In a case with implications for companies with controlling stockholders, the Delaware Supreme Court held that the MWF Doctrine applies to any transaction involving a controlling shareholder receiving a non-ratable benefit, and both MFW cleansing mechanisms must be satisfied for business judgment review, rather than entire fairness, to apply to such transactions.
As discussed in our December 2023 LawFlash, the Delaware Supreme Court has been considering two key questions: (1) whether the “MFW Doctrine” applies to all controlling stockholder transactions (not limited to squeeze-out mergers), and (2) whether both prongs of MFW must be satisfied to invoke business judgment review of a transaction with a controlling stockholder in which it receives a non-ratable benefit.
Delaware’s “MFW Doctrine” generally provides that a transaction involving a controlling stockholder receiving a non-ratable benefit—typically subject to the more exacting “entire fairness” review—will be subject to the business judgment rule only if the transaction is conditioned, ab initio, on approval by both (1) an independent, fully functioning special committee of independent directors, and (2) a fully-informed, uncoerced vote of a majority of disinterested stockholders. MFW is essentially designed to replicate arm’s-length bargaining by removing the inherent conflicts that come from the controlling stockholder’s influence over the company and the board.
Whether a court applies the business judgment rule or the entire fairness standard of review can be, but is not always, outcome-determinative of litigation challenging the transaction.
The MFW Doctrine arose out of Kahn v. M&F Worldwide Corp. (MFW), a case concerning a “squeeze-out” merger whereby the company’s controlling stockholder sought to forcibly cash out the company’s remaining investors at a price set by the controlling stockholder. However, since MFW, Delaware courts have applied the Doctrine to a variety of nonmerger controller transactions, such as service agreements with a controlling stockholder and executive compensation for a majority shareholder that was also the company’s chief executive officer.
The Match Group case concerns minority stockholders’ challenge to a reverse spinoff of dating website Match.com by IAC/InterActiveCorp, the company’s then-controlling stockholder, arguing that the transaction unfairly benefitted the controlling stockholder at the expense of the minority stockholders.
Vice Chancellor Morgan T. Zurn of the Delaware Court of Chancery dismissed the challenge under the business judgment rule, concluding that the company complied with the procedures set forth in MFW. Vice Chancellor Zurn found that while the plaintiffs conceivably alleged that one member of the company’s three-person special committee lacked independence, that did not negate the application of the business judgment rule because the majority of the company’s special committee was independent. The plaintiffs appealed, arguing that the company did not comply with the MFW Doctrine because at least one of the directors on the special committee was not independent.
In the course of the appeal, the Delaware Supreme Court took an unusual step: it asked the parties for supplemental briefing on whether the MFW Doctrine should even apply outside the context of a freeze out merger with a controlling stockholder, even though neither party raised the issue in the Court of Chancery.
On April 4, 2024, the Delaware Supreme Court handed down its decision, holding the following:
The decision provides a measure of certainty in the marketplace. While the precise boundaries of the MFW Doctrine have been uncertain since the Delaware Supreme Court’s decision in MFW, transactional lawyers have often advised companies to observe the MFW Doctrine when considering any transaction with a controlling stockholder to limit subsequent litigation risk. Match Group confirms that advice—any transaction where a controlling stockholder stands on both sides and receives a “non-ratable benefit” will enjoy the protections of the business judgment rule only if the company complies with both prongs of the MFW Doctrine.
However, where a company cannot comply (or cannot justify incurring the time and expense to comply) with all of the procedures in MFW, then it can still mitigate the litigation risks arising from a controlling stockholder transaction. The company can shift the burden of persuasion to any future plaintiffs to prove that the controlling stockholder transaction was not entirely fair (not supported by a fair process or resulted in an unfair price) if the company observes one of MFW’s dual procedural protections: either approval by a wholly independent special committee or by a fully informed uncoerced vote of a majority of stockholders unaffiliated with the controller.
The decision also provides some guidance on complying with the MFW Doctrine. The Court of Chancery had previously applied a test where a committee with a conflicted member could still be “independent” as long as a majority of the members were independent or the conflicted member did not “infect” or “dominate” the committee process. However, the court in Match rejected that test and held that the special committee must be wholly independent to disable the controller’s influence. Thus, when a company considering a controlling stockholder transaction wants to invoke the protections of the business judgment rule, it must pay close attention to ensure the independence of all of the special committee members.
Morgan Lewis’s lawyers are well-suited to advise corporation directors and officers on these issues. If you have any questions or would like more information on the issues discussed in this LawFlash, please contact any of the following:
[1] The court noted that derivative claims against controlling stockholders remain subject to the Court of Chancery Rule 23.1 demand futility requirement.
[2] The court also distinguished Aronson and other precedent in the demand futility review context from the substantive standard of review in controlling stockholder transactions.