Delaware Court of Chancery Extends Business Judgment Protection to Control Shareholders Selling to a Third Party

Theodore N. Mirvis is a partner in the Litigation Department at Wachtell, Lipton, Rosen & Katz. This post is based on a publication by Mr. Mirvis, Paul K. Rowe, and Andrew J. Nussbaum. This post is part of the Delaware law series; links to other posts in the series are available here.

In 2014, the Delaware Supreme Court ruled that a control stockholder buying out the public minority interest could achieve the safe haven of business judgment review, provided that the controller structured the transaction to provide certain protections, notably special committee approval, full disclosure and a majority-of-minority vote condition. Kahn v. M&F Worldwide, 88 A.3d 635 (Del. 2014) (“MFW”). (Our previous post on the case is here.)

While MFW provided a clear path for controllers pursuing “squeeze out” transactions, its more general application to controller conflicts has not been addressed until now. The Court of Chancery has just issued an opinion holding that the presence of the three cleansing mechanisms identified in MFW will provide business judgment protection to controllers in contexts outside of squeeze-outs. In re Martha Stewart Living Omnimedia, Inc. Shareholders Lit., C.A. No. 11202-VCS (Del. Ch. Aug. 18, 2017) (“MSLO”).

In the MSLO case, stockholder plaintiffs contended that Delaware law required the application of the stringent entire fairness standard to employment and intellectual property rights agreements that the third-party buyer of MSLO negotiated with Martha Stewart, who controlled MSLO. The plaintiffs alleged that these personal arrangements “diverted” merger consideration to the controller from the public, even though Ms. Stewart received the same stated price per share as the public stockholders.

Ms. Stewart had agreed to structure a sale process for MSLO that included the three MFW features. Accordingly, the Court held that claims that she had breached any duties to stockholders were unfounded, and that the stockholder claims should be dismissed under the business judgment rule. Describing the fact pattern as a “one-sided conflict transaction” because the buyer was unaffiliated, the Court applied the reasoning of MFW, thereby rewarding Ms. Stewart’s disavowal of her control power with dismissal of the stockholder challenge.

The MSLO decision is clear evidence that the utility of the MFW approach for controllers is broad indeed. Despite the potential for conflict when a controlled company is sold or its ownership restructured, Delaware appears committed to providing strong-form protection against litigation challenges to many types of transactions structured along MFW lines.

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