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The Geography of MFW-Land and the Limits of
Controlling Shareholder Ratification
Itai Fiegenbaum
Table of Contents
I. Introduction
2
II. Related Party Transactions with a Controlling Shareholders 5
A. Controlling Shareholders - General
5
B. Controlling Shareholders under Delaware Law 8
C. Controlling Shareholders – A Complicated Taxonomy 9
D. Controlling Shareholders and Related Party Transactions 12
III.Standards of Review in Delaware Law 14
A. Introduction
14
B. Business Judgment Rule
15
C. Enhanced Scrutiny
17
D. Entire Fairness
19
E. Downgrading from Enhanced Fairness 22
IV. Questioning MFW's Reach – Doctrine 27
a. Introduction
27
b. MFW and the Unification of Final Period Review 27
c. Standards of Review for Going-Concern RPTs 27
V. Questioning MFW's Reach – Policy 28
a. Independent Board Committees – A Critique 28
b. Majority of Minority Shareholder Approval – A Critique 32
VI. The Geography of MFW-LAND 35

PhD Candidate, Tel Aviv University. LL.B, Tel Aviv University, LL.M, Columbia University.
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I. Introduction
Judicial standards of review for board actions and inactions are a foundational
element of Delaware corporate law.1 Market forces are believed to correct egregious
episodes of simple mismanagement more swiftly and mercilessly than the courts.
Accordingly, a shareholder complaint against decisions undertaken by the board of
directors will be met with the default deferential business judgment rule standard of
review.2 This standard's hallmark is a heavy presumption that the board acted in the
corporation's best interests. Application of the business judgment rule usually results
in a swift dismissal of the complaint.
Factual situations that cast suspicion on the board's ability to champion
shareholder interests result in an upgrade of the standard of review. Arrival of an
outside bidder that seeks to wrest control from incumbent management is an example
of such a scenario. Lingering doubts regarding the actual motivation behind the
board’s response towards an unwanted suitor undermines the presumption of fidelity
and justifies adoption of an intermediate 'enhanced scrutiny' level of review. Once
enhanced scrutiny applies, the onus shifts to the board to prove that the defensive
measures were reasonable to the recognized threat.
Transactions between the corporation and its controlling shareholder provide
another example of a suspect situation. Ownership of a control block of shares
connotes a heavy influence over board composition and by implication corporate
policy. An inherent suspicion that board approval was induced by the desire to stay on
the controller's good graces justifies evocation of an even more stringent standard of
review. Under the entire fairness standard, it is up to the board to prove that the
challenged transaction materialized after an impeccable negotiating process that
successfully safeguarded minority shareholder interests.
1
2
Robert B. Thompson, Mapping Judicial Review: Sinclair v. Levien, in THE ICONIC CASES IN
CORPORATE LAW 79 (Jonathan R. Macey, ed.) (2008) ("The intensity of judicial review of
corporate decisions is the central issue of corporate law"). "Distinguishing among standards
of review is an important (and frequently dispositive) exercise" (In Re Molycorp, Inc.
Shareholder Derivative Litigation, Consolidated C.A. No 7282-VCN, (Del. Ch. May 27, 2015)
*20-21). This is because “[t]he applicable standard of judicial review often controls often
controls the outcome of the litigation on the merits” Emerald Partners v. Berlin, 787 A.2d 85,
89 (Del. 2001) (citations omitted).
Carsanaro v. Bloodhound Technologies, Inc., 65 A.3d 618, 637 (Del. Ch. 2013) ("The business
judgment rule serves as Delaware's default standard of review and applies to the
overwhelming majority of decisions that boards make").
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Court deference to independent, disinterested, and sufficiently informed
decision makers is an additional feature of Delaware law.3 Under certain conditions,
effective employment of a qualified decision maker results in a reduction of the
standard of review.4 Recent case law and scholarly endeavors have elucidated the
effect of qualified decision maker approval in certain situations.5 While helpful, these
clarifications have done little to redress the scarcity of settled authority detailing the
effect of qualified decision maker(s) approval in problematic scenarios involving the
corporation and a controlling shareholder.6
This article attempts to fill that void. Specifically, it questions whether
effective employment of a ratification procedure should ever restore the business
judgment rule review for transactions with a controlling shareholder. At first glance,
the answer appears obvious to faithful followers of Delaware law.
In a highly celebrated decision, the Delaware Supreme Court concluded that a
going private merger with a controlling shareholder will be granted deferential
business judgment rule review, so long as it was approved by two procedural
safeguards:7 (i) a special board committee composed of disinterested directors armed
with independent counsel, advisors with actual bargaining power and (ii) conditioning
the consummation of the transaction on the non-revocable acceptance by a majority of
minority shareholders.8 Prior to this decision, Delaware case law declined to provide a
ratification avenue that results in business judgment rule review for going private
mergers.9
Contrary to the "classic" ratification doctrine, which merely calls for
shareholder approval,10 the MFW guideline demands the aggregate endorsement of
3
4
5
6
7
8
9
10
J. Travis Laster, The Effect of Stockholder Approval on Enhanced Scrutiny, 40 WM. MITCHELL L.
REV. 1443 (2013). In accordance with the terminology adopted by Vice-Chancellor Laster, this
article adopts the phrase "qualified decision maker" as shorthand for the list of necessary
attributes.
Id., at 1444 ("A court applying Delaware law moves along the standards depending on the
degree to which a qualified decision maker exists").
See fn. == infra and accompanying text.
Laster, supra note 4, at 1444 ("Delaware decisions explain how the standard of review
escalates from the business judgment rule to entire fairness and back again… But Delaware
cases address to a far lesser degree how the standard of review can diminish from enhanced
scrutiny to the business judgment rule"). This article will prove that the lack of clarity exists in
the controlling shareholder context as well.
Kahn v. M & F Worldwide Corp., 88 A.3d 635 (2014) [hereinafter MFW Supreme]. To be more
precise, the Supreme Court affirmed the analysis and framework established by the Court of
Chancery; see In re MFW Shareholders Litigation, 67 A.3d 496 (2013) [hereinafter MFW
Chancery].
See fn. == infra and accompanying text.
See fn. == infra and accompanying text.
Conceptually, the term "shareholder ratification" has been used to describe slightly different
sets of circumstances. "Classic" ratification depicts situations where shareholders are asked
to approve board action that would be legally valid even without shareholder approval.
Examples of this type of ratification include director compensation or a board stock option
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two separate qualified decision makers. In essence, MFW creates an enhanced
ratification mechanism for going private mergers.
Going private transactions differ from going concern transactions in that their
successful completion wipes out the minority float. This distinction accelerates
shareholders' divergent incentives and raises the possibility for minority shareholder
abuse. All shareholders gain in value that accrues to a publicly traded corporation. An
unscrupulous controller might structure the transaction in a manner that captures all
unlocked value for later private consumption.11 Additionally, going private
transactions allow controlling shareholders to shed the restrictions of the public
market, thereby evading future retribution by minority shareholders.12 Accordingly,
policy considerations call for superior protection of minority shareholders
participating in a going private transaction.
Since MFW establishes a procedure for achieving narrower judicial review for
going private transactions, it stands to reason that the effect of this procedure should
apply to all transactions involving a controlling shareholder. After all, if the courts are
willing to downgrade their involvement in the most problematic of settings for
minority shareholders, what possible rationale is there for staying put with enhanced
review in apparently more benign circumstances?
This article shows that the borders of "MFW-Land" are not as clear-cut as they
appear. Across-the-board application of business judgment rule review for all
controlling shareholder transactions that employ the MFW enhanced ratification
blueprint does not necessarily flow from the Supreme Court's decision. Two main
arguments form the basis of this contention.
The dual tenets of doctrinal clarity and cohesion underpin the first argument.
MFW stems from a line of cases that deal specifically with going private transactions
with a controlling shareholder. Different strands of Delaware authority seemingly
govern other instances of controlling shareholder self-dealing. A careful reading of
the MFW decision fails to detect any mention of competing precedent or any
11
12
plan. Ratification has also been used to describe the effect of an informed shareholder vote
that was statutorily required for the transaction to have legal existence. Examples of the
"organic" ratification alternative include mergers and amendments to a corporation's
certificate of incorporation. See: In Re Wheelabrator Tech. Shareholders Lit., 663 A,2d 1194,
1201 fn. 4 (Del. Ch. 1995). Recent case law and a scholarly article authored by ViceChancellor Laster have clarified language in prior Supreme Court opinions that arguably
question the effect of shareholder ratification on organic corporate acts. See: In Re KKR
Financial Holdings LLC, 101 A.3d 980, 1001-1003 (Del. Ch. 2014) and Laster, supra note 4 at
p. 1848-1491. Since no statutory authority requires shareholder approval for related party
transactions with a controlling shareholder, this article's focus remains on the "classic" form
of shareholder ratification.
Ronald J. Gilson & Jeffrey N. Gordon, Controlling Controlling Shareholders, 152 U. PA. L. REV.
785, 804 (2003).
Sean J. Griffith, Deal Protection Provisions in the Last Period of Play, 71 FORDHAM L. REV. 1899,
1941-1947 (2002) (discussing the last period problem).
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reference regarding its application to other types of controlling shareholder
transactions. Canons of judicial interpretation counsel against an indirect reversal or
modification of established precedent.
The second argument derives from the policy justifications explicitly
articulated by the MFW court. The doctrinal shift is grounded on the twin pillars
representing the competency of independent directors and non-affiliated shareholders.
Whatever the validity of these mechanisms in the freeze out context, the empirical
literature does not advocate an extension to going concern transactions. Serious flaws
hamper the ability of independent directors and non-affiliated shareholders to pass
meaningful judgment on going concern transactions. Ultimately, the courts' own
reasoning does not support the establishment of an enhanced ratification procedure for
all controlling shareholder transactions.
The rest of the article is structured as follows. Since this article deals
specifically with related party transaction with controlling shareholders, Part II
defines the pertinent terms and expands on the policy issues that these types of
transactions engender. Part III describes the Delaware judiciary's use of shifting
standards of review to police potentially harmful transactions. Part IV traces the
doctrinal evolution of the standards applicable to going-private transactions and
demonstrates that their shared ancestry with the general authority regarding going
concern transactions with a controlling shareholder is tenuous at best. Part V takes a
closer look at the underlying policy rationales behind the MFW decision. Critically,
this part will reveal the drawbacks associated with each justification. Taken together,
Parts IV and V conclude that that expansion of the MFW doctrine to other types of
controlling shareholder transactions is not a compulsory outcome.
II. Related Party Transactions with a Controlling
Shareholder
A. Controlling Shareholders - General
This paper questions the effect of an enhanced ratification procedure on the
standard of review used to evaluate related party transactions (RPTs) with a
controlling shareholder. Brisk definitions of the pertinent terms will prove useful for
the analysis.
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The dominant corporate governance model entrusts the board of directors with
plenary authority over the whole of the corporate enterprise.13 This authority entails
the ability to hire active management, set their pay, and if need be, fire them.14 A
republican theory of shareholder democracy justifies this broad vest of authority.15 If
shareholders are displeased, they are entitled to attempt to galvanize the electorate in
an effort to replace the board.16 By virtue of their legal capability to set board
composition, ultimate indirect control over the corporation belongs to shareholders.
Firm-specific shareholder ownership displays significant variance.17 An
accepted taxonomy distinguishes between 'dispersed' and 'concentrated' ownership.
Dispersed ownership occurs when shareholder fragmentation is so severe that no
single shareholder or groups of shareholders can singlehandedly determine the
shareholder vote. This scenario entertains the theoretic possibility that the next annual
shareholders meeting transfers de-facto control over the corporation to a new slate of
directors.
Ownership of a corporation is considered 'concentrated' if either a single
shareholder or a group of shareholders, working in unison, are able to unilaterally
dictate the result of the shareholder vote. Ownership of over half the shares renders
most shareholder votes foregone conclusions. However, actual control can be
achieved by means of a much lower ownership stake. Fragmented shareholders face
prohibitive collective action problems that are amplified by legal rules skewed in
favor of the incumbent board.18 For this reason, the comparative corporate law
13
14
15
16
17
18
REINIER KRAAKMAN ET AL., THE ANATOMY OF CORPORATE LAW: A COMPARATIVE AND FUNCTIONAL
APPROACH (2nd ed. 2009), pp. 56-60.
Id. PP. 60-62.
Stephen M. Bainbridge, Why a Board - Group Decisionmaking in Corporate Governance, 55
VAND. L. REV. 1, 4 (2002).
