In In re Match Group, Inc. Derivative Litigation, the Delaware Supreme Court answered some important questions about the standard of review applicable to conflicted transactions under Delaware law. The first question relates to the application of the model used in Kahn v. M & F Worldwide Corp., commonly referred to as the “MFW framework.” In that 2014 case, the Delaware Supreme Court held that, instead of the more stringent “entire fairness” standard of review that would ordinarily apply in the context of mergers between a controlling stockholder and its corporate subsidiary, the business judgment standard of review should govern “where the merger is conditioned ab initio upon both the approval of an independent, adequately-empowered Special Committee that fulfills its duty of care; and the uncoerced, informed vote of a majority of the minority stockholders.” The question remained, however, whether, in the context of conflicted controlling stockholder transactions that do not involve freeze-out mergers, MFW may be applied to invoke the business judgment rule. And in a related question, can the business judgment rule be applied if the “defendant shows either approval by an independent special committee or approval by an uncoerced, fully informed, unaffiliated stockholder vote,” but not both? In addition, the Court addressed the question of whether all members of an “independent special committee” must be “independent” to satisfy the requirements of MFW.
In Match, the Court concluded that, in a transaction where a controlling stockholder “stood on both sides of a transaction with the controlled corporation and received a non-ratable benefit, entire fairness is the presumptive standard of review.” However, the controlling stockholder “can shift the burden of proof to the plaintiff by properly employing a special committee or an unaffiliated stockholder vote. But the use of just one of these procedural devices does not change the standard of review. If the controlling stockholder wants to secure the benefits of business judgment review, it must follow all MFW’s requirements,” that is, “properly employ[] both a special committee and an unaffiliated stockholder vote.” The Court also concluded that, in the context of MFW, “to replicate arm’s length bargaining, all separation committee members must be independent of the controlling stockholder.” Here, one of the committee members was adequately alleged to have lacked independence. As a result, the Court reversed the finding of the lower court “that the separation committee functioned as an independent negotiating body,” holding that the entire fairness standard should apply.
Background. In this case, according to the complaint, in 1999, IAC/InterActiveCorp, a Delaware internet and media company, acquired the business of Match.com, a market leader in online dating products. In 2015, Match had an IPO. In 2019, IAC announced to its stockholders that it wanted to separate its internet and media businesses from its controlled subsidiary Match Group, Inc. and other online dating businesses through a reverse spin-off. At the time of the reverse spin-off, IAC held 98.2% of Match’s voting power. From the get-go, the IAC board required that any transaction would be conditioned on “both the recommendation of an Old Match board special committee and the approval of the holders of a majority of the shares held by Old Match’s unaffiliated stockholders.” The Match board formed a “separation committee”; one of its three members was IAC’s former CFO.
The proposal for the reverse spin-off from IAC involved the creation of two separate public companies, with all Match and IAC stockholders receiving stock in New Match. In addition, among the many complex terms, Match was to issue a “$2 billion dividend to its stockholders before the Separation, which would be financed with $1.8 billion of new debt. Old IAC, as Old Match’s majority stockholder, would receive most of the dividend proceeds.” Following negotiation, the deal terms reduced the Old Match dividend to $850 million, and allocated an additional 2% of equity in New Match to the Old Match stockholders, with Old IAC receiving approximately $680 million of that amount because of its equity in Old Match. The deal was approved and closed. In the transaction, “Old Match minority stockholders received shares in New Match. The New Match minority stockholders now owned common stock in a widely held and highly leveraged corporation, subject to short-term restrictive governance provisions. The New Match minority stockholders also gained an additional 2% of the Match business. IAC stockholders received most of the interest in New Match, as well as shares in a cash-rich corporation with little to no debt, New IAC.”
In the Chancery Court. Plaintiff Old Match stockholders sued, challenging the fairness of the separation transaction and alleging that “IAC/InterActiveCorp, a controlling stockholder of Match, received benefits in the transaction at the expense of the Match minority stockholders.” They contended that “an unfair process yielded an unfair price to the detriment of Old Match’s minority stockholders.” They also argued that the “Separation Committee was conflicted and that the proxy disclosures misled the Old Match minority stockholders.”
Defendants claimed that they were entitled to business judgment review of the transaction instead of the presumed entire fairness standard, notwithstanding the role of the controlling stockholder, “because they followed the so-called MFW framework, which included approval by an independent and disinterested ‘separation committee’ and a majority of uncoerced, fully informed, and unaffiliated Match stockholders.”
The Court of Chancery agreed and dismissed the complaint.” The Court of Chancery held that the defendants satisfied MFW’s requirements, even though plaintiffs pleaded facts that created a reasonable inference that one of the directors on the separation committee was not independent of Old IAC. To taint the Committee, the court said, plaintiffs must “show that ‘either (i) 50% or more of the special committee was not disinterested and independent,’ or ‘(ii) the minority of the special committee “somehow infect[ed]” or “dominate[ed]” the special committee’s decisionmaking [sic] process.’” Because plaintiffs did not make that showing, the court found that the committee was independent under MFW. The court also held that the minority stockholder vote was fully informed. Applying the business judgment standard of review, the court dismissed the case.
Plaintiffs appealed, arguing that the Chancery Court erred in finding that the separation committee satisfied MFW’s independent committee requirement and that the vote was fully informed. Defendants disagreed with those contentions and raised additional alternative grounds to affirm the decision, among them, a claim that, because the separation transaction was not a stockholder freeze-out transaction, there was no need to “employ both of MFW’s procedural safeguards to change the standard of review to business judgment. According to the defendants, Supreme Court and Court of Chancery precedent recognizes a distinction between controlling stockholder freeze out transactions, and other controlling stockholder transactions. They contend that, because the Separation was not a freeze out, business judgment review governs if the controlling stockholder employs either of the independent committee or minority vote procedural devices.”
