The Effect of Delaware Doctrine on Freezeout Structure and Outcomes

Guhan Subramanian is the Joseph Flom Professor of Law and Business at the Harvard Law School. The following post is based on a paper co-authored by Professor Subramanian and Fernan Restrepo of Stanford Law School. This post is part of the Delaware law series, which is cosponsored by the Forum and Corporation Service Company; links to other posts in the series are available here.

Historically, buyouts by controlling shareholders (also known as “going-private transactions,” “squeeze-outs,” and hereinafter “freezeouts”) were subject to different standards of judicial scrutiny under Delaware corporate law based on the transactional form used by the controlling shareholder to execute the deal. In a line of cases dating back at least to the Delaware Supreme Court’s 1994 decision in Kahn v. Lynch Communications, a freezeout executed as a statutory merger was subject to stringent “entire fairness” review, due to the self-dealing nature of the transaction. In contrast, in a line of cases beginning with the Delaware Chancery Court’s 2001 opinion in In re Siliconix Inc. Shareholder Litigation, a freezeout executed as a tender offer was subject to deferential business judgment review.

Subramanian (2007) presents evidence that, after Siliconix, minority shareholders received less in tender offer freezeouts than in merger freezeouts. Restrepo (2013) finds that these differences in outcomes occurred only after Siliconix, and that the incidence of tender offer freezeouts increased after this opinion, also supporting the idea that controlling shareholders took advantage of the opportunity provided by Siliconix. Subramanian (2005) describes why these differences in outcomes for minority shareholders create a social welfare loss and not just a one-time wealth transfer from minority shareholders to the controlling shareholder.

In In re Cox Communications, Inc. Shareholders Litigation, then-Vice Chancellor Strine, citing empirical evidence presented in the working paper version of Subramanian (2007) as well as other academic commentary, proposed in dicta a “unified approach” that would govern freezeout transactions: business judgment review for freezeouts that are approved by a special committee of independent directors and by a majority-of-the-minority shares, regardless of the transactional form used by the controller, and entire fairness review for freezeouts that do not have these procedural protections. Subsequent decisions by the Delaware Chancery Court have both accepted (Hammons Hotels, CNX Gas, MFW) and implicitly rejected (Cox Radio) this unified approach. With no definitive pronouncement from the Delaware Supreme Court, transactional planners have been left without clear guidance on the standard of judicial review for freezeout transactions.

This paper presents new empirical evidence on freezeouts in the pre- and post-Cox era. We construct a new sample of all freezeouts of Delaware targets announced between Siliconix and Cox (n=79) and a sample of all freezeouts of Delaware targets announced since Cox (n=66). We find that:

  • (1) the differences in outcomes during the pre-Cox era, as identified in Subramanian (2007) and Restrepo (2013), have disappeared since Cox;
  • (2) the incidence of freezeout tender offers has declined since Cox, consistent with practitioner intuition that the unified approach proposed in that decision reduced the benefits of the freezeout tender offer form relative to the freezeout merger form; and
  • (3) while the incidence of majority-of-the-minority conditions has increased since Cox, consistent with the intuition that more deals are attempting to fit into the unified approach blueprint, approximately half of merger freezeouts did not include MOM conditions.

Taken together, these findings suggest that:

  • (1) transactional planners seem to respond to even probabilistic changes in the Delaware case law regarding standards of judicial review;
  • (2) even without Delaware Supreme Court endorsement of the unified approach, the social welfare loss identified in Subramanian (2005) seems to no longer be present in the post-Cox era; but
  • (3) the Delaware Supreme Court may still wish to “finish the job” by endorsing the unified approach in order to promote MOM conditions, which provide an important check against a captured or conflicted special committee in a merger freezeout process.

The full paper is available for download here.

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