October 15, 2018
On October 9, 2018, in Flood v. Synutra Intth’l, Inc.,[1] the Delaware Supreme Court further refined when in a controller transaction the procedural safeguards of Kahn v. M & F Worldwide Corp.[2] (“MFW“) must be implemented to obtain business judgment rule review of the transaction. Under MFW, a merger with a controlling stockholder will be reviewed under the deferential business judgment rule standard, rather than the stringent entire fairness standard, if the merger is conditioned “ab initio” upon approval by both an independent, adequately-empowered Special Committee that fulfills its duty of care, and the uncoerced, informed vote of a majority of the minority stockholders.[3] Writing for the majority in Synutra, Chief Justice Strine emphasized that the objective of MFW and its progeny is to incentivize controlling stockholders to adopt the MFW procedural safeguards early in the transaction process, because those safeguards can provide minority stockholders with the greatest likelihood of receiving terms and conditions that most closely resemble those that would be available in an arms’ length transaction with a non-affiliated third party. Accordingly, the Court held that “ab initio” (Latin for “from the beginning”) requires that the MFW protections be in place prior to any substantive economic negotiations taking place with the target (or its board or Special Committee). The Court declined to adopt a “bright line” rule that the MFW procedures had to be a condition of the controller’s “first offer” or other initial communication with the target about a potential transaction.
Synutra affirmed the Chancery Court’s dismissal of claims against Liang Zhang and related entities, who controlled 63.5% of Synutra’s stock. In January 2016, Zhang wrote a letter to the Synutra board proposing to take the company private, but failed to include the MFW procedural prerequisites of Special Committee and majority of the minority approvals in the initial bid. One week after Zhang’s first letter, the board formed a Special Committee to evaluate the proposal and, one week after that, Zhang submitted a revised bid letter that included the MFW protections. The Special Committee declined to engage in any price negotiations until it had retained and received projections from its own investment bank, and such negotiations did not begin until seven months after Zhang’s second offer.
The plaintiff argued that because Zhang’s initial letter did not contain the dual procedural safeguards of MFW as pre-conditions of any transaction, the “ab initio” requirement of MFW was not satisfied and therefore business judgment standard of review had been irreparably forfeited. The Court declined to adopt this rigid position, and considered that “ab initio” for MFW purposes can be assessed more flexibly. To arrive at this view, the Court explored the meaning of “the beginning” as used in ordinary language to denote an early period rather than a fixed point in time. The Court also parsed potential ambiguities in the language of the Chancery Court’s MFW opinion, which provided that MFW pre-conditions must be in place “from the time of the controller’s first overture”[4] and “from inception.”[5]
Ultimately, the Court looked to the purpose of the MFW protections to find that “ab initio” need not be read as referring to the single moment of a controller’s first offer. As Synutra emphasizes, the key is that the controller not be able to trade adherence to MFW protections for a concession on price. Hence the “ab initio” analysis focuses on whether deal economics remain untainted by controller coercion, so that the transaction can approximate an arms’ length transaction process with an unaffiliated third party. As such, the Court’s reasoning is consistent with the standard espoused by the Chancery Court in its prior decision in Swomley v. Schlecht,[6] which the Court summarily affirmed in 2015, that MFW requires procedural protections be in place prior to the commencement of negotiations.[7]
In a lengthy dissent, Justice Valihura opined that the “ab initio” requirement should be deemed satisfied only when MFW safeguards are included in the controller’s initial formal written proposal, and that the “negotiations” test undesirably introduces the potential for a fact-intensive inquiry that would complicate a pleadings-stage decision on what standard of review should be applied. Chief Justice Strine acknowledged the potential appeal of a bright line test but ultimately rejected it because of the Court’s desire to provide strong incentive and opportunity for controllers to adopt and adhere to the MFW procedural safeguards, for the benefit of minority stockholders. In doing so, the Court acknowledged that its approach “may give rise to close cases.” However, the Court went on to add, “our Chancery Court is expert in the adjudication of corporate law cases.” The Court also concluded that the facts in Synutra did not make it a close case.[8]
