August 10, 2020

Volume X, Number 223

August 10, 2020

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Delaware Court of Chancery Applies Entire Fairness Standard to Going-Private Transaction with a Controlling Stockholder Negotiated by Special Committee and Approved by a Majority of the Minority Stockholders

In In re Orchard Enterprises, Inc. Stockholder Litigation, the Delaware Court of Chancery held that the entire fairness standard of review applied to a going-private transaction with a controlling stockholder, even though the transaction was negotiated by a special committee of independent directors and approved by a majority of the minority stockholders.

Dimensional Associates, LLC, which held 42 percent of the common stock of Orchard Enterprises, Inc. and 99 percent of Orchard’s senior convertible preferred stock, proposed to acquire all of the outstanding shares of Orchard’s capital stock held by the minority stockholders for $2.05 per share. Orchard’s board of directors formed a special committee of independent directors to evaluate the proposal. The special committee had the exclusive power and authority to negotiate with Dimensional, terminate consideration of Dimensional’s proposal, solicit interest from third parties and retain independent advisors. After several rounds of negotiations, Dimensional and the special committee agreed that the transaction would be subject to a non-waivable condition that the majority of the minority stockholders approve the transaction.   

The court held that, even though the transaction was subject to the approval of Orchard’s special committee and a majority of the minority stockholders, the transaction would be subject to review under the entire fairness standard rather than the business judgment rule. In distinguishing the court’s decision in In re MFW Shareholders Litigation and the Delaware Supreme Court’s decision in Kahn v. M&F Worldwide Corp., which affirmed the court’s decision in In re MFW Shareholders Litigation, the court explained that, in order to avoid entire fairness review, a controlling stockholder must agree “up front, before any negotiations begin” that the transaction will be subject to (i) the affirmative recommendation of a special committee composed of independent and disinterested directors that is empowered to freely select its own advisors and to say no definitively and (ii) the affirmative vote of an informed majority of the minority stockholders. If none or only one of the protections is agreed to up front, the transaction will be subject to entire fairness review. If the controlling stockholder can show that at least one of the protections was in place, the controlling stockholder can shift the burden of proof to the plaintiffs to show that the transaction was unfair, even if such protections are not agreed to up front. If the controlling stockholder is unable to shift the burden of proof such that the plaintiff challenging the transaction must prove unfairness, the controlling stockholder will bear the burden at trial of proving that the transaction was the product of a fair process and that the price paid was fair.   

Click here to read the opinion.

Stanley Polit, a summer associate, contributed to this article.

©2020 Katten Muchin Rosenman LLPNational Law Review, Volume IV, Number 171


About this Author

Mark D. Wood, corporate securities lawyer Katten Muchin Chicago Law firm

Mark D. Wood is head of Katten's Securities practice and concentrates in corporate and securities law. Mark represents public companies, issuers and investment banks in initial public offerings (IPOs) and other public offerings, private investment in public equity (PIPE) transactions, debt securities and other securities matters.

Mark also represents clients in complex corporate transactions, including tender offers, mergers, acquisitions, dispositions, going-private transactions, private equity investments, joint ventures and...

Martin Q. Ruhaak, Katten Muchin Law Firm, private equity transactions lawyer

Martin Ruhaak concentrates his practice on corporate matters, with an emphasis on private equity transactions, mergers and acquisitions, distressed investments and securities matters. He has represented financial sponsors and corporate clients in transactions across a variety of industries, including automotive, financial services, distribution and logistics, technology and government contracting.