If MOM says NO, the deal don’t go!

Corporate transactions are on the rise, and increased activity results in an increase in shareholder challenges. A recent WSJ article stated that 94% of U.S. public company deals were challenged by shareholders last year versus 44% in 2007. Lawsuits are typically directed toward corporate Boards. In most situations, these cases settle after the Boards disclose to the shareholders further details about the deal, in addition to paying shareholder attorney fees. Advisors stress the importance of obtaining an independent fairness opinion as a shield against shareholder dissension. When a change-of-control occurs, a fairness opinion increases the probability that Directors’ decisions will be protected. Under the Business Judgment Rule, the burden of proof falls to the plaintiff. This contrasts with the Entire Fairness Standard where the corporate board has the burden to evidence that the transaction is fair by demonstrating both fair price (substance) and fair dealing (process) (e.g., see Weinberger v. UOP Inc., 1983).

On March 14, 2014, the Delaware Supreme Court affirmed the Del. Chancery Court’s May 2013 decision that the “Business Judgment Rule” should apply instead of the stricter “Entire Fairness Standard” to evaluate acquisition fairness in certain purchases by controlling shareholders. The Chancery Court’s ruling In re MFW Shareholders Litigation (“MFW”) and Supreme Court’s decisionholds that Delaware courts will rely upon the Business Judgment Rule instead of the Entire Fairness Standard if a buy-out of a minority interest has been approved by both (i) a special committee of the seller’s independent directors and (ii) a majority of the acquiree’s non-controlling shareholders (majority of minority, or “MOM”).

The essence of the Business Judgment Rule is that directors, officers, managers, and other agents of a company will not be held liable for losses incurred in company transactions that are within their authority and power to effect, so long as they are independent and disinterested with respect to the action at issue, such transactions are completed in good faith, and the parties apply reasonable skill and prudence in their decisions. If directors or fiduciaries are not independent and disinterested, transactions may be subject to the more rigorous fact-intensive scrutiny of the Entire Fairness Standard.

Delaware courts have been debating for years whether the Entire Fairness Standard should apply if procedures, such as an independent committee, minority approval, or a go-shop provision, were in place to allay conflicts of interest. However, the MFW ruling indicates a clear path for the courts to use the Business Judgment Rule to assess transaction fairness when controlling shareholder influence has been mitigated through dual procedural protections to minority holders.

However, even in the wake of the MFW ruling, further considerations that stakeholders should evaluate include:

Giving minority shareholders (MOM) effective veto power over a transaction to obtain favorable post-transaction review could block the deal.
Controlling shareholders should agree to dual minority protections (special committee and MOM) as in MFW from the beginning to enhance the likelihood that the transaction will be subject to the Business Judgment Rule.
The courts will not give weight to minority shareholder votes influenced or obtained by coercive, incomplete, or misleading proxy information, such as projections or pricing data.If the court believes there were inherent conflicts or the Board was not proactive to reach the best deal for shareholders, the transaction may be subject to the Entire Fairness Standard.

Houlihan Capital can provide critical valuation information to interested parties in a transaction by rendering an independent fairness opinion which can provide additional protections to the Board.. Houlihan Capital provides clients with independent valuations and has a history of working closely with clients’ legal counsel, regulators, auditors, and investors on matters of transaction fairness.

For further information regarding independent third party valuation services, please contact Paul Clark (pclark@houlihancapital.com) at 312-450-8656  or visit Houlihan Capital’s website www.houlihancapital.com.

Houlihan Capital is a leading, solutions-driven valuation, financial advisory, and boutique investment banking firm committed to delivering superior client value and thought leadership in an ever-changing landscape. The firm has extensive experience in providing fairness and solvency opinions, and objective, independent and defensible opinions of value that meet accounting and regulatory requirements. Our clients include some of the largest asset managers, private equity funds, hedge funds, fund administrators, and both public and private operating companies, who benefit from our comprehensive valuation and financial advisory services. Houlihan Capital is a Financial Industry Regulatory Authority (FINRA) and SIPC member, committed to the highest levels of professional ethics and standard