The Delaware Court of Chancery, Delaware Supreme Court, and Delaware Bankruptcy Blog

The Chancery Court recently clarified the boundaries of the protective framework for mergers in which one of the corporations holds a controlling interest in the other—known as squeeze-out mergers. In re HomeFed Corporation Stockholder Litig., No. CV 2019-0592-AGB, 2020 WL 3960335 (Del. Ch. July 13, 2020). The Delaware Supreme Court established this framework in Kahn v. M & F Worldwide Corporation, 88 A.3d 635 (Del. 2014) (“MFW”), holding that, under certain circumstances, the business-judgment rule rather than entire-fairness review is the appropriate standard for assessing claims based on squeeze-out mergers. 

Specifically, the business-judgment rule will apply and warrant dismissal of claims against the controlling corporation and related defendants “if an only if” all six of the following MFW conditions apply:

1. The controlling corporation conditions the procession of the transaction on the approval of both a Special Committee and a majority of the minority stockholders; 
2. The Special Committee is independent; 
3. The Special Committee is empowered to freely select its own advisors and to say no definitively; 
4. The Special Committee meets its duty of care in negotiating a fair price; 
5. The vote of the minority is informed; and 
6. There is no coercion of the minority.

But if a plaintiff plausibly alleges that the merger did not satisfy one or more of these conditions, the case proceeds to discovery and potentially trial. Critically, these conditions must be present “ab initio”—i.e., from the start of any “substantive economic negotiations.”   

In HomeFed, the Chancery Court held that the controlling corporation did not satisfy this ab initio requirement because it engaged in discussions with the other corporation’s largest minority shareholder before several of the MFW conditions were in place. There are at least two important takeaways from this decision.

The relevance of a “pause” in negotiations: Attempting to show that the implementation of the MFW conditions was timely, the controlling corporation, Jefferies, argued that its initial negotiations, which began in September 2017, ended in March 2018 when it informed the other corporation, HomeFed, that it no longer wanted to pursue the merger. In Jefferies’ view, the negotiations that later occurred and resulted in a February 2019 share-exchange offer satisfied the ab initio requirement because those negotiations initiated “a separate process” that began only after the MFW conditions were in place. In rejecting this argument, the Chancery Court, highlighted the following allegations:

• HomeFed’s board of directors never dissolved the Special Committee it appointed or repealed the resolution empowering this committee to negotiate the merger;
• The Special Committee’s minutes referred to the March 2018 letter as a “pause” rather than the conclusion of negotiations;
• After March 2018, Jefferies had several “substantive economic discussions” with HomeFed’s largest minority shareholder;
• Because of these discussions, this shareholder later supported the merger under the same terms that Jefferies proposed in its September 2017 offer that resulted in the need for a Special Committee. 

Based on these factors, the court found that it was plausible that the later February 2019 offer was part of the same negotiation that initiated in September 2017. And because the process allegedly lacked some of the MFW conditions at its onset, it was plausible that Jefferies failed to satisfy the ab initio requirement. 

Accordingly, corporations considering a squeeze-out merger should carefully consider the timing of their negotiations. Although a controlling corporation may be inclined to perceive initial discussions as separate from negotiations that eventually result in a merger, HomeFed demonstrates that ab initio truly means “from the beginning.” Corporations should therefore consider ensuring that the MFW conditions are present as soon as possible. 

Discussions with minority shareholders: The court separately held that, regardless of whether the February 2019 offer initiated a new negotiation independent of the initial September 2017 offer, the later “starting” date did not comply with the MFW conditions. The court again highlighted that Jefferies had engaged in “substantive economic negotiations” with HomeFed’s largest minority shareholder. In so holding, the court rejected Jefferies’ argument that these discussions were “preliminary” and involved only “an unaffiliated minority stockholder with no ability or authority to bind the corporation or any other stockholder.” The court reasoned that these discussions were substantial because Jefferies later cited the minority shareholder’s support for the proposed share-exchange ratio in rejecting the Special Committee’s fixed-value counteroffer and thus concerned “the key economic term of the [merger]—price.”

Similarly, the court determined that it was inconsequential that these discussions took place before the Special Committee invoked the MFW conditions. The purpose of these conditions, the court explained, is to ensure that the controlling corporation negotiates “with an independent and adequately empowered” committee of directors. This goal is undermined if the controlling corporation “preemptively” negotiates with the other corporation’s shareholders.  

This decision thus demonstrates how strictly the Chancery Court construes the ab initio requirement and counsels for a cautious approach to any communications related to a squeeze-out merger.