See Leo E. Strine, Jr., The Story of Blasius v. Atlas Corp.: Keeping the Electoral Path to
Takeovers Clear, in J. MARK RAMSEYER, CORPORATE LAW STORIES 243 (2009) (detailing how
Delaware law severely limits director actions designed to impede stockholder access to the
voting booth). The actual scope of stockholders' ability to displace incumbent directors is
subject to some debate; compare Lucian A. Bebchuk, The Myth of the Shareholder Franchise,
93 VA. L. REV. 675 (2007) with E. Norman Veasey, The Stockholder Franchise Is Not a Myth: A
Response to Professor Bebchuk, 93 VA. L. REV. 811 (2007) and Martin Lipton & William Savitt,
The Many Myths of Lucian Bebchuk, 93 VA. L. REV. 733 (2007). Since this article's analysis of
enhanced ratification procedure premises the existence of a controlling shareholder, I
sidestep the debate regarding the actual efficacy of stockholder democracy in corporations
characterized with disperse ownership.
Beyond simple serendipity, this variance may also result from the relative costs associated
with jointly owning different types of enterprises; see ZOHAR GOSHEN & RICHARD SQUIRE,
PRINCIPAL COSTS, http://papers.ssrn.com/abstract=2571739 (last visited Aug 3, 2015).
Two examples come readily into mind. The first is the general case law that permits the
corporation to reimburse incumbent directors for election and proxy solicitation expenses
while denying unsuccessful insurgents the same benefit; see Rosenfeld v. Fairchild Engine &
Airplane Corp., 309 NY 168 (N.Y. 1955), Steinberg v. Adams, 90 F. SUPP. 604 (S.D.N.Y 1950).
The second is the Delaware courts' validation of a shareholder right plan (colloquially
referred to as a poison pill), which allows the corporation to heavily dilute a shareholder that
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literature has settled on the 20% ownership threshold as evidence of control.19 Beyond
this point, the largest shareholder usually has a clear ability to influence the
shareholder vote and is accordingly identified as the controlling shareholder.
The traditional narrative of American public corporation ownership posits
extreme stockholder fragmentation.20 This is unfortunate, since the absence of
controlling shareholders would relegate an article pondering the legal rules that
govern controlling shareholder self-dealing into a work of fiction. Luckily, recent
scholarship has documented significant nuance in the actual levels of shareholder
ownership. Dominant shareholders, while not unheard of, are indeed a rare occurrence
in the largest publicly traded corporations.21 However, expanding the universe of
surveyed corporations to include both mid-size and even relatively small publicly
traded corporations reveals an increase in the average size of the largest shareholder.22
The continued survival of large shareholders in publicly traded corporations assures
that this article's motivating question generates practical applications.23
19
20
21
22
23
passes a pre-determined ownership threshold without board permission; see Moran v.
Household Intern., Inc., 500 A.2d 1346 (Del. 1985) and Versata Enterprises v. Selectica, Inc., 5
A.3d 586 (Del. 2010). The aggregate effect of these rules is to hamper shareholders' ability to
marshal a voting coalition aimed at displacing the incumbent board. Coincidentally, this
means that a relatively small shareholder support base in necessary to help the incumbent
board retain control.
Rafael La Porta, Florencio Lopez-De-Silanes & Andrei Shleifer, Corporate Ownership
Around the World, 54 J. FIN. 471, 476-477 (1999), Mara Faccio & Larry H. P Lang, The
Ultimate Ownership of Western European corporations, 65 J. FIN. ECON. 365, 369 (2002).
The narrative stems from a highly influential depiction of American corporate ownership coauthored by two depression-era scholars; see Adolph Berle and Gardner Means, THE
MODERN CORPORATION AND PRIVATE PROPERTY (1932). The prevalence of the Berle-Means
ownership model as the go-to depiction of American shareholder ownership probably stems
from the disproportionate amount of research devoted to the largest corporations. Since
ownership fragmentation is more severe in larger corporations, ignorance of smaller
corporations leads to a failure to recognize the actual frequency of controlled corporations in
American stock markets; see Brian Cheffins & Steven Bank, Is Berle and Means Really a
Myth?, 83 BUS. HIST. REV. 443, 464 (2009) ("[E]vidence concerning ownership patters in very
large companies has perpetuated the idea that a split between ownership and control
characterizes U.S. corporate governance").
Id., Appendix 5 (summarizing studies of ownership dispersion that focus predominantly on
very large U.S. companies, c. 1980-2005).
Mining a database composed of a random sample of 375 corporations traded on NYSE,
AMEX, and NASDAQ, Holderness provides evidence that 96% of the sampled firms had a
blockholder owning more than 5% of the shares. Moreover, the average aggregate stock
ownership of all blockholders was 39%. For firms with a blockholder, the largest blockholder
owned on average 26% of the voting shares; see Clifford G. Holderness, The Myth of Diffuse
Ownership in the United States, 22 REV. FIN. STUD. 1377 (2009). Other studies, which focused
primarily on larger corporations, found lower levels of shareholder ownership. For a useful
overview and synthesis of the data regarding small and mid-sized publicly trade corporations,
see Cheffins and Bank, supra note 20, at 463-466.
Another recent trend that undermines the validity of the Berle-Means model of corporate
ownership is the growing ownership shares of intermediary financial institutions; see Ronald
J. Gilson & Jeffrey N. Gordon, The Agency Costs of Agency Capitalism: Activist Investors and
the Revaluation of Governance Rights, 113 COLUM. L. REV. 863 (2013). Taking the ownership
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B. Controlling Shareholders under Delaware Law
Delaware law recognizes two sets of circumstance that implicate the existence
of a controlling shareholder. Ownership of at least 50% of the voting rights provides
evidence of control.24 Alternatively, domination over the board's decision-making
process can transform a substantial stockholder owning less than a majority of the
voting rights into a controlling stockholder25 with regards to a challenged board
action.26
The second option requires further clarification. The Delaware General
Corporate Law's (DGCL) broad grant of authority to the board of directors is
predicated on the grounds of efficiency. 27 Empowering a select group of motivated
individuals28 to manage the business and affairs of the corporation facilitates decisionmaking.29 The next chapter details the courts' well thought-out use of standards of
review to police board actions. Suffice it for now, the default standard of review
includes a heavy presumption against judicial intrusion in the challenged business
decision. While not outcome-definitive, the existence of a controlling shareholder is
more likely to invoke a more exacting standard of review. However, a higher standard
come at a price. Overcoming procedural and transactional hurdles requires meticulous
and costly planning. Even then, the realities of representative stockholder litigation all
but assure that nearly all large transactions will be challenged in court.30 While this
might deter blatant over-reaching, higher transaction costs and the risk of being forced
to run a judicial gauntlet could just as easily dissuade the corporation from advancing
24
25
26
27
28
29
30
stake of these financial institutions into account produces large blockholders in almost all
publicly traded corporations.
Weinstein Enterprises, Inc. v. Orloff, 870 A.2d 499, 507 (Del. 2005) ("In the context of
imposing fiduciary responsibilities, it is well established in the corporate jurisprudence of
Delaware that control exists when a stockholder owns, directly or indirectly, more than half
of the corporation's voting power") (footnotes omitted).
Citron v. Fairchild Camera & Instrument, 569 A.2d 53, 70 (Del. 1989) ("For a dominating
relationship to exist in the absence of controlling stock ownership, a plaintiff must allege
domination by a minority shareholder through actual control of corporate conduct").
IN RE KKR FINANCIAL HOLDINGS LLC, supra note 7, at 991 ("To survive a motion to dismiss under
this theory, plaintiffs must allege facts demonstrating actual control with regard to the
particular action that is being challenged") (internal quotations omitted), Williamson v. Cox
Commc'ns, Inc., 2006 WL 1586375, at *4 (Del. Ch. June 5, 2006).
8 DEL. CODE ANN. tit 8, § 141(a).
For a provocative argument advocating that specialized firms be allowed to take up the
directorship mantle, see: Stephen M. Bainbridge & M. Todd Henderson, Boards-R-Us:
Reconceptualizing Corporate Boards, 66 STAN. L. REV. 1051 (2014).
Stephen M. Bainbridge, The Business Judgment Rule as Abstention Doctrine, 57 VAND. L. REV.
83, 104-109 (2004) (applying Kenneth Arrow's authority vs. accountability framework as a
normative justification for the board's large grant of authority).
Matthew D. Cain & Steven Davidoff Solomon, A Great Game: The Dynamics of State
Competition and Litigation, 100 IOWA L. REV. 465, 475 (2014) ("[I]n the past ten years
[takeover litigation] has experienced a significant uptick as almost every transaction is
challenged").
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value-enhancing transactions. An overly-cavalier attitude when contemplating the
status of a large shareholder is ultimately detrimental to stockholders' interests.31
These overarching rationales are ingrained in the "actual domination" test
endorsed by the Delaware courts. Ownership of a large bundle of stock carries with it
legitimate rights, such as the ability to effectively veto transactions that require
approval by the general stockholder assembly.32 However, ownership of even a large
block of stock does not impinge on the board's mandate to manage the company.33
Bullying the board to plot a course of action is an illegitimate abuse of power. The
test's fact-intensive inquiry is designed to reveal instances where board discretion was
usurped by a non-majority shareholder.34 Absent evidence of this type of abuse,
efficiency gains realized by deference to board authority advocate against classifying
every large shareholder a controller.35
C. Controlling Shareholders – A Complicated Taxonomy
Realization of one of the alternative sets of circumstances set out in Delaware
case law verifies the existence of a controlling shareholder. The controller's
concomitant potential to distort elements of effective corporate governance is
31
32
33
34
35
In addition to measurable expenditures, such as legal and financial counsel, a comprehensive
tally must include immeasurable costs as well. Examples of immeasurable costs include
management resources spent on the lawsuit that would otherwise be devoted to corporate
needs as well as the chilling effect that subsequent litigation poses for the consummation of
value-enhancing transactions.
Mendel v. Carroll, 651 A.2d 297, 306 (Del. Ch. 1994) ("No part of their duty as controlling
shareholders requires them to sell their interest").
WEINSTEIN ENTERPRISES, INC. V. ORLOFF, supra note 24, at 508-509 ("For publicly held
corporations, the Delaware General Corporate Law contemplates a separation of control and
ownership. The board of directors has the legal responsibility to manage the business of the
corporation for the benefit of its stockholders. This Court has consistently held that the fact
the directors of a corporation are elected by the majority stockholder does not relieve those
directors of their fiduciary duties to the corporation and its minority stockholder) (footnotes
omitted).
Superior Vision Services, Inc. v. ReliaStar Life Insurance Co., 2006 WL 2403999, at *4 (Del. Ch.
Aug. 18, 2006) ("[T]he focus of the inquiry has been on the de fact power of a significant (but
less than majority) shareholder, which, when coupled with other factors, gives that
shareholder the ability to dominate the corporate decision-making process. The concern is
that the significant shareholder will use its power to obtain (or compel) favorable actions by
the board to the ultimate detriment of other shareholders").
In Re Crimson Exploration Inc. Stockholder Litigation, at *29-30 (Del. Ch. Oct. 24, 2014)
("These [surveyed] cases show that a large blockholder will not be considered a controlling
stockholder unless they actually control the board's decisions about the challenged
transaction... Absent a significant showing such as was made in these prior cases, the courts
have been reluctant to apply the label of controlling stockholder - potentially triggering
fiduciary duties - to large, but minority, blockholders"). See also Bainbridge, supra note 28, at
104 ("Given the significant virtues of [board] discretion, however, one should not lightly
interfere with management or the board's decision-making authority in the name of
accountability. Preservation of managerial discretion should always be the null hypothesis").
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noteworthy. The lack of a credible hostile takeover threat impairs the market for
corporate control's ability to function as a natural policing mechanism against board
malfeasance.36 An additional complication stems from the controller's substantial
sway over board composition.
In Delaware, like most jurisdictions, the default rule is that director elections
take place via simple shareholder vote.37 Even in our era of increased board
independence,38 a directorial candidate's chances of success hinge on at least tacit
endorsement by a controlling shareholder.39
Once elected, incumbent directors enjoy ample motivation to stay on the
controller's good graces. Assuming a director wishes to maintain her post, a rebuked
controlling shareholder might affect retribution by withholding support in a
subsequent director election.40 Although wielding no formal power under most
corporate law statutes, the nomenclature of "controlling shareholder" recognizes the
harsh reality that a control block of shares allows a shareholder to exert indirect and
informal influence over corporate policy.41
36
37
38
39
40
41
Lucian A. Bebchuk & Assaf Hamdani, The Elusive Quest for Global Governance Standards, 157
U. PA. L. REV. 1263, 1282 (2009). For the positive impact that control contestability has on
share value, see: Lucian A. Bebchuk & Alma Cohen, The Costs of Entrenched Boards, 78 J. FIN.
