No Shortcuts Allowed: Court of Chancery Rejects Attempt To Circumvent MFW’s Two-Step Mandate

On June 30, 2021, the Delaware Court of Chancery largely denied defendant directors’ motion to dismiss derivative claims for breaches of fiduciary duty arising from a controlling stockholder transaction. Vice Chancellor Fioravanti’s decision in Berteau v. Glazek rejected defendants’ “novel” argument that the “MFW doctrine,” set forth in Kahn v. M & F Worldwide Corp., could mandate application of the business judgment rule absent a majority-of-the-minority vote, and thus also serves as a reminder of the contours of the MFW doctrine.

The Berteau decision arose from a transaction that collapsed a corporate structure by eliminating an intermediate public company called SDI.  Pre-transaction, SDI was a controlled, publicly traded operating company whose only material asset was a majority of the common stock of Turning Point Brands, Inc. (“TPB”). TPB acquired SDI to eliminate the inefficiencies inherent in an intermediate public company; TPB paid 0.97 shares of TPB common stock for each TPB share owned by SDI.

Particularly because certain members of the TPB board of directors were also directors and officers of SDI, the TPB board established a Special Committee to evaluate the transaction. The Special Committee was granted broad powers, including hiring legal and financial advisors and approving or rejecting the proposed transaction. During the negotiations, the Special Committee requested that the transaction be conditioned on a vote of TPB’s minority stockholders — a vote that was not required by statute. SDI rejected this proposal, and the vote was later described as “inapplicable” due to the lack of statutory mandate. After five months of negotiations, the Special Committee determined that the proposed merger was “fair to and in the best interests of the stockholders of the Company.” The merger agreement was executed on April 7, 2020, and the transaction closed in July. The Berteau Plaintiffs filed their derivative suit in October 2020, bringing claims against TPB’s directors and controller for, among other things, breaches of fiduciary duty in connection with the transaction.

Typically, a self-dealing transaction effectuated by a controlling stockholder is subject to entire fairness review. Because the transaction was effectuated by TPB, a controlled company, and ultimately created a non-ratable benefit for the controller, the Court found that entire fairness applied, and none of the defendants “meaningfully contend[ed] otherwise.”

Nevertheless, members of the Special Committee (but not the other director defendants) argued that the business judgment rule should apply pursuant to the MFW doctrine. The Court held that this argument “ignore[d] the history of the MFW doctrine and what it was intended to address.”

In MFW, the Delaware Supreme Court held that a controlling stockholder transaction would be subject to the business judgment rule where “the merger is conditioned ab initio upon both the approval of an independent, adequately empowered Special Committee that fulfills its duty of care, and the uncoerced, informed vote of a majority of the minority stockholders.” MFW thus created a pathway for controller transactions to obtain a pleading-stage, pre-discovery dismissal where (1) a special committee was formed to create a “bargaining agent who can negotiate price and address the collective action problem facing stockholders” and (2) a majority of the minority voted approvingly, thus giving stockholders the “chance to protect themselves.” Because the defendants in Berteau had completed the transaction without a vote of TPB’s minority stockholders, let alone conditioning it on their approval, the Court reasoned that MFW’s business judgment protection could not attach, and found no principled reason to depart from, MFW’s dual mandate.

Berteau reflects the Court’s unwillingness to erode the MFW doctrine and apply the business judgment standard of review to scenarios where both protections — a special committee and a majority-of-the-minority vote — are not satisfied. It is thus a reminder that those contemplating a controller-driven transaction should consider whether to seek MFW protection early in any deal process and discuss with counsel how best to effectuate its dual requirements.

This post is as of the posting date stated above. Sidley Austin LLP assumes no duty to update this post or post about any subsequent developments having a bearing on this post.