In March, April and May 2024, the Delaware Supreme Court (the “Court”) clarified important issues regarding the application of the special committee requirements it set forth ten years ago in its seminal Kahn v. M & F Worldwide Corp., 88 A.3d 635, 642 (Del 2014) (“MFW”) decision. The three decisions clarifying the MFW framework application are:

• TerraForm Power v. Brookfield Asset Management, et al., C.A. No. 202-0097 (March 25, 2024) (“Brookfield”), in which the Court revived minority stockholders’ claims, holding that the special committee failed to disclose its legal and financial advisors’ conflicts;
• In re Match Group Derivative Litigation., C.A. No. 2020-0505 (April 4, 2024) (“Match Group”), in which the Court confirmed that, as an overarching rule, entire fairness applies to all transactions in which a controller receives a non-ratable benefit; in addition, all members of the special committee, and not just a majority, must be independent to avoid entire fairness; and
• City of Sarasota Firefighters’ Pension Fund v. Inovalon Holdings, Inc., C.A. No. 2022-0698 (May 1, 2024) (“Inovalon”), in which the Court reached a similar holding as in Brookfield and reversed the Court of Chancery’s dismissal of the stockholder’s claims due to inadequate and incomplete disclosure relating to the special committee advisors’ conflicts.

Under MFW, a case involving a squeeze-out merger, if a controlling stockholder receives a non-ratable benefit, the more exacting entire fairness standard of review applies (as opposed to business judgment), unless the transaction is approved by both a special committee of independent directors and a vote of the majority of the minority stockholders.¹

Key practical guidelines from these recent decisions, clarifying MFW, are as follows:

• Any transaction – not only squeeze-out mergers – in which a controller receives a non-ratable benefit will be subject to entire fairness, unless the MFW framework is adhered to.
• When forming an independent committee, boards and advisors should carefully vet the independence of each member, recognizing that the lack of independence of one member can taint the independence of the entire committee for purposes of MFW.
• Evaluation of independent committee members’ independence must be comprehensive and not limited to formal ties with the controller. Both the Court of Chancery and the Court in Match Group agreed with the plaintiffs that long-standing business relationship with “personal ties of respect, loyalty, and affection” between the controller and a committee member may cast doubt over the latter’s independence. 
• Boards may not rely solely on stock exchange rules for director independence, which can be only one of the many factors ultimately considered by courts. 
• Special committees should investigate their financial and legal advisors’ potential conflicts, and if material conflicts are found, mitigate the conflicts’ effects; and the company must disclose both the conflicts and the mitigation to the minority shareholders. The disclosure must be carefully drafted and reviewed in the context of each particular transaction to mitigate the risk of allegations that such disclosure is incomplete or misleading. 

In Brookfield, the Court held that a special committee should determine and then disclose its financial and legal advisors’ material conflicts of interest.

The Court reversed the Court of Chancery’s dismissal of minority stockholders’ claims that certain of TerraForm’s and its controlling stockholder’s officers and directors breached their fiduciary duties in connection with a squeeze-out merger by a subsidiary of the controlling stockholder.  A fully independent special committee of TerraForm’s board was formed on the day the merger offer was made, and granted exclusive authority to evaluate and negotiate the offer, and to either reject or recommend approval of the deal. The special committee was also empowered to retain its own financial and legal advisors, which it did. Among those advisors was an investment bank that had previously been retained by TerraForm and the controller in unrelated matters, and which together with the bank’s affiliates held a $470 million stake in entities affiliated with the controller.  The special committee also retained as legal advisor a firm that had also advised the controller on unrelated transactions.  As alleged, while the financial advisor had a conflict stemming from the equity investment, such conflict was described as a hypothetical (“may have committed … to invest”). The legal advisor’s alleged conflict was not disclosed to the stockholders.  In addition, neither advisor’s alleged conflicts were disclosed to the special committee; nor did the committee request a conflict disclosure from either advisor.

