The Delaware Supreme Court has clarified that controlling stockholder take-private transactions will be reviewed under the business judgment rule, rather than the less deferential entire fairness standard, if the controlling stockholder self-disables by committing to special committee and majority-of-the-minority approval before “economic negotiations” take place, even if the controlling stockholder fails to do so in its initial written offer.  See Flood v. Synutra Int’l, Inc., No. 101, 2018 (Del. Oct. 9, 2018).[1]

The Delaware Supreme Court first announced in Kahn v. M&F Worldwide Corp., 88 A.3d 635 (Del. 2014) (“MFW”) that business judgment review applies to a merger proposed by a controlling stockholder conditioned “ab initio” on two procedural protections: (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.[2]

In this case, the controlling stockholder’s initial proposal to take Synutra private did not include the dual MFW protections.  However, shortly after an independent Special Committee was formed, the controller sent a second letter making clear that the transaction was subject to both approval by the Special Committee and a majority-of-the-minority vote.  Critically, this second proposal was received before the Special Committee had engaged its own investment bank or counsel, before any projections were shared, and before any price negotiations took place.

Based on what the Court admitted was “ambiguous language” in MFW, the plaintiff argued in favor of “the brightest of lines,” and contended that a controller “must include the conditions in its ‘first offer’ or else lose out on the business judgment rule.”  The Delaware Supreme Court disagreed, explaining that it did not embrace such a “rigid” reading of MFW, and elaborating on the more flexible standard that should be applied.

Writing for a majority of the court, Chief Justice Strine explained that “what is critical for the application of the business judgment rule is that the controller accept that no transaction goes forward without special committee and disinterested stockholder approval early in the process and before there has been any economic horse trading.”  He noted that even if those protections were not included in the “first offer,” the key concern of MFW—“ensuring that controllers could not use the conditions as bargaining chips during economic negotiations”—would still be addressed if the protections were in place before any economic negotiations commenced.  Thus, he reasoned that “[u]sing this point in time fulfills the goals of disabling the controller for purposes of the negotiations and ensuring that the controller cannot dangle a majority-of-the-minority vote before the special committee late in the process as a deal-closer rather than having to make a price move.”

Justice Valihura dissented, arguing that the holding “invites factual inquiries that defeat the purpose of what should be more of a bright line and narrower pathway for pleading-stage dismissals in this context.”  The majority acknowledged that the rule “may give rise to close cases,” but concluded that the Court of Chancery is expert in the adjudication of corporate law cases, and could be trusted to apply the standard appropriately.

The Delaware Supreme Court’s important decision in Synutra provides further protection for controlling stockholder transactions that are structured to comply with MFW, even if for whatever reason the controlling stockholder’s initial proposal does not explicitly contain the MFW conditions.  The court cautioned, however, that its holding should not be read as an invitation to wait until a deal is negotiated before making a formal “first offer” with the MFW conditions – rather, the touchstone of a court’s analysis will be whether there was any “economic horse trading” before the conditions were put in place.

[1]  Cleary Gottlieb Steen & Hamilton represented Synutra’s special committee in obtaining dismissal of Plaintiff’s claims in the Delaware Court of Chancery and successfully argued the appeal before the Delaware Supreme Court on behalf of all defendants.

[2]  128 A.3d 992 (Del. 2015) (TABLE).