The Court also upheld the Chancery Court’s dismissal of plaintiff’s claim that the Special Committee had breached its duty of care by failing to obtain a sufficient price. Following the Chancery Court’s reasoning in Swomley, Synutra held that where the procedural safeguards of MFW have been observed, there is no duty of care breach at issue where a plaintiff alleges that a Special Committee could have negotiated differently or perhaps obtained a better price – what the Chancery Court in Swomley described as “a matter of strategy and tactics that’s debatable.”[9] Instead, the Court confirmed that a duty of care violation would require a finding that the Special Committee had acted in a grossly negligent fashion. Observing that the Synutra Special Committee had retained qualified and independent financial and legal advisors and engaged in a lengthy negotiation and deal process, the Court found nothing to support an inference of gross negligence and thus deferred to the Special Committee regarding deal price.[10]
Synutra dismissed the plaintiff’s complaint at the pleadings stage. In its procedural posture, the Court followed Swomley, which allowed courts to resolve the MFW analysis based on the pleadings. The dissent noted that adoption of a bright-line test would be more appropriate for pleadings-stage dismissals. However, the Court established that it would be willing to engage some degree of fact-finding at the pleadings stage in order to allow cases to be dismissed at the earliest opportunity, even using the Court’s admittedly more flexible view of the application of MFW.
Synutra reaffirms the Court’s commitment to promoting implementation of MFW safeguards in controller transactions. In particular:
Although under Synutra a transaction may receive business judgment rule review despite unintentional or premature controller communications that do not reference the MFW procedural safeguards as inherent deal pre-conditions, deal professionals would be well advised not to push this flexibility too far. Of course, there can be situations where a controller concludes that deal execution risks or burdens attendant to observance of the MFW safeguards are too great (or simply not feasible), and thus is willing to confront the close scrutiny of an entire fairness review if a deal is later challenged. However, if a controller wants to ensure it will receive the benefit of business judgment rule review, the prudent course is to indicate, in any expression of interest, no matter how early or informal, that adherence to MFW procedural safeguards is a pre-condition to any transaction. Synutra makes clear that the availability of business judgment review under MFW will be a facts and circumstances assessment, but we do not yet know what the outer limits of the Court’s flexibility will be, should it have to consider a more contentious set of facts in the future.
[1] Flood v. Synutra Int’l, Inc., No. 101, 2018 WL 4869248 (Del. Oct. 9, 2018).
[2] Kahn v. M&F Worldwide Corp., 88 A.3d 635 (Del. 2014).
[3] Id. at 644.
[4] In re MFW Shareholders Litigation, 67 A.3d 496, 503 (Del. Ch. 2013).
[5] Id. at 528.
[6] Swomley v. Schlecht, 2014 WL 4470947 (Del. Ch. 2014), aff’d 128 A.3d 992 (Del. 2015) (TABLE).
[7] The Court did not consider that certain matters that transpired between Zhang’s first and second offer letters, namely Synutra’s granting of a conflict waiver to allow its long-time counsel to represent Zhang (the Special Committee subsequently hired separate counsel), constituted substantive “negotiations” for this purpose since the waiver was not exchanged for any economic consideration.
[8] Synutra, 2018 WL 4869248, at *8.
[9] Id. at *11, citing Swomley, 2014 WL 4470947, at 21.
[10] In a footnote, the Court expressly overruled dicta in its MFW decision that the plaintiff cited to argue that a duty of care claim could be premised on the Special Committee’s obtaining of an allegedly insufficient price. Id. at *10, Footnote 81.
The following Gibson Dunn lawyers assisted in preparing this client update: Barbara Becker, Jeffrey Chapman, Stephen Glover, Mark Director, Eduardo Gallardo, Marina Szteinbok and Justice Flores.
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