Jason R. Jones

Ensuring that all requirements of Kahn v. M&F Worldwide (MFW)1 are complied with is paramount in order for the business judgment rule to apply to transactions involving a controlling stockholder who receives a non-ratable benefit at the expense of the minority stockholders. In case you missed it, the Delaware Supreme Court rendered a decision on this very issue earlier this year in In re Match Group Derivative Litigation.2 The ruling held that entire fairness is the presumptive standard of review where (1) a controlling stockholder stood on both sides of a transaction with the controlled corporation and received a non-ratable benefit and (2) the defendant failed to satisfy all of the requirements set forth in MFW to change the standard of review to business judgment. What the Chancery Court Found IAC/InterActiveCorp incorporated Match Group Inc. in 2009 to hold its Match.com business and other dating platforms. A portion of Match’s common stock was sold in 2015 to the public in a public offering, and in 2019, IAC announced in a letter to its stockholders that it was considering separating from Match. Match’s board appointed three of its directors to a “separation committee” to assess a proposed transaction. One of the directors appointed to the separation committee was IAC’s former chief financial officer (CFO), who had worked for IAC from 1999 to 2012, including seven years as the CFO. The separation committee retained its own legal counsel and financial adviser. The proposed transaction envisioned creating two separate public companies and eliminating Match’s dual-class capital structure via a reverse spin-off (the separation). After reaching a final agreement with IAC, the separation committee recommended that Match’s board approve the separation. The board approved the separation and submitted it to a vote of the stockholders, who voted in favor of the separation. At the time, IAC held 98.2% of Match’s voting power through ownership of 24.9% of Match’s common stock and all of Match’s Class B high-vote common stock. Certain former Match stockholders challenged the separation in the Delaware Court of Chancery, claiming that the separation was a conflicted transaction where IAC, as Match’s controlling stockholder, stood on both sides of the transaction and obtained significant non-ratable benefits to the detriment of Match and its minority stockholders. The defendants made a motion to dismiss. The Court of Chancery held that the defendants satisfied the requirements set forth in MFW for the application of the business judgment rule and dismissed the case, finding that the separation conditioned the transaction on the approvals of a fully empowered, well-functioning special committee of independent directors and the uncoerced, fully informed vote of the minority stockholders. What the Delaware Supreme Court Found Following the transactions consummated in connection with the separation, the Delaware Supreme Court found that: (1) the former minority stockholders of Match owned common stock in a widely held and highly leveraged corporation (referred to herein as New Match), subject to short-term restrictive governance provisions; and (2) the former stockholders of IAC received most of the interest in New Match, as well as shares in a cash-rich corporation with little to no debt that was spun off from IAC in connection with the separation. After reviewing the development of Delaware case law related to judicial review of controlling stockholder transactions, the court found that entire fairness is the standard of review in transactions between a controlled corporation and a controlling stockholder when the controlling stockholder receives a non-ratable benefit, except that, under MFW, the business judgment rule applies when all of the following are satisfied: A controlling stockholder conditions a transaction from the start on the approval of both a special committee and a majority of the minority stockholders. The special committee is independent. The special committee is fully empowered. The special committee meets its duty of care. The vote of the minority is informed. There is no coercion of the minority.   The defendants argued that MFW and the cases that preceded it involved freeze-out mergers and that outside the context of a freeze-out merger, traditional principles of Delaware corporate law recognize that any one of the following three cleansing mechanisms suffices to invoke the business judgment standard of review in a conflicted transaction: approval by (1) a board with an independent director majority; or (2) a special committee of independent directors; or (3) a majority of the unaffiliated stockholders. According to the defendants, the rule has always been that, other than freeze-out mergers, any one of such procedural devices described in (1) through (3) above could invoke business judgment review in controlling stockholder transactions. The court rejected that argument and held that the requirements set forth in MFW are not limited to freeze-out merger transactions and that all requirements of MFW must be satisfied for the business judgment rule to apply where a controlling stockholder stands on both sides of a transaction and receives a non-ratable benefit. The court further found, for purposes of applying the business judgment rule, that when a controlling stockholder transacts with the corporation and receives a non-ratable benefit, the special committee created and empowered to oversee and consider such a conflicted transaction must be fully independent — not just a majority independent. The court noted that a controlling stockholder’s influence is not disabled when the special committee is staffed with members loyal to the controlling stockholder. In the present case, the court found that the complaint pleaded facts that raise a reasonable doubt about the former CFO’s independence from IAC and, therefore, the entire separation committee’s independence. Accordingly, the court reversed the Court of Chancery’s decision to apply the business judgment rule, dismissed the plaintiffs’ claims, and held that entire fairness remains the standard of review. Moving Forward All of MFW’s requirements must be satisfied in order for the business judgment rule to apply when a controlling stockholder stands on both sides of a transaction with the controlled corporation and receives a non-ratable benefit. Companies should ensure that all members of a special committee created and empowered to oversee and consider a transaction involving a controlling stockholder that receives a non-ratable benefit are independent. 1 88 A.3d 635 (Del. 2014). 2 315 A.3d 446 (Del. 2024).

