Important MFW Developments

The MFW framework provides a pathway to business judgment review, rather than entire fairness review, of transactions involving a conflicted controller or a conflicted board (i.e., where a controller, or a majority of the board, has a personal interest in or will receive a non-ratable benefit from the transaction). The MWF prerequisites for business judgment review of such a transaction are that the transaction was, from the outset, conditioned on approval by both (i) an independent special committee of directors that fulfilled its duty of care and (ii) a majority of the unaffiliated stockholders in a fully informed, uncoerced vote. If such a transaction is challenged, and the MFW prerequisites were met, then any fiduciary breaches by the controller or directors are “cleansed”—with the result that any claims of breach of fiduciary duties are dismissed at the early pleading stage of litigation.

Delaware Supreme Court Considers Eliminating MFW Prerequisites for Business Judgment Review of Conflicted Transactions Other than in the Squeeze-Out Merger Context—Match Group

Since MFW was affirmed by the Delaware Supreme Court in 2014, the Delaware courts have expanded the doctrine to apply to a broad variety of conflicted transactions, both within and outside the M&A/PE context. In various cases, the court has applied the MFW framework to, for example, a reverse spin-off initiated by a controller, a de-SPAC merger, a charter amendment that prolonged a company’s dual class structure, a redemption of tracking stock, consulting arrangements with a controller, and a compensation package for a controller. Then-Chancellor Bouchard, applying MFW to a stock reclassification (in Ahmed v. Crane (2017)), stated that there was “no principled basis on which to conclude that the dual protections in the MFW framework should apply to squeeze-out mergers but not to other forms of controller transactions.” In the Court of Chancery’s 2022 Match Group decision, Vice Chancellor Zurn observed that, with each new application of MFW, the Delaware courts offer “incentive for controllers to embrace the procedural approach most favorable to minority investors, with the incentive of obtaining the protection of the business judgment rule standard of review.”

Recently, however, a debate has emerged as to whether the MFW prerequisites should have to be met to cleanse fiduciary breaches in all conflicted transactions (as has been the case), or whether the MFW prerequisites for cleansing fiduciary breaches should be required only in going private mergers (so-called squeeze-out mergers), which was the context in which MFW itself was decided—and all other types of conflicted transactions should be subject to business judgment review without compliance with MFW so long as the merger was approved either by the independent directors or the minority stockholders.

This narrower approach to MFW applicability was advocated in a 2021 article by Delaware law experts Lawrence Hamermesh (Professor of Law at University of Pennsylvania), Jack B. Jacobs (former Chief Justice of the Delaware Supreme Court), and Leo E. Strine, Jr. (former Chancellor of the Court of Chancery). The authors concede that fiduciary breaches in a controller’s freeze-out merger should be subject to the higher MFW standards because, in such a transaction (in which a controlling stockholder acquires complete ownership of the company), by definition, the controller benefits at the expense and to the exclusion of the minority stockholders. In this context, “the dangers of overreaching are particularly grave” and it makes sense to apply the MFW prerequisites which replicate the protections afforded to stockholders in a third party arms-length merger. However, they argue, in today’s world, with primarily institutional stockholders, sophisticated independent directors, and robust disclosure requirements, outside the controller freeze-out context, MFW procedures are not necessary to protect minority stockholders from a controller’s influence or conflicts, and either independent directors’ or minority stockholders’ approval should be sufficient to invoke business judgment review.

In a significant recent development, the Delaware Supreme Court, sua sponte, requested that parties in the appeal of the Court of Chancery’s decision in In re Match Group brief for the Supreme Court the issue whether MFW should apply to all conflicted controller transactions or only to squeeze-out mergers. In the litigation below, Vice Chancellor Morgan T. Zurn had held that the MFW prerequisites were satisfied in the challenged reverse spinoff in which the controller allegedly obtained a non-ratable benefit—and she thus applied business judgment review and dismissed the case. On appeal, the Supreme Court, conceding that the parties had waived this very issue in the litigation below, stated that it was requesting briefing on this issue because “resolving the issue…is in the interests of justice to provide certainty to boards and their advisors who look to Delaware law to manage their business affairs.”

