Chancery Court Finds Conflicted Controller Spinoff Met MFW Prerequisites

Gail Weinstein is Senior Counsel, and Steven J. Steinman and Randi Lally are Partners at Fried, Frank, Harris, Shriver & Jacobson LLP. This post is based on a Fried Frank memorandum by Ms. Weinstein, Mr. Steinman, Ms. Lally, David L. Shaw, Mark H. Lucas, and Maxwell Yim, and is part of the Delaware law series; links to other posts in the series are available here. Related research from the Program on Corporate Governance includes Independent Directors and Controlling Shareholders (discussed on the Forum here) by Lucian Bebchuk and Assaf Hamdani. 

In In re Match Group, Inc. Derivative Litigation (Sept. 1, 2022), a stockholder of IAC/InterActiveCorp (“Old IAC”) challenged the multi-step reverse spin-off that was initiated by the company’s controller, a company allegedly indirectly controlled by Barry Diller. Vice Chancellor Morgan T. Zurn, at the pleading stage of litigation, found that the transaction met the MFW prerequisites for business judgment review and dismissed the case.

Background. While the transaction shifted some voting power from the controller to the minority stockholders, certain minority stockholders were dissatisfied with the transaction’s diversion of cash to the post-spin company and the allocation of assets as between the controller and the post-spin company. The reverse spinoff, which concededly was a conflicted controller transaction with the controller standing on both sides of the transaction, was approved by a special committee of the pre-spin company’s board and by the pre-spin company’s minority stockholders. The plaintiffs claimed breaches of fiduciary duties by the pre-spin company’s board, the controller, and the controller’s alleged controller—alleging that the transaction had been orchestrated by the controller to benefit the post-spin company but to the detriment of the minority stockholders. The court disagreed with the plaintiff’s contentions that the special committee was not independent, was not empowered to choose its own advisors and definitively “say no,” and did not meet its duty of care, and that the minority shareholder vote was not fully informed.

The court found that the special committee was independent. The court found that only one of the three members of the board’s “Separation Committee” had relationships with Old IAC sufficient to suggest possible lack of independence. That member had worked for Old IAC or its affiliates as an employee or director for over 20 years, and had relied on those positions as his primary employment, receiving at least $58 million for that work. The court concluded that these facts supported an inference at the pleading stage of “pecuniary materiality,” which, when viewed “holistically,” supported a reasonable inference that this member lacked independence from Old IAC. The court held, further, however, that the plaintiff’s allegations that this member was the lead negotiator for the Committee, and that the lead negotiator for Old IAC had reported to him when (before 2012) he was Old IAC’s CFO, did not support an inference that he had dominated the Committee. The court noted that there were no allegations that he controlled the information flow to the other committee members, undermined the Committee’s process, or exerted undue influence or control over the other members.

The court rejected the plaintiff’s contentions that one of the Committee members was non-independent based on her having acted as Old IAC’s outside counsel from 1994 until she retired from her law firm in 2015, and on her since then having served on the board of one of Old IAC’s affiliates (receiving almost $2 million in compensation for that service), and on her having served since 2020 as a director of Old IAC (as restructured after the transaction). As pled, the court stated, the allegations indicated only that this Committee member’s relationship with Old IAC and its affiliates had been that of “an arms’ length service provider, and no more.” The court noted that the plaintiff did not allege a deep “friendship between [this member] and anyone.” The court also rejected the plaintiff’s contentions that the third member of the Committee lacked independence on the basis that she had been the Vice President of Human Resources and later a Senior Vice President at Graham Holding Company (formerly The Washington Post Company) while Diller served on the GHC board.

The court found that the Committee was sufficiently empowered. First, the court noted, it was undisputed that the Committee had selected its own financial and legal advisors. The plaintiff had pointed out that some members of the team at the financial advisor the Committee had selected to represent it were also on an Investment Banking Division team “serving Old IAC and [one of its affiliates].” However, the court observed that that work involved underwriting services on two relatively small transactions, with no basis to conclude that the advisor “was ‘powerfully conflicted’ in favor of IAC.” Second, as to whether the Committee was empowered to “say no,” the plaintiff alleged that the Committee agreed to unfavorable terms because it believed it was contractually bound to do so under a tax-sharing agreement and investor rights agreement entered into in 2015 in connection with the IPO of its subsidiary holding its dating match businesses. The court noted that while such agreements “can complicate saying ‘no,’” in this case the plaintiff “specifically and clearly pled” that, as the reverse spin-off was not a “distribution,” the 2015 agreements did not apply to it.

The court found that the Committee met its duty of care. The court emphasized that a special committee can meet its duty of care by “negotiating diligently with the assistance of advisors.” A plaintiff’s disagreement with the committee’s strategy, dissatisfaction with the results of its negotiations, or view that the committee did not try hard enough, do not support an inference that the committee was grossly negligent and did not satisfy its duty of due care. The plaintiff alleged that the Committee “acted with a controlled mindset” given that it agreed either “too quickly or not quickly enough” with a long list of items during the negotiations. These complaints reflected disagreement with the Committee’s strategy, the court wrote, and “were not examples of reckless indifference or actions that are without the bounds of reason.” The court noted that the Committee met at least twenty times, consulted with its own financial and legal advisors, considered the implications of saying “no” to the Separation, and successfully negotiated benefits for the minority that were not included in Old IAC’s initial proposal. These concessions included favorable adjustments to Old IAC’s reclassification exchange ratio for reclassifying its high-vote and regular-vote shares in one class of regular-vote shares, a 57.5% reduction of Old IAC’s dividend request, and Old IAC’s commitment to bear 40% of the cost of the post-spin company’s options.

The court also rejected the plaintiff’s contention that the Committee failed to meet its duty of care by having knowingly engaged a conflicted financial advisor. The court noted that the banker had disclosed its conflicts to the Committee and its legal counsel “by letter and in at least two meetings.” The court observed that hiring a conflicted advisor is not per se grossly negligent; that the Committee retained the banker only after consideration and discussion of the conflict issue with its legal counsel; that the conflict was not a material one (such as advising both sides of a transaction would be); and that the conflict, and the Committee’s considerations and conclusions regarding it were disclosed in the proxy. “At bottom, [the plaintiff] failed to allege that [the financial advisor] failed or betrayed the Separation Committee in any way, or that the Separation Committee would reasonably have expected [it] to do so at the time of hiring.”

The court found that the minority stockholders were fully informed. The plaintiff contended that the proxy failed to disclose disabling conflicts with respect to Diller and IAC, based on “the deep and decades-long professional and financial ties” of two of the Committee members to Diller and IAC. The court stated that, because it had concluded that the plaintiff failed to plead allegations supporting an inference that the Committee members were conflicted, disclosures related to their supposed conflicts were immaterial.

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