In a decision rendered on May 29, 2023, the Delaware Court of Chancery, in the case HControl Holdings LLC et al. v. Antin Infrastructure Partners S.A.S. and OTI Parent LLC,¹ enforced a buyer’s right to terminate a merger agreement on the basis that certain representations made by the sellers in the merger agreement concerning the target companies’ capitalization were not true and correct in all respects. Factual Background Antin Infrastructure Partners S.A.S., a private equity firm formed under French law, and OTI Parent LLC (collectively, the Buyers) entered into a merger agreement (Merger Agreement) with the Purchased Entities (as defined below) and Mario Bustamante, as the sellers’ representative (together with the Purchased Entities, collectively, the Sellers) to acquire a group of privately held Florida broadband companies, collectively referred to as OpticalTel, for a base purchase price of $230 million plus an earnout of up to $30 million contingent on meeting certain milestones after closing. OpticalTel consists of four top-level limited liability companies (collectively referred to as the Purchased Entities) and their subsidiaries. The Merger Agreement is governed by Delaware law. Under the Merger Agreement, the Sellers made representations and warranties concerning who owned the businesses being sold (Capitalization Representations) and agreed that all Fundamental Representations, which were defined to include the Capitalization Representations, would be true and correct in all respects at closing (the Bring-Down Provision). During negotiations, the Sellers and Buyers went back and forth on whether a de minimis failure of the Fundamental Representations to be true and correct would be excluded from the Bring-Down Provision. Ultimately, the Sellers and Buyers agreed on a flat Bring-Down Provision that would require the Fundamental Representations, including the Capitalization Representations, to be true and correct in all respects at closing and would not include a de minimis qualification. After the Merger Agreement was signed, an employee of OpticalTel, Rafael Marquez, claimed an ownership interest in an OpticalTel entity, HControl Corporation (HControl Corp.), a subsidiary of one of the Purchased Entities, HControl Holdings LLC, based on a software development agreement entered into with Marquez pursuant to which he provided certain services related to the implementation of software used in OpticalTel’s business. The software development agreement provided for HControl Corp. to pay Marquez, as consideration for his services, among other things, “5% ownership of HControl Corp. to be distributed upon a liquidation event.” The interest that Marquez claimed he had in HControl Corp. was not included in the disclosure schedule to the Merger Agreement relating to the Capitalization Representations. Marquez aggressively pursued his claim, including by directly contacting the Buyers. The Sellers made several attempts to settle with Marquez and ultimately made an offer to him of $300,000, based on a $9.5 million valuation of HControl Corp., which was rejected. Marquez’s counsel made an offer of $4.5 million to $5.4 million to resolve the claim, based on Marquez’s position that he was entitled to 5% of the total deal proceeds, not only the proceeds attributable to HControl Corp. The Sellers were unable to reach a settlement with Marquez. The Sellers then proposed restructuring the merger transaction to exclude HControl Corp. and provide the other OpticalTel entities with access to its software via a licensing arrangement. The Buyers rejected this proposal and shortly thereafter served a notice of breach of the Merger Agreement on the Sellers based on a breach of the Capitalization Representations. The Sellers then proposed a plan (the Transfer-Dissolution Plan) to transfer HControl Corp.’s proprietary software to HControl Holdings – one of the Purchased Entities that would be acquired by the Buyers in the merger – in exchange for $215,000, or 5% of the software’s valuation of $4.3 million, paid into a trust and then dissolve HControl Corp., with the objective of reducing any claim to equity by Marquez to a claim for monetary damages. The Buyers took the position that the Transfer-Dissolution Plan would breach certain interim covenants regarding the Sellers’ operation of the OpticalTel business between signing and closing, and they noted that the dissolution process could take months and the statute of limitations period for bringing claims against HControl Corp. would extend for another four years. The Sellers responded by seeking the Buyers’ consent to the Transfer-Dissolution Plan. The Buyers did not consent. Nonetheless, the Sellers went forward and consummated the Transfer-Dissolution Plan. Following the Sellers’ consummation of the Transfer-Dissolution Plan, the Buyers sent a second notice of breach, stating that the dissolution of HControl Corp. failed to resolve the Sellers’ breach of the Capitalization Representations related to Marquez and resulted in further breaches of the Merger Agreement. Shortly thereafter, the Buyers terminated the Merger Agreement due to the Sellers’ failure to cure the breach of the Capitalization Representations relating to Marquez, and about a month after that, the Buyers sent another notice terminating the Merger Agreement due to the Sellers’ failure to cure their breaches of the Merger Agreement arising out of the Transfer-Dissolution Plan and certain other breaches. The