MFW Rocked the Rules for Controller Takeovers in Delaware, will the Delaware Court of Chancery Apply that Same Revolutionary Framework to More Contexts?

By: Robert Lackey

The Delaware Court of Chancery has given controlling shareholders a ticket to get out of entire fairness review for freeze-out mergers—but now that same ticket might get them out of entire fairness review in other contexts as well. For most of the past three decades, Delaware law required the Delaware Court of Chancery to hold an entire fairness trial to review any transaction where a controlling shareholder stood “on both sides” of the deal, upon any well plead fiduciary duty claim.[1] By default, the controller bore the burden of establishing that the deal was intrinsically fair, but they could shift the burden onto a challenger to demonstrate unfairness by utilizing either an independent committee to validate the proceedings or by affirming the deal with a vote of the majority of the minority shareholders.[2] In its landmark MFW ruling, the Delaware Court of Chancery declared that a controlling shareholder doing a freeze-out transaction would be entitled to have only a business judgement review of their actions so long as they had used both an independent committee anda vote of the majority of the minority.[3] So long as the plaintiff challenging the transaction doesn’t plead that those conditions were not met, the controller gets the benefit of a highly deferential standard of review—that all but assures them of victory.[4]

This development had a major impact on the world of controller transactions in Delaware because it alleviated the immense cost of fighting back borderline-extortionist plaintiffs when a controlling shareholder attempts to merge with another corporation.[5] One of the goals of the Court of Chancery in making this mechanism was to deprive frivolous challenges to controller transactions of their “settlement value.”[6] More recently, there have been rumblings that the “dual protection” framework (requiring both the approval of a properly empowered independent committee and an approval of the majority of the minority shareholders) might be applied to even broader contexts.[7] Should this occur, there may be a massive disruption to other areas of controlling shareholder transactions in the same way that the original MFW decision disrupted the controller merger market.

While the Delaware Supreme Court has a quite narrow view of which portions of its prior decisions have precedential effect,[8] it has a long history of telegraphing future decisions with dicta, as it did for the MFW decision itself.[9] In that vein, the opinion in Tornetta v. Musk[10] has consolidated more indirect signals that the Delaware Court of Chancery is inclined to extend MFW’s dual protection framework to other contexts which previously invoked the entire fairness standard. Thus far, the expansion of the MFW framework has been implemented for the sale of a company to a third party,[11] as well as for a stock reclassification.[12]Musk was a breach of fiduciary action over executive compensation, and the Court of Chancery directly applied the MFW framework to analyze what standard of review should apply to the motion to dismiss even though there was no apparent binding authority dictating (or permitting) this.[13] This is framed as part of a pattern of Court of Chancery decisions extending the MFW framework to any context where a controlling shareholder is involved.[14] This cavalier approach to MFW, that it is the panacea for controlling shareholder involvement, could lead to that same framework being applied in circumstances even farther from the original MFW premise simply because they involve a question about the fiduciary duty of a controlling shareholder.

The MFW framework was created with an eye towards imitating the dual statutory requirements for an arm’s-length merger.[15] Lacking similar statutory requirements for these other situations, the MFW framework has become increasingly irrelevant, especially considering the extent of the decision’s binding effect.[16] This increasingly broad application of a narrowly t ailored framework may require intervention from the Delaware Supreme Court as none of its past rulings have declared a policy goal of all controlling shareholder actions to first pass through dual protections.

[1] See Kahn v. M & F Worldwide Corp., 88 A.3d 635, 642 (Del. 2014) (acknowledging the aforementioned standard as the court begins its analysis, though the opinion proceeds to affirm a new standard for future application); see also Itai Fiegenbaum, The Geography of MFW-Land, 41 Del. J. Corp. L. 763, 764-68 (2017) (documenting the predecessors of Kahn v. M & F Worldwide and arguing that MFW’s scope is limited to controlling shareholder takeovers).

[2] Id.; Kahn v. Lynch Commc’n Sys., Inc., 638 A.2d 1110, # (Del. 1994).

[3] See In re MFW S’holders Litig., 67 A.3d 496, 496-99 (Del. Ch. 2013); see also Kahn v. M&F Worldwide Corp., 88 A.3d 635, 635-38 (Del. 2014).

[4] See Fiegenbaum, supra note 1, at 774.

[5] See Fiegenbaum, supra note 1, at 765-68.

[6] See In re MFW S’holders Litig., 67 A.32 496, 504 (Del. Ch. 2013) (describing policy justifications for the new mechanism).

[7] Chelsea Naso, Delaware Courts Further Shape MFW, Appraisals in Q3, LAW360 (Oct. 11, 2019), https://www.law360.com/articles/1208728/delaware-courts-further-shape-mfw-appraisals-in-q3.

[8] See MFW, 67 A.3d at 520-24 (discussing at length the Delaware Supreme Court’s view of which portions of its opinions have a binding effect—chiefly that a prior case’s decision must have turned on a particular issue, or that the court must have been asked to address the issue in order for a prior decision to be binding for that same issue in the future).

[9] See In re Cox Commc’ns, Inc. S’holders Litig., 879 A.2d 604, 604-08 (Del. Ch. 2005); In re Trans World Airlines, Inc. S’holders Litig., 1988 WL 111271, at *1-4 (Del. Ch. Oct. 21, 1988).

[10] Tornetta v. Musk, 2019 WL 4566943, at *3 (Del. Ch. Sept. 20, 2019).

[11] See Id. (citing In re Martha Stewart Living Omnimedia, Inc. S’holder Litig., 2017 WL 3568089 (Del. Ch. Aug. 18, 2017)).

[12] See Id. (citing IRA Trust FBO Bobby Ahmed v. Crane, 2017 WL 7053964 (Del. Ch. Dec. 11, 2017)).

[13] See Id.

[14] See Id. (discussing previous Court of Chancery decisions which applied MFW in unusual contexts).

[15] See MFW, 67 A.3d at 501 (discussing how the dual framework “replicates” the statutory requirement).

[16] See Iman Anabtawi, The Twilight of Enhanced Scrutiny in Delaware¸ 43 Del. J. Corp. L. 161, 184 (2019) (highlighting the historical distinctions that the Delaware Supreme Court has drawn between stockholder votes that are required by the DGCL, and ones that are “merely” used to legitimize a transaction).