Delaware Court Dismisses Challenge to Going Private Transaction
Last month, I received my copy of Business Organizations in Focus in the mail from Wolters Kluwer. I am incredibly grateful to have had the opportunity to work on this book with my wonderful co-author Deborah Bouchoux. Every so often, I will post about recent developments relevant to the book and to the teaching of business organizations. Please let me know if you have any questions or comments!
This purpose of this book update post is to alert readers to In re Books-A-Million, Inc. Stockholders Litigation, C.A. No. 11343-VCL (Del. Ch. Oct. 10, 2016), a recent decision from the Delaware Chancery Court in which Vice Chancellor Laster addressed issues relating to the obligations of a controlling stockholder in so-called going private transactions. The post relates to the material discussed in Chapter 11 (Changes in Corporate Structure and Corporate Combinations), and specifically to the discussion at pp. 664-679 concerning Kahn v. M&F Worldwide Corp., 88 A.3d 635 (Del. 2014).
In a going private transaction, a corporation’s controlling shareholder seeks to buy out minority shareholders via a statutory merger. See Del. Code Ann. tit. 8, § 251(a)–(c). Traditionally, Delaware courts subjected going private transactions to review under the entire fairness standard. The entire fairness standard is the highest level of scrutiny applicable to takeover challenges under Delaware law. It requires a reviewing court to evaluate the fairness of both the price (via the court’s own valuation assessment) and the process/course of dealing (focusing on the timing, structure, negotiation and disclosures, approval process, etc.) leading up to a challenged transaction. See Weinberger v. UOP, Inc., 457 A.2d 701, 711 (Del. 1983). Delaware courts initially placed the burden of demonstrating entire fairness upon the controlling shareholder-defendant. In its 1994 decision Kahn v. Lynch Commc’n Sys., Inc., 638 A.2d 1110, 1117 (Del. 1994), however, the Delaware Supreme Court left the entire fairness in place, but held that controller-defendants could shift the burden of persuasion under entire fairness review to plaintiffs by showing that the transaction was either (i) negotiated by a well-functioning special committee of independent directors or (ii) conditioned on the approval of a majority of the minority shareholders. The applicable standard of review for transactions employing both procedural devices remained an open question.
In 2014, the Delaware Supreme Court took up the standard of review issue left open by Kahn v. Lynch. In Kahn v. M&F Worldwide Corp., 88 A.3d 635, 644 (Del. 2014) (“the MFW Decision”), the Delaware Supreme Court held that a going private transaction involving both procedural protections for minority shareholders — i.e., a transaction that was (i) negotiated by a well-functioning special committee of independent directors, AND (ii) conditioned on the approval of a majority of the minority shareholders — should be reviewed under the highly deferential business judgment standard. Id. at 644.
This brings us to In re Books-A-Million, Inc. Stockholders Litigation. In Books-A-Million , a controlling stockholder (the Anderson family) sought to acquire the remaining shares of Books-A-Million, Inc. (“BAM”) from BAM’s minority stockholders. The family structured the proposal with the goal of satisfying the conditions of the MFW Decision so that the transaction would be reviewed under the BJR in the event of a challenge. In litigation challenging the buyout, however, minority stockholders of BAM alleged that the BJR standard should not apply because members of BAM’s special committee of independent directors acted irrationally and in bad faith, and thus contrary to the requirements of MFW. In particular, the plaintiffs claimed that the committee’s decision to recommend the transaction was irrational and in bad faith because (i) a third party had expressed interest in acquiring BAM at a price higher than that offered by the family, (ii) the committee concluded that pursuing the third party offer was not feasible because the family indicated it was unwilling to sell its controlling interest in BAM and (iii) the committee negotiated with the family and ultimately recommend that the family’s offer be accepted even though the price offered by the family was less than that proposed by the third party.
Vice Chancellor Laster rejected the plaintiffs’ theory and, after concluding that the family had complied with the other elements of MFW, reviewed the claim under the business judgment rule and granted defendants’ motion to dismiss the complaint. With this ruling, the Chancery Court confirmed several principles applicable to going private transactions:
- First, the Court held that a controlling stockholder is not obligated to sell its share of the company or otherwise facilitate a third party offer. The Vice Chancellor observed that the “rights of [controlling stockholders] include the right not to have to sell their shares,” and held that the Anderson family “did not breach its duties by refusing to sell its shares” to the third party offering a higher price.
- Second, the Court held that a controlling stockholder does not breach its fiduciary duties simply by offering to acquire the minority’s share, even if the controller’s offer is at a price lower than the price that might be available from a third party bidder. As Vice Chancellor Laster observed, the Anderson family “did not breach any duty to the corporation or its minority, nor did it overreach or threaten exploitation, by proposing a going-private transaction at a substantial premium to the market price” — even though that price that the family proposed was lower than the price offered by the third party.
- Third, the Court recognized that independent directors generally have no obligation to seek to dilute a control block to facilitate a third party transaction opposed by the controlling stockholder. In some cases, a board may consider seeking to dilute a controlling stockholder’s control position for purposes of facilitating the acquisition of the company by a third party. With its BAM decision, however, the Chancery Court confirmed that the directors have no obligation to do so.
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