Sellers filed suit against the Buyers for specific performance. The Sellers claimed that the Buyers breached the Merger Agreement by, among other things, wrongfully terminating the Merger Agreement and failing to use their best efforts to consummate the merger. The Court’s Findings The court found that Marquez’s rights under the software development agreement to a cash payment upon a liquidation event in the amount of 5% of the value of HControl Corp. constituted phantom equity, which rendered the Capitalization Representations false, and that the Transfer-Dissolution Plan did not cure the Sellers’ breach of the Capitalization Representations. The court noted that the Bring-Down Provision does not include a de minimis qualifier. The Buyers negotiated for the Fundamental Representations, including the Capitalization Representations, to be true and correct in all respects. The Capitalization Representations were not true and correct in all respects, and the Buyers proved that the Sellers breached the Capitalization Representations based on the Marquez issue. In its decision, the court noted that the parties disputed the Buyers’ motive for serving notice of breach and that the Sellers came to believe that the notice had something to do with an investigative report on the OpticalTel companies, the principal owner and the CEO that was prepared by a third party that the Buyers commissioned upon learning about the Marquez issue. The report cast a number of aspersions on the Sellers that the Sellers denied. The Sellers pointed to this report as the impetus behind the Buyers’ decision to back out of the deal and insinuated that the Buyers’ legal grounds were pretextual. However, the court found that the Buyers’ representatives testified credibly that the Marquez issue concerned them. In that regard, the Buyers acknowledged that the post-closing risks related to Marquez were not primarily financial and that they viewed Marquez’s claim as worth a minimal amount of money compared to the deal. The Buyers believed that Marquez would continue to pursue his claims aggressively post-closing and that litigation would consume and distract the Sellers’ management. The Buyers also had reputation concerns related to the Marquez issue. Notwithstanding the analysis in the court decision concerning the Buyers’ motives, the court noted that, in all events, the parties’ dispute over the Buyers’ motives was largely beside the point and the real issue was whether they had a legal basis to notice a breach and terminate the Merger Agreement. The court found that the Sellers did not prove that the Buyers breached their obligation to use best efforts to close, noting that the Buyers continued to take specific steps to proceed to closing even after learning about the issue involving Marquez. The court stated that between signing and closing, the Buyers had the right not to close if the Capitalization Representations were not true and correct in all respects and that the best-efforts provision did not require the Buyers to sacrifice their negotiated contractual rights to solve a breach. The court held that the Buyers had the right to terminate the Merger Agreement as a result of the Sellers’ breach of the Capitalization Representations with respect to the Marquez issue. However, with regard to the Transfer-Dissolution Plan, the court found that the consummation of the Transfer-Dissolution Plan neither breached the Sellers’ obligations under the Merger Agreement to operate OpticalTel in the ordinary course of business between signing and closing or use commercially reasonable efforts to preserve intact its business organization nor breached the provision of the Merger Agreement that prohibits the Sellers from dissolving any member of the OpticalTel companies, other than immaterial subsidiaries, without the Buyers’ consent. The court found that the Optical-Tel business was not altered by the transfer of the assets of HControl Corp. to HControl Holdings because the OpticalTel companies still held the assets following such transfer and noted that before and after the transfer, the OpticalTel companies owned the same assets and had the same contracts and that the business was essentially the same as it was at the time of the signing of the Merger Agreement. The court also found that while HControl Corp. was a material subsidiary before the consummation of the Transfer-Dissolution Plan, it was not a material subsidiary after its assets were transferred pursuant to the Transfer-Dissolution Plan. Nevertheless, the court’s findings with regard to the Transfer-Dissolution Plan did not affect the Buyers’ right to terminate the Merger Agreement based on the breach of the Capitalization Representations. Conclusion This case indicates that (i) the Delaware courts may enforce the right of a buyer to terminate a merger agreement based on the failure of a seller’s representations and warranties to be true and correct at closing even where the financial value of the breach is minor relative to the overall deal value if the terms of the merger agreement require the applicable representations and warranties to be true and correct in all respects at closing (without any de minimis or materiality qualification) and (ii) any obligation of the parties under a merger agreement to use best efforts to consummate the merger may not require a buyer to take actions to assist a seller with curing the seller’s breach of representations and warranties in order to satisfy a condition to the buyer’s obligation to consummate the merger. Accordingly, counsel for buyers and sellers should give careful consideration in negotiating such bring-down provisions and the extent to which those provisions should be qualified by materiality. ¹ 2023 WL 3698535 (Del. Ch. May 29, 2023)

