“Optimizing” and Match: Bad Policy Threatens to Drive Bad Law

Greg Varallo is a Partner, Andrew Blumberg is a Senior Counsel, and James Janison is an Associate at Bernstein Litowitz Berger & Grossmann LLP. This post is based on their BLB&G memorandum 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 2021, Professor Larry Hamermesh and former Court of Chancery and Delaware Supreme Court judges Leo Strine and Jack Jacobs (together, the “MatchMakers”) wrote an article titled Optimizing the World’s Leading Corporate Law: A 20-Year Retrospective and Look Ahead (hereinafter “Optimizing”).[1] The article argues, among other things, that conflicted controller transactions other than controller squeeze-outs should be subject to business judgment review if approved by either a well-functioning special committee or a majority of minority shareholders on a non-coerced and fully informed basis, proposing to set aside 25 years of settled Delaware law to the contrary.[2] All but ignoring this precedent, the MatchMakers attempt to turn settled law on its head by claiming that the expansion of MFW’s defendant-friendly carve-out from universal application of entire fairness review of conflicted controller transactions reflects “MFW creep.”[3] The issue is the subject of further proceedings before the Delaware Supreme Court in the In re Match Group, Inc. Derivative Litigation appeal. The Match briefs, including several amicus briefs, have now been filed and argument has been set before the Court.[4]

We do not revisit here the Match plaintiffs’ arguments or those of the amici, but we do write to express our views with respect to several discreet points advocated in Optimizing and/or by Professor Hamermesh with which we strongly disagree.

First, the MatchMakers observe an inconsistency between, on the one hand, how Delaware courts treat non-squeeze out conflicted controller transactions and, on the other hand, Aronson v. Lewis[5]—as modified by United Food & Commercial Workers Union & Participating Food Industry Employers Tri-State Pension Fund v. Zuckerberg, 250 A.3d 862 (Del. Ch. 2020), aff’d, 262 A.3d 1034 (Del. 2021)—and Zapata Corp. v. Maldonado.[6]

Long-standing Delaware precedent, including Kahn v. Lynch and Kahn v. Tremont, apply the exacting entire fairness standard to conflicted controller transactions because of their inherently coercive dynamic.[7] Kahn v. Tremont stands for the proposition that employment of a single protection—either approval by an independent special committee or a majority of the minority stockholders—is insufficient to invoke business judgment review even for a non-squeeze out conflicted controller transaction.[8] Many subsequent decisions—including several Delaware Supreme Court decisions—say the same.[9] A logical extension of this line of cases is that the concept of inherent coercion should render demand per se excused in derivative challenges to conflicted controller transactions that invoke entire fairness review.

Yet Aronson and Zuckerberg hold that boards remain empowered to consider bringing derivative litigation against controllers. Aronson and Zuckerberg require stockholder plaintiffs to plead particularized allegations demonstrating that a majority of the board is incapable of considering a demand to sue the controller because, e.g., a majority of the board lacks independence of the controller. Aronson and Zuckerberg therefore elevate a board’s control of derivative litigation above the inherently coercive dynamic of conflicted controller transactions.

Why is this the case? Consistent with Vice Chancellor Laster’s analysis in In re Ezcorp Inc. Consulting Agreement Derivative Litigation,[10] we think the distinction is best thought of as a public policy carveout to the general rule that has animated our law for nearly three decades since Lynch. That public policy concern lies in business judgment principles, which emphasize the “freedom of directors” and their “managerial prerogatives” consistent with Section 141(a) of the Delaware General Corporation Law.[11] A narrow carveout to Lynch when analyzing demand futility concepts thus seeks to create salutary results, such as channeling “intracorporate” disputes to the board and “safeguard[ing] against strike suits.”[12]

The MatchMakers now seek to drive a proverbial truck through the narrow Aronson carveout. But we submit that if the resulting disconnect in our law is deemed untenable, the simpler and more intellectually honest approach is to eliminate the Aronson carveout. Still, we submit that the disconnect in the law is in fact tenable, in large measure because, in practice, it is quite narrow.

Indeed, derivative cases since Aronson have folded the presence of a controller into their analysis of director independence for demand futility purposes. As then-Chancellor Bouchard explained in In re BGC Partners, Inc., the “practical realities” of board engagement with a controlling stockholder make “the presence and influence of a controller” “an important factor that should be considered in the director-based focus of the demand futility inquiry under the first prong of Aronson, particularly on the issue of independence.”[13] Thus, although a controller’s presence does not automatically render demand futile, the presence of a controller is highly relevant, and pleading-stage dismissal of derivative conflicted controller transactions is therefore somewhat unusual. This relevant-but-not-dispositive approach leaves it in the capable hands of the Court of Chancery to manage the minor tension between Aronson and other decisional authority.