The Court of Chancery rejected the plaintiffs’ arguments that these allegations cast doubt on the reasonableness and good faith nature of the special committee’s decision to hire the advisors, highlighting both the relatively small economic value of the allegedly conflicting work to the advisors, and the quality of the work that the record demonstrated the special committee was able to perform in negotiating the transaction.  It similarly rejected claims that the proxy statement failed to disclose these conflicts, based on its prior finding that the plaintiffs had failed to plead that the advisor was “meaningfully conflicted as to the merger.” 

On appeal, the plaintiffs dropped their claim that the special committee breached its duty of care in engaging the two advisors, but pressed forward with their claim that the proxy’s failure to disclose those conflicts was a material omission.  The Court found the trial court’s analysis of that issue “problematic,” holding both that a failure to plead a duty of care violation in connection with the hiring of allegedly conflicted advisors does not answer the question whether the alleged conflict was material such that it must be disclosed, and also that the materiality analysis necessary to the disclosure claim must focus on the alleged omission from the perspective of the stockholder, rather than whether the conflict would be material from the perspective of the advisor.

Through this lens, the Court held that it was reasonably conceivable that both advisors’ alleged conflicts would have been material to a stockholder in assessing the advisors’ objectivity.  The Court observed that “Delaware law places great importance on the need for transparency in the special committee’s reliance on its advisors: ‘it is imperative for the stockholders to be able to understand what factors might influence the financial advisor’s analytical efforts.’”  In stating a claim that a conflict should have been disclosed, a plaintiff need not allege facts showing that the conflict impacted the advisor’s analysis; it is sufficient that a disclosable material conflict existed: “[t]here is no rule that conflicts of interest must be disclosed only where there is evidence that the [] advisor’s opinion was actually affected by the conflict.”  

In Match Group, the Court held that entire fairness applies to all transactions involving a controlling stockholder receiving a non-ratable benefit, unless the requirements of MFW are satisfied.

The Court held in Match Group that the exacting entire fairness standard of review applies to all transactions (not only squeeze-out mergers) involving a controlling stockholder that receives a non-ratable benefit, unless the MFW factors are satisfied.  The Court also clarified that all members of an independent committee need to be independent for purposes of MFW. 

For decades, MFW and its predecessors served as guideposts for application of the entire fairness standard of review.

Through three key cases spanning three decades, Delaware law determined transactions involving a conflicted controller would be subject to different standards of review and burdens of proof depending on the process used to consider and approve that transaction. In 1983, the Court in Weinberger held that, in a squeeze-out merger where the controlling stockholder receives preferential treatment and the transaction is approved by a vote of a majority of the minority stockholders, entire fairness applies, but the burden shifts to the plaintiff to show the transaction was unfair.  Weinberger v. UOP, 457 A.2d 701 (Del. 1983).  In 1994, the Court in Lynch held the burden would also shift to the plaintiff if the transaction was negotiated by a special committee of independent directors, but the standard of review was unchanged: entire fairness still applies.  Kahn v. Lynch Comc’n Sys., Inc., 638 A.2d 1110, 1117 (Del. 1994). 

In 2014, MFW addressed the applicable standard of review when both a special committee and a minority vote were employed. MFW held that when a board utilized both protections (consistent with the six elements enumerated in footnote 1), the business judgment rule applied. 

The Match Group litigation presented the question of whether MFW would apply outside the context of a squeeze-out merger.

Before effecting a reverse spin-off that separated Match Group Inc. from IAC/Interactive Corp, Match Group received approval by a separation committee of Match Group, Inc. and by a vote of the majority of its minority stockholders.  Plaintiffs claimed that the transaction was unfair because it left the spun-off company (and its public stockholders) with lesser quality assets than the controller.  Defendants claimed they satisfied the requirements of MFW through their use of a special committee and minority vote.  Defendants also argued in the alternative that, because this transaction was not a squeeze-out merger, the MFW requirements need not be satisfied for the court to apply the business judgment standard.  