In a decision rendered on March 15, 2023, the Delaware Court of Chancery, in the case In Re Mindbody, Inc. Stockholder Litigation,¹ held Richard Stollmeyer (the CEO), the chief executive officer and a director of Mindbody, Inc. (the Company), a public company incorporated under the laws of Delaware, liable for breaches of the fiduciary duties of care and loyalty to the Company and its stockholders in a transaction involving the sale of the Company via merger to Vista Equity Partners Management, LLC (Vista). The Court also held Vista liable for aiding and abetting such breaches. The plaintiffs claimed that the CEO breached his fiduciary duties by tilting the sale process in favor of Vista and committed disclosure violations by failing to disclose facts about the sale process and that Vista aided and abetted such breaches. Sale Process Claims Under Delaware law, in the context of a sale of control of a Delaware corporation, directors are required to focus on one primary objective, securing the transaction which offers the best value reasonably available to the stockholders. This means that directors, in exercising their fiduciary duties, must seek a deal that offers the best price and other terms reasonably available under the circumstances. Directors must prioritize Revlon duties over other long-term corporate and financial objectives. Where a stockholder challenges a change-of-control transaction, enhanced scrutiny, as set forth in Revlon, Inc. v. MacAndrews & Forbes Holdings, Inc.² is the presumptive standard of review. Under Revlon, the directors have the burden of demonstrating both (i) the reasonableness of the decision-making process employed by the directors, including the information on which the directors based their decision and (ii) the reasonableness of the directors’ action in light of the circumstances then existing. The business judgment rule, under which there otherwise would be 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 was taken in the best interest of the Company, does not apply except where the transaction is approved by a “cleansing vote” of a fully informed, uncoerced majority of the disinterested stockholders. In deciding whether the business judgment rule standard could be restored in the case at hand by such a cleansing vote, the Court found that the stockholder vote was flawed because the stockholders were not made aware of the CEO’s conflicts or the way in which the sale process favored Vista as described below, and therefore, the transaction was not approved by a fully informed, uncoerced majority of the disinterested stockholders. Accordingly, the Court found that enhanced scrutiny was the appropriate standard of review. In holding the CEO liable, the Court found that the conduct leading to the merger fell outside the range of reasonableness. The following summarizes certain findings of the Court as set forth in its opinion. The CEO was subjectively motivated in large part by his need for liquidity. He had substantial financial commitments; approximately 98% of his net worth was in stock of the Company and he was substantially limited in the amount of stock he could sell from time to time. This created a disabling conflict. The CEO set the sale process in motion largely without the involvement or knowledge of the Board of Directors. Without informing the board and prior to the commencement of a formal sale process by the board, the CEO met with a banker who introduced him to Vista, and the CEO had initial meetings with Vista. The CEO attended a Vista summit for chief executive officers of ex-public companies that Vista had acquired, at which Vista made presentations advertising the immense wealth that the chief executive officers had achieved by selling to and working for Vista. After the summit, the CEO believed that selling to Vista gave him the opportunity to both gain liquidity and remain as chief executive officer in pursuit of post-acquisition equity-based upside. The CEO became focused on a sale to Vista and wanted to sell to Vista. The CEO held shares of a super-voting class of stock, which provided control of approximately 19.8% of the Company’s voting power. The super-voting stock was set to automatically convert to common stock in approximately three years, which would carry less than 4% of the Company’s fully diluted voting power. Tactically, it was best for the CEO to take action quickly on a sale before the super-voting class of shares converted to common and his voting power was diluted. The CEO did not inform the full board of directors immediately upon receipt of an expression of interest from Vista to acquire the Company. Rather, the CEO had a lengthy discussion with the director, who was the director designee of the Company’s largest shareholder, whom the CEO knew also wanted a near-term exit from its investment in the Company. It was not until approximately a week later that the CEO informed the full board of Vista’s expression of interest. However, the full board was not made aware of the full extent of the discussions that the CEO had with Vista, and the board did not form a transaction committee to consider running a sale process until approximately