ECON. 409 (2005) and Alma Cohen & Charles C. Y. Wang, How do Staggered Boards Affect
Shareholder Value? Evidence from a Natural Experiment, 110 J. FIN. ECON. 627 (2013).
8 DEL. CODE ANN. tit 8, § 211(b). Initiatives aimed at changing the default rule include the
requirement that a majority of voting rights in the corporation vote in favor of the directorial
candidate, instead of a plurality of votes rendered; see: LISA M. FAIRFAX, SHAREHOLDER
DEMOCRACY: A PRIMER ON SHAREHOLDER ACTIVISM AND PARTICIPATION (2011), pp. 90-91.
Jeffrey N. Gordon, The Rise of Independent Directors in the United States, 1950-2005: Of
Shareholder Value and Stock Market Prices, 59 STAN. L. REV. 1465 (2007) (detailing and
explaining the shift from boards comprised of approximately 20% independent directors in
the 1950s to boards comprised of approximately 75% independent directors in the mid2000s) .
For an enlightening analysis of the legal issues relating to director nominations, see:
Lawrence A. Hamermesh, Director Nominations, 39 DEL. J. CORP. LAW 117 (2014).
In an earlier academic article, current Delaware Chief Justice Leo Strine candidly depicted a
judge's dueling concerns when adjudicating shareholder claims in a controlled corporation:
"Nagging at the judge will be a concern that the [subsidiary] board is going to be unduly
responsive to [the controlling shareholder], and that even the independent directors will be
subtly influenced by the fact that [the controlling shareholder] has the voting power to
unseat them the next time around. On the other hand, the judge will consider that the
independent directors were only making a modest director's fee and were persons of some
means and reputation. Would such persons approve an unfair transaction if they did not
believe in good faith that it was beneficial to [the subsidiary]?"; Leo E. Strine, Jr., The
Inescapably Empirical Foundation of the Common Law of Corporations, 27 DEL. J. CORP. LAW
499, 504 (2002).
Assaf Hamdani & Ehud Kamar, Hidden Government Influence over Privatized Banks, 13 THEOR.
INQ. LAW 567, 580 (2012).
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For these reasons, the infirmaries associated with so-called 'structural bias' are
arguably at their most severe in corporations with a controlling shareholder.42 A
director's ability to curb and if need be defy the controlling shareholder's wishes is
weakened by the fear of relinquishing her post.
The preceding analysis does not lead to a conclusion that minority
shareholders in controlled corporations are necessarily in worse shape than
shareholders in a corporation devoid of a controller. A comprehensive analysis of the
benefits and drawbacks associated with controlling shareholders must take into
account agency costs that fail to materialize because of the controller’s presence.
While long considered a bane in 'bad law' jurisdictions,43 controlling shareholders can
prove quite useful for Delaware corporations.
The alternative to a controlled corporation is a corporation bereft of a
controlling shareholder. In this highly frequent scenario, management of the
corporation is entrusted with the board and senior officers. Opportunities for abuse
arise when a course of action that is beneficial to management but detrimental to
shareholders presents itself.44 Shareholder fragmentation undermines the effectiveness
of capital market disciple. Collective action costs facilitate managerial malfeasance,
contributing to the suppressed stock price. The counter-factual scenario highlights the
benefits associated with controlling shareholders.
Unlike dispersed shareholders, a controlling shareholder's considerable equity
position provides sufficient financial motivation to actively monitor her investment
and initiate corrective action when necessary.45 Monetary incentive is backed by
implicit legal power, as ownership of a large share block brings with it the ability to
42
43
44
45
See: Claire A. Hill & Brett H. McDonnell, Disney, Good Faith, and Structural Bias, 32 J. CORP. L.
833, 853 (2006) ("No definitive or consensus definition of structural bias exists. In our view,
the strongest case is where a director makes a decision that she knows or ought to know may
favor her own interests or those of another director, officer, or controlling stockholder to
whom she is beholden over those of the corporation"). While acknowledging the potential
infirmaries that potentially rise in these types of situations, recent case law requires
shareholder plaintiffs to successfully plead a non-exculpated claim against disinterested,
independent directors that approved a suspect transaction with a controlling shareholder;
see: In Re Cornerstone Theraputics Inc, Stockholder Litigation, Nos. 564, 706 (Del. 2015).
Ronald J. Gilson, Controlling Shareholders and Corporate Governance: Complicating the
Comparative Taxonomy, 119 HARV. L. REV. 1641, 1653-1657 (2005).
In economic terms, this scenario is referred to as the agency problem; see: Michael C. Jensen
& William H. Meckling, Theory of the Firm: Managerial Behavior, Agency Costs and
Ownership Structure, 3 J. FIN. ECON. 305 (1976).
Stijn Claessens et al., Disentangling the Incentive and Entrenchment Effects of Large
Shareholdings, 57 J. FIN. 2741 (2002) (finding a positive correlation between an increase in
the holdings of the largest shareholder and corporate value in eight East Asian economies),
Lucian A. Bebchuk & Robert J. Jr Jackson, The Law and Economics of Blockholder Disclosure, 2
HARV. BUS. L. REV. 39, 47-49 (2012) (summarizing empirical evidence of the value of large
blockholders on corporate value). But cf. Kobi Kastiel, Executive Compensation in Controlled
Companies, 90 IND. L. J. 1131 (2015) (arguing that some controllers might overpay corporate
officers in exchange for tacit support of controllers' consumption of private benefits).
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effectuate change in board composition. Efficient controlling shareholders therefore
bear monitoring costs that would otherwise be borne (or not) by all shareholders.46 In
the same vein, while transactions between the corporation and its controller should
make shareholders wary, valid arguments support this common practice.
Often, an insider will be the one to offer the best terms to the corporation. This
is obvious in situations where the corporation's dire financial situation discourages
third parties seeking out a prolonged commercial relationship.47 However, this
scenario can also take place in financially viable corporations where informational
asymmetries create unbridgeable valuation gaps between the corporation and
outsiders.48 A weak bargaining position or an inability to bridge information
asymmetries often means that the controlling shareholder's offer is the best available
for the corporation.49
Ultimately, this more nuanced calculus informs our position regarding
controlling shareholders. As long as the benefits accrued from the duties performed
by the controller at least offset the negative aspects, dispersed shareholders are better
off. Indeed, since many controllers sacrifice the liquidity benefits enjoyed by other
shareholders, a case can be made that minority shareholders tolerate low-level
expropriation by controlling shareholders as reparation for their loss of liquidity and
compensation for provided services.50
D. Controlling Shareholders and Related Party Transactions
The above analysis informs our conclusion that the presence of a controller is
not inherently harmful to minority shareholders. Normally, it is safe to assume that
corporate agents endeavor to maximize corporate value. However, this assumption is
questioned when the controlling shareholder is either a direct or indirect counterparty
to the transaction. Even a peripheral awareness of the controller's influence over board
composition might erode the agent’s motivation to bargain for the best deal possible
for the corporation, or even worse, covertly champion the counterparty’s position.51
46
47
48
49
50
51
Gilson, supra note 44.
Ronald J. Gilson, Controlling Family Shareholders in Developing Countries: Anchoring
Relational Exchange, 60 STAN. L. REV. 633, 640-641 (2007).
STEPHEN M. BAINBRIDGE, CORPORATION LAW AND ECONOMICS 308 (2002).
Id.
Gilson, supra note 44, at 1652.
This does not imply that the corporate agent necessarily acts in bad faith. Unconscious
processes unknowingly undermine the effectiveness of even the most subjectively earnest
agent; see: Antony Page, Unconscious Bias and the Limits of Director Independence, 2009 U.
ILL. L REV. 237, 259-276 (2009) (detailing the unconscious processes that bias the decisionmaking process).
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Different terms have been used to describe the same basic state of affairs.52
The distinguishing attribute of a controlling shareholder related party transaction is a
divergence of interests between the controller and the rest of the shareholder base.53
Myriad methods exist though which unscrupulous controllers can extract a
disproportionate level of corporate value. A particularly useful dichotomy
distinguishes between asset tunneling, cash flow tunneling, and equity tunneling.54
Asset tunneling involves the transfer of productive corporate assets between
the corporation and its controlling shareholder.55 Since the corporation's value derives
from assets under control, unfair asset pricing directly harms the value of minority
shares. In a related party scenario, minority shareholders should be wary that the
corporation will overpay to buy assets from the controller and accept low-ball offers
to sell assets.
Cash flow tunneling differs from asset tunneling in that the corporation's longterm productive assets remain unharmed.56 Obviously, employees and agents should
be expected to be compensated for their endeavors on behalf of the corporation.
However, owing to the uneven playing field, cash flow tunneling with controlling
shareholders diverts what would otherwise be operating cash flow from the firm to the
coffers of the controller or affiliated entities.57
By contrast, equity tunneling does not directly affect a corporation's
operations. However, equity tunneling allows the controller to increase her ownership
share over the corporation's assets, at the expense of minority shareholders.58 Freeze
out transactions and dilutive equity issuances, are examples of possible equity
tunneling.
52
53
54
55
56
57
58
See, e.g.,: Simon Johnson, et al., Tunneling, 90 AM. ECON. REV. 22, 22 (2000) (tunneling),
Simeon Djankov et al., The Law and Economics of Self-Dealing, 88 J. FIN. ECON. 430, 430 (2008)
(self-dealing), Claire Hill & Brett McDonnell, Sanitizing Interested Transactions, 36 DEL. J.
CORP. L. 903, 904 (2011) (interested transactions) and Lewis H. Lazarus & Brett M. McCartney,
Standards of Review in Conflict Transactions on Motions to Dismiss: Lessons Learned in the
Past Decade, 36 DEL. J. CORP. L. 967, 972 (2011) (conflict transactions).
Most often, the divergence of interests stems from a corporate insider's ability to extract
private pecuniary benefits not available to the broad shareholder base; see: ZOHAR GOSHEN &
ASSAF HAMDANI, CONCENTRATED OWNERSHIP REVISITED: THE IDIOSYNCRATIC VALUE OF CORPORATE
CONTROL (2013), http://papers.ssrn.com/abstract=2228194 (last visited Sep 21, 2015).
This taxonomy is established in Vladimir Atanasov, Bernard Black & Conrad S. Ciccotello, Law
and Tunneling, 37 J. CORP. L. 1 (2011).
Id, at p.7.
Id, at p.6.
Excess executive compensation is the emblematic example of cash flow tunneling. See:
LUCIAN A. BEBCHUK & JESSE FRIED, PAY WITHOUT PERFORMANCE: THE UNFULFILLED PROMISE OF EXECUTIVE
COMPENSATION (2009).
Atanasov, Black, and Ciccotello, supra note 55, at p. 8-9.
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This chapter's purpose is to introduce the terms and concepts necessary for the
forthcoming analysis. Delaware law recognizes two distinct tests used to unveil the
presence of a controlling shareholder: (i) ownership of at least a majority of shares; or
(ii) actual domination of the board that resulted in a specific course of action, albeit
with ownership of less than a majority of shares. Without more, the existence of a
controlling shareholder reveals little about the predicament that minority shareholders
find themselves in. While controllers have the capacity to harm minority share value,
they can also provide a valuable service. Lawmakers and the courts are expected to
craft solutions that balance two competing principles. On one hand, the solution
should provide effective protection and redress for minority shareholders that find
themselves faced with a potentially dire situation; on the other hand, the solution
should minimize unnecessary transaction costs that ultimately harm minority
shareholders. The next chapter will focus on Delaware's resourceful use of shifting
standards of review to achieve these dual goals.
III. Standards of Review in Delaware Law
A. Introduction
Delaware law has long endeavored to enhance the protection afforded to minority
shareholders. Judicial standards of review serve as a crucial component of this effort.
Technically, a standard of review is a "test that a court should apply when it reviews
an actor's conduct whether to impose liability or grant injunctive relief."59 This
modest definition understates the significance that the choice of standard entails.
Standards of review in Delaware corporate law differ amongst themselves in the
level of judicial scrutiny applied to the challenged board action. Put differently, the
selected standard determines the relative deference granted to the corporate
defendants.60 Sound policy justifications dictate the types of factual patterns that call
for greater or lesser judicial interference.61 Heightened judicial oversight is warranted
in situations that question the board's devotion to shareholders' interests. Precise
application of the appropriate standard allows the courts to strike a delicate balance
between board authority and board accountability.