With respect to Zapata—a point not raised in Optimizing, but subsequently discussed by Professor Hamermesh—we see no inconsistency in the law.  Under Zapata, the recommendation of a special litigation committee (“SLC”) to dismiss a conflicted controller transaction is not reflexively afforded business judgment deference. In analyzing a dismissal recommendation by an SLC, the court as a first step decides whether the SLC acted independently and in good faith and, as a second step, exercises its own independent business judgment regarding whether dismissal is warranted.[14] This second step is designed for situations where “corporate actions meet the criteria of step one, but the result does not appear to satisfy its spirit, or where corporate actions would simply prematurely terminate a stockholder grievance deserving of further consideration in the corporation’s interest.”[15] Zapata step two requires the court to weigh how “compelling the corporate interest in dismissal is” and to “give special consideration to matters of law and public policy[.]”[16] Thus, far from providing business judgment deference to conflicted controller transactions reviewed by an SLC, Zapata lets the Court of Chancery subject an SLC’s dismissal recommendation to exacting scrutiny akin to entire fairness review.

Second, the MatchMakers observe that there are conflicted controller transactions that cannot reasonably be subjected both to approval by an independent committee and a majority of the minority stockholder vote. We again agree with the premise but disagree with the proposed solution. Where a conflicted controller transaction cannot reasonably be conditioned on the dual prongs of MFW, such transactions should be subject to entire fairness review. Although the MatchMakers apparently foresee doom and gloom from doing so, entire fairness has been the status quo in these cases for the past quarter century and has caused no tectonic shifts in Western civilization or Delaware jurisprudence. (Indeed, as advocates, we wish our results were so consequential). Importantly, most such instances give rise to derivative claims, and the Aronson carveout already serves as a meaningful pleading-stage hurdle for a stockholder plaintiff attempting to seize the reins of corporate machinery. Even were the Delaware courts to consider changes to our law to address conflicted controller transactions that cannot reasonably be subjected to the dual prongs of MFW, the proper approach would be to do so on a case-by-case basis. Overturning an entire doctrine to address a problem of primarily academic interest would be inconsistent with how the Delaware Supreme Court has traditionally operated.[17]

Third, the MatchMakers seem to suggest that there will be a proliferation of litigation if the Delaware Supreme Court confirms that non-squeeze out conflicted controller transactions are subject to entire fairness review when approved by either (but not both of) a well-functioning special committee or a majority of the minority stockholders. Here, we fundamentally disagree. The situation would be no different than it has been for the past quarter century, at least since Kahn v. Tremont made clear that the use of only a special committee did not allow a controller to escape entire fairness review. A ruling in favor of the plaintiffs on this point in Match, therefore, would cause no increase in litigation, much less a proliferation. . From our vantage point, the MatchMakers’ proposal would do little more than make a ‘perfect match’ for corporate controllers.

Fourth, we understand the MatchMakers to suggest that the outcome of a cost-benefit analysis of their proposal is unclear, i.e., that it is hard to compare the benefit of reduced litigation costs, on the one hand, and permitting controlling stockholders to occasionally skim, on the other hand. We again fundamentally disagree. The combination of the Aronson carveout and the ubiquity of D&O insurance renders the benefits of reduced litigation minimal (and, in fact, because the litigations are frequently derivative, the company often receives a monetary benefit when the litigation is resolved).[18] Conversely, as Vice Chancellor Laster discussed in Ezcorp, it is well established that “‘[m]anagers and controlling shareholders (insiders) can extract (tunnel) wealth from firms using a variety of methods.’”[19] Tunneling, in turn, reduces firm value. Adopting the MatchMakers’ position would expand controllers’ avenues for tunneling, undermine investor confidence in Delaware courts to police controller tunneling, and reduce the value of controlled Delaware corporations.

In sum, while the MatchMakers raise some interesting theoretical points, they fall far short of demonstrating that overruling decades of precedent would be in the best interest of Delaware corporations and investors. Sound policy supports the past quarter century of case law that subject conflicted controller transactions to entire fairness review absent compliance with MFW. To depart from this well-understood and well-functioning policy would sanitize controller conflicts in the opaque name of “optimization.”

It is said that bad facts make bad law. Here, the MatchMakers’ misguided policy suggestions threaten to make very bad law indeed. Delaware should not try to outrace Nevada to create a ‘judgment-free zone’ for corporate controllers. The structure of our law—while far from perfect in application—is built on sound legal, social, and economic policy. It should be changed only incrementally and then only on a showing of real need, and not merely to facilitate a wealth transfer from the investing public to powerful controlling stockholders.


[1] Lawrence A. Hamermesh, Jack B. Jacobs, Leo E. Strine, Jr., Optimizing the World’s Leading Corporate Law: A Twenty-Year Retrospective and Look Ahead, 77 Bus. Law. 321 (2022).

[2] See Kahn v. Tremont Corp., 694 A.2d 422, 428 (Del. 1997) (holding that a purchase of shares from one controlled company by another was subject to entire fairness and that the standard of review “remains applicable even when an independent committee is utilized because the underlying factors which raise the specter of impropriety can never be completely eradicated and still require careful judicial scrutiny.”); Emerald P’rs v. Berlin, 726 A.2d 1215 (Del. 1999) (acquisition of 13 companies from controller by controlled company subject to entire fairness review despite approval by independent committee); and Levco Alternative Fund Ltd. v. Reader’s Digest Ass’n, Inc., 803 A.2d 428 (Del. 2002) (challenge to recapitalization transaction subject to entire fairness review despite approval by special committee).

