Court of Chancery Determines MFW Can Apply at Motion to Dismiss Stage Where Controlling Stockholder Is a Seller

Skadden, Arps, Slate, Meagher & Flom LLP

In re Martha Stewart Living Omnimedia, Inc. Stockholder Litig., Consol. C.A. No. 11202-VCS (Del. Ch. Aug. 18, 2017)

Vice Chancellor Joseph R. Slights III dismissed stockholder claims challenging the acquisition of Martha Stewart Living Omnimedia, Inc. (MSLO) by Sequential Brands Group, Inc. (Sequential), and determined that compliance with the procedural protections elaborated in MFW would result in application of the business judgment rule in third-party sales with a conflicted controller.

Stockholders of MSLO brought claims against Martha Stewart, MSLO’s former controlling stockholder, for breach of fiduciary duty and against Sequential for aiding and abetting that breach in connection with the MSLO board’s approval of the merger. To determine the standard of review, the court first analyzed whether Stewart engaged in a conflicted transaction. Although Stewart was only on the sell side of the transaction and received the same per-share merger consideration as other stockholders, the plaintiffs alleged that Sequential lowered its offer after agreeing to “side deals” with Stewart. However, the court concluded that the plaintiffs had failed to plead facts supporting a reasonable inference that side deals with Stewart were unfair or “diverted” merger consideration that would otherwise have been paid to the minority stockholders. The court said “[i]t was entirely proper for [buyer] to pay, and for Stewart to accept, extra consideration (just as MSLO had paid before the Merger) to secure the immeasurable value of ” Stewart’s commitment of “time, energy and talent to keep the brand alive and thriving.” Because the plaintiffs failed to allege facts that supported an inference “that the side payment represented an improper diversion” of consideration, the business judgment standard applied.

Nevertheless, the court also analyzed whether the approval by an independent, disinterested and properly empowered special committee and a nonwaivable, fully informed and uncoerced vote of a majority of the minority stockholders provided an independent basis to invoke the business judgment rule. Determining that the “need to incentivize fiduciaries to act in the best interests of minority stockholders ... is equally important in one-sided and two-sided conflicted controller transactions,” the court held that “strict compliance with the transactional road map” in MFW “is required for the controlling stockholder to earn pleadings-stage business judgment deference when it is well-pled that the controller, as seller, engaged in a conflicted transaction ...” The court then considered when in the negotiation process the MFW protections would need to be agreed upon and determined that to obtain business judgment rule protection at the pleading stage, the dual protections must be in place before the controlling stockholder begins to negotiate with an acquirer for additional consideration. Finding that the plaintiffs failed to adequately plead that (1) the special committee lacked independence and was ineffective and (2) the majority of the minority vote condition was ineffective, business judgment review was appropriate. The court granted the motions to dismiss for all claims.

This summary can be found in the September 2017 issue of Inside the Courts.