By Renee Zaytsev and Marc Ayala
On April 4, the Delaware Supreme Court issued its decision in the appeal of In re: Match Group Inc. Derivative Litigation, a closely watched case in which it was asked to break up with a decade of Delaware Chancery Court precedent and ease the requirements to obtain business judgment review of most transactions with controlling stockholders.
With Delaware facing public criticism over certain recent decisions — and other states actively wooing Delaware corporations through the promise of more fiduciary-friendly regimes — the case fueled intense speculation over what the Delaware Supreme Court would do.
Ultimately, the court decided to stay wedded to the existing framework, confirming that defendants who wish to obtain business judgment review of conflicted controller transactions must implement two procedural protections designed to protect minority stockholders from any potentially coercive influence of the controller.
The Delaware Framework
When a corporate transaction is challenged, Delaware applies different standards of review depending on the specifics of the situation.
Delaware's default standard of review is the business judgment rule, which generally protects decisions made by disinterested, independent boards of directors from judicial second-guessing, as long as the decision is not facially irrational. Where the business judgment rule applies, a claim is highly unlikely to survive a motion to dismiss.
Where a board is conflicted, the entire fairness test — Delaware's most onerous standard — applies. Under this standard, the board bears the burden of establishing that the challenged transaction was entirely fair to the corporation and its stockholders, both in terms of process and price.
Application of the entire fairness standard will typically preclude dismissal, as it usually is not possible for defendants to meet their burden of proving fairness at the pleading stage.
Conflicted controller transactions are the quintessential context in which the entire fairness standard applies. Such transactions have long been viewed as inherently coercive, with Delaware courts sometimes comparing the controlling stockholder to an "800-pound gorilla whose urgent hunger for the rest of the bananas" is likely to generate a "fear of retribution" if the gorilla does not get his way. [1]
For decades, entire fairness has been the standard of review applicable to conflicted controller transactions. However, as the Delaware Supreme Court held in Kahn v. Lynch in 1994,[2] corporate fiduciaries can shift the burden of proof on the issue of fairness to the plaintiff if a transaction is approved by either:
- A committee of independent directors; or
- An informed majority of minority stockholders.
Lynch involved a controller buyout, but the same framework was subsequently extended to other types of controller transactions. [3]
One problem with Lynch is that it provided no guidance on what would happen if more than one cleansing device was used, and thus created no incentive to better protect minority stockholders through the use of more than one device.
The Delaware Supreme Court solved this problem in 2014, holding in Kahn v. M&F Worldwide Corp., often abbreviated as MFW,[4] that in controller buyouts, the business judgment standard of review applies if a transaction is conditioned ab initio on the approval of both:
- An independent, adequately empowered special committee that fulfills its duty of care; and
- The uncoerced, informed vote of a majority of the minority stockholders.
Together, these dual protections are seen as neutralizing the coercive effect of the controller, and allow defendants in controlling stockholder transactions to obtain pleading-stage dismissal of complaints.
In a phenomenon sometimes referred to as "MFW creep," over the decade since MFW was decided, the Chancery Court has steadily applied the MFW framework to conflicted controller transactions outside the controller buyout context.[5]
As discussed below, the Match appeal had the potential to upend this framework, with the Delaware Supreme Court being asked to find that just one of the protective devices is sufficient to obtain business judgment review in all conflicted controller transactions other than controller buyouts, the context in which MFW was decided.
In re: Match Group Appeal
The Match appeal involves a stockholder challenge to a series of transactions pursuant to which dating website Match.com spun off from its then-controlling stockholder, IAC/InterActive Corp. Match stockholders filed suit, alleging that the spinoff transactions constituted a breach of fiduciary duty by the Match board of directors, IAC and IAC Chair Barry Diller.
On Sept. 1, 2022, the Chancery Court dismissed the plaintiff's claims, holding that the transactions satisfied the requirements to obtain business judgment review under MFW because they were approved by:
- A separation committee made up of a majority of disinterested, independent directors; and
- An uncoerced, fully informed vote of Match's minority stockholders.
The plaintiffs appealed, challenging the Chancery Court's findings that the special committee was independent and that the stockholder vote was fully informed.
In response, the defendants raised a new and novel argument, contending that MFW applies only to controller buyouts and that, for all other controlling stockholder transactions, business judgment review applies if the transaction is approved either by an independent committee or a majority-of-the-minority vote.
Ordinarily, the Delaware Supreme Court does not consider arguments raised for the first time on appeal. But in Match, the court agreed to consider the defendants' MFW argument in the interests of justice and requested supplemental briefing on the issue, citing a desire to provide certainty to boards of directors, board advisers and the Chancery Court.
The Match Decision
On April 4, the Delaware Supreme Court decided Match, holding that the use of just one of MFW's procedural devices does not change the standard of review in any conflicted controller transaction. In other words, the Delaware Supreme Court declined to ease the requirements to obtain business judgment review outside the controller buyout context.
Notably, the Delaware Supreme Court also clarified that, to satisfy MFW, the special committee must be "wholly independent." The Chancery Court had dismissed the complaint even though one of the committee members allegedly lacked independence, explaining that a majority of the committee was independent and that there was no allegation that the challenged director "dominated" or "infected" the committee's decision-making process.
