Standard of Review Changes for Freeze-Out Mergers

On May 29, 2013, the Delaware Chancery Court, in its landmark decision of In re MFW Shareholders Litigation (MFW), held that the “deferential business judgment rule” is the correct standard of review for freeze-out mergers, as opposed to the more rigorous “entire fairness standard.” This decision requires that a freeze-out merger, from the inception of merger negotiations, be subject to both (1) negotiation and approval by a fully empowered special committee of independent directors and (2) ratification by a fully-informed, uncoerced vote of the majority of the minority of outstanding shares.

In MFW, the initial merger proposal went so far as to guarantee that no adverse action would be taken if the committee or the minority shareholders did not vote to approve the proposed merger. The MFW committee was found to have satisfied its duty of care by meeting eight times over the course of three months, choosing its own legal and financial advisors after interviewing several, considering other options for sale and whether it could solicit a higher outside bid, and negotiating with the acquirer to raise its offer price by a dollar, which was within all five ranges of stock value provided by the committee’s financial advisors. Further, the court rejected the plaintiff’s claims of interested directors based on past business relationships, deeming casual friendship as immaterial to the overall merger negotiation. Lastly, because MFW had disclosed a complete history of the merger, the committee’s recommendation, and the details of the negotiations, the court held that the minority shareholders were fully informed to approve the merger.

The underlying premise of the Chancellor’s decision is that the controlling shareholder and the board of directors protected the interests of the minority shareholders. MFW is likely to incentivize controlling shareholders to provide minority shareholders with the procedural protections when proposing a merger because doing so will give controlling shareholders the shield under the deferential business judgment rule.

However, MFW does not entirely negate existing Delaware precedents by permitting a burden shift from entire fairness review to business judgment rule. If there is any uncertainty about obtaining minority approval or if a controlling stockholder is willing to expend the litigation costs of entire fairness review, the court is likely to hear the case notwithstanding MFW.