Olenik v. Lodzinski, No. 392, 2018 (Del. Apr. 5, 2019)
The Delaware Supreme Court reversed a dismissal of stockholder litigation under the framework set forth in Kahn v. M & F Worldwide Corp. (MFW), finding that the challenged merger transaction was not ab initio conditioned on MFW’s dual protections.
The MFW decision sets forth a framework that, if followed, reduces the standard of review under which the court will evaluate a challenge to an acquisition by a controlling stockholder from the onerous “entire fairness” standard of review to the highly deferential business judgment rule. In order to obtain business judgment review under MFW, the controller must condition the transaction ab initio on approval by both an empowered, independent special committee and a fully informed vote of disinterested stockholders. In another recent case, Flood v. Synutra International, Inc., No. 101, 2018 (Del. Oct. 9, 2018), the Delaware Supreme Court clarified that under MFW’s ab initio requirement, “the key dual procedural protections must be in place before economic negotiations so the protections are not used as a bargaining tool in substitution for economic concessions by the controller.”
In the case below, the Court of Chancery dismissed a stockholder challenge to an “Up-C” transaction, whereby two companies (Earthstone and Bold) under the same controller (EnCap) entered into an all-stock merger. Beginning in April 2016, before MFW’s dual protections were in place, EnCap, Earthstone and Bold engaged in discussions regarding valuations of Bold, the structure of the proposed transaction and the post-transaction equity split between Earthstone and Bold. Earthstone did not formally establish a special committee until late July 2016, and the controller did not condition the transaction on MFW’s dual protections until August 2016. Earthstone and Bold reached an agreement in November 2016, which provided that Earthstone stockholders would own 39% of the combined company. The Court of Chancery held that the ab initio requirement was satisfied because the acquirer’s first offer letter — the starting point of “negotiations” — expressly conditioned the deal on approval of both a special committee of independent directors and a majority vote of the acquirer’s stockholders unaffiliated with the controller. It therefore applied the business judgment rule to dismiss the claims.
On appeal, the Supreme Court reversed the dismissal, finding that the plaintiff had pleaded facts supporting a reasonable inference that the parties had “engaged in substantive economic negotiations before the Earthstone special committee put in place the MFW conditions.” The Supreme Court explained that although the “Court of Chancery held correctly that preliminary discussions between a controller’s representatives and representatives of the controlled company do not pass the point of no return for invoking MFW’s protections,” when viewed along “the negotiating continuum, the well pled facts show[ed] that substantial economic negotiations took place well before the August 19 Letter with the MFW conditions.”
The Supreme Court also refused to affirm the Court of Chancery’s decision on the alternative basis that EnCap was not a controlling stockholder, finding that the plaintiff had adequately pleaded that EnCap acted as Earthstone’s controlling stockholder while key economic negotiations took place and, further, Earthstone had described itself as a “company with a controlling shareholder.” The court also rejected the plaintiff’s additional argument that the majority of the minority vote was not fully informed and affirmed the Court of Chancery’s ruling on that issue.
This summary can be found in the June 2019 issue of Inside the Courts.