Mergers and Acquisitions Litigation Update: April 2025

Recent Delaware Cases on the Standard of Review for Conflicted Controller Transactions

In Kahn v. M & F Worldwide Corp., 88 A.3d 635 (Del. 2014) (“MFW”), the Delaware Supreme Court held that a freeze out merger—a transaction in which the controlling stockholder of a corporation buys out the minority shares and takes the company private—is nonetheless reviewed under the deferential business judgment rule if the merger is conditioned on (1) approval by a Special Committee of independent and disinterested directors and (2) the informed vote of a majority of the minority stockholders.  Application of the business judgment rule through satisfaction of these two conditions has become known as “MFW cleansing.”  Two recent decisions of the Delaware Supreme Court—In re Match Group, Inc. Derivative Litigation, 315 A.3d 446 (Del. 2024), and City of Sarasota Firefighters’ Pension Fund v. Inovalon Holdings, Inc., 319 A.3d 271 (Del. 2024)—have clarified the reach of MFW, including by extending MFW cleansing to all conflicted controller transactions, not just freeze out mergers.

            In managing the business and affairs of a Delaware corporation, the board of directors owes fiduciary duties of care and loyalty to the corporation and its stockholders.  The default standard for reviewing directors’ compliance with their fiduciary duties is the business judgment rule, “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 and its shareholders.”  Emerald Partners v. Berlin, 787 A.2d 85, 90 (Del. 2001) (cleaned up).  Application of the default business judgment rule ensures that Delaware courts generally do not second-guess the business judgment of a corporation’s directors. 

            However, a stockholder challenging a transaction can rebut the business judgment rule by pleading particularized facts that the directors lacked independence in approving the transaction.  In such cases, the entire fairness standard applies:  the directors must show that the challenged transaction was entirely fair under a unitary analysis of fair dealing 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 [transaction], 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.”  In re Tesla Motors, Inc. S’holder Litig., 298 A.3d 667, 700 (Del. 2023). 

            Delaware courts recognize certain scenarios in which directors inherently lack independence, including when a controlling stockholder stands on both sides of a transaction and receives a non-ratable benefit, i.e., a “unique benefit  . . .  uniquely valuable to the controller, even if the controller nominally receives the same consideration as all other stockholders.”  City of Dearborn Police & Fire Revised Ret. Sys. v. Brookfield Asset Mgmt. Inc., 314 A.3d 1108, 1137 n.130 (Del. 2024).  One such inherently coercive transaction is the freeze out merger, where the controlling stockholder has been compared to “the 800-pound gorilla whose urgent hunger for the rest of the bananas is likely to frighten less powerful primates like putatively independent directors who might well have been hand-picked by the gorilla (and who at the very least owed their seats on the board to his support).”  In re Pure Resources, Inc., S’holders Litig., 808 A.2d 421, 436 (Del. Ch. 2002).  For inherently coercive transactions like the freeze out merger, the presumptive standard of review is entire fairness. 

            In MFW, the Delaware Supreme Court held that a freeze out merger is nonetheless subject to business judgment review if the merger is conditioned on (1) approval by a Special Committee of independent and disinterested directors and (2) the informed vote of a majority of the minority shareholders.  If only one of the MFW cleansing conditions is met, the standard of review remains entire fairness but the burden of persuasion shifts to the challenging stockholder to prove that the merger was not entirely fair. 

            In the recent Match Group decision, the Delaware Supreme Court addressed a question that MFW left unresolved:  whether MFW cleansing is limited to freeze out mergers or applies more generally.  The defendants in Match Group argued that MFW cleansing should be limited to freeze out mergers because those transactions involve the specific problem of the controller’s ability to “bypass the board and make a tender offer directly to the stockholders.”  Match Group, 315 A.3d at 467.  The Delaware Supreme Court rejected that argument, holding that because the procedural requirements of MFW “replicate arm’s length bargaining,” id. at 463, MFW cleansing applies to all scenarios in which a controlling stockholder stands on both sides of a transaction and receives a non-ratable benefit.

            Delaware corporations seeking the benefit of business judgment review for conflicted controller transactions should strictly implement the MFW procedural safeguards of (1) approval by a Special Committee of independent and disinterested directors and (2) the informed vote of a majority of the minority stockholders.  In the recent Inovalon decision, the Delaware Supreme Court confirmed that the vote of the minority stockholders must be fully informed, including about the potential conflicts of interest of financial advisory firms providing services in connection with the challenged transaction.  Inovalon, 319 A.3d at 291-304.  Given MFW’s extension to all conflicted controller transactions, we expect the Delaware Supreme Court to further elucidate MFW’s procedural requirements in the years to come.