Majority Owner’s New Blueprint for Forcing out Minority Owners
The Delaware Supreme Court, arguably the nation’s most influential business court, recently approved a pathway for majority owners of private companies to remove minority owners. While this comes as great news to controlling stockholders, it puts minority owners on notice that their shares of future company returns may not be as secure as they originally estimated.
The Court confirmed for the first time in Swomley v. Schlecht that the business judgment standard of review applies to controlling stockholder acquisitions of private companies that satisfy certain criteria.1 In doing so, the court offered private equity groups and other substantial stockholders of closely held private companies a transactional playbook that, if strictly observed, can provide a substantial measure of comfort that their minority buyout acquisitions will withstand stockholder challenges and that the often considerable legal expenses attending those challenges would be minimized under a standard of review more favorable than would otherwise apply.
Under prior Delaware law, controlling stockholder transactions were governed by the demanding entire fairness standard, the satisfaction of which is usually synonymous with protracted proceedings and substantial litigation expense and is rarely finally determined on an initial pleadings or summary judgment basis. However, last year the Court announced that the substantially less demanding business judgment standard of review would apply to controlling stockholder buyouts of public companies where (i) the controlling stockholder conditions the transaction on the approval of both a special committee and a majority of the minority stockholders, (ii) the special committee is independent, (iii) the special committee is empowered to freely select its own advisors and to reject any transaction proposal, (iv) the special committee discharges its duty of care in negotiating a fair price, (v) the vote of minority stockholders is fully informed and (vi) the absence of coercion of the minority stockholders with respect to the transaction.2 The Swomley decision confirmed that satisfaction of the above criteria and corresponding beneficial shift of standard of review applies to private company acquisitions.
The Swomley decision is one among other recent Delaware Supreme Court decisions attempting to reduce unnecessary expenses incurred in connection with challenges to corporate transactions. While strict compliance with each of the above criteria likely entails additional front end transaction costs, after Swomley such costs are better viewed as reasonable insurance payments for the substantial procedural protections the decision affords controlling stockholders, the amount of which would pale in comparison to the additional time and expense that would be incurred in the absence of those protections.
1 Swomley v. Schlecht, No. 180, 2015-RJH, 2015 Del. LEXIS 622 (Del. Nov. 19, 2015) (affirming without discussion the Delaware Chancery Court’s bench ruling dismissing a stockholder complaint challenging the fairness of a controlling stockholder merger transaction, Swomley v. Schlecht, CA No. 9355-VCL (Del. Ch. Aug. 27, 2014) (transcript)).
2 Kahn v. M&F Worldwide Corp., 88 A.3d 635, 645 (Del. 2014) (announcing criteria in connection with the evaluation of a take private merger transaction).