Commercial Division Blog
Going-Private Mergers Subject to Business Judgment Rule So Long As Shareholders Protected
On May 5, 2016, the Court of Appeals issued a decision in Matter of Kenneth Cole Products, Inc., 2016 NY Slip Op. 03545, holding that the decision to engage in a going-private merger was subject to the business judgment rule so long as certain shareholder protections are included in the deal, explaining:
The primary issue before us is what standard should be applied by courts reviewing a going-private merger that is subject from the outset to approval by both a special committee of independent directors and a majority of the minority shareholders. Plaintiff urges that we apply the entire fairness standard, which places the burden on the corporation's directors to demonstrate that they engaged in a fair process and obtained a fair price. Defendants seek application of the business judgment rule, with or without certain conditions. We are persuaded to adopt a middle ground. Specifically, the business judgment rule should be applied as long as the corporation's directors establish that certain shareholder-protective conditions are met; however, if those conditions are not met, the entire fairness standard should be applied.
We begin with the general principal that courts should strive to avoid interfering with the internal management of business corporations. To that end, we have long adhered to the business judgment rule, which provides that, where corporate officers or directors exercise unbiased judgment in determining that certain actions will promote the corporation's interests, courts will defer to those determinations if they were made in good faith. The doctrine is based, at least in part, on a recognition that: courts are ill equipped to evaluate what are essentially business judgments; there is no objective standard by which to measure the correctness of many corporate decisions (which involve the weighing of various considerations); and corporate directors are charged with the authority to make those decisions. Hence, absent fraud or bad faith, courts should respect those business determinations and refrain from any further judicial inquiry (see id. at 631). We have, therefore, held that the substantive determination of a committee of disinterested directors is beyond judicial inquiry under the business judgment rule, but that the court may inquire as to the disinterested independence of the members of that committee and as to the appropriateness and sufficiency of the investigative procedures chosen and pursued by the committee.
A freeze-out merger is typical of situations in which a director's loyalty may be divided or compromised, thereby calling into question the applicability of the business judgment rule. In such a merger, the majority stock owner or group in control attempts to freeze out the interests of minority shareholders. There are three main types of freeze-out mergers: (1) two-step mergers, in which an outside investor purchases control of the majority shares of a target company, then uses that control to merge the target with a second company, thereby freezing out the minority shareholders of the target and forcing a cash-out of their shares; (2) parent-subsidiary mergers; and (3) going-private mergers, in which the majority shareholder seeks to remove public investors and gain ownership of the entire company.
[In t]his Court's seminal decision regarding freeze-out mergers . . . , we recognized that, where there are common directors or majority ownership between the parties involved in a transaction, the inherent conflict of interest and the potential for self-dealing requires careful scrutiny of the transaction. In reviewing a two-step merger . . . we held that while, generally, the plaintiff has the burden of proving that the merger violated the duty of fairness, when there is an inherent conflict of interest, the burden shifts to the interested directors or shareholders to prove good faith and the entire fairness of the merger . . . .
We now adopt [the] standard of review in [the Delaware Supreme Court decision in Kahn v M & F Worldwide Corp.] for courts reviewing challenges to going-private mergers. The standard set forth in MFW reinforces that the business judgment rule is our general standard of review of corporate management decisions, and is consistent with this Court's [prior holding] that the substantive determination of a committee of disinterested directors is beyond judicial inquiry under the business judgment rule, but that courts may inquire as to the disinterested independence of the members of a special committee and as to the appropriateness and sufficiency of the investigative procedures chosen and pursued by the committee. While the business judgment rule is deferential to corporate boards, minority shareholders are sufficiently protected by MFW's conditions precedent to the application of that standard in going-private mergers. . . . .
According to the Delaware Supreme Court, for purposes of this rule, a complaint is sufficient to state a cause of action for breach of fiduciary duty — and the plaintiff may proceed to discovery — if it alleges a reasonably conceivable set of facts showing that any of the six enumerated shareholder-protective conditions did not exist. Conclusory allegations or bare legal assertions with no factual specificity are not sufficient, and will not survive a motion to dismiss. Mere speculation cannot support a cause of action for breach of fiduciary. If the pleading requirements are met, in order to defeat summary judgment, a plaintiff must then demonstrate that there is a question of fact as to the establishment or efficacy of any of the enumerated conditions designed to protect the minority shareholders. Finally, if the evidence demonstrates that any of the protections were not in place, then the business judgment rule is inapplicable and the entire fairness standard applies.
Reviewing the complaint here under the MFW standard, we conclude that the courts below properly determined that the allegations do not withstand defendants' motions to dismiss. Plaintiff did not sufficiently and specifically allege that any of MFW's six enumerated conditions were absent from the merger here. Beginning with the first condition, plaintiff concedes that Cole conditioned the merger, from the outset, upon approval by both a special committee of independent directors and a majority of the minority shareholders.
(Internal quotations and citations omitted).