59
60
61
Melvin Aron Eisenberg, The Divergence of Standards of Conduct and Standards of Review in
Corporate Law, 62 FORDHAM L. REV. 437, 437 (1993).
William T. Allen, Jack B. Jacobs & Leo E. Strine Jr., Function over Form: A Reassessment of
Standards of Review in Delaware Corporation Law, 26 DEL. J. CORP. L. 859, 867 (2001).
Id. at 869.
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The most frequently used standard of review involves a relatively lax judicial
inquiry over the challenged transaction.62 As long as no discernible divergence of
interests with the shareholders exists and the board was reasonably diligent in
fulfilling its role, the standard will normally hold.63 Suspect motivations support an
upgrade in the applied standard of review and consequent intensity of judicial
evaluation. Importantly, employment of self-cleansing mechanisms in the form of
qualified decisionmakers allow for a relaxation of the intensity of judicial review.
The following sections will more fully describe the three main standards of review
under Delaware law64 as well as the settled law regarding shareholder ratification.
B. Business Judgment Rule
The business judgment rule (BJR) is the default standard of review utilized by
Delaware courts to adjudicate a shareholder claim against the board of directors.65
The rule’s animating principal is a judicial attitude of deference towards real-world
62
63
64
65
Laster, supra note 5, at p. 1445 (“At the bottom of the pyramid [of standards of review] is the
business judgment rule, which gives the pyramid a capaciously broad foundation”).
Two residual doctrines serve as safety valves that allow the court to intervene in apparently
non-conflicted situations. The waste standard permits a court to set aside a transfer of assets
where the consideration is "so inadequate in value that no person of ordinary, sound
business judgment would deem it worth what the corporation has paid"; Saxe v. Brady, 184
A.2d 602, 610 (Del. 1962). The duty to act in good faith is violated when, for instance, "a
fiduciary intentionally acts with a purpose other than that of advancing the best interests of
the corporation, where the fiduciary acts with the intent to violate applicable positive law, or
where the fiduciary intentionally fails to act in the face of a known duty to act, demonstrating
a conscious disregard for his duties;" In re Walt Disney Co. Derivative Litigation, 906 A.2d 27,
67 (Del. 2006) (citations omitted). Both of these exceptions are extremely difficult for a
plaintiff to meet; see In re Lear Corp. Shareholder Litigation, 967 A.2d 640, 657 (Del. Ch.
2008) (describing the waste standard as a "rigorous test designed to smoke out shady, bad
faith deals) and Lyondell Chem. Co. v. Ryan, 970 A.2d 235, 243 (Del. 2009) ("[T]here is a vast
difference between an inadequate or flawed effort to carry out fiduciary duties and a
conscious disregard for those duties").
“When shareholder litigation challenges actions by boards of directors, generally one of
three standards of judicial review is applied” Emerald Partners v. Berlin, 787 A.2d 85, 89 (Del.
2001), reversed on other grounds In Re Cornerstone Theraputics Inc, Stockholder Litigation,
(Del. 2015). For slightly differing categorizations of the other standards of review in
Delaware, compare Julian Velasco, How Many Fiduciary Duties are There in Corporate Law,
83 S. CAL. L. REV. 1231, 1237-1256 (2009) with Mary Siegel, The Illusion of Enhanced Review of
Board Actions, 15 U. PA. J. BUS. L. 599, 602-616 (2012).
CITRON V. FAIRCHILD CAMERA & INSTRUMENT, supra note 28, at 64 ("The presumption initially
attaches to a director-approved transaction within a board's conferred or apparent authority
in the absence of any evidence of fraud, bad faith, or self-dealing in the usual sense of
personal profit or betterment" (internal quotations omitted) and Reis v. Hazelett StripCasting Corp., 28 A.3d 442, 457 (Del. Ch. 2011) ("The business judgment rule is the default
standard of review").
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decisions carried out by unconflicted directors.66 Absent well-plead allegations
necessary to rebut the rule’s initial presumption, the substantial merits of the business
decision are essentially immune from judicial second-guessing.67
Perhaps the most famous formulation68 of the business judgment rule depicts it as
"a presumption that in making a business decision, the directors of a corporation acted
on an informed basis, in good faith and in the honest belief that the action taken was
in the best interests of the company."69
The respect afforded to well thought-out business decisions is grounded in more
than judicial humility. Adoption of the rule facilitates shareholder value
maximization. Rational and diversified shareholders would prefer that their elected
directors advance investment projects with the highest risk adjusted rate of return.70
The rule's de-facto prohibition against second-guessing failed business decisions
empowers directors to overcome understandable risk-aversion and fear of being
sued.71 Competitive markets police simple mismanagement ruthlessly and
66
67
68
69
70
71
D.
GORDON
SMITH,
THE
MODERN
BUSINESS
JUDGMENT
RULE,
http://papers.ssrn.com/abstract=2620536 (last visited Jun 19, 2015), at *5 ("[T]he crucial
feature of the business judgment rule.. is not a presumption that the directors have acted
well, but rather a commitment not to question the substance of director action when there is
no proof that the directors have acted badly"). While one prominent scholar characterizes
the business judgment rule as an abstention doctrine, litigation realities lead to court
oversight over the process adopted by the directors at the outset of the litigation; cf.
Bainbridge, supra note 32 with SMITH, supra at *7 and E. Norman Veasey & Christine T. Di
Guglielmo, What Happened in Delaware Corporate Law and Governance from 1992-2004? A
Retrospective on Some Key Developments, 153 U. PA. L. REV. 1399, 1421 (2005) ("[T]he focus
of the business judgment rule remains on the process that directors use in reaching their
decisions").
CITRON V. FAIRCHILD CAMERA & INSTRUMENT, supra note 28, at 64 ("The burden falls upon the
proponent of a claim to rebut the presumption by introducing evidence either of director
self-interest, if not self-dealing, or that the directors either lacked good faith or failed to
exercise due care"). In order to rebut the business judgment rule's presumption of care, a
plaintiff must plead and later prove gross negligence; see Brehm v. Eisner, 746 A.2d 244, 264
(Del. 2000).
Siegel, supra note 68, at p. 602 ("Perhaps the most often quoted description of the business
judgment rule is found in Aronson v. Lewis") and SMITH, supra note 71 at *5 ("Over the years,
the presumption [of good faith] expanded and contracted in various ways before achieving
its modern form in Aronson v. Lewis").
Aronson v. Lewis, 473 A.2d 805, 812 (Del. 1984), overruled on other grounds by Brehm v.
Eisner, 746 A.2d 244 (Del. 2000).
Gagliardi v. TriFoods Intern., Inc., 683 A.2d 1049, 1052 (Del. Ch. 1996).
Roberta Romano, Corporate Governance in the Aftermath of the Insurance Crisis, 39 EMORY L.
J. 1155, 1160 (1990) (detailing how 42 states reacted to a perceived insurance crisis by
amending their corporation statutes to reduce directors' liability exposure). The question of
optimal liability exposure is an open debate in corporate law. It is entirely possible that an
overly lax corporate law might be detrimental to shareholders' interests; see Michal Barzuza
& David C. Smith, What Happens in Nevada? Self-Selecting into Lax Law, REV. FINANC. STUD.
(forthcoming 2014) (finding that firms prone to financial reporting failures are more likely to
reincorporate in a state with lax corporate law).
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efficiently.72 Insulation from shareholder intervention in a regular business setting has
the added value of preserving board authority.73
The business judgment rule is the starting off point in a judicial inquiry of a
challenged board action. Judicial respect towards outcomes produced by rational
business procedures usually results in a loss for the plaintiff.74 The next sections will
depict less defendant-friendly standards of review.
C. Enhanced Scrutiny
The educated belief that non-conflicted directors are innately motivated to
maximize shareholder value heavily influences the business judgment rule's
deferential attitude. Creeping suspicions about the board's true motivations therefore
chip away at the rule's basic assumption and invite heightened judicial involvement.
Delaware courts carry out this involvement through the medium of more exacting
standards of review.
Enhanced scrutiny is Delaware's intermediate standard of review.75 The
standard applies in factual situations that call into question a director's ability to
impartially advance shareholders' best interests.76 Two main transactional archetypes
lead to application of this standard.77
Board defensive responses in the face of a hostile takeover attempt epitomize
the first factual pattern that warrants application of enhanced scrutiny. A successful
hostile takeover results in removal of incumbent board members. The "omnipresent
specter" surrounding the board's self-serving motivation justifies subjecting the
selected reaction to a more stringent judicial examination.78
72
73
74
75
76
77
78
REIS V. HAZELETT STRIP-CASTING CORP., supra note 66, at p. 458.
STEPHEN M. BAINBRIDGE, CORPORATION LAW AND ECONOMICS 268 (2002).
Nixon v. Blackwell, 626 A.2d 1366, 1376 (Del. 1993) ("It is sometimes thought that the
decision to apply the business judgment rule or the entire fairness test can be outcomedeterminative").
REIS V. HAZELETT STRIP-CASTING CORP., supra note 69 at p. 457.
Id. ("Enhanced scrutiny applies when the realities of the decision-making context can subtly
undermine the decisions of even independent and disinterested directors").
Enhanced scrutiny is also applied to adjudicate board postponement of a shareholder
meeting that does not deal with director elections; see Mercier v. Inter-Tel (Delaware), Inc.,
929 A.2d 786 (Del. Ch. 2007) (applying enhanced scrutiny instead of the more demanding
Blasius standard to a board decision to postpone a shareholder vote on an impending merger
so as to provide more information and not jeopardize what the board believes to be an
irrevocable loss of a pending offer).
Unocal Corp. v. Mesa Petroleum Co., 493 A.2d 946, 954 (Del. 1985).
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In this context, enhanced scrutiny consists of a two-part analysis conducted by
the courts. The first part of the test requires corporate defendants to prove reasonable
grounds for believing that a danger to corporate policy existed.79 After proving that,
the directors must then prove that their response was reasonable relative to the threat
posed.80
The second main fact-pattern that engenders enhanced scrutiny is colloquially
referenced by the seminal case that introduced the analysis.81 In what would become a
cornerstone of Delaware jurisprudence, the Supreme Court held that the broad
deference usually afforded to the board of directors no longer applies in the face of an
impending sale or break-up of the corporation. When finding itself in this situation,
the board's raison d'etre focuses on "maximization of the company's value at a sale
for the stockholder's benefit."82 While subsequent cases have attempted to clarify
what a "sale or break-up" of the corporation entails,83 recent scholarship still grapples
with this seemingly unsettled issue.84
Since even a self-initiated sale of the corporation results in broad personnel
changes amongst the corporate hierarchy, enhanced judicial scrutiny attempts to weed
out subtle manipulation of the sales process. In a Revlon setting, the burden shifts to
the board to prove that they have taken reasonable steps to ensure shareholders
receive the best price possible for their shares. Although the term "auctioneer" was
originally used to describe the board's new function,85 subsequent decisions clarified
that there is no single blueprint for the board to follow.86
In sum, the policy justifications that counsel against judicial interference hold
considerably less sway when directors are faced with the tangible prospect of
79
80
81
82
83
84
85
86
Id., at 955.
Id. Significant refinement of the Unocal doctrine occurred in Unitrin, Inc. v. American General
Corp., 651 A.2d 1361, 1387-1390 (Del. 1995) (a reasonable response by the board must be
neither coercive nor preclusive, and should not impinge on the shareholder's ability to vote
directors out of office).
See for example, Lyman Johnson & Robert Ricca, The Dwindling of Revlon, 71 WASH. & LEE L.
REV. 167 (2014), and Stephen M. Bainbridge, The Geography of Revlon-Land, 81 FORDHAM L.
REV. 3277 (2012), which obviously inspired this article's title.
Revlon, Inc. v. MacAndrews & Forbes Holdings, 506 A.2d 173, 182 (Del. 1986).
Most famously, Paramount Communications v. QVC Network, 637 A.2d 34, 47-48 (Del. 1994)
(for the purpose of the Revlon test, a "sale" occurs when the consummation of a transaction
introduces a new controlling shareholder to an entity previously has none).