The Delaware Supreme Court reversed, holding that, to satisfy MFW, the committee cannot be staffed with any "members loyal to the controlling stockholder" and must be composed entirely of independent directors.
The Delaware Supreme Court remanded the case to the Chancery Court for further proceedings.
Match Litigation In Context
Match was one of the most closely watched cases in Delaware, and it's easy to see why. To start, the court took the unusual step of considering the defendants' MFW argument even though it was raised for the first time on appeal — a move that was largely seen as signaling an openness to potentially easing the requirements to obtain business judgment review, and thus a likely pleading-stage dismissal, of most controlling stockholder transactions.
As the appeal was pending, Delaware doomsaying fueled interest in the case. Over the last few years, other jurisdictions have stepped up their efforts to court Delaware corporations with the promise of more fiduciary-friendly regimes. Nevada, for example, has statutorily eliminated entire fairness review altogether.[6]
Though Nevada is still far from displacing Delaware, a number of large corporations have chosen Nevada as their new home in recent years. One such high-profile departure from Delaware to Nevada is Tripadvisor, whose 2023 reincorporation announcement led to Palkon v. Maffei, a stockholder challenge seeking to block the company from leaving the state.
As the decision loomed, some commentators wondered whether, much like "Hotel California," Delaware would become the jurisdiction you can never leave. Ultimately, in a Feb. 20 decision, the court declined to block Tripadvisor's move out of Delaware but held that the stockholders could proceed with a claim for damages over the reduction in litigation rights.[7]
Meanwhile, Delaware has faced criticism over several controversial decisions. Most recently, the Chancery Court issued two decisions holding that certain long-standing market practices ran afoul of Delaware law, generating uncharacteristic uncertainty for Delaware corporations, boards and practitioners.
In West Palm Beach Firefighters' Pension Fund v. Moelis & Co., issued Feb. 23, the court found that certain preapproval rights in a stockholder agreement violated the Delaware General Corporation Law, or DGCL.[8]
Although the court in Moelis acknowledged that other corporations have entered into similar types of agreements, it held that "market practice is not law" and found that the provisions improperly removed or impaired the board's ability to manage the corporation as required by Delaware law. The decision has led to a wave of stockholder challenges to similar agreements.
Six days after Moelis, on Feb. 29, the court decided Sjunde AP-Fonden v. Activision Blizzard Inc., again finding that market practice — board approval of nonfinal merger agreements — ran afoul of the DGCL. As the court held, "where market practice exceeds the generous bounds of private ordering afforded by the DGCL, then market practice needs to check itself."
Against this backdrop, it's not hard to see why there was intense interest in the outcome of the Match appeal. The case not only had the potential to upend a decade of Chancery Court precedent — with significant consequences for controlled corporations — but also formed part of a broader discussion about Delaware's continued dominance as the go-to state of incorporation.
Ultimately, the Delaware Supreme Court did not bow to the criticisms and, if anything, by clarifying that the special committee must be wholly independent, arguably made the standard even more exacting.
As the Match decision reflects, Delaware remains committed to maintaining a balanced approach that encourages the protection of minority stockholders from any potentially coercive influence of controllers, while also giving defendants a path to obtain a pleading-stage dismissal of stockholder challenges to conflicted controller transactions.
Renee Zaytsev and Marc Ayala are partners at Boies Schiller Flexner LLP.
The opinions expressed are those of the author(s) and do not necessarily reflect the views of their employer, its clients, or Portfolio Media Inc., or any of its or their respective affiliates. This article is for general information purposes and is not intended to be and should not be taken as legal advice.
[1] In re: Pure Resources Inc. Shareholder Litigation, 808 A.2d 421, 436 (Del. Ch. 2002).
[2] Kahn v. Lynch Communicationn Systems Inc., 638 A.2d 1110, 1117 (Del. 1994).
[3] Kahn v. Tremont Corp., 694 A.2d 422, 428 (Del. 1997).
[4] Kahn v. M & F Worldwide Corp., 88 A.3d 635, 645 (Del. 2014).
[5] See In re: Ezcorp Inc. Consulting Agreement Derivative Litigation, 2016 WL 301245 (Del. Ch. Jan. 25, 2016); IRA Trust FBO Bobbie Ahmed v. Crane, 2017 WL 7053964 (Del. Ch. Dec. 11, 2017); Berteau v. Glazek, 2021 WL 2711678 (Del. Ch. June 30, 2021); Tornetta v. Musk, 2024 WL 343699 (Del. Ch. Jan. 30, 2024).
[6] NRS 78.138(7); see also Guzman v. Johnson, 137 Nev. 126 (2021).
[7] Palkon v. Maffei, 2024 WL 678204 (Del. Ch. Feb. 20, 2024).
[8] West Palm Beach Firefighters' Pension Fund v. Moelis & Co., 2024 WL 747180 (Del. Ch. Feb. 23, 2024).
This article was first published by Law360 on April 18, 2024.