Albert H. Manwaring IV

Section 203 of the Delaware General Corporation Law is a company anti-takeover statute. Section 203 prohibits a stockholder from engaging in a business combination with a company for three years after the stockholder acquires 15% or more of the company’s voting equity. If a company’s board pre-approves such a business combination, however, the Section 203 anti-takeover protections do not apply.

To avoid Section 203’s three-year anti-takeover period in Arkansas Teacher Retirement System v. Alon USA Energy, C.A. No. 2017-0453-KSJM (Del. Ch. Jun. 28, 2019), a stockholder sought pre-approval from the company’s board of its proposed acquisition of 48% of the company’s stock from its largest stockholder. The company’s board agreed to the proposed acquisition on the condition that the stockholder enter into an agreement with the company that limited the three-year anti-takeover period in Section 203 to one year. Plaintiff stockholders subsequently brought suit, challenging the acquisition because the acquiring stockholder failed to comply with the one-year anti-takeover period in breach of its agreement with the company.

The court held that the plaintiff stockholders had standing as intended third-party beneficiaries to enforce the company’s agreement with the acquiring stockholder. The court reasoned that Section 203 was enacted to benefit stockholders by limiting hostile takeovers and encouraging fair, noncoercive acquisitions. Here, the acquiring stockholder’s agreement with the company adopted those protections, albeit for only one year, for the same purpose of directly benefiting stockholders of the company. Moreover, the court found that the plaintiffs had stated a claim under Section 203 itself at the pleadings stage because the acquiring stockholder’s alleged breach of the agreement may have excused any waiver of the Section 203 three-year anti-takeover period, and therefore, potentially revived the Section 203 statutory anti-takeover protections.

Lastly, turning to the fiduciary duty claims against the company’s directors, the court declined to invoke deferential business judgment review because the acquiring stockholder was conceivably a controlling stockholder, and failed to timely establish the procedural safeguards endorsed by the Delaware Supreme Court’s 2014 MFW decision. To obtain business-judgment review of a business combination with a controlling stockholder under MFW, the transaction must be conditioned at or near its inception on approval of a special committee of independent directors and a majority of the disinterested minority stockholders. Here, a special committee was used, but without clear delineation of its powers, and the special committee engaged in discussions with the acquiring stockholder over the form of consideration, the exchange ratio and price terms for months before the MFW safeguards were put in place at the time of the first formal exchange of offers in the proposed acquisition. The special committee had also already hired legal and financial advisers and entered into a confidentiality agreement to allow the exchange of nonpublic information with the company. Therefore, the court found that, under the Delaware Supreme Court’s recent decisions in Flood v. Synutra International (2018) and Olenik v. Lodzinski (2019), the MFW safeguards were imposed after “the germination stage” of the special committee process, and after “substantive economic negotiations” had occurred. Accordingly, the court declined to apply business-judgment review under MFW to dismiss the plaintiffs’ breach of fiduciary duty claims against the company’s directors.

Albert H. Manwaring IV ([email protected]) is a corporate governance and fiduciary litigation partner at Morris James in Wilmington.