Cf. Bainbridge, supra note 82. (arguing that the Revlon standard of review is motivated by a
conflicts of interest) with Mohsen Manesh, Defined by Dictum: The Geography of RevlonLand in Cash and Mixed Consideration Transactions, 59 VILL. L. REV. 1 (2014) (refuting
Bainbridge's claim). A recent article authored by Vice-Chancellor Laster professes his
personal views that the Revlon standard should apply in all final-period transactions,
regardless of choice of consideration; see J. Travis Laster, Revlon Is a Standard of Review:
Why It’s True and What It Means, 19 FORD. J. CORP. FIN. L. 5 (2013).
REVLON, INC. V. MACANDREWS & FORBES HOLDINGS, supra note 83 at p. 184.
Johnson and Ricca, supra note 85, at p. 189-193 (summarizing subsequent holdings detailing
the board's proper conduct in the sales process).
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relinquishing their post. Unocal and Revlon situations place the onus on the board to
prove the reasonableness of their actions. While not an extremely difficult test to
pass,87 the enhanced scrutiny standard of review allows a certain degree of judicial
oversight in inherently problematic settings. The next section will detail the most
extracting standard of review in a transactional setting.
D. Entire Fairness
An inverse correlation exists between the severity of the impediments that
possibly undermine corporate decisionmaker's ability to advance shareholder interests
and the applicable standard of review. The differential default standard transforms
into enhanced scrutiny when the challenged board action implicates the director's
continued incumbency. Full-fledged conflicts of interest between the corporation and
members of the corporate hierarchy necessitate a further upgrade in the intensity of
judicial oversight.
Immediate realization of profit in a related party transaction usually more than
offsets the prospect of market discipline.88 Delaware law accordingly requires that
these transactions pass through the filter of entire fairness review.
A helpful preliminary taxonomy of related party transactions distinguishes
between director self-dealing and controlling shareholder self-dealing. As long as the
director's conflict is sufficiently disclosed and approved by an otherwise independent
and disinterested board, even a direct transaction with a corporate director will enjoy
the presumptions afforded by the business judgment rule.89 In order to rebut the
business judgment rule's application regarding director self-dealing, a shareholder has
87
88
89
MERCIER V. INTER-TEL (DELAWARE), INC., supra note 81 at p. 810 ("I recognize.. that some of the
prior Unocal case law gave reason to fear that that standard, and the related Revlon
standard, were being denuded into simply another name for business judgment review"
(footnotes omitted). Mary Siegal provides data that defendants are able to pass Unocal and
Revlon scrutiny almost 80% of the time the standards are evoked; see Siegel, supra note 68,
at p. 621, 629.
FRANK H. EASTERBROOK & DANIEL R. FISCHEL, THE ECONOMIC STRUCTURE OF CORPORATE LAW (1996),at p.
103 ("Duty-of-loyalty problems often involve spectacular, one-shot appropriations, of the
"take the money and run" sort, in which subsequent penalties through markets are
inadequate"); see also Claire Hill & Brett McDonnell, Sanitizing Interested Transactions, 36
DEL. J. CORP. L. 903, 908-909 (2011) ("[T]he law has long treated self-dealing with suspicion.
The reasons for the suspicion are obvious: If the leading decisionmakers, or those with strong
influence over such decisionmakers, can gain personally by making a decision that hurts the
corporation, they may make decisions that benefit them at the corporation's expense").
Telxon Corp. v. Meyerson, 802 A.2d 257, 264 (Del. 2002) ("Where only one director has an
interest in a transaction, however, a plaintiff seeking to rebut the presumption of the
business judgment rule under the duty of loyalty must show that the interested director
controls or dominates the board as a whole") (internal quotations omitted).
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to plead facts demonstrating that a majority of the board either had a financial interest
in the transaction or was otherwise dominated by a materially interested director.90
In this context, the Delaware Supreme Court has identified independence to
exist in situations where "a director's decision is based on the corporate merits of the
subject before the board rather than extraneous considerations or influences."91
Overcoming the presumption of director independence relies on "pleading facts that
support a reasonable inference that the director is beholden to a controlling person or
so under their influence that their discretion would be sterilized."92
The Aronson court additionally articulated what would be recognized as the
canonical definition for director self-interest.93 In order to be considered disinterested,
a director "can neither appear on both sides of a transaction nor expect to derive any
personal financial benefit from it in the sense of self-dealing, as opposed to a benefit
which devolves upon the corporation or all stockholders generally."94 Subsequent
cases have clarified that director self-interest is not limited to direct personal dealings
with a corporation, and further manifests in situations where the director has a stake in
or serves as an executive at the corporation's counterparty.95 The pecuniary benefit
creates a disqualifying interest, regardless of whether or not the benefit was in fact
material for the director.96
Even more nuances affect the applied standard of review for transactions with
a controlling shareholder. The relationship between the strands of authority that
90
91
92
93
94
95
96
The pleading requirement stems from Chancery Court Rule 23.1, which requires a
shareholder plaintiff prosecuting a derivative action to "allege with peculiarity" reasons for
not making a demand on the board of directs. ARONSON V. LEWIS, supra note 73, at 812 ("[I]f
such director interest is present, and the transaction is not approved by a majority consisting
of the disinterested directors, then the business judgment rule has no application whatever
in determining demand futility"). See also Laster, supra note 5, at p. 1455 ("To change the
standard of review from the business judgment rule to entire fairness, a plaintiff must show
that there were not enough independent, disinterested, and sufficiently informed individuals
who acted in good faith when making the challenged decision to constitute a board
majority").
ARONSON V. LEWIS, supra note 73, at p. 816.
IN RE KKR FINANCIAL HOLDINGS LLC, supra note 7, at *25 (internal quotations omitted). For
examples of a paralyzing interest, see Harbor Finance Partners v. Huizenga, 751 A.2d 879,
889 (Del. Ch. 1999) (familial relationship casts doubt on a director's ability to impartially
consider a board demand), and New Jersey Carpenters Pension Fund v. Infogroup, Inc., C.A.
No. 5334-VCN (Del. Ch. Oct. 6, 2011) (ostensibly independent directors were actually the
control of a dominant and bullying blockholder and member of the board).
IN RE CRIMSON EXPLORATION INC. STOCKHOLDER LITIGATION, supra note 38, at *51 ("Aronson v. Lewis
set forth the now-standard definitions for the terms "interested" and "independent")
(footnote omitted).
ARONSON V. LEWIS, supra note 73, at p. 812 (citations omitted).
Cinerama, Inc. v. Technicolor, Inc., 663 A.2d 1156, 1169 (Del. 1995) (subsequent history
omitted) (citing 8 Del. § 144(a)). See also Rales v. Blasband, 634 A.2d 927, 936 (Del. 1993)
("Directorial interest also exists where a corporate decision will have a materially detrimental
impact on the director, but not on the corporation and the stockholders").
Cambridge Retirement System v. Bosnjak, C.A. No. 9178-CB (Del. Ch. June 26, 2014), at *9.
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govern going private and non-going private transactions with a controlling
shareholder will be dealt with at length in Chapter IV. Regardless of whether or not
the transaction consummates with the elimination of minority shareholders, the
authorities seem to be in agreement that entire fairness applies in situations where the
controlling shareholder engages in a conflicted transaction.97 A direct transaction
between the controller and the corporation is the essence of a conflicted transaction.98
Under certain conditions, going-private transaction with a bona fide third party can
also lead to application of entire fairness review.
Although Delaware law imposes minimal restrictions on the controller's ability
to sell her shares at a premium,99 receipt of unequal consideration in a going-private
transaction will invite entire fairness review. Unequal consideration may manifest in
either a tangible or non-tangible form. Higher prices for the same class of shares or a
continuing equity stake in the surviving entity are examples of a tangible unequal
consideration.100 Unavoidable competition for a larger proportion of the deal
consideration necessitates heightened court involvement.
Extinguishment of a derivative claim or immediate realization of much-needed
liquidity are examples of a non-tangible unique benefit.101 Although receipt of prorata treatment should usually assuage minority shareholder' fears of
misappropriation,102 the controller's acceptance of a unique benefit might detract from
the price ultimately offered for all shares.
The definitive formulation of the entire fairness test has remained virtually the
same for three decades: "The concept of fairness has two basic aspects: fair dealing
97
98
99
100
101
102
IN RE CRIMSON EXPLORATION INC. STOCKHOLDER LITIGATION, supra note 38, at p. 30.
Kahn v. Lynch Communication Systems, 638 A.2d 1110, 1115 (Del. 1994) ("A controlling or
dominating shareholder standing on both sides of a transaction, as in a parent-subsidiary
context, bears the burden of proving its entire fairness"). The main competitor for the
primary doctrine regarding controlling shareholder self-dealing includes an additional wrinkle
that the controlling shareholder is able to extract from the corporation a benefit to the
exclusion of, and detriment to, the minority stockholders of the corporation; see: Sinclair Oil
Corporation v. Levien, 280 A.2d 717, 720 (Del. 1971).
Abraham v. Emerson Radio Corp., 901 A.2d 751, 753 (Del. Ch. 2006) ("Under Delaware law, a
controller remains free to sell its stock for a premium not shared with other stockholders
except in very narrow circumstances"). Examples of these very narrow circumstances exist
when the controller has entered into a contractual commitment not to receive a premium or
she knows that the buyer is a looter or was aware of circumstances that would alert a
reasonably prudent person to a risk that the buyer was dishonest in a material aspect; see In
re Delphi Fin. Gp. S'holder Litig., 2012 WL 729323 (Del. Ch. Mar. 6, 2012) and Harris v. Carter,
582 A.2d 222, 235 (Del.1990).
IN RE CRIMSON EXPLORATION INC. STOCKHOLDER LITIGATION, supra note 38, *31-33 (analyzing and
generating a rule from In re Tel-Communications, Inc. S'holder Litig., 2005 WL 3642727 (Del.
Ch. Jan. 10, 2006), In re Delphi Fin. Gp. S'holder Litig., 2012 WL 729232 (Del. Ch. Mar. 6,
2012), In re John Q. Hammons Hotels Inc. S'holder Litig., 2009 WL 3165613 (Del. Ch. Oct. 2,
2009), and In re LNR Prop. Corp. S'holder Litig., 896 A.2d 169 (Del. Ch. 2005)).
In re Primedia, Inc. Shareholders Litig., 67 A.3d 455 (Del. Ch. 2013) and In re Synthes, Inc.
Shareholder Litigation, 50 A.3d 1022 (Del. Ch. 2012).
IN RE SYNTHES, INC. SHAREHOLDER LITIGATION, supra note 105, at p. 1039-1040.
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and fair price. The former embraces questions of when the transaction was timed, how
it was initiated, structured, negotiated, disclosed to the directors, and how the
approvals of the directors and the stockholders were obtained. The latter aspect of
fairness relates to the economic and financial considerations of the proposed merger,
including all relevant factors: assets, market value, earnings, future prospects, and any
other elements that affect the intrinsic or inherent value of a company's stock.
However, the test for fairness is not a bifurcated one as between fair dealing and
price. All aspects of the issue must be examined as a whole since the question is one
of entire fairness."103
Special attention is called to the relationship between a motion to dismiss and
the standard of review.104 A successful motion results in the immediate dismissal of
the shareholder complaint. A failed motion adds discovery and trial costs to the
already substantial transaction bill.105 Importantly, application of the entire fairness
standard proves a near-insurmountable obstacle for a defendant's motion to dismiss.106
The chosen standard's influence on the litigation dynamic guarantees that it
remains one of the most heavily debated aspects in corporate litigation.107 Onerous
standards of review invite some of the more unscrupulous and entrepreneurial
members of the plaintiffs' bar to file hastily crafted complaints in an effort to secure
settlements that offer no discernible advantage to the remaining shareholders.108 The
next section will detail how careful implementation of corporate self-cleansing
mechanisms allows for a downgrade in the severity of the standard of review.
E. Downgrading from Entire Fairness
103
104
105
106
107
108
Weinberger v. UOP, Inc., 457 A.2d 701, 711 (Del. 1983) (internal citations omitted).
Court of Chancery Rule 12 governs the motion for judgment at the pleadings stage.
Importantly, Rule 12(b)(6) allows defendants to file a motion to dismiss for "failure to state a
claim upon which relief can be granted".
To be sure, it is still possible for the defendant to prevail in proving the entire fairness of the
transaction. For examples of defendant success in proving entire fairness, see: CINERAMA, INC.
V. TECHNICOLOR, INC., supra note 99, NIXON V. BLACKWELL, supra note 78, and Kahn v. Lynch
Communication Systems, 669 A.2d 79 (Del. 1995).
Even when entire fairness undoubtedly applies, the complaint must contain well-plead
allegations disputing either the fair price or fair process of the transaction. See: Monroe Cnty.
