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An important corporate governance development occurred in New York in 2016 which could have an impact on business owners looking to buy, sell or merge their businesses.
The New York Court of Appeals followed the guidance of corporate law-making jurisdiction, Delaware, as to when the business judgment rule applies to a squeeze-out merger. The New York Court of Appeals adopted the standard of review set forth by the Delaware Supreme Court in Kahn v. M&F Worldwide Corp.(“MFW”) for squeeze-out mergers, becoming the first instance of the highest court in another state following the MFW precedent.
Squeeze-out mergers, also referred to as freeze-outs, are corporate transactions in which two entities are merged into a single entity, which may be one of the preexisting entities or a newly formed entity, and the minority shareholder(s) are forced to sell their stock for a cash buyout as part of the transaction. A number of state courts have considered the following factors to determine when majority shareholders may have breached their fiduciary duty to minority shareholder in connection with these transactions:
- Common majority shareholders before and after the transaction
- Common directors before and after the transaction
- The majority is permitted continued participation in the equity of the surviving corporation while the minority has no choice but to surrender their shares for cash
- Freeze-out of minority stockholders on a cash-out basis is the sole purpose of the merger or there was no independent purpose of the merger
- Price paid for the minority shareholders’ shares
- Procedural fairness of the transaction, such as its timing, initiation, structure, financing, development, disclosure to the independent directors and shareholders, and how necessary approvals were obtained
The business judgment rule is a case law-derived doctrine in corporate law which provides that in making a business decision, the directors of a corporation acted on an informed basis, in good faith and in the honest belief that the action taken was in the best interests of the company.
The MFW decision provided that “the business judgment standard of review will be applied if and only if: (i) the controller conditions the procession of the transaction on the approval of both a Special Committee and a majority of the minority shareholders; (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.”
In 2016, the New York Court of Appeals adopted Delaware’s standard for evaluating squeeze-out mergers in In re: Kenneