Securities and Structured Finance Litigation Update – December 2021 | Quinn Emanuel Urquhart & Sullivan, LLP

Litigation by shareholders after MFW and Dell

Controlling shareholders (“controllers”) who engage in transactions in their own interest may be held liable for breaches of fiduciary duties owed to minority shareholders. Such “monitor” claims are generally assessed in accordance with Delaware’s strict “total fairness” standard. The controller bears the burden of proving both ‘fair price’ and ‘fair use’ – that the disputed transaction was substantively and procedurally fair. This is demanding and its application can result in significant liability for supervisors, including exposure to class actions by shareholders seeking significant damages. But the decision of the Delaware Supreme Court in Kahn v. M & F Worldwide Corp. (“MFW”), 88 A.3d 635 (Del. 2014) creates a “safe harbor” whereby auditors can avoid fairness scrutiny and thereby minimize their liability. This article deals with the MFW decision and recent cases applying it, including the Dell Class V litigation, in which a court dismissed a motion to dismiss based on MFW.

MFW: In MFW, the Delaware Supreme Court ruled that the entire fairness review does not apply to Monitor transactions that are conditioned, from the outset, on the approval of two: (1) a special committee fully empowered, disinterested and independent who represents the interests of minority shareholders; and (2) a fully informed and unconstrained “minority majority” shareholder vote. Identifier. Delaware courts assess six conditions to determine whether MFWthe requirements of are met:

  • The controlling shareholder must make the transaction conditional both on the approval of a special committee and on a majority vote of the minority of shareholders;
  • The special committee must be independent;
  • The special committee must be empowered to freely choose its own advisers and to say “no” definitively to the operation;
  • The special committee must fulfill its duty of care in negotiating a fair price;
  • The vote of minority shareholders must be informed; and
  • There should be no constraints on minority shareholders.

The objective of MFW is to protect minority shareholders by ensuring that the procedural guarantees of an independent special committee and majority majority vote prevent supervisors from engaging in unfair transactions that benefit them to the detriment of minority shareholders. As the Dell court explained: “MFW The dual conditions create a powerful tool for extracting good value for the minority, because from the outset of negotiations, the controlling shareholder knows that he cannot bypass the ability of the special committee to say “no”. Regarding Dell Techs. Inc. Class V Shareholders Litigation. (“Dell“), 2020 WL 3096748, at * 15 (Del. Ch. 11 June 2020). If both MFW conditions are met, the deferential business judgment rule applies rather than the fairness test as a whole. Under the rule of business judgment, almost all corporate actions, except overt waste, are allowed. Therefore, if the business judgment rule applies, the complainants’ claims are generally dismissed.

Getting around MFW: Although several controllers have successfully invoked MFW to gain the protection of the business judgment rule, more recent decisions illustrate the limits of MFW– and the potential pitfalls for controlling shareholders who seek to escape full fairness scrutiny.

In Dell, a category of investors for which Quinn Emanuel is co-lead adviser rejected the application of the MFW. Dell concerned a 2018 transaction in which controlling Dell shareholders repurchased one class of shares (“class V” shares) held by minority shareholders for a mixture of cash and another class of Dell shares (“class C” shares). Invoke MFW, Dell’s board of directors appointed a special committee to negotiate on behalf of Class V shareholders and held a shareholder vote in which a majority of minority shareholders voted in favor of the deal. Class V investors disputed the transaction as unfair and alleged that the transaction price was too low and the special committee was conflicted and ineffective. Investors have filed fiduciary breach complaints against Dell’s majority shareholders (Michael Dell and Silver Lake Partners) and members of the special committee. The defendants asked to be dismissed under MFW. Vice Chancellor Laster rejected the motion.