Emps. Ret. Sys. V. Carlson, 2010 WL 2376890, at *2 (Del. Ch. June 7, 2010) ("Delaware law is
clear that even where a transaction between the controlling shareholder and the company is
involved – such that entire fairness review is in play – plaintiff must make factual allegations
about the transaction in the complaint that demonstrate the absence of fairness") and
Ravenswood Investment Company, L.P. v. Winmill, C.A. No. 3730-VCN (Del. Ch. May 31,
2011).
Lewis H. Lazarus, Standards of Review in Conflict Transactions: An Examination of Decisions
Rendered on Motions to Dismiss, 26 DEL. J. CORP. L. 911, 926 (2001).
Johnson and Ricca, supra note 85, at p. 168.
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Higher standards of review all but ascertain that a shareholder complaint
survives a motion to dismiss. The credible threat of a prolonged and costly trial is
arguably at the root of what some consider a non-meritorious litigation epidemic.109
Conditioning the transaction on the approval of qualified decisionmakers offers
transactional planners a way to downgrade the standard of review and thus recover
from a tactical litigation disadvantage.110 The collective wisdom of qualified
decisionmakers is considered a suitable substitute for court oversight.
A clarifying note on terminology is warranted at the outset. Although
frequently used, "ratification" is not the most precise legal term to describe the selfcleansing mechanism. In agency law, ratification consists of "the affirmance of a prior
act done by another, whereby the act is given effect as if done by an agent acting with
actual authority."111 Most shareholder challenges against corporate acts focus on
potential breaches of fiduciary duties, not a lack of actual authority. The selfcleansing mechanisms are not intended to confer actual authority upon the corporate
actors, but to de-escalate the standard of review.112
Two equally competent corporate organs form the core of the Delaware selfcleansing framework:113 a committee of independent and disinterested directors and a
disinterested shareholder vote.114
109
110
111
112
113
Cain & Davidoff Solomon, footnote 30 supra. One recent study found that plaintiff attorneys
filed lawsuits in 93% of all mergers and acquisition deals announced in 2014 and valued at
over $100 million. For Delaware-incorporated firms, plaintiffs filed lawsuits either exclusively
in Delaware or in conjunction with litigation in other courts on 88% of the deals. Merger and
acquisition oriented lawsuits obviously implicate either the enhanced scrutiny or entire
fairness standard of review, thus considerably raising the complaint's probability of surviving
a motion to dismiss. Cornerstone Research, Shareholder Litigation Involving Acquisitions of
Public Companies – Review of 2014 M&A Litigation, at 2-3.
Scott V. Simpson & Katherine Brody, The Evolving Role of Special Committees in M&A
Transactions: Seeking Business Judgment Rule Protection in the Context of Controlling
Shareholder Transactions and Other Corporate Transactions Involving Conflicts of Interest, 69
BUS. LAW. 1117, 1120 (2014) ("[T]he ability to structure a board's process in connection with
its consideration of a transaction such that its decisions will benefit from the protection of
the business judgment rule provides significant practical comfort that its decisions will not be
overturned by a court").
Restatement (3rd) of Agency §4.01 (2006).
SMITH, supra note 67, at *3 ("The modern business judgment rule is applied not only in cases
without procedural infirmities, but in cases where procedural infirmities at the board level
have been mitigated by a special committee, stockholder approval, or partial substantive
review by the courts. In these new contexts, a court must satisfy itself that a board decision
is worthy of respect, not because the decision was substantively correct, but because the
effect of the procedural infirmities was sufficiently muted").
The corporation, as an artificial entity, requires actors to act on its behalf. A corporate organ
is one such actor. An organ, such as the board of directors or a stockholder general assembly,
acts on the corporation's behalf but is not subject to its control; Amitai Aviram, Officers’
Fiduciary Duties and the Nature of Corporate Organs, 2013 U. ILL. L. REV. 763, 768 (2013). See
also Arnold v. Soc'y for Sav. Bancorp, Inc., 678 A.2d 533, 539-540 (Del. 1996) ("Directors, in
the ordinary course of their service as directors, do not act as agents of the corporation… An
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Reliance on independent director committees is a natural extension to the
respect Delaware law affords the board of directors. Absent a disabling conflict for a
majority of the board, the courts are reluctant to intrude into the realm of business
judgment. Deference to the wisdom of the board is no longer justifiable when a
majority of the board is conflicted. Importantly, the DGCL permits the board to cede a
portion of its authority to a board committee.115 The logic behind the refusal to
impinge on the authority of a non-conflicted board equally applies to a non-conflicted
and duly authorized board committee.116
By itself, this legislative interpretation would have a hard time justifying the
deference afforded to a committee of qualified directors. Even legally independent
and disinterested directors cannot erase a joint history of mutual service. Unchecked
camaraderie can potentially undermine the committee's ability to carry out its
function. Adherence to court-mandated guidelines designed to weed out lingering
biases or structural dependencies is therefore an essential component of this selfcleansing avenue. Insulation from even the hint of undue influence substantially
reinforces the committee's resolve to impartially review the merits of the proposed
transaction.
An independent stockholder vote is the second independent element of
Delaware's self-cleansing mechanism.117 Subjecting key events in the corporation's
life to stockholder approval is supported by several complimentary justifications.
Even in the cradle of director primacy, the stockholder vote remains the "ideological
114
115
116
117
agent acts under the control of the principal. The board of directors of a corporation is
charged with the ultimate responsibility to manage or direct the management of the
business and affairs of the corporation. A board of directors, in fulfilling its fiduciary duty,
controls the corporation, not vice versa" (citations omitted)).
The resemblance between the two organs comprising the Delaware ratification process and
Section 144 of the DGCL is easily discernable. An apparent resemblance does not mean that
Section 144 governs the ratification procedure. Section 144 was enacted in order to
counteract the old common law principle that voided related party transactions and provide
transaction planners a road map to avoid such a fate; see: Blake Rohrbacher et. al., Finding
Safe Harbor: Clarifying the Limited Application of Section 144, 33 DEL. J. CORP. L. 719, 719720 (2008). Determination of "when an interested transaction might give rise to a claim for
breach of fiduciary duty … was left to the common law of corporations to answer;" In re Cox
Commc'ns, Inc. S'holders Litig., 879 A.2d 604, 615 (Del. Ch. 2005).
DEL. CODE ANN. tit. 8, Sect. 141(c).
Laster, supra note 4, at 1456.
Previous case law can be read to create an analytical distinction between "classic"
shareholder ratification and instances where a stockholder vote was a necessary step in
authorizing the transaction, such as a statutory merger or amendment to the certificate of
incorporation. A recent Chancery Court opinion clarified that the stockholder self-cleansing
doctrine applies with equal force to both types of stockholder votes; see: IN RE KKR FINANCIAL
HOLDINGS LLC, supra note 11, at 1002 ("Although the language from the Supreme Court's
decision quoted above could be interpreted to imply that the legal effect of a fully informed
stockholder vote would be different when the vote was voluntary as opposed to statutorily
required, I do not read it that way").
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underpinning upon which the legitimacy of directorial powers rests".118 Under this
view, the voting mechanism aggregates the preferences of the stockholder
constituency and thus legitimizes the chosen course of action.119
A slightly different rationalization focuses on the accountability aspect of the
stockholder vote. Conflicts of interest are an unavoidable consequence of publicly
traded corporations. Subjecting a contentious course of action to stockholder approval
serves to align the interests of the corporate directors with those of the entire
stockholder base. The stockholder vote thus functions as a means to reduce the
likelihood of a self-serving error by the original corporate actors.120
Implicit in both of these views is the fact that rational stockholders vote for
their own interests.121 Manipulation of the process invalidates the cleansing effect of
the stockholder vote. Courts therefore police the voting mechanism in order to prevent
substantive coercion and ensure that stockholders are given enough information from
which to arrive at an informed decision.
After detailing the independent components of the self-cleansing mechanism, I
will now explain their effect on the entire fairness standard of review.122 A starting
dichotomy distinguishes between the entire fairness standard that stems from a
majority-conflicted board and entire fairness resulting from a related party transaction
with a controlling shareholder.
The effect of a competent approval by either a qualified director committee or
a qualified stockholder vote when no controlling shareholder is involved is relatively
straightforward. Valid approval by either one of the corporate organs reaffirms the
presumptions of the business judgment rule to the transaction.123 Once the business
118
119
120
121
122
123
Blasius Industries, Inc. v. Atlas Corp., 564 A.2d 651, 659 (Del. 1988).
FAIRFAX, supra note 38, at p. 29.
Robert B. Thompson & Paul H. Edelman, Corporate Voting, 62 VAND. L. REV. 127, 132-133
(2009).
Laster, supra note 4, at p. 1457 ("[S]tockholders are collectively well-positioned to decide
whether to endorse what the board did, and that for purposes of determining how easy it
should be for a stockholder plaintiff to challenge the action taken by the board (i.e., to
determine the standard of review), a court should take into account and defer to an
uncoerced endorsement from fully informed, disinterested stockholders").
Vice-Chancellor Laster recently professed his scholarly view that a qualified stockholder vote
lower the standard of review from enhanced scrutiny to the business judgment rule; see:
Laster, supra note 4, p. 1463-1470.
See Valeant Pharmaceuticals Intern. v. Jerney, 921 A.2d 732, 745-746 (Del. Ch. 2007)
(Approval by a well-functioning independent director compensation committee reaffirms the
presumptions of the business judgment rule to the interested transaction) and IN RE KKR
FINANCIAL HOLDINGS LLC, supra note 11, at p. 1001 (Approval by a fully-informed stockholder
vote of a transaction with a non-controlling stockholder reaffirms the presumptions of the
business judgment rule to the transaction).
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judgment rule applies, judicial review is presumably limited to issues of gift or waste
with the burden of proof upon the plaintiffs.124
Introduction of a controlling shareholder adds some uncertainty to the
analysis. Until fairly recently, it was seemingly well-settled that a self-dealing
transaction with a controlling shareholder would without fail evoke the entire fairness
standard of review.125 The controlling shareholder's superior bargaining position and
ability to extract revenge should the corporate agents refuse to bow down to her
demand necessitated continuous court oversight.126 The Delaware Supreme Court
clarified that at most, defendants can receive a shift in the burden of proof properly
employing one of the self-cleansing mechanisms.127
Critically, the above holding was rendered in connection with a going-private
merger with a controlling shareholder. Confusion exists regarding the degree of
overlap between the line of holdings governing going-private mergers and those
applicable to controlling shareholder related party transaction that do not constitute a
going-private merger.128 Since both strands arrived at the same result of heightened
judicial scrutiny, this confusion had little practical effect and did not engender a
torrent of judicial or scholarly commentary.
All this changed once the Delaware courts accepted the notion that effective
employment of both self-cleansing mechanisms prior to effectuating a going-private
merger with a controlling shareholder will subject the transaction to business
judgment rule review. Suddenly, the relationship between the holdings applicable to
going-private transactions and those applicable to going-concern transactions has
124
125
126
127
128
IN RE WHEELABRATOR TECH. SHAREHOLDERS LIT., supra note 11, at 1200 (the effect of the informed
stockholder vote is to invoke the business judgment standard, which limits review to issues
of gift or waste with the burden of proof upon the plaintiffs).
KAHN V. LYNCH COMMUNICATION SYSTEMS, supra note 99, at 1116. This determination would not
change even if the majority of the board was independent from the controlling shareholder;
see EMERALD PARTNERS V. BERLIN, supra note 2, at 96-97 (overturned on other grounds in IN RE
CORNERSTONE THERAPUTICS INC, STOCKHOLDER LITIGATION, supra note 43).
Id, at 1116-1117 (quoting Citron v. EI Du Pont de Nemours & Co., 584 A.2d 490, 502 (Del.
1990).
KAHN V. LYNCH COMMUNICATION SYSTEMS, supra note 99, at 1117. The practical effect of the
burden shift is subject to debate; for Chief Justice Strine's view (as Vice-Chancellor), see In re
Cysive, Inc. Shareholders Litigation, 836 A.2d 531, 548 (Del. Ch. 2003) ("The practical effect of
the Lynch doctrine's burden shift is slight. One reason why this is so is that shifting the
burden of persuasion under a preponderance standard is not a major move, if one assumes,
as I do, that the outcome of very few cases hinges on what happens if in the evidence is in
equipoise").
Hill and McDonnell, supra note 53, at 923-924 ("[I]t is somewhat unclear whether the
Weinberger entire fairness framework applies only to freezeout acquisitions, or whether it
applies to all transactions in which a shareholder has a controlling interest… The applicability
of Weinberger outside of the freezeout context is an open and important question").