[3] On October 12, 2023, the Weinberg Center hosted the Delaware Governance Institute, which included a panel titled “Conflict Transactions under a Microscope: When does (and should) MFW apply?”  During his presentation on that panel, Professor Hamermesh first expressed regret for using the phrase “MFW creep” and then doubled down and suggested that the MatchMakers should instead have used the phrase “MFW gallop.”

[4] See generally In re Match Gp., Inc. Deriv. Litig., No. 368, 2022 (Del. 2022). The authors’ firm is counsel to some of the amici in the Delaware Supreme Court. See id., Dkt. 140.

[5] 473 A.2d 805 (Del. 1984).

[6] 430 A.2d 779 (Del 1981).

[7] Kahn v. Lynch Commc’n Sys., Inc., 638 A.2d 1110, 1116 (Del. 1994) (“Entire fairness remains the proper focus of judicial analysis in examining an interested merger, irrespective of whether the burden of proof remains upon or is shifted away from the controlling or dominating shareholder, because the unchanging nature of the underlying interested transaction requires careful scrutiny.”) (internal quotation marks omitted); see also id. at 1116–1117 (“The policy rationale for the exclusive application of the entire fairness standard to interested merger transactions has been stated as follows: . . . ‘Even where no coercion is intended, shareholders voting on a parent subsidiary merger might perceive that their disapproval could risk retaliation of some kind by the controlling stockholder.’”) (quoting Citron v. E.I. Du Pont de Nemours & Co., 584 A.2d 490, 502 (Del. Ch. 1990)); Tremont, 694 A.2d at 428 (justifying entire fairness review for controller transactions “because the underlying factors which raise the specter of impropriety can never be completely eradicated and still require careful judicial scrutiny” and stating “[t]his policy reflects the reality that in a transaction such as the one considered in this appeal, the controlling shareholder will continue to dominate the company regardless of the outcome of the transaction.”); see also Weinberger v. UOP, Inc., 457 A.2d 701, 710 (Del. 1983).

[8] See 694 A.2d at 428–29.

[9] See supra n.3; see also, e.g., In re Ezcorp. Inc. Consulting Agreement Deriv. Litig., 2016 WL 301245, at *11 (Del. Ch. Jan. 25, 2016); Berteau v. Glazek, 2021 WL 2711678, at *12­–15 (Del. Ch. June 30, 2021) (explicitly rejecting the argument that a special committee is sufficient to restore business judgment review).

[10] See 2016 WL 301245, at *24­–30 (Del. Ch. Jan. 25, 2016).

[11] Aronson, 473 A.2d at 811–812.

[12] Id.

[13] 2019 WL 4745121, at *8 (Del. Ch. Sept. 30, 2019) (Bouchard, C.).

[14] Zapata, 430 A.2d at 789. Although Zapata arguably suggests that the second step is discretionary, at least some members of the Court of Chancery have said that they would always apply the second step of Zapata in light of how the law developed since that case was decided. See, e.g., Group 42 Inc., et al. v. Paul Kesterton, et al., C.A. No. 5906-VCL, 145:2–10 (Del. Ch. Nov. 2, 2012) (TRANSCRIPT) (stating that the second step of Zapata is either “conducted implicitly under the first prong” of the test or “conducted expressly” as a separate step).

[15] Zapata, 430 A.2d at 789.

[16] Id.

[17] See, e.g., Brookfield Asset Mgmt., Inc. v. Rosson, 261 A.3d 1251, 1278–1280 (Del. 2021) (explaining the conditions under which the court will respect stare decisis and stating that “[m]ere disagreement with the reasoning and outcome of a prior case, even strong disagreement, cannot be adequate justification for departing from precedent or stare decisis would have no meaning.”) (emphasis in original); see also E. Norman Veasey, The Defining Tension in Corporate Governance in America, 52 Bus. Law. 393, 399 (1997) (“The fact is that courts sit like clams in the water; they wait for whatever is brought to them by the tides[.] . . . We do not issue advisory opinions, and we only rule on matters that are brought before us in which there is a real case or controversy.”) (internal quotation marks omitted).

[18] Moreover, corporate controllers have alternative deal structures and financing methods available to them to further reduce costs. See Ezcorp 2016 WL 301245, at *23 (“Importantly, it is the controller, not the court, who creates the scenario calling for substantive fairness review. If a controller does not want to assume fiduciary obligations, then it can choose not to issue stock to the public, or not to acquire a dominant stake in a publicly funded firm. If a controller wants to use other people’s money, it can do so using debt, which establishes a contractual relationship that does not carry fiduciary obligations.  Or a controller can use an alternative entity vehicle and eliminate or restrict fiduciary duties. If a controller chooses the corporate form and issues equity, then the controller need not serve as a compensated executive or consultant.  Even at that point, the controllers can obtain business judgment review by following M & F Worldwide, having a committee approve the compensation arrangement, and then submitting it to the disinterested stockholders for approval at the next annual meeting.  Only if the controller makes choices in a way that invites entire fairness review will that framework come into play.”).

[19] 2016 WL 301245, at *21.

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