The Delaware Court of Chancery (the Court) in In re Homefed Corporation Stockholder Litigation chronicles a controlling stockholder’s failed attempt to use the protections outlined in Kahn v. M & F Worldwide Corp. (MFW) to qualify for a business judgment review of its going-private, minority stockholder buyout. The court addresses when and how communications directly between controlling and minority stockholders can undermine MFW processes and result in the court reviewing claims under the “entire fairness” standard of review.
The controlling stockholder in question was Jefferies Financial Group Inc. (Jefferies), which owned 70% of the shares of HomeFed Corporation (HomeFed). On September 26, 2017, a HomeFed director proposed that Jefferies acquire the remainder of the company’s shares in a go-private transaction structured as a 2:1 stock exchange. In December 2017, a Special Committee (Special Committee) of HomeFed’s board of directors (board) was installed to negotiate with Jefferies. The process was paused in March 2018 due to Jefferies stating that it had lost interest in the transaction.
Despite the continuing existence of the Special Committee, Jefferies continued to have deal discussions directly with HomeFed’s largest minority stockholder, Beck, Mack and Oliver LLC (BMO), whose support was essential to get a deal done. BMO indicated in early February 2019 that it would support a 2:1 share exchange, and Jefferies issued a press release formally proposing to acquire all of HomeFed’s stock in exchange for two shares of Jefferies stock conditioned on obtaining the approval of a special committee and a majority of the minority stockholders.
In March 2019, the Special Committee formally engaged Houlihan Lokey as its financial advisor to evaluate the value of Jefferies’ offer and ultimately presented a counter offer of $42 per share. Although the Special Committee led the discussions, BMO and Jefferies continued to communicate directly throughout the process despite the Special Committee’s repeated requests that Jefferies cease communicating with BMO. The Special Committee in its meetings expressed doubts about its continued effectiveness and damaged negotiating position due to Jefferies’ actions.
On April 2, 2019, the Special Committee agreed to a 2:1 share exchange with a two-way price collar of $38 to $42 a share, and a merger agreement was signed. However, BMO and RBC Capital Markets (RBC), another minority stockholder of Homefed, publicly expressed their opposition to the $42 share price ceiling in the merger agreement. On April 16, 2019, Jefferies was authorized by the Special Committee to communicate directly with BMO and RBC because they wanted the collar removed. Additional negotiations resulted in the Special Committee approving an amendment to the merger agreement to remove both price collars, and Homefed’s minority stockholders subsequently approved the transaction.
A class action complaint against Jefferies and Homefed’s board of directors was filed, alleging breach of fiduciary duty by board resulting in unfairly low consideration for the minority shares and breach of fiduciary duty by the controlling stockholder for orchestrating a self-dealing transaction that was unfair to the minority stockholders.
The MFW Procedural Protections
The defendants filed a motion to dismiss the complaint. The Court noted that the business judgment rule would be the appropriate standard of review for a challenge to a squeeze-out merger by a controlling stockholder if the transaction satisfies the procedural protections outlined by the Delaware Supreme Court in MFW, which are: the transaction must be conditioned ab initio upon the approval of (i) an independent, adequately-empowered special committee that fulfills its duty of care and (ii) the uncoerced, informed vote of a majority of the minority stockholders (together, the ab initio requirement). The Court highlighted the desired outcome stated in MFW, which is that the “controller irrevocably and publicly disables itself from its control to dictate the outcome of the negotiations.”
The Court then summarized the six conditions outlined in MFW that must be satisfied in order to satisfy the ab initio requirement and qualify for business judgment review: “. . . (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.” A failure of any one of these conditions is sufficient to disqualify a defendant from a review under the business judgment rule.
The Court’s Analysis
The Court found that although it was reasonably conceivable that Jefferies’ February 2019 offer was part of the same process that led to the empowerment of the Special Committee, it made no difference whether the February 2019 offer triggered a new process. In either case, Jefferies did not commit to condition a transaction ab initio on the dual MFW protections before engaging in what the Court termed to be “substantive economic discussions.”
The Court noted that Jefferies had engaged in a series of discussions with BMO and RBC before Jefferies agreed to the dual MFW protections and had undermined the Special Committee’s ability to bargain effectively on behalf of the minority stockholders. Defendants argued that Jefferies’ discussions with BMO were preliminary and inconsequential given that BMO was a minority stockholder with no ability to bind any other stockholder or HomeFed. Rejecting this, the Court emphasized that the ab initio requirement means that substantive economic negotiations cannot occur before the protections required by MFW are instituted because MFW contemplates that the special committee will act as the bargaining agent for the minority stockholders.
In the context of a minority squeeze-out merger by a controlling stockholder, any substantive economic discussions between the controlling and minority stockholders prior to the establishment of MFW protections are likely to result in the business judgment rule being rendered inapplicable as the standard of review of the transaction. Controlling stockholders should exercise caution when communicating with minority stockholders regarding potential transactions both before MFW protections are put in place as well as after such protections are put in place. Failing to do so before MFW protections are put in place could result in MFW’s ab initio requirement failing. Failing to so after MFW protections are put in place could result in the controlling stockholder being deemed to have engaged in substantive communications with the minority stockholder, thereby causing MFW’s requirement that the special committee be empowered to negotiate pricing on behalf of the minority to fail.