Delaware Court of Chancery Provides Guidance On Application of MFW On Motion To Dismiss
The Delaware Court of Chancery’s September 8, 2014 bench ruling in Swomley v. Schlecht has provided new guidance on the application of Kahn v. MFW Worldwide Corp. (MFW), which outlined the manner in which to structure a transaction with a controlling stockholder in order to obtain the protections of the more deferential business judgment rule, rather than an entire fairness standard of review. The Delaware Court of Chancery applied the business judgment rule at the pleading stage to dismiss the complaint, holding that the plaintiffs had failed to adequately plead facts sufficient to destabilize the six elements of the MFW test.
The MFW Decision
Generally, Delaware courts apply the entire fairness standard of judicial review when determining whether a controlling stockholder buyout has been properly challenged. However, the recent MFW decision allows defendants to avoid the entire fairness standard of review and instead be subject to the less onerous business judgment standard of review when the following six factors are established:
- The controlling stockholder conditions the procession of the transaction of the transaction on the approval of both a special committee and a majority of the minority stockholders;
- The special committee is independent;
- The special committee is empowered to freely select its own advisors and to say no definitively;
- The special committee meets its duty of care in negotiating a fair price;
- The vote of the minority is informed; and
- There is no coercion of the minority stockholders.
Each of these conditions must be met in order for the business judgment review standard to apply.
The Swomley Decision and Implications
In the Swomley decision, Vice Chancellor Laster found that that defendants were entitled to application of the business judgment rule and granted their motion to dismiss on the basis that the plaintiffs did not adequately allege facts sufficient to discount the six factors required by MFW and proceed beyond the pleading stage.
As a threshold matter, Vice Chancellor Laster determined that Delaware courts are not likely to make a distinction between public and private companies in determining whether MFW, which involved a public company, should be applied to cases involving private companies. He then explained that the MFW standard was “born with the goal of establishing a technique, a practice, a structure, where, at the pleading stage, defendants could show that they were not subject to a breach of fiduciary duty challenge” and, thus, should be applied at the pleading stage. In this regard, Vice Chancellor Laster described the Court’s obligation to distinguish between cases that raise actual breach of fiduciary duty claims and those cases that only challenge judgmental factors in valuation, the latter of which are subject to dismissal at the pleading stage.
According to Vice Chancellor Laster, plaintiffs bear the burden of pleading facts that would legitimately call into question or raise a debate about the existence of the six elements of the MFW test. The plaintiffs were unable to meet that burden in this instance because:
- They did not call into question whether the deal was conditioned on both the approval of a special committee and a majority-of-the-minority vote of the disinterested stockholders;
- Historical election to the board by the company founders and compensation for board service are typically not disqualifying, and so there were not allegations that would call into question from a traditional standpoint either the disinterestedness or independence of either member of the special committee;
- The special committee was empowered to freely select its own advisors and to say no definitively;
- Duty of care is measured by a gross negligence standard, and although the valuation methodology for the cash-out pricing was somewhat unorthodox, it was a proper exercise of the special committee’s judgment not amounting to a breach of the duty of care;
- They did not assert any material facts to question whether the vote of the minority was informed, particularly since a public company styled proxy statement was issued and supplemented with additional disclosures; and
- There was no coercion and no retributive threats were made since the effect of a no vote was maintenance of the pre-cash out status quo.
Consequently, Vice Chancellor Laster held that since the stockholders did not vote down the deal, their only other recourse was to seek an appraisal. He acknowledged that this decision represents his view on how MFW functions at the pleading stage, which may be different from how other courts eventually interpret MFW. Nonetheless, the Swomley decision provides guidance as to the bounds and application of the requirements of the MFW test. This decision indicates that more controlling stockholder mergers will be undertaken in accordance with the requirements of MFW in order to reap the advantages of the business judgment rule and attain dismissal prior to engaging in discovery.
For more information regarding the application of the business judgment standard of review at the pleading stage to dismiss a complaint in Delaware, please contact John McCarrick (212.714.3072; firstname.lastname@example.org) or Lori Smith (212.714.3075; email@example.com) in our New York office.
 Kahn v. M&F Worldwide Corp., 2014 WL 996270 (Del. March 14, 2014).