Delaware Supreme Court Chief Justice Leo E. Strine Jr.

The Delaware Supreme Court on Tuesday ruled that mergers involving a controlling shareholder qualify for review under the business judgment rule if two key procedural protections are adopted prior to economic negotiations, rejecting a proposed bright-line rule that would have made it easier for plaintiffs to challenge conflicted transactions.

The 4-1 ruling from the high court upheld the Delaware Court of Chancery's dismissal earlier this year of an investor challenge to leading Chinese infant formula firm Synutra International Inc.'s $125 million go-private deal in 2016. And it clarified at what point in the process that a controller must condition its offer on approval by an independent special committee and an informed and uncoerced vote of a majority of the company's controlling stockholders.

On appeal, the case centered on the language of the Supreme Court's landmark opinion in Kahn v. M&F Worldwide, which held that a controller must outline the dual protections at the beginning of a going private bid in order to secure director-friendly business judgment protections.

Plaintiff Arthur Flood and his Levi & Korsinsky attorneys argued for a literal reading of the requirement, saying that the twin conditions must be present in a controller's first written merger proposal to investors. Flood, who had challenged the $6.05 per share deal price as unfair, said Synutra CEO Liang Zhang left the M&F Worldwide protections out of his initial overture, exposing the deal to the more rigorous entire fairness standard of review.

But Chief Justice Leo E. Strine Jr. said Zhang's second proposal, just two weeks later, made clear that he intended to comply with the road map laid out in M&F Worldwide. At that time, Strine said, neither Zhang nor the special committee had engaged in any negotiations or other meetings on Zhang's initial offer.

In a 26-page majority opinion, Delaware Supreme Court Chief Justice Leo Strine criticized Flood's “quite specific and exacting” reading of M&F Worldwide as the “brightest of lines,” which would run counter to the goal of preventing controllers from using the conditions as bargaining chips to obtain economic concessions.

“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 advisers, establishing its method of proceeding, beginning its due diligence, and has not commenced substantive economic negotiations with the controller, the purpose of the precondition requirement of MFW is satisfied,” Strine wrote.

“In that situation, the special committee and the controller know, at all times during economic bargaining, that a transaction cannot proceed if the special committee says no, and the special committee knows that if they agree to a price, their judgment will be subject to stockholder scrutiny and approval.”

The ruling came over the dissent of Justice Karen L. Valihura, who wrote that the conditions must be raised in the controller's initial written proposal in order to satisfy the M&F Worldwide standard.

Valihura said there should be a narrower pathway to dismissal for suits contesting controller buyouts, and the majority's holding would lead to the “factual morass” of determining when serious bargaining began.

“This bright-line makes sense because the controller dictates when to commence the transactional process so that the outset is clear,” she said in her 25-page dissent.

Strine admitted that the court's decision “may give rise to close cases,” but he said the Chancery Court was equipped to handle those disputes.

“When a plaintiff has pled facts that support a reasonable inference that the two procedural protections were not put in place early and before substantive economic negotiation took place, the Court of Chancery can be trusted to apply appropriate pleading stage principles and refuse to dismiss the case,” he wrote.

Attorneys from both sides were not immediately available Tuesday afternoon to comment.

Flood was represented by Donald J. Enright and Elizabeth K. Tripodi of Levi & Korsinsky in Washington, D.C., and Ryan M. Ernst and Daniel P. Murray of O'Kelly Ernst & Joyce in Wilmington.

Synutra was represented by Roger A. Cooper, Rishi N. Zutshi, Vanessa C. Richardson and Hana Choi of Cleary Gottlieb Steen & Hamilton in New York and Matthew E. Fischer, Matthew R. Dreyfuss of Potter Anderson & Corroon in Wilmington.

Zhang was represented by Lawrence Portnoy and Rebecca L. Martin of Davis Polk & Wardwell in New York and William M. Lafferty and John P. DiTomo of Morris, Nichols, Arsht & Tunnell.

The case was captioned Flood v. Synutra International.