the Dell court found that almost all MFW the requirements were not met, despite the appointment of the special committee and the vote of the shareholders. First of all, the special committee was not empowered within the meaning of MFW because Dell had reserved the right to resort to backup transactions, including a forced conversion of class V shares into class C shares, if the proposed deal failed, and had not given the special committee l authority to prevent such a “plan B”. Identifier. to * 17. Second, the controllers “bypassed the special committee and negotiated directly with [shareholders], which deprived the special committee of the power to function. Identifier. Third, the controllers “created a coercive situation by threatening” to resort to backup options if the operation failed, such as a forced conversion of class V shares into class C. In doing so, [Defendants] both undermined the special committee’s ability to negotiate effectively and the ability of shareholders to vote against the deal. ” Identifier. at * 31 Fourth, the special committee was in conflict, not least because one of its members (David Dorman) belonged to the same very exclusive golf clubs – Augusta National and San Francisco Golf Club – as a managing partner of Silver Lake Partners. Identifier. to * 36. Fifth, the shareholder vote was not informed, as the controllers did not disclose material information, including Dell’s previous valuations that were well below the valuation used in the transaction. Identifier. at * 39-41.

Dell shows that courts can look beyond the formal imposition of a special committee and a majority vote of the minority when a monitor has done nothing but lip service MFW without meticulously respecting its requirements. Beyond Dell, other recent Delaware court decisions also illustrate the scope and limitations of MFWprotections for controlling shareholders.

Ab initio Requirement: Controllers must appoint a special committee ab initio– before the start of the transaction. But exactly what “ab initio” means-that is to say, when MFW requirements come into play — has been the subject of frequent litigation. The Delaware Supreme Court decision in Flood v Synutra Int’l, Inc., 195 A.3d 754, 762 (Del. 2018) is instructive. There, the complainants argued that the controller had failed to qualify for MFWprotections because the controller sent a letter to minority shareholders offering to take a company (Synutra) private before appoint a special commission. Liang Zhang and his subsidiaries controlled 63.5% of Synutra. Zhang sent a letter offering to privatize Synutra by acquiring the rest of its shares. A week later, the board formed a special committee, but did not discuss the proposal. Two weeks after the initial offer, Zhang sent a second letter, this time with MFW conditions. Price negotiations did not begin until seven months after the second letter. Minority shareholders contested the transaction, claiming that the first the letter should have contained MFW conditions. The Delaware Supreme Court disagreed and ruled that MFW applied because its twin conditions were put in place “before any substantive economic negotiation”. Identifier. to 762. Flood confirms that all securities transactions carried out by a supervisor do not trigger the imposition of MFW requirements. But later cases make it clear that supervisors must be careful not to enter into “substantive economic negotiations” before appointing a special committee, otherwise they risk losing the protections of the business judgment rule. Compare Olenik v. Lodzinski, 208 A.3d 704, 717 (Del. 2019) (ab initio requirement not met when the controlling shareholder has engaged in months of discussions on the valuation of a merger target before appointing a special committee).

Daily Transactions: Delaware courts have also clarified that MFW does not only apply to “business stake” transactions. Yes MFW conditions are not met, even more common decisions may be subject to a full fairness review. In Tornetta vs. Musk, 250 A.3d 793 (Del. Ch. 2019), the court considered whether the compensation plan of Tesla CEO Elon Musk was subject to a full fairness review or to the rule of law. business appreciation. The court concluded that because MFW conditions had not been met, the entire fairness review was governed, even though the contested decision was not a “transformational” transaction such as a merger or share buyback. Identifier. to 800.

What is a “controlling” shareholder? Courts applying MFW have sometimes applied the “full equity” control even to shareholders who control less than the majority of the voting shares of a company. In In re Tesla Motors, Inc. Shareholding Litigation., 2020 WL 553902, at * 4 (Del. Ch. February 4, 2020), minority shareholders challenged Tesla’s acquisition of another company, Solar City, and sued Musk. He argued that he was not a majority shareholder because he only owned 22% of the voting shares. The court rejected this argument and concluded that a “minority shareholder can, in law, be a majority shareholder through a combination of potential voting rights. and management control in such a way that the shareholder can be considered to have effective control of the board of directors without actually owning the majority of the shares. Identifier.

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