will favor the transaction, irrespective of the fairness of the offering price. Disinterested shareholder approval is not a categorical substitute for fairness.
So, there are traditional statements that ought to put the listener on alert. "The check is in the mail" is one of them. This will be a "benefit to minority stockholders" is another, at least if spoken by the Delaware courts.