Professors Gilson, Gordon, and Khanna seem to believe that going concern related party
transactions are governed by different authority than freeze out mergers. See Gilson and
Gordon, supra note 12 and Vikramaditya Khanna, The Growth of the Fiduciary Duty Class
Actions for Freeze Out Mergers: Weinberger v. UOP, Inc. in MACEY, supra note 2.
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gained practical import. Accordingly, the next section will trace the doctrinal
evolution applicable to each type of transaction.
IV.
Questioning MFW's Reach – Doctrine
a. Introduction
At the heart of the MFW decision,129 the Delaware Supreme Court overturned
long-standing precedent and decreed that defendants orchestrating a going-private
merger with a controlling shareholder are entitled to a deferential judicial standard of
review, so long as they effectively employ two procedural safeguards: (i) a special
board committee composed of disinterested and duly authorized directors equipped
with independent counsel and advisors and (ii) conditioning the consummation of the
transaction on a non-revocable acceptance by a majority of minority shareholders.
This latest ruling invites further analysis and review. The decision makes it
clear that the holding applies to going-private transactions with a controlling
shareholder. Moreover, the decision provides an admirable articulation of the
underlying policy rationales responsible for the doctrinal shift. Unfortunately, the
decision lacks any reference to the multitude of other factual situations that would
otherwise compel entire fairness review of a transaction undertaken with a controlling
shareholder. Thus, business planners are left with an unanswered question following
the MFW decision: what effect, if any, does proper employment of both of the selfcleansing mechanisms have in those scenarios?
b. MFW and the Unification of Final Period Review
[depicting the coherent evolution of the standard of review applicable to going private
transactions – ed.]
c. Standards of Review for Going-Concern RPTs
129
Kahn v. M & F Worldwide Corp., 88 A.3d 635 (Del. 2014) (affirming In re MFW S'holders Litig.,
67 A.3d 496 (Del. Ch. 2013)).
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[depicting the standards of review applicable to RPTs with a controlling shareholder that
do not conclude with the elimination of minority shareholders. In contrast with the coherent
evolution found in going private transactions, diverging strands of authority govern this type
of transaction. There are no compelling textual justifications found in the cases to conclude
that the MFW standard applies to going-concern transactions as well – ed.]
V. Questioning MFW's Reach – Policy
a. Independent Board Committees – A Critique
One does not have to be overly cynical in order to question the utility of allowing
committees composed of nominally independent directors to serve as the first line of
defense against potentially abusive RPTs. While bereft of noticeable material
connections to the corporation, the controlling shareholder or the transaction at hand,
this does not ensure that independent directors obtain optimal results for shareholders.
Opponents of the 'director independence movement' focus their criticism along two
main fronts: (1) the overarching presumption that director independence leads to
director objectivity similar to which is found in a bona fide arm's-length counterparty;
and, even assuming that such objectivity exists, (2) the utility that independent
directors add to the corporation. We begin by taking a closer look at the argument
questioning the independent director's actual objectivity.
Corporate governance reforms promoting director independence rely on the
assumption that independent directors add much needed objectivity to the board. This
objectivity is crucial to combating complacent tendencies that undermine the board's
effectiveness. However, numerous studies have shown that formal independence by
itself does not lead to an ability to overcome the psychological factors that damper
actual objectivity.
Independent directors are generally pre-approved by the controlling
shareholder and the incumbent board. At least tacit support and an affirmative vote by
the controller are essential in elevating the director to his esteemed position.130
Gratitude towards the controller and the other board members contributes to the wideheld notion that "none of the outside directors are likely to bite the hand that feeds
them."131
130
Lucien Bebchuk, The Myth of the Shareholder Franchise, 93 VA. L. REV. 675, 677 ("[F]or directors of
public companies, the incidence of replacement by a rival slate seeking to manage the company
better as a stand-alone entity is negligible").
131
Stephen M. Bainbridge CORPORATE GOVERNANCE AFTER THE FINANCIL CRISIS 88. See also
Claire A. Hill, Brett McDonnell, Disney, Good Faith and Structural Bias, 32 J. CORP. L. 834, 853 (2007)
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Following the appointment, additional phenomena identified in the social
psychology literature further weakens the ability of an independent director to
replicate the bargaining dynamic such as that found with an objective counterparty.
While the courts definition of independence ostensibly encompasses more than just
financial relationships, commentators versed in the intricacies of Delaware law
conclude that in practice a director's designation of independence is rarely invalidated
by anything but financial ties.132
Maintaining the focus on financial ties neglects objectivity-hampering norms
and biases that emanate from repeated interactions between members of a close-knit
and highly-esteemed group such as a board of directors. In-group bias arises from
human beings' natural tendency to categorize people around them.133 The basic
partition distinguishes between individuals that belong to one's in-group from those
that do not.134 An innate affinity subsequently flows towards other members of the ingroup.135 This affinity translates into a placating disposition toward members of the
in-group that does not extend to members of the out-group.
Application of this phenomenon in the board context has led commentators to
question the ability of technically independent directors to achieve true objectivity.136
("[P]otentially touching every director's decision is her desire to keep her director position. Doing so
depends on whether she stays in management's good graces") and Lucien Bebchuk, Jesse Fried, PAY
WITHOUT PERFORMANCE: THE UNFULFILLED PROMISE OF EXECUTIVE COMPENSATION pp. 25-27
(2006).
132
Lisa M. Fairfax, The Elusive Quest for the Inside Director, (in RESEARCH HANDBOOK OF THE
ECONOMICS OF CORPORATE LAW), 174; see also J. Robert Brown, Disloyalty Without Limits:
"Independent" Directors and the Elimination of the Duty of Loyalty, 95 KY. L. J. 53 (2006).
One of the most famous or notorious examples, depending on one's point of view, for a
court finding that sustained social connections do not create a disabling conflict is found In re
Martha Stewart 845 A.2d 1040, 1051-52. (Del. 2004).
133
C. Neil Macrae, Galen V. Bodenhausen, Social Cognition: Thinking Categorically About Others, 51 ANNU.
REV. PSYCHOL. 93 (2000). This categorization is a heuristic shortcut used to help arrange the
overflow of information the mind is constantly forced to decipher; D. H. J. Wigboldus, et al.,
Capacity and Comprehension: Spontaneous Stereotyping Under Cognitive Load, 22 SOCIAL COGNITION
292 (2004).
Henri Tajfel, et al., Social Categorization and Inter-group Behavior, 1 EUR. J. SOC. PSYCHOL. 149, 172177 (1971) and Michael Billig & Henri Tajfel, Social Categorization and Similarity in Intergroup Behavior,
3 EUR. J. SOC. PSYCHOL. 27, 37-48 (1973) ; for a more updated study, see: Jerry M. Burger et al., What a
Coincidence! The Effects of Incidental Similarity on Compliance, 30 PERSONALITY & SOC. PSYCHOL.
BULL. 35 (2004).
134
135
In the ground-breaking research that depicted this phenomena, Muzafar Sharif and
colleagues examined the behavior of pre-adolescent boys in a setting with no parental
guidance. Campers were randomly assigned to one of two insular groups. Following
introduction of the two groups, the subsequent camp athletic competitions were
characterized by excessive violence between members of the two groups; Muzafer Sherif, et
al., INTERGROUP CONFLICT AND COOPERATION: THE ROBBERS CAVE EXPERIMENT, ch. 5 (1961)
available at http://psychclassics.yorku.ca/Sherif/chap5.html.
136
Lisa Fairfax, The Elusive Quest for the Inside Director p 176; Julian Velasco, Structural Bias and
the Need for Substantive Review, 82 WASH. U. L. Q. 821 (2004); James D. Cox & Harry L.
Musinger, Bias in the Boardroom: Psychological Foundations and Legal Implications of
Corporate Cohesion, 48 LAW & CONTEMPORARY PROBLEMS 83 (1985).
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At best, the legal rules foster "cosmetic independence" that result in a poor facsimile
of an arm's-length counterparty.137
Arguably, judicial oversight of procedural best practices empowers
independent directors to overcome structural biases and fulfill their role in an
objective manner. The MFW opinion stresses that independent committee adherence
to procedural guidelines is essential for a downgrade of the standard of review.
Assuming this view to be correct does not detract from the second main argument
lobbed against increased authority to independent board members and committees.
Substantial literature has failed to detect the undeniable benefits that increased
board independence supposedly adds to the corporation. On the contrary, a claim can
be made that in certain situations, increased board independence actually harms
performance. Whatever evidence supports the usefulness of properly empowered
independent committees in the freeze out context does not easily extrapolate to going
concern transactions as well. The rest of this section will describe the benefits and
pitfalls associated with independent directors and independent committees.
Proponents of independent directors rely on the notion that distance from the
powers that run the corporation leads to increased objectivity. The argument further
equates objectivity with more efficient fulfillment of their duties. This account,
however, ignores the fact that increased objectivity comes at a price. Independent
directors often have no first-hand knowledge of the corporation or its' business and
must rely on second-hand accounts.138
Arguably, corporate law rules – like those found in the MFW guidelines –
minimize the information gap by facilitating and even mandating the supply of
information to independent directors. However, a caveat applies. "Information" does
not necessarily equate with "knowledge." While independence and objectivity might
be beneficial to satisfying the board's monitoring functions, this is but one aspect of
the board's role.139 A dearth of firm-specific or industry-specific knowledge hampers
137
Nicola F. Sharpe, The Cosmetic Independence of Corporate Boards, 34 SEA. L. REV. 1435
(2011) (arguing that cosmetic independence only takes into account a corporate director's
relationship with the corporation and not the tools a director needs to achieve substantive
independence).
138
Arnoud W. A. Boot & Jonathan Macey, Monitoring Corporate Performance: The Role of Objectivity,
Proximity and Adaptability in Corporate Governance, 89 CORN. L. REV. 356 (2003) (objectivity and
proximity of monitors is tradeoff that cannot co-exist); Jill Fisch, Taking Boards Seriously, 19 CARD. L.
REV. 265, 267 (1998) (director independence comes at the expense of a decline in the board's
management capacity).
For a taxonomy of board functions, see: Stephen Bainbridge, CORPORATE GOVERNANCE AFTER THE
FINANCIAL CRISIS 49-50, 61 (2012) (monitoring and disciplining management, providing advice and
guidance for management and providing a network of useful business contacts), Lynne L. Dallas, The
Multiple Roles of Corporate Boards of Directors, 40 SAN DIEGO L. REV. 781, 782-783 (2003)
(characterizing the functions of the board as monitoring, relational and strategic).
139
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the independent director's ability to observe and assess a corporation's strategic
direction.140
The empirical research that attempts to identify causation or at least
correlation between the incidence of independent directors on boards and corporate
performance supports the above hypothesis. To date, the studies have not been able to
find an undeniable link between board independence and improved performance.141
Studies that purport to uncover economic benefits of increased board independence
cabin their conclusion to a specific context. The important variable is the relative cost
associated with acquiring knowledge about the firm and the industry. Increased
director independence in a corporation operating in a straightforward industry is
followed by performance growth. Conversely, for corporations that operate in a niche
industry where expertise is hard to gain, appointment of independent directors
actually leads to a decrease in performance parameters.142
The above research analyzes the connection between board independence and
corporate performance. Studies that focus on the impact of independent directors on
board committees have also been unable to verify an irrefutable correlation between
committee independence and committee performance. As in the case of board
independence, the committee's function is an important variable on the effect that
enhanced independence has on committee performance.143
140
Fisch, Taking Boards Seriously, 282-286; Nicola F. Sharpe, Rethinking Board Function in the
Wake of the 2008 Financial Crisis, 5 J. BUS. & TECH. L. 99, 108-110 (2010).
141
Sanjai Bhagat & Bernard Black, The Non-Correlation Between Board Independence and Long-Term Firm
Performance, 27 J. CORP. L. 231 (2002) (Taken as a whole, the empirical evidence does not
convincingly prove that independent directors necessarily lead to more effective and efficient
monitoring); David Larcker & Brian Tayan, CORPORATE GOVERNANCE MATTERS, 144 (2011) ("Most
142
studies fail to find a significant relationship between formal board independence and
improved corporate outcomes… In aggregate, they tend to demonstrate either a modest
relationship or no relationship between independence and long-term performance")
Ran Duchin, et. al., When Are Outside Directors Effective? 96 J. FIN. ECO. 195 (2010). For
studies casting further doubt about the utility of independent directors in the banks and
financial holding sector, see: David. H. Erkens, et al., Corporate Governance in the 2007-2008
Financial Crisis: Evidence from Financial Institutions Worldwide (January, 2012) Available at SSRN:
http://ssrn.com/abstract=139768 ("[W]e find that firms with higher institutional ownership and more
independent boards had worse stock returns than other firms during the crisis") and Renee B. Adams &
Hamid Mehran Bank Board Structure and Performance: Evidence for Large Bank Holding Companies,
(October, 2011) Available at SSRN: http://ssrn.com/abstract=1945548 ("As in many studies of nonfinancial firms, we find that the proportion of independent outsiders on the board [of bank holding
companies] is not significantly related to performance").
