The Court of Chancery in In re Amtrust Financial Services, Inc. Stockholder Litigation, C.A. No. 2018-0396-Agb (Feb. 26, 2020), recently declined to apply the business judgment rule to a controlling-shareholder going-private transaction and instead provided that the transaction must be evaluated using the stringent entire fairness standard of review.

The case involved a four-person special committee (the “Committee”) constituted to negotiate a going-private transaction with the controlling-shareholders of AmTrust Financial Services, Inc. (“AmTrust”) in connection with a private equity firm (collectively the “MBO Group”).  The transaction was conditioned on receiving approval from both the Committee and a majority of AmTrust’s minority stockholders. The approval of the Committee and the minority stockholders was an attempt to cleanse the transaction under the cleansing mechanism described by the Delaware Supreme Court in Kahn v. M & F Worldwide Corp., 88 A.3d 635 (Del. 2014) (“MFW”) for squeeze-out mergers by controlling stockholders.  If the requirements of MFW were met, the transaction would be reviewed under the business judgment rule instead of the entire fairness standard.

The plaintiffs’ claims arose from the following events. On January 9, 2018, AmTrust’s board heard a bid by the MBO Group for the squeeze-out of all minority shareholders’ shares at $12.25 per share.  On the same day, the board constituted the Committee to negotiate and evaluate the initial proposal. The four person Committee included three directors who were named defendants in a still pending 2015 shareholder action (the “Cambridge Claim”). Throughout January and February of 2018, the MBO Group and the Committee exchanged counter-proposals. On February 28, 2018, the Committee recommended that the board approve the MBO Group’s offer of $13.50 per share. Public stockholders, including Carl Icahn, opposed the transaction in large part due to belief that the MBO Group’s offer undervalued the shares. In June of 2018, the public shareholders ultimately approved a transaction at $14.75 per share.  A byproduct of the squeeze-out would be that the Cambridge Claim would effectively be extinguished, which the complaint alleged would personally benefit three Committee members.  The defendants asserted that the standard of MFW had been satisfied, and that the transaction should be reviewed under the business judgment rule rather than the entire fairness standard.

The Delaware Supreme Court in MFW identified six conditions that must be satisfied to invoke business judgment review in a controlling stockholder squeeze-out merger: (i) the controller conditions the procession of the transaction 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 empowered to freely select its own advisors and to say no definitively; (iv) the Special Committee meets its duty of care in negotiating a fair price; (v) the vote of the minority is informed; and (vi) there is no coercion of the minority.[1]  The Court stated that the plaintiffs need only demonstrate that a single MFW condition was not satisfied. Specifically, the Court focused on the second condition: that sufficient facts had been pled showing that three of the four Committee members had a material self-interest in the transaction.  The Cambridge Claim, for which three of the four members of the Committee could be personally liable, was estimated by the Committee’s financial advisor to have a net settlement value of $15 to $25 million. The going-private merger would effectively extinguish the Cambridge Claim. As a result of that material self-interest, the Court concluded that the Committee was not independent. The court then found that the MFW framework could not be met although the transaction was conditioned ab initio upon approval by a special committee and fully informed, unaffiliated minority stockholders, and the transaction should be reviewed under the entire fairness standard.