On appeal, the Court requested supplemental briefing addressing whether MFW applied outside the context of squeeze-out mergers, leading some to speculate that the Court may use the opportunity to rein in the “MFW creep” that had in the past decade seen lower courts apply the MFW standard in transactions other than the squeeze-out context. Ultimately, the Court held that the MFW requirements applied to Match despite the fact that the transaction did not involve a squeeze-out.  The Court stated that the “common thread running through” its decisions was “a heightened concern for self-dealing when a controlling stockholder stands on both sides of the transaction and receives a non-ratable benefit.” 

The Court also held that all members of a special committee must be independent for purposes of MFW and that prior employment with a controller could compromise independence.

MFW requires that the special committee approving the transaction be independent.  Reversing the Court of Chancery ruling, the Court held that a special committee must be completely independent, down to every member, not just a majority, for purposes of MFW. In Match Group, a member of the special committee was employed by the controlling stockholder for several years as CFO and continued to serve on various boards related to the controlling stockholder after his employment ceased.  The Court of Chancery held that the plaintiffs had pleaded a reasonable inference that one committee member was not independent, but held (relying on a bevy of other Court of Chancery opinions in agreement) that a single member’s lack of independence did not extinguish the defendants’ ability to rely on MFW so long as a majority of the committee was independent.  The Court reversed, holding that the independence of only a majority of the special committee does not accomplish MFW’s requirement that the special committee “should function ‘in a manner which indicates that the controlling stockholder did not dictate the terms of the transaction and that the committee exercised real bargaining power at an arm’s length.’”  The Court further agreed with the Court of Chancery’s holding that the plaintiffs had pleaded a reasonable inference of the one member’s lack of independence, due in part to his employment as IAC’s CFO for over decade (even though such employment terminated eight years before the transaction).  Noting that those years of employment formed the basis of the committee member’s overall success, both courts pointed to public statements of mutual respect from both the committee member and the controlling stockholder, and determined that this kind of longstanding business affiliation built on mutual respect is of the sort that can impair a director’s independence. 

In Inovalon, as in Brookfield, the Court found inadequate disclosure of financial advisors’ alleged conflicts to be sufficient for entire fairness to apply.

As was the case in Brookfield, the Court reversed the Court of Chancery’s dismissal of a minority stockholder’s claim based on incomplete disclosure of financial advisors’ alleged conflicts.  Inovalon’s special committee engaged two investment banks in connection with a sale of Inovalon to a private equity consortium, which sale featured a substantial equity rollover by the controlling stockholder.  The Court held that Inovalon failed to adequately disclose the alleged conflicts faced by both of them.

The first financial advisor had prior and concurrent relationships with several members of the consortium.  Inovalon’s proxy statement disclosed the existence of those relationships and certain fees earned by the advisor in the past from the lead member of the consortium, but failed to disclose other fees earned from past and concurrent representation of several of the consortium members. Such fees, however, were 25 times the fees earned from the lead member and 10 times the fees earned in the Transaction.  While the Court stopped short of requiring disclosure of fees in all circumstances, absence of full fee disclosure in that particular case “prevented stockholders from contextualizing and evaluating [the advisor’s] concurrent conflicts of interest”, since “stockholders could be misled into thinking that the undisclosed fees earned in the concurrent representations were of a similar magnitude” to the disclosed fees.

The second financial advisor was concurrently representing two members of the acquiror consortium.  The disclosure in the proxy statement was found to have the same deficiency as the disclosure at issue in Brookfield; namely, that it used the words “may provide financial advisory and other services” to describe engagements that were in existence rather than a possibility. 

The above disclosure deficiencies were sufficient for the Court to cast doubt on whether the stockholder vote was informed, and to allow the minority stockholder’s claim to proceed.  In addition, while not treating it as a basis for its decision, the Court addressed the claim that Inovalon’s proxy statement overstated the role of the second advisor in the transaction process compared to what was recorded in the special committee’s minutes and urged more accurate disclosures.  

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¹For business judgment to apply, MFW requires that: (i) the controller conditioned the transaction on the approval of both a special committee and a majority of the minority stockholders; (ii) the special committee was independent; (iii) the special committee was empowered to freely select its own advisors and to say no definitively; (iv) the special committee met its duty of care in negotiating a fair price; (v) the vote of the minority was informed; and (vi) there was no coercion of the minority.

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