Delaware Supreme Court Clarifies MFW Framework In Take Private Transaction
The Delaware Supreme Court recently upheld a lower court’s decision to dismiss a shareholder lawsuit challenging a $125 buyout of Synutra International Inc., in a ruling that clarifies the framework laid out in Kahn v. M&F Worldwide Corp.
The state Supreme Court’s 2014 ruling in MFW held the deferential business judgment standard applies to a controlling stockholder ‘take private’ transaction when the transaction is conditioned “ab initio” on two procedural protections: the approval of a special committee of the board of directors, and the informed vote of a majority of the minority stockholders.
The case clarified a question left open in MFW about when the procedural protections will be determined to have been in place “ab initio” (Latin for, ‘from the beginning’).
Liang Zhang and entities related to him controlled 63.5 percent of Synutra International’s stock. In January 2016 he proposed taking Synutra - which, together with its subsidiaries, sells nutritional products for children and adults - private by acquiring the rest of the stock.
Zhang’s initial letter did not include the procedural protections outlined in MFW. However, a second letter that was sent shortly after a special committee was formed stipulated that Zhang would not proceed with the transaction unless it was approved by the committee and the holders of a majority of the voting stock that was not controlled by Zhang.
Two Synutra minority stockholders, Arthur Flood and Rudy Murillo, filed lawsuits in 2017 challenging the deal, arguing the $125 million buyout was not a fair price. The Court of Chancery dismissed the lawsuit in February, finding the MFW conditions were satisfied and the business judgment rule applied.
If the business judgment rule applies, there is a presumption that the defendants acted in good faith and in the best interest of the corporation's stockholders so that a court will not second-guess the defendant's business decision. This is more lenient than the entire fairness rule, which requires the defendants to prove the transaction is entirely fair to the corporation.
On appeal, Flood argued the lower court misapplied MFW. He maintained that because Zhang’s initial offer letter did not contain the special committee approval and majority-of-the-minority vote conditions, the business judgment rule did not apply.
In a ruling October 9, the state Supreme Court affirmed the lower court’s ruling and held that Zhang’s second letter satisfied the “ab initio” requirement as it came in the beginning of the process, before any economic negotiations had started.
Writing for the majority, Chief Justice Leo E. Strine Jr. said Flood was pushing for the “the brightest of lines: ”either the controller include the conditions in its first offer, or else lose out on the business judgment rule. The court said this “cramped reading” contradicts the use of the word “beginning” in everyday speech. The court noted, for instance, that a goal scored within five minutes of a 90-minute soccer match would be referred to as a goal at the beginning of the game.
“[A]s a matter of language, ‘from the beginning’ can encompass more than the narrow sense in which the plaintiff reads those words,” Justice Strine wrote.
More importantly, the court said the rigid reading Flood proposed was at odds with the reason why the MFW decision requires that the controller condition its offer early in the process. Doing so incentivizes controllers to pre-commit to the protections early on in order to take advantage of the business judgment rule, ensuring controllers can’t use the protections as bargaining chips during negotiations.
“Thus, so long as the controller conditions its offer on the key protections at the germination stage of the Special Committee process, when it is selecting its advisors, establishing its method of proceeding, beginning its due diligence, and has not commenced substantive economic negotiations with the controller, the purpose of the pre-condition requirement of MFW is satisfied,” the court wrote.
The justices acknowledged the adoption of this sort of rule could create some close calls in future cases. But it expressed confidence the Court of Chancery will be able to sort through these situations, saying the court is “expert in the adjudication of corporate law cases.”