143
Cf. April Klein, Firm Performance and Board Composition Structure, 41 J. L. & ECO. 275 (1998)
(little evidence that additional independence on the nominating, audit or compensation
committees positively impact firm performance) with Robert A. Prentice & David B. Spence,
Sarbanes-Oxley as Quack Corporate Governance: How Wise is the Perceived Wisdom? 95
GEO. L. J. 1843 (2007) (greater independence on the auditing committee improves financial
reporting)
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An important study by Davidoff and Cain underscores this point.144 Focusing
solely on end game transactions in which incumbent management are part of the buyout team (MBOs), the authors find that the existence of special committees is
associated with higher offer premiums.145 A closer look at their findings, however,
does support the proposition that independent committees necessarily bring value to
shareholders in other types of RPTs.146 This is because independent committees
analyzing a going concern RPT fulfill a different role than those pondering a going
private offer.
Independent committees examining a going-concern RPT fulfill more than one
function. While it is expected that they monitor the transaction for potential abuses,
many going-concern RPTs are an integral part of long-term corporate strategy. The
collected data does not support the conclusion that increased independence assists
board committees to accomplish this task.147
MFW provides guidelines that allow a controlling shareholder to receive
deferential BJR review while orchestrating a going-private transaction. These
guidelines emphasize the role of independent board committees and an affirmative
vote of a majority of the minority shareholders. This section focused on the two main
criticisms lobbied against independent directors and committees. First, that deeprooted structural bias prevents the independent director from achieving similar
objectivity to that which is found in an arm's-length counterparty; and second,
available data is incapable of proving a causal link between increased independence
and increased performance. The next sections will take a closer look at shareholder
voting and ponder whether the supreme court's confidence in the minority vote is
misplaced.
b. Majority of Minority Shareholder Approval – A Critique
Shareholder voting is predicated on the twin principals of corporate legitimacy
and error-correction. However, systemic impediments hamper achievement of those
goals. Ultimately, conditioning the course of action on shareholder approval cannot
144
145
146
147
Steven M. Davidoff & Matthew D. Cain Form Over Substance? The Value of Corporate Process
and Management Buy-Outs, 36 DEL. J. CORP. L. 849 (2011).
Id., p 889-890.
Critically, the study finds that independent directors committees are not associated with
higher takeover premiums in controlling shareholder freeze-outs subject to the WeinbergerLynch standard; id p. 892.
This could be because of the cognitive limitations on the type of decision they are asked to
make. A going-private decision has one main variable – the adequacy of the share price offer.
A decision regarding a going concern RPT contemplates many input-based metrics can
properly be calculated by a director with some proximity to the corporation; Bainbridge,
CORPORATE GOVERNANCE AFTER THE FINANCIAL CRISIS 99.
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guarantee efficient results. A majority of the minority condition does not change the
basic calculus, and in fact has the potential to engender even more harm.
In order for the voting mechanism to achieve the desired result, the voting
constituency must be suitably informed and educated regarding the contents of the
ballot. However, a rational voter's effort to inform himself about the intricacies of the
voted-upon subject is linked to the benefit that will personally accrue from the
anticipated result. Implementation of both axioms in the corporate sphere leads to dire
conclusions.
Monitoring a publicly-held corporation is a costly endeavor; forming an
educated opinion about business intricacies requires the shareholder to collect and
process a vast amount of information. Owing to the minute share ownership of most
minority shareholders, chances are that most shareholders do not play a pivotal role in
the vote. In addition, any benefits that a value-producing vote accrues to the
corporation will be distributed among all shareholders. As a result, the expected
benefits of an informed vote are microscopic and at the very best marginally related to
the incurred costs. The above analysis leads to a phenomenon labeled by the finance
literature as 'rational apathy': a typical shareholder has no incentive to inform himself
and participate in the vote, and therefore will not.148
Arguably, a majority of the minority condition works to dissipate the rational
apathy associated with the shareholder vote. Exclusion of the controlling shareholder
from the voting constituency increases the relative voting power attached to a
minority shareholder's holdings; the possibility that a minority shareholder's vote will
prove pivotal rises. Increased voting power provides a greater incentive to acquire
adequate information on the voted-upon issues. In theory, the minority of the majority
condition facilitates an informed and efficient vote by the shareholder constituency.
Unfortunately, the realities of shareholder voting cast serious doubt on achievement of
this goal.
Conditioning a going concern RPT on the approval of a majority of minority
shareholders has the potential to unleash harmful unintended consequences. First,
although minority shareholders subject to this condition ostensibly have a greater
incentive to collect information on the issues on the ballot box, there is no guarantee
that this incentive is enough to overcome rational apathy; the high costs associated
with becoming informed and the division of potential benefits conspire to preclude
minority shareholders from actually carrying out this endeavor. In all likelihood,
minority shareholders that wish to make their vote count – but not enough to actually
148
Stephen M. Bainbridge, The Case for Limited Shareholder Voting Rights, 53 UCLA L. REV. 601,
607.
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incur the costs necessary to become informed – will blindly vote in accordance with
the recommendation of proxy advisory services.149
A second unintended consequence regards the effect that conditioning the
transaction on minority shareholder approval has on the motivations and actions of
members of the independent director committee. Recall that prior to MFW, although
they were not enough to cause a downgrade of the standard of review, corporate best
practices dictated the creation of independent director committees. Indeed, the actions
of the committee were heavily scrutinized under the exhaustive entire fairness
standard. In the post-MFW landscape, independent shareholder approval of
independent committee recommendation has become the norm. However, buttressing
the independent committee's actions on the approval of minority shareholders
weakens the committee's ex ante incentive to act in the interests of minority
shareholders. Under the MFW guidelines, independent directors bear joint
responsibility with minority shareholders. The independent committee's incentive to
properly fulfill its' task is further undermined by the lax standard of review that MFW
affords. The net result is that the addition of minority shareholders approval might
result in the dismantling of incentives that compel effective independent director
oversight.150
Increasing the power given to minority shareholders is a potentially misguided
strategy for a different reason. Minority shareholders, even relatively substantial ones,
are not all cut from the same cloth. In fact, minority shareholders are motivated by
widely divergent interests.151 Recall that for the error-correcting role of the
shareholder vote to function correctly, shareholders must share a common goal.
Raising the relative voting power of minority shareholders transforms formerly
disenfranchised shareholders into potential swing-votes. Under these conditions, it is
perfectly rational for a minority shareholder to utilize his new-found voting power to
engage in 'rent-seeking' behavior; i.e. to condition his agreement on the promotion of
private interests that have the potential to be detrimental to the rest of the
shareholders.152
Before moving on to explore the geography of MFW-Land, another distinction
between shareholder voting on freeze-out transactions and going-concern RPTs needs
to be made. In both scenarios, public shareholders generally suffer from information
149
150
151
152
Larcker & Tayan, CORPORATE GOVERNANCE MATTERS 403. Another pitfall associated with
proxy advisory firms are the proliferation of "one size fits all" recommendations based upon
purported corporate best practices that are not supported by the literature; see Asaf Ekstein,
Great Expectations: The Perils of Proxy Advisor Regulation, forthcoming DEL. J. CORP. L.
Minor Myers, The Perils of Shareholder Voting on Executive Compensation, 36 DEL. J. CORP.
L. 417 (2011).
Iman Anabtawi, Some Skepticism About Increasing Shareholder Power, 53 UCLA L. REV. 561
(2006) (depicting the divergent interests of minority shareholders along the following axis:
investment horizon (short vs. long termism), risk preference (diversified vs. non-diversified),
and degree of "social" considerations (union-affiliated shareholders vs. financial institutions).
Bainbridge, The Case for Limited Shareholder Voting Rights, p. 634.
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deficits regarding the intrinsic value of the corporation or the transaction at hand.
Incentivizing shareholders to carry out an informed vote is an essential component of
a well-operating voting regime. Shareholders in a going-private scenario have higher
motivation to inform themselves about the value of the transaction as well as a much
cheaper way to do so.
A successful undertaking of a going-private transaction results in the
elimination of the public float. Shareholders are in fact voting on whether to cash in
on the future revenue stream associated with their shares. A 'wrong' decision cannot
be easily rectified; shareholders that successfully defeat a value-enhancing deal will
be left owning something of worse value. Conversely, agreeing to sell means that the
shareholder will not participate in future gains. The incentive to make an informed
decision will never be higher. In addition, the capital market's ability to aggregate
available information into a single stock price offers the shareholders a clear
benchmark of the value of their shares.153
In contrast, shareholders asked to approve a going-concern RPT have neither
the incentive nor the informational shortcut that attach to a going-private transaction.
Regardless of the final tally, their shares will still be in their possession. Continued
share ownership allows them to enjoy future gains if the transaction is valueproducing or punish the corporation if the transaction is value-reducing. Regardless,
shareholders can defer passing judgment on the transaction to a later period. There is
no unique incentive to accrue costs designed to inform themselves about the efficacy
of the transaction. Not only is there no incentive, in contrast to a going-private
decision the deliberating shareholders cannot readily rely on the market price of the
shares. Considerable evidence casts doubt on the market's ability to disentangle the
and accurately price discrete portions of the corporate enterprise.154
VI.
The Geography of MFW-LAND
We now return to ponder the impact of the MFW decision in other factual
situations involving a controlling shareholder that would otherwise require heightened
judicial review. Specifically, does utilization of both approval mechanisms mandate
application of lax judicial review?
At first glance, the answer appears obvious. MFW was rendered in connection
with a going-private transaction with a controlling shareholder. Going private
153
154
Bainbridge, The Case for Limited Shareholder Voting Rights, p. 624.
Sudha Krishnaswami, Venkat Subramanium, Information Asymmetry, Valuation and the
Corporate Spin-off Decision, 53 J. FIN. ECON. 73 (1999) (providing evidence that information
asymmetries prevent the market from correctly pricing independent firm units and that the
actual value is recognized following a spin-off).
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transactions differ from going-concern transactions in that their successful completion
wipes out the minority float. With regards to enterprise transactions, abusive actions
undertaken by the controlling shareholder will be embedded in the collective memory
of the public market. When the opportunity arises, minority shareholders will most
assuredly punish the controlling shareholder for past transgressions. Conventional
wisdom holds that the equilibrium established by this balance of power works to curb
overly-aggressive actions contemplated for the betterment of the controlling
shareholder.
Following a going-private transaction, minority shareholders are wiped out
and can no longer threaten future retribution. Accordingly, policy considerations call
for superior protection of minority shareholders participating in a going-private
transaction as a substitute for relinquishment of their side of the balance of power
equilibrium. Since MFW establishes narrower judicial review following a doublebarreled self-cleansing mechanism for going private transactions, it stands to reason
that this standard should apply to all transactions involving a controlling shareholder.
After all, if the courts are willing to downgrade their involvement in the most
problematic of settings for minority shareholders, what possible rationale is there for
staying put with enhanced review in apparently more benign circumstances?
Another avenue, predicated on canons of judicial interpretation, distinguishes
MFW as stemming from a line of cases dealing specifically with going private
transactions. Accordingly, MFW does not change the judicial standard of review for
all other transactions with a controlling shareholder, as those are governed by
different Supreme Court authority.
Still another avenue of development emerges from careful reading of the
Chancery Court decision. Dealing with an issue of first impression, then-Chancellor
Strine adopted the novel argument that effective double-barreled approval lowers the
applicable standard of review. In his careful analysis of the situation, the former
Chancellor gave great weight to the prevalence of non-meritorious "strike-suits" and
the inefficiencies stemming from mandatory entire fairness review for all going
private transactions. While this portion of the analysis was not replicated by the
Supreme Court, the underlying rationale holds persuasive analytical force and should
not be ignored. Should the doctrine advance in this direction, the borders of "MFWLand" will extend only to those factual situations that nearly always give rise to
shareholder claims while leaving out all seldom-litigated scenarios that currently
invite intrusive judicial review.
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