A roadmap for success in going-private transactions

February 2017 | SPOTLIGHT | MERGERS & ACQUISITIONS

Financier Worldwide Magazine

Shareholder litigation challenging major corporate transactions remains prevalent. Recent landmark court decisions in Delaware and New York state courts have resulted in a seismic shift for defending going-private transactions against litigation initiated by minority shareholders. Courts have rejected the application of the ‘entire fairness’ standard of review and instead have affirmed that the business judgment standard should be employed in evaluating going-private transactions. The business judgment standard of review consists of a rebuttable presumption that any action taken by a director on behalf of the corporation is taken in good faith and for the benefit of the corporation. In contrast, under the ‘entire fairness’ standard, directors bear the burden of demonstrating the inherent fairness of the transaction, both in terms of process and price. As a result, these recent rulings make it more likely that going-private deals involving controlling shareholders – if they have the correct procedural protections – will be reviewed and resolved earlier than at a full trial. More importantly, these decisions provide a useful roadmap for corporate attorneys, boards of directors and general counsels for structuring going-private transactions in a manner that withstands vexatious shareholder suits.

In M&F Worldwide – the landmark decision for controller-led mergers under Delaware law – the Delaware Supreme Court held that directors and controlling shareholders are presumed to have met the business judgment rule if certain procedural protections were satisfied. The Delaware Supreme Court held that the business judgment standard of review governs a merger between a controlling shareholder and the controlled publicly traded company, “where the merger is conditioned ab initio upon the approval of both an independent, adequately-empowered Special Committee that fulfils its duty of care, and the uncoerced, informed vote of a majority of the minority stockholders”. As the Delaware Supreme Court explained, the simultaneous deployment of these dual procedural protections creates “a countervailing, offsetting influence of equal – if not greater – force. That is, where the controller irrevocably and publicly disables itself from using its control to dictate the outcome of negotiations and the shareholder vote, the controlled merger then acquires the shareholder-protective characteristics of third-party, arm’s length mergers, which are reviewed under the business judgment standard”.

The dual procedural protections “operate to restore the court’s confidence in both [the board’s and the shareholders’] decisions”, and the court will apply the business judgment standard of review. Upon the application of the business judgment rule, “the court is precluded from inquiring into the substantive fairness of the merger, and must dismiss the challenge to the merger unless the merger’s terms were so disparate that no rational person acting in good faith could have thought the merger was fair to the minority”. And, “[b]y definition, at that point, rational people who were members of the minority thought the merger was fair”.

A controlling shareholder’s willingness to commit to these dual protections is an important piece of the risk-reward assessment of a going-private transaction. The decision to commit to the dual protection process carries real risk: a special committee that understands its power to “just say no” can do just that; minority shareholders who understand that their votes will be dispositive, and that the controller’s voting power will be neutralised will be motivated to vote in their own best interests – and unless the deal is attractive enough, can collectively reject a transaction. Controlling shareholders should be willing to assume those risks and present a transaction and process that would be viewed by both management and shareholders as substantively and procedurally fair and non-coercive, to qualify for protection under the business judgment rule and satisfy the heightened standards imposed by Delaware law for controller-led mergers.

The recent court decisions employing the business judgment standard of review make sense. A guiding principle of corporate governance is that management strives to maximise long-term shareholder value, and a primary motivation to undertake the trouble of a going-private transaction is to maximise that value: to integrate operations more efficiently, focus on long-term corporate objectives, reap certain financial efficiencies from de-listing as a public company, or for shareholders to realise a better share price. Under the dual protection process, the independent and empowered special committee and the majority vote of non-controlling shareholders offer strong assurances that shareholder value will be maximised as a result of a successful transaction.

Adherence to the dual procedural protections risks the outcome of a transaction, to the extent that the special committee and minority shareholders can reject the deal. However, controlling shareholders who are willing to take that risk will find that the deference accorded them by the courts following the successful completion of a transaction provides the legal clarity and cost savings that, on balance, are well worth the risk.

Todd G. Cosenza is a litigation partner and Katherine Doty Hanniford is a senior associate at Willkie Farr & Gallagher LLP. Mr Cosenza can be contacted on +1 (212) 728 8677 or by email: tcosenza@willkie.com. Ms Hanniford can be contacted on +1 (202) 303 1157 or by email: khanniford@willkie.com.

Todd G. Cosenza and Katherine Doty Hanniford

Willkie Farr & Gallagher LLP