two weeks thereafter. The CEO knew that Vista might attempt to move fast to gain a competitive advantage over other bidders. While the transaction committee formed by the board of directors established certain guidelines to cabin management’s communication with potential bidders, the CEO ignored them and, among other things, tipped Vista that a formal sale process was beginning. However, the CEO did not tip other potential bidders of the sale process. By causing a delay in providing information to the board and tipping Vista on the sale process, the CEO gave Vista a huge head start. When Vista was ready to make a firm offer, the other bidders (seven other parties signed non-disclosure agreements and were given access to the data room) were still in the early stages of their due diligence review of the Company and were largely unable to respond within the timeframe requested to make best and final offers. After Vista made a firm offer, the investment committee countered and Vista raised its final bid to $1 per share below where its deal team thought that the deal price would land. That offer was ultimately accepted by the Company. The evidence shows that Vista could and would have gone higher if it had been pressured to do so. The plaintiffs also argued and presented evidence that the CEO lowered earnings guidance to depress the Company’s stock price and make a deal seem more attractive. The Board of Directors was kept in the dark and did not know of the conflicts involving the CEO that infected the sale process. Among other things, the board did know about the CEO’s need for liquidity, the Company’s largest stockholder’s desire for a near-term exit, the details of certain meetings that the CEO had with Vista or information the CEO communicated to Vista regarding his desire to find a home for his Company or that he had tipped Vista about the start of the formal sale process giving Vista a huge head start. The CEO’s actions deprived the board of information needed to employ a reasonable decision-making process. Ultimately, the Court found that the CEO did not strive in good faith to pursue the best transaction reasonably available. He instead pursued a fast sale to Vista to further his personal interests. Because he tilted the sale process in Vista’s favor for personal reasons, the process did not achieve a result that fell within the range of reasonableness. Vista prevailed against the plaintiffs and was not held liable for the plaintiffs’ sale-process claims on procedural grounds because the plaintiffs failed to assert a claim against Vista for aiding and abetting in the sale-process breaches until trial. However, as noted below, the plaintiffs prevailed against Vista on aiding and abetting disclosure violations. Disclosure Violations With regard to the claims that the CEO committed disclosure violations by failing to disclose facts about the sale process, the Court held that the CEO breached his duty of disclosure and Vista aided and abetted such breach. The Court found that the CEO failed to disclose the full extent of his involvement with Vista in the proxy materials delivered to the stockholders, which was a material omission, and that Vista aided and abetted the CEO’s breach by failing to correct the proxy materials to include a full and fair description of its own interactions with him. Under the merger agreement between the Company and Vista, Vista was contractually obligated to review the proxy materials and inform the Company if there were material omissions from the proxy materials. The record shows that Vista personnel who interacted with the CEO reviewed the proxy materials; Vista knew about its own interactions; it was evident that they were not disclosed and Vista knowingly participated in the breach by not speaking up. Conclusion This case reinforces that in running any sale process, it is important for the board to be proactive in managing the sale process in a reasonable manner and to uncover any conflicts of interest or interference in the process by particular individuals. As is often the case, continuing management may be key to the sale and will have both an interest in the transaction terms and influence over the potential buyers and process. Beyond the issues in this case, boards need to be cognizant that in deals involving conflicts of interest (i.e., where a majority of the directors approving the transaction were interested or where a majority stockholder stands on both sides of the transaction), an even higher standard of entire fairness could be applicable. As a result, it is important to run a process that will withstand scrutiny not only under the Revlon standard but also as to overall fairness to all stockholders. The Board of Directors or a special committee formed to manage the process can weigh various factors, including the feasibility of closing the transaction (e.g., availability of financing), any regulatory approval hurdles, the identity of the bidder and the bidder’s plans for the Company and other reasonable factors but must ensure that the overall process is fair and free of conflicts of interest that impact obtaining the best result for the stockholders. The board must also ensure that in seeking any cleansing vote of the disinterested stockholders, all disclosures are complete, accurate and do not omit any material information that is necessary for stockholders to make a fully informed decision. ¹ 2023 WL 2518149 (Del. Ch. March 15. 2023) ² 606 A.2d 173 (Del. 1986)