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U.S. M&A Newsletter — May 21, 2024

Delaware Supreme Court Clarifies MFW Framework for Transactions Involving Controlling Stockholders

In two recent decisions, the Supreme Court of Delaware (the “Court”) has clarified the Court’s approach to the so-called MFW framework under the Court’s decision in Kahn v. M&F Worldwide Corp. (“MFW”) in relation to conflicted transactions involving controlling stockholders. 

In 2014, the Court held in MFW that the more deferential business judgment rule standard of review applies in freeze-out mergers between a controlled corporation and its controlling stockholder only when the controlling stockholder conditions the transaction on the approval of (i) a fully empowered and independent special committee which meets its duty of care and (ii) a majority of uncoerced and fully informed minority stockholders. Question remained on whether the MFW framework applied in the context of controlling stockholder transactions which were not freeze-out mergers. 

In In re Match Group, Inc. (April 4, 2024), the Court clarified the following: 

  • the MFW framework applies in a non-freeze-out controlling stockholder transaction where the controlling stockholder received a non-ratable benefit;
  • both requirements under the MFW framework must be met for the business judgment standard of review to apply; and
  • for a special committee to be independent, all members of the special committee must be independent. 

In City of Sarasota Firefighters’ Pension Fund et al. v. Inovalon Holdings Inc. et al. (May 1, 2024), the Court provided guidance on the adequacy of disclosure of conflicts of interest of the financial advisors required for a fully informed minority stockholder vote.

In re Match Group, Inc. 

Background

In 2020, IAC/InterActiveCorp (“Old IAC”) completed a reverse spin-off which separated Old IAC’s internet and media business from the online dating business held by its controlled public subsidiary, pre-separation Match Group, Inc. (“Old Match”), through a newly formed subsidiary, IAC, Inc. (“New IAC”). At closing of the reverse spin-off, Old IAC was renamed to Match Group, Inc. (“New Match”). As part of the transaction, Old IAC, as Old Match’s controlling stockholder, received cash dividend proceeds financed by debt incurred by New Match. The transaction was conditioned upon the recommendation of a separation committee consisting of three directors appointed by the board of directors of Old Match (the “Separation Committee”) and the approval of a majority of the unaffiliated shareholders of Old Match. Both conditions were met and the transaction was completed.

Former Old Match stockholders challenged the fairness of the transaction. The Court of Chancery dismissed the stockholder suit, agreeing with the defendants that the requirements of the MFW framework were met and that the business judgment rule standard of review applied. The Court of Chancery found that even though one of the members of the Separation Committee lacked independence, because a majority of the Special Committee was independent, the special committee met its independence requirement. Plaintiffs appealed.

Court’s Analysis

The Court reversed the Court of Chancery’s ruling and held that (i) where a controlling stockholder transacts with the controlled corporation and receives a non-ratable benefit, the transaction must meet both requirements for the MFW framework for the business judgment standard to apply, and (ii) because not all of the members of the Separation Committee were independent, the reverse spin-off failed to satisfy the MFW framework.

Entire fairness standard applies to a controlled stockholder transaction where the controlling stockholder receives a non-ratable benefit unless both MFW requirements are met.

The Court stated that in a transaction in which a controlling stockholder “stands on both sides” and receives a non-ratable benefit, such stockholder “generally has inherently coercive authority over the board and the minority stockholders.” Thus, such transaction is subject to the entire fairness standard of review, which requires the controlling stockholder to show fair price and fair dealing. The Court called this a “default” position. However,

  • if the controlling stockholder met both requirements under the MFW framework, the court would apply the business judgment rule standard of review; but
  • if the controlling stockholder met only one of the two requirements under the MFW framework, the court would still apply the entire fairness standard of review, but the burden of proof would shift to the plaintiff.

The Court found that Old IAC, as the controlling stockholder, “deliberately advanced its own interests to the detriment and expense of the Old Match minority stockholders, in breach of their fiduciary duties,” when carrying out the spin-off. Therefore, the Court held 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 the more deferential business judgment rule standard.

To satisfy the MFW requirements, all special committee members must be independent of the controlling stockholder.

