Delaware Guidance on Controlling Stockholder Transactions under MFW

In a recent bench ruling, the Court of Chancery provided guidance to controlling stockholders in seeking business judgment rule review of freeze-out transactions.  Most importantly, the court indicated that the commitment “ab initio” to condition the transaction on the approval of both a special committee of independent directors and a majority-of-the-minority shareholder vote must be irrevocable for the duration of the negotiations.  The court also upheld claims that the outside directors on the special committee acted in bad faith by allowing management to manipulate the process, including through the use of internal projections that excluded a new business opportunity.

MH Haberkorn 2006 Trust v. Empire Resorts, Inc. involved the 2019 go-private transaction involving Empire Resorts, Inc., and its controlling stockholder.¹  The controller had previously entered into an agreement with the corporation in which the controller committed not to pursue a freeze-out merger without the approval of a majority of the unaffiliated shares and a majority of the disinterested directors. The agreement was set to expire in February 2020 — roughly seven months after the controlling stockholder proposed the freeze-out — and thus loomed over the negotiations.  The controller informed the special committee that it would not agree to an extension.  Ultimately, the special committee approved a freeze-out transaction, and it was narrowly approved by the unaffiliated stockholders in November 2019.

Under the Delaware Supreme Court’s decision in Kahn v. M&F Worldwide Corp. (“MFW”), a freeze-out merger will be reviewed under the business judgment rule instead of the “entire fairness” test “if and only if: (i) the controller conditions the procession of the transaction on the approval of both a Special Committee and a majority of the minority stockholders; (ii) the Special Committee is independent; (iii) the Special Committee is empowered to freely select its own advisors and to say no definitively; (iv) the Special Committee meets its duty of care in negotiating a fair price; (v) the vote of the minority is informed; and (vi) there is no coercion of the minority.”²

Applying MFW, Empire Resorts focused on whether the transaction was conditioned, ab initio, on the approval of the special committee and a majority of the minority shares.  Although the agreement between the controller and the corporation put both conditions in place, the court found that MFW’s requirement was not satisfied because of the agreement’s looming expiration.  Chancellor McCormick stated that “the condition must be irrevocable, in the sense that it remains in place for the duration of the negotiations over the offer.”

The court also questioned whether the majority-of-the-minority stockholder approval condition was satisfied.  At the special meeting, 53% of the minority stockholders approved the merger.  Chancellor McCormick indicated that, had the corporation not obtained the approval of its second largest stockholder, the merger vote would have failed.  Because that stockholder had a business relationship with the corporation, the Chancellor said there were sufficient questions at the pleading stage as to whether it had an interest “not shared by the other minority stockholders” that undermined the cleansing effect of the vote.  

In denying the defendants’ motion to dismiss, the court found that the complaint sufficiently alleged that the freeze-out merger was not “entirely fair” to the minority stockholders.  Among other things, the plaintiff claimed that:

• the controller publicly threatened to cut off financing for the corporation, which depressed the corporation’s stock price;
• the controller accelerated the timeline for entering into the merger agreement after a third-party contacted the corporation about making a potential investment;
• the special committee’s deliberations were allegedly leaked to the controller; and
• a ten-day “go-shop” right in the merger agreement did not provide an effective opportunity to consider other strategic alternatives.

Lastly, the court upheld claims brought against the outside directors who served on the special committee.  In particular, the court focused on the fact that the corporation’s projections failed to give effect to a new business opportunity of which the directors were allegedly aware.  For that and other reasons, the court held that the plaintiff adequately alleged the special committee “approved a deal it knew undervalued Empire’s minority shares, based on management projections that excluded the impact of plans and issues that were allegedly lucrative [and] discussed by the board in prior meetings.”

Importantly, Empire Resorts was issued in response to the defendants’ motion to dismiss in which the court was required to accept the truth of the plaintiff’s allegations.  In addition, Delaware’s judges have repeatedly noted that transcript rulings lack the precedential value of written opinions.  Nevertheless, Empire Resorts’ focus on the “ab initio requirement” provides important guidance under the MFW framework.

¹ C.A. No. 2020-0619 (Del. Ch. Jul. 23, 2021) (Transcript).

² 88 A.3d 635, 645-46 (Del. 2014).