Getting to Business Judgment in an Interested Transaction: Controlling Stockholder Must Put Procedural Protections in Place Prior to the Commencement of Economic Negotiations
In Flood v. Synutra Int’l, Inc., No. 101, 2018, 2018 Del. LEXIS 460 (Del. Oct. 9, 2018), the Delaware Supreme Court (Strine, C.J.) held that a controlling stockholder who pursues a merger with the controlled company will have the benefit of business judgment review pursuant to Kahn v. M&F Worldwide Corp., 88 A.3d 635 (Del. 2014) (“MFW”), as long as the requisite procedural protections under MFW are put in place prior to the commencement of economic negotiations. In MFW, the Delaware Supreme Court created a framework through which a controlling stockholder could enter into a strategic transaction with the controlled company and still avail itself of the deferential business judgment standard of review. To have the business judgment standard apply, the transaction must be conditioned “ab initio” upon both (1) the approval of an independent, adequately-empowered Special Committee of the board of directors that fulfills its duty of care, and (2) the uncoerced, informed vote of a majority of the minority stockholders (the “MFW Procedural Protections”). Synutra arose from an issue left open in MFW regarding when the MFW Procedural Protections will be deemed to have been in place “ab initio.”
Synutra International Inc. was a publicly traded Delaware corporation. On January 14, 2016, controlling stockholder Liang Zhang proposed to take Synutra private by acquiring the rest of the company’s outstanding stock. Zhang’s initial proposal sought to purchase all outstanding shares for $5.91 per share, but he did not condition the offer on the MFW Procedural Protections. One week later, the Board met and formed a Special Committee, but did not discuss or evaluate the substance of Zhang’s proposal at that time. On January 30, 2016, Zhang made a second proposal that conditioned any merger on the MFW Procedural Protections. The price negotiations did not begin until September 2016, seven months after the second offer, at which time Zhang agreed to increase his offer to $6.05 per share. The Special Committee ultimately agreed to accept the offer. Before doing so, the Special Committee met over 15 times over a nine-month period and was advised by independent financial, legal, and economic advisors.
Two minority stockholders filed class actions challenging the merger, and the cases were ultimately consolidated in Delaware Court of Chancery. The operative complaint alleged breach of fiduciary duty and aiding and abetting in connection with Zhang’s acquisition of Synutra.
Defendants moved to dismiss the complaint arguing, in part, the MFW ab initio requirement was satisfied, and thus, the business judgment rule applied. The Chancery Court granted the motion. In doing so, the Chancery Court determined that the MFW ab initio requirement was satisfied because the MFW Procedural Protections were announced prior to the initiation of economic negotiations, and the allegation that the negotiated price was not fair did not support an inference of gross negligence against the Special Committee. Plaintiffs appealed.
Plaintiffs argued the Chancery Court misapplied the MFW standard in two respects. First, plaintiffs claimed the business judgment rule should not apply because Zhang’s initial proposal did not contain the MFW Procedural Protections and, thus, could not be considered to have been in place “ab initio” (i.e., “from the beginning”). Second, plaintiffs argued the Court of Chancery erred in finding that no due care violation was pled because plaintiffs alleged that the Special Committee agreed to an insufficient price.
The Delaware Supreme Court rejected plaintiffs’ arguments and affirmed the Chancery Court’s ruling. The Court explained the MFW ab initio requirement is satisfied if the controller conditions the buyout on the MFW Procedural Protections at the beginning of the deal process and before economic negotiations commence. Further, the Court clarified that “a plaintiff can plead a duty of care violation only by showing that the Special Committee acted with gross negligence, not by questioning the sufficiency of the price.” The Court explained “[t]he price question is not one for a court applying the business judgment rule standard, and was for [the] stockholders to vote on themselves.”
Justice Valihura dissented, arguing in favor of a bright-line requirement that, to obtain review under the deferential business judgment standard, the MFW Procedural Protections must be contained in the controller’s initial formal written proposal. She argued this is consistent with the intent of the MFW framework; i.e., to provide a roadmap in controller buyouts regarding the precise process to obtain business judgment review. In the dissent’s view, the majority’s more amorphous test leads to an overly fact-intensive pleadings-stage inquiry.
Although Synutra eschews a bright-line rule for determining whether the MFW Procedural Protections were put in place “ab initio,” it nevertheless provides substantial guidance to boards and controlling stockholders who are eager to preserve business judgment review in connection with (nearly inevitable) post-announcement litigation over the proposed merger.