Corporations contemplating going private should take note of recent rulings from the Delaware Court of Chancery, which provide clear guidance on how to structure their transactions to reduce the risk of being subjected to the "entire fairness" standard of review.
Several months ago, the Delaware Court of Chancery issued an important MFW decision, in which Chancellor Strine set forth the procedural mechanisms a company can employ so that a going-private transaction with its controlling stockholder can be reviewed under the deferential business judgment rule, as opposed to the more stringent entire fairness standard. In that decision, Chancellor Strine held that the business judgment rule would apply if: (1) the controlling stockholder at the outset conditions the transaction on the approval of both a special committee and a non-waivable vote of a majority of the minority investors; (2) the special committee was independent, (3) fully empowered to negotiate the transaction, or to say no definitively, and to select its own advisors, and (4) satisfied its requisite duty of care; and (5) the stockholders were fully informed and uncoerced.
More recently, in SEPTA v. Volgenau, C.A. No. 6354-VCN (Del. Ch. Aug. 5, 2013), Vice Chancellor Noble provided further clarity on when a sale of a company with a controlling stockholder will be entitled to business judgment rule review. In SEPTA, Vice Chancellor Noble applied the business judgment rule and granted summary judgment to the defendants in case that challenged the acquisition of SRA International by Providence Equity Partners. Like the change-in-control transaction in MFW, the change-in-control transaction in SEPTA was negotiated by a disinterested and independent special committee and approved by a majority of the minority stockholders. Unlike MFW, however, where the controlling stockholder was the buyer in the transaction, SEPTA involved a transaction in which a third party was the buyer, and in which the controlling stockholder agreed to roll over a portion of his shares into the merged entity.
According to the Vice Chancellor, a transaction like the one in SEPTA "is entitled to review under the business judgment rule if the transaction is (1) recommended by a disinterested and independent special committee and (2) approved by stockholders in a non-waivable vote of the majority of all the minority stockholders." Moreover, the fact that the controlling stockholder in SEPTA agreed to roll over a portion of his shares into the merged entity did not make the controller a "buyer," which could have triggered the entire fairness standard of review. As the Vice Chancellor noted, under Delaware law, when a corporation "with a controlling stockholder merges with an unaffiliated company, the minority stockholders of the controlled corporation are cashed-out, and the controlling stockholder receives a minority interest in the surviving company, the controlling stockholder does not 'stand on both sides' of the merger."
Vice Chancellor Noble's SEPTA decision, like Chancellor Strine's MFW decision, provides a road map on how to structure a change-in-control transaction involving a controlling stockholder so that a board defending against stockholder challenges to the transaction can avoid judicial review under the strict entire fairness standard of review, and instead enjoy the substantial shield afforded to directors by the deferential business judgment rule.
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