Richard L. Renck, Duane Morris

Most readers of this publication will likely be familiar with the MFW conditions announced by the Delaware Supreme Court in 2014, and which, when present, alter the standard of review of transactions between a Delaware corporation and a controller from the traditional—and onerous—entire fairness standard of review to the application of the business judgment rule, see, Kahn v. M&F Worldwide, 88 A.3d 635 (Del. 2014). As the state Supreme Court held in that case, business judgment will be the standard of judicial review of such a transaction “where the merger is conditioned ab initio upon both the approval of an independent, adequately-empowered special committee that fulfills its duty of care; and the uncoerced, informed vote of a majority of the minority stockholders.”

While the MFW conditions were perhaps easy enough to understand in concept, in practice several issues in their application have arisen and been addressed by the courts of Delaware. One such issue has been the precise timing by which a potential transaction between a corporation and a controller must be clearly subject to the MFW conditions—that is, when is it ab initio? The Delaware Supreme Court has dilated on this topic twice recently, with the most recent occasion being in the matter Olenik v. Lodzinski, 2019 Del. LEXIS 177 (Del. 2019). In Olenik, the Supreme Court explained that to effectively obtain the substantial benefits that inure from conditioning a transaction between a corporation and its controller on the MFW conditions, those conditions must be adopted before “substantive economic negotiations” take place.

So, why does timing matter on this point? As the Supreme Court explained in 2014, the most rigorous standard of judicial review (entire fairness) was unnecessary to protect minority stockholders where the controller “irrevocably and publicly disables itself from using its control to dictate the outcome of the negotiations and the shareholder vote,” quoting M&F Worldwide, 88 A.3d at 644. The Supreme Court further explained that by adopting the MFW conditions “up front,” a “controlling stockholder knows that it cannot bypass the special committee's ability to say no.” This aspect is critical, as it means the controller “cannot dangle a majority-of-the-minority vote before the special committee late in the process as a deal-closer rather than having to make a price move.”

In 2018, the Supreme Court had the opportunity to address what it meant when it held that the MFW conditions must be agreed to “up front” in Flood v. Synutra, 195 A.3d 754 (Del. 201*). In discussing its rulings in Synutra, the Supreme Court highlighted the facts that the controller conditioned its offer on the MFW conditions “at the germination stage of the special committee process, when it was selecting its advisers, established its method of proceeding, began its due diligence, and had not commenced substantive economic negotiations with the controller,” Lodzinski, 2019 Del. LEXIS 177, at *23 (quoting Synutra, 193 A.3d at 765). As the Supreme Court saw it, the MFW conditions must be in place before there has been “any economic horse trading” to invoke their benefits (quoting Synutra, 193 A.3d at 756).

In Lodzinski, however, the Supreme Court found that MFW conditions were not a fixture in the deal negotiations ab initio, or “up front,” because the complaint alleged that substantive economic negotiations had indeed occurred before the MFW conditions were adopted. Thus, it was error for the trial court to dismiss the complaint by applying the business judgment level of review. The Supreme Court found the following factual allegations in the complaint (among others) indicative of “substantive economic negotiations”:

• Allegations that the controller was negotiating with the company while the special committee was “getting up to speed.”
• The relevant parties had begun the process of exchanging confidential information with each other.
• The parties were meeting with investment banks to get their views on valuation metrics.
• Presentation materials exchanged between the parties showed specific proposed valuations.
• The parties were engaged in robust due diligence for the transaction.

Ultimately, the Supreme Court noted that while the above-listed allegations could be “fairly described as preliminary discussions outside of MFW's 'from the beginning' requirement,” those preliminary discussions “transitioned to substantive economic negotiations when the parties engaged in a joint exercise to value” the entities involved. Those joint valuation exercises, as the court viewed it, “set the field of play for the economic negotiations to come by fixing the range in which offers and counteroffers might be made.”

The key takeaway from the Lodzinski opinion is that the MFW conditions must be in place before “substantive economic negotiations” take place for the conditions to be effective for business judgment review of the transaction. Absent that, the courts will continue to default to the entire fairness standard of review (with either the controller or the plaintiff bearing the burden of persuasion depending on the circumstances).

As a final note, and perhaps providing a preview of the next iteration of analysis of the MFW conditions, be aware that in Lodzinski the MFW conditions were first raised by the special committee, not the controller. The Supreme Court did not address, however, whether such a distinction mattered and has left for another day the issue of whether the controller must be the party to affirmatively offer up the MFW conditions.

Richard L. Renck, a partner at Duane Morris, has nearly 20 years of experience litigating matters in both the state and federal courts in Delaware. His practice focuses on complex corporate and commercial litigation with a particular emphasis on corporate governance disputes and statutory actions arising under the Delaware General Corporation Law.