In the Delaware Supreme Court. The Court reviewed the decision of the lower court de novo, accepting all well pleaded factual allegations as true. The Court advised that the judgment of the lower court would “be affirmed only if the plaintiff would not be entitled to recover under any reasonably conceivable set of circumstances.”
The Court began by reviewing the two standards: the default business judgment rule “is 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.’ If the business judgment standard of review applies, a court will not second guess the decisions of disinterested and independent directors. The reviewing court will only interfere if the board’s decision lacks any rationally conceivable basis, thereby resulting in waste or a lack of good faith.” Entire fairness review imposes on the defendants “the burden of demonstrating that the corporate act being challenged is entirely fair to the corporation and its stockholders.” A court examines “both the price and the process elements of the transaction.” While business judgment may be the default, “the level of judicial scrutiny increases in certain situations when the danger of conflicts is inherent in the board’s decision-making process.” In instances “where a controlling stockholder transacts with the controlled corporation and receives a non-ratable benefit, the presumptive standard of review is entire fairness.” That’s because “without arm’s length negotiation, controlling stockholders can exert outsized influence over the board and minority stockholders.”
The Court emphasized, however, that, while “close scrutiny is required for transactions where the controlling stockholder receives a non-ratable benefit, it is important to recognize that ‘an interest conflict is not in itself a crime or a tort or necessarily injurious to others.’ In other words, ‘having a “conflict of interest” is not something one is “guilty of.’” Indeed, a corporation and its stockholders may benefit from a controlling stockholder’s influence.”
The Court analyzed a number of precedents, including Kahn v. Lynch, a 1994 case involving a conflicted freeze out. There, the Court observed, the Delaware Supreme Court had “clarified that if the defendants demonstrated that the transaction was either (i) negotiated by a well-functioning special committee of independent directors or (ii) conditioned on the approval of a majority of the minority shareholders, then the burden shifted to the plaintiffs to prove that the transaction was not entirely fair. The standard of review, however, did not change.” Subsequently, the Court observed, MFW made clear that the business judgment rule will apply when: (i) a controlling stockholder conditions a transaction from the start on the approval of both a special committee and a majority of the minority stockholders; (ii) the special committee is independent; (iii) the special committee is fully empowered; (iv) the special committee meets its duty of care; (v) the vote of the minority is informed; and (vi) there is no coercion of the minority.” In essence, both the independent special committee and informed vote of the minority are required. These procedural protections are employed “to replicate arm’s length bargaining”; if they are established pretrial, “the board’s decision will be upheld unless it cannot be attributed to any rational business purpose.”
But all those cases discussed by the Court involved freeze outs. Defendants argued that, outside that context, any one of three different procedural mechanisms, drawn from Delaware Corporations Code § 144(a), “could invoke business judgment review in controlling stockholder transactions.”
But the Court read the “Supreme Court precedent differently.” To the Court, there is a “common thread running through our decisions: a heightened concern for self-dealing when a controlling stockholder stands on both sides of a transaction and receives a non-ratable benefit.” The Court found no reason to limit MFW to freeze outs, citing an earlier decision in which Chancellor Allen observed that “[d]efendants seek to limit Lynch to cases in which mergers give rise to the claim of unfairness, but offer no plausible rationale for a distinction between mergers and other corporate transactions and in principle I can perceive none.” Under Delaware precedents involving non-freeze out controlling stockholder cases, adhering to a procedural protection did not lead to business judgment review, the Court concluded, it merely shifted the burden of proof under entire fairness. Accordingly, the Court concluded that the “presumptive standard of review is entire fairness, unless the defendants can satisfy all of MFW’s requirements to change the standard of review to business judgment.”
And that’s where the defendants had a hiccup. The plaintiffs maintained that the Court of Chancery’s “analysis was flawed on two grounds—the Separation Committee lacked independence, and the proxy statement disclosures were inadequate.” The Court agreed with the lower court that, based on the allegations, one of the Committee members was not independent: it was alleged that he worked at IAC for 13 years, including seven as CFO, earning over $55 million during his employment. He “also served as a director of various IAC-affiliated companies since 2008, including Old Match.” In addition, he had expressed gratitude to IAC’s Chair for his opportunities. The Court reasoned that “[l]ongstanding business affiliations, particularly those based on mutual respect, are of the sort that can undermine a director’s independence. Directors who owe their success to another will conceivably feel as though they owe a ‘debt of gratitude’ to the individual.” The Court concluded that a reasonable inference could be drawn “that he was not independent of Old IAC when negotiating the Separation.”
The Chancery Court had found that only a majority of the committee needed to be independent, so MFW was satisfied. On that point, the Supreme Court disagreed. According to the Court, to “apply the business judgment rule when a controlling stockholder transacts with the corporation and receives a non-ratable benefit,…the inherently coercive presence of the controlling stockholder requires it to ‘irrevocably and publicly disable[] itself from using its control to dictate the outcome of the negotiations’ to ensure an ‘arm’s-length’ outcome. A controlling stockholder’s influence is not ‘disabled’ when the special committee is staffed with members loyal to the controlling stockholder.” In addition, the Court pointed out that MFW provided that “the special committee must be independent, not that only a majority of the committee must be independent.” As a result, the Court reversed the lower court decision “to apply the business judgment rule and dismiss the plaintiffs’ claims. Entire fairness remains the standard of review.”