We note the following:

• Open issue for now. Pending the Supreme Court’s decision in Match Group, the court may now question in stockholder challenges to conflicted-controller transactions whether MFW cleansing applies in a non-squeeze-out context—or, instead, business judgment standard applies so long as the transaction was approved by the independent directors or the minority stockholders.
• Context matters when the court determines MFW applicability. We note that, when MFW potentially applies, the Court of Chancery must make numerous relatively subjective determinations in concluding whether the MFW prerequisites have been met. As a court of equity, the Court of Chancery takes into account the overall factual context when making its determinations. When the facts and circumstances enerally suggest exploitation of the minority stockholders (or, conversely, suggest a good faith effort and hard work on behalf of the minority stockholders), these will tend to influence the court’s conclusions as to whether, for example, the directors were independent of the controller; the controller did not exert influence that tainted the process; the approval conditions were in place from “the outset”; the special committee functioned effectively; the disclosure was sufficient for a “fully informed” stockholder vote; the vote was not subject to implicit coercion; and so on. That said, we note that even when MFW has been applied, some cases involving apparently egregious fact situations have passed judicial muster (see, for example, the discussion of BridgeBio below).
• Reincorporation in Nevada. There has been much public commentary over the reincorporation of some Delaware companies to Nevada—a state that has sometimes been referred to as the “legal wild West” for, among other things, its more permissive standards of review for conflicted controller transactions. Elon Musk (the controller of Twitter and other companies) recently reincorporated Twitter (now X Corp.) in Nevada following results unfavorable to him in various Delaware litigations. The controller of TripAdvisor has also stated that he is reincorporating his companies in Nevada, explicitly for the purpose of being able to engage in transactions with his companies under less stringent standards than afforded under Delaware law. While Nevada may attract some number of controlled companies, we do not expect non-controlled companies to seek to leave Delaware given the unlikelihood of stockholder approval for such a move. Moreover, any company reincorporating to Nevada would be foregoing the benefits provided by Delaware’s established and expansive body of corporate law and highly specialized and sophisticated judiciary.

A Board’s Ignoring a Superior Competing Offer Does Not Defeat Business Judgment Review for a Merger Approved Under the MFW Framework—Smart Local Union v. BridgeBio Pharma

The Delaware Supreme Court, in a decision issued August 9, 2023, affirmed the Court of Chancery’s decision, in Smart Local Unions & Councils Pension Fund v. BridgeBio Pharma, Inc. (Dec. 29, 2022), that a conflicted controller merger satisfied the MFW prerequisites for business judgment review (leading to dismissal of the plaintiffs’ claims), even though a credible competing bidder made a substantially higher offer than that made by the controller and that bid was rejected by the controller and not considered by the board. The Supreme Court’s one-page decision, without commentary, upheld the dismissal based on the reasoning set forth in the lower court’s opinion.

The case reinforces that Delaware law does not require a controlling stockholder to accept a sale of the company or the controller’s shares to a third party. The court of Chancery had expressly rejected the plaintiff’s policy argument that business judgment review under MFW should never be applicable where a bid superior to the controller’s is made and the controller refuses to sell. The decision clarifies that such a refusal by a controller does not preclude business judgment review of the controller’s transaction under the MFW framework.

The court then found that the MFW prerequisites were satisfied—that is, the controller’s transaction had been approved by an effectively functioning independent committee and by the stockholders unaffiliated with the controller in a fully informed and uncoerced vote. Therefore, business judgment review applied and the plaintiff’s claims were dismissed.

The court rejected the plaintiff’s argument that the special committee’s failing to pursue the competing bid and accepting the controller’s lower priced bid indicated that the committee had not fulfilled its fiduciary duties in the sale process. The court observed that the special committee had responded to the competing bidder’s proposals, had pushed the controller to consider selling its shares, and had caused the full board to discuss the proposals. The court also rejected the plaintiff’s argument that the disclosure to stockholders was inadequate as the competing bidder’s identity was not revealed. The court noted that the disclosure informed the stockholders that the competing bidder was a bona fide purchaser that could close the transaction and that its bid was superior to the controller’s offer. Finally, the court rejected the plaintiff’s argument that the minority stockholders’ vote was subject to situational coercion. The court stated that, in this case, the target was not a distressed company and had other viable alternatives to the controller’s proposed merger, and the status quo was not so “undesirable or unpleasant” that it forced the minority stockholders to vote for the merger.