The Court stated the MFW framework requires that the Separation Committee must have functioned as an independent negotiating body to replicate arm’s length bargaining. The Court disagreed with the Court of Chancery that only a majority of the Separation Committee must be independent. Rather, all special committee members must be independent to satisfy the MFW requirements. The Court agreed with the Court of Chancery that one of the Separation Committee members lacked independence and thus held the defendants failed to show that the transaction met the MFW requirements. The Court held that the entire fairness must remain the standard of review and reversed the Court of Chancery’s decision.

City of Sarasota Firefighters’ Pension Fund et al. v. Inovalon Holdings Inc. et al.

Background

Inovalon Holdings, Inc. (“Inovalon”) was controlled by its founder and CEO, and a board member, each of whom held approximately 64% and 23% of Inovalon’s total voting power, respectively. In 2021, Nordic Capital (“Nordic”), a Swedish private equity firm, contacted Inovalon on the potential acquisition of Inovalon. In response, Inovalon’s board of directors (the “Inovalon Board”) retained J.P. Morgan Securities LLC (“J.P. Morgan”) to explore strategic alternatives. 

When Nordic expressed preference for members of Inovalon’s management to roll over equity, the Inovalon Board formed a Special Committee. The Special Committee retained Evercore, Inc. (“Evercore”) as its financial advisor in addition to J.P. Morgan. J.P. Morgan and Evercore each provided advisory services to Nordic and members of the equity consortium led by Nordic. The equity consortium acquired Inovalon in 2021.

Certain holders of Inovalon Class A Common Stock challenged the transaction and alleged that the CEO and the other Inovalon directors breached their fiduciary duties. They also claimed that the proxy disclosure (the “Proxy”) failed to adequately disclose the conflicts of the two financial advisors and therefore the majority-of-the-minority vote for the transaction was not fully informed. The Court of Chancery held that the requirements under the MFW framework had been met and dismissed the claims. Plaintiffs appealed.

Court’s Analysis

The Court reiterated what it stated in In re Match, that “an interest conflict is not in itself a crime or a tort or necessarily injurious to others.” Thus, the Court’s focus was not the conflict of interest itself, but on the inadequate disclosure of the existence of such conflict. The Court held that the Proxy omitted material information about J.P. Morgan and Evercore’s conflicts which rendered the minority stockholders’ vote to approve the Transaction uninformed. Thus, the “cleansing” under the MFW framework was unavailable and the transaction was subject to the entire fairness standard of review.

In particular, the Court held that the following conflicts were not adequately disclosed in the Proxy:

  • Evercore’s concurrent conflict with Nordic and another member of the equity consortium: The Proxy did not adequately disclose Evercore’s conflict where it stated that Evercore “may” provide advisory services to counterparties of the transaction when Evercore was actually providing services to such counterparties in unrelated transactions.
  • The amount of J.P. Morgan’s fees it received from its concurrent and past representation of Nordic and other members of the equity consortium on unrelated transactions: Although the $15.2 million fees that J.P. Morgan received from Nordic in the two years preceding the transaction were disclosed, the Proxy otherwise only stated that J.P. Morgan and its affiliates received and will receive “customary compensation” without disclosing the exact amounts. Given that the undisclosed amount of fees earned from other consortium members during the same period were “about 25 times the disclosed fees” and “10 times the fees in connection with the transaction,” the Court held that disclosure was misleading and inadequate.

Due to the inadequate disclosure, the Court found that the minority stockholder’s vote was not fully informed and the transaction did not meet the requirements of the MFW framework. The Court reversed and remanded the Court of Chancery’s decision. 

Our take

In re Match and Inovalon provides guidance and clarifies the scope of the application of MFW framework. To secure the deferential business judgment rule standard of review, a controlling stockholder must ensure that the transaction is conditioned from the outset on both prongs under the MFW framework, with a fully empowered and independent special committee negotiating and approving the deal, and a majority of the minority stockholders voting for the transaction on a fully informed basis. If only one of the prongs are met, the burden of proof will shift to the plaintiff, but the entire fairness standard of review would continue to apply.

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