In Re MFW Shareholders Litigation: Controlling Shareholder In Going-Private Transaction May Gain The Benefit Of The Business Judgment Rule

Article by Joel C. Haims and James J. Beha II1

In a decision with great potential significance for the structuring of going-private transactions, Delaware Chancellor Leo Strine recently held in In re MFW Shareholders Litigation 2 that a merger with a controlling stockholder would be reviewed under the highly deferential business judgment rule rather than the "entire fairness" standard if the merger is structured to include certain procedural safeguards for minority shareholders.

THE BUSINESS JUDGMENT RULE AND THE ENTIRE FAIRNESS STANDARD

As the Delaware Supreme Court has recognized, in litigation challenging board action, "[t]he choice of the applicable 'test' to judge director action often determines the outcome of the case."3 Most board action—including a decision to approve a third-party merger offer—is reviewed under the business judgment rule, which precludes the court from inquiring into the fundamental fairness of the deal. Under that rule, the court must dismiss any challenge to a corporate transaction unless the terms were so disparate than no rational person in good faith could have thought the transaction was fair.4

One notable exception to application of the business judgment rule is judicial review of a corporation's transactions with its controlling or dominating shareholder, such as a going-private transaction. Those transactions are generally considered under the "entire fairness" standard, requiring the controlling shareholder to affirmatively demonstrate both "fair dealing" with the board and that the transaction was completed at a fair price.5 The application of the "entire fairness" standard "normally will preclude dismissal of a complaint in a Rule 12(b)(6) motion to dismiss."6

The Delaware Supreme Court has held that the burden under the entire fairness doctrine will be shifted to the plaintiff challenging a transaction if the transaction was approved either by an independent special committee of the board or by the majority of the non-controlling stockholders (i.e., a "majority-of-the-minority vote").7 But this shifting of the ultimate burden of proof does not change the fact that "the initial burden of establishing entire fairness rests upon the party who stands on both sides of the transaction."

8 As a result, even with one of those procedural safeguards in place, lawsuits challenging going-private transactions generally have a low threshold to survive a motion to dismiss. And, whoever bears the burden, entire fairness review requires a fact (and discovery)...