Delaware Supreme Court Sheds Light on Standard for Application of Business Judgment Rule to Controlling Shareholder Mergers - Articles

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Posted by: Matthew Lyon on Nov 15, 2018

The Delaware Supreme Court has clarified the standard it set forth in Kahn v. M&F Worldwide Co. (Del. 2014) (“MFW”) regarding when the business judgment rule applies to mergers proposed by a controlling shareholder that have been “cleansed” by a vote of a special committee of disinterested directors and the informed vote of the majority of minority shareholders. In MFW, the Delaware Supreme Court “held that business judgment review applied to a merger proposed by a controlling stockholder conditioned before the start of negotiations on” both sets of votes.

In the recent opinion, Flood v. Synutra International, Inc., Chief Justice Strine wrote for a divided court that in order for the business judgment rule to apply, the conditions of a majority vote of independent directors and minority shareholders must be in place ab initio, or at the beginning of negotiations. This requirement is to ensure “that controllers could not use the conditions as bargaining chips during economic negotiations.” The ab initio requirement should not be taken literally, however, to mean that the conditions of the “cleansing” votes must be in the controlling shareholder’s first offer. Rather, they need only be established before any “substantive economic negotiations” take place.

The opinion also clarified that if the business judgment rule applies, “a plaintiff can plead a duty of care violation only by showing that the Special Committee acted with gross negligence, not by questioning the sufficiency of the price.” A dissenting justice argued that the court should have maintained a bright-line rule and held that the ab initio requirement is only satisfied “when the Dual Protections are contained in the controller’s initial formal written proposal.” Otherwise, the controlling shareholder transaction should be subject to the less-forgiving “entire fairness” standard.