Ann Lipton reports on an interesting new development:
Putting aside the question of how control is defined, we still have the issue of how conflict transactions are cleansed. As I said, Chancery has settled on the proposition that all conflicted controller transactions are cleansed exclusively through MFW. ...
at the end of May, the Delaware Supreme Court ordered the parties in In re Match Group Derivative Litigation, No. 368, 2022, to brief the issue whether MFW cleansing is required for all interested controller transactions, or whether ordinary cleansing is permissible outside the freezeout context. The case involved a series of transactions by which the old Match Group reorganized its assets, in a manner that public shareholders claimed benefitted the controller at the expense of the minority. VC Zurn held that MFW cleansing was satisfied and the public shareholders appealed, arguing that the stringent MFW requirements were not met – leading to the question whether MFW was even necessary to trigger business judgment review.
Significantly, this issue was waived by the Match Group defendants before the Court of Chancery; the Delaware Supreme Court said that notwithstanding that waiver, “the Court finds that resolving the issue raised by the IAC Defendants is in the interests of justice to provide certainty to boards and their advisors who look to Delaware law to manage their business affairs.”
Please go read Ann's post for her take on this important question. As for me, however, I'm going to take a dive into my archives to bring you my long-held view of the matter:
My own view is that not all controlling shareholder transactions need cleansing. I start with the Delaware Supreme Court's decision in
Sinclair Oil. v. Levien, 280 A.2d (Del. 1971). Under Sinclair Oil, the initial question is whether the controlling shareholder “has received a benefit to the exclusion and at the expense of the subsidiary.” (To be sure, Sinclair Oil involved a parent-subsidiary relationship, but the parent by definition is a controlling shareholder and the principles are the same.)
The fact that the controlling shareholder is a party to the transaction is not enough. The controlling shareholder must have gotten a benefit that is both at the expense of and to the exclusion of the minority shareholders.
This is made clear by the court’s treatment of the minority’s objection to the subsidiary’s dividend policy. Sinven (the subsidiary) had adopted at Sinclair Oil’s behest a policy of paying out the maximum lawful dividend. This benefited Sinclair Oil but did not constitute self-dealing by Sinclair Oil because Sinclair received nothing from Sinven to the exclusion of its minority stockholders.” Id. at 772.
Unlike Restatement subsection (3), moreover, it is not enough that the controlling shareholder get a benefit or even that the benefit is not shared. The controlling shareholder must get a benefit not only that excludes the minority but comes at their expense. This is made clear by the court’s treatment of the minority’s complaint that Sinclair Oil had denied Sinven opportunities to develop oil properties outside of Venezuela. “From 1960 to 1966 Sinclair purchased or developed oil fields in Alaska, Canada, Paraguay, and other places around the world. The plaintiff contends that these were all opportunities which could have been taken by Sinven.” Id. But the court rejected that claim: “Sinclair usurped no business opportunity belonging to Sinven. Since Sinclair received nothing from Sinven to the exclusion of and detriment to Sinven's minority stockholders, there was no self-dealing.” Id. Again, you must have both exclusion AND detriment.
I will grant you that some recent Chancery Court cases appear to assume that
any “interested” transaction involving a controller is subject to intrinsic fairness analysis (unless cleansed as per below). But that is not the law, at least in Delaware. Under Sinclair Oil, there are two standards of review. If the plaintiff can carry the burden of proof of showing that the controlling shareholder benefited itself at the expense and exclusion of the minority, then entire fairness is the standard. But if the plaintiff cannot, the business judgment rule is the standard of review.
The rule thus is not: Controlling shareholder > was controlling shareholder connected to transaction > fairness unless cleansing.
The rule is: Controlling shareholder > did controlling shareholder benefited at the expense of and to the exclusion of minority shareholders > if yes, fairness unless cleansed; if no, business judgment rule.
In other words, If the plaintiff can't carry the burden of proof of showing that the controlling shareholder benefited itself at the expense and exclusion of the minority, then no cleansing--whether ordinary Kahn v. Lynch or MFW--is required.
As a policy matter, it is certainly the case that cleansing is necessary when the controlling shareholder benefited at the expense of and to the exclusion of minority shareholders, such as in the freezeout merger context. The potential conflict of interest is especially pronounced in this context. After all, “a merger in which it is bought out is the most important event that can occur in a small corporation's life, to wit, its death . . ..” SEC v. Geon Industries, Inc., 531 F.2d 39, 47 (1976). In a freeze out merger, the transaction takes on even greater significance than in the ordinary case because the controlling shareholder is buying the company and thus has a strong incentive to minimize the prize at the expense of the minority. Freeze out mergers thus have long been the subject of especially close review.
Yet, as been ably said by a court otherwise quite protective of minority shareholder rights, “The majority . . . have certain rights to what has been termed ‘selfish ownership’ in the corporation which should be balanced against the concept of their fiduciary obligation to the minority.” Wilkes v. Springside Nursing Home, Inc., 353 N.E.2d 657, 663 (Mass. 1976). This seems to be the principle animating Sinclair Oil, which allows some controlling shareholder transactions the protection of the business judgment rule even without the sort of cleansing envisioned by either Kahn v. Lynch or MFW.
If I can get all the other stuff on my desk cleared by summer's end, I'm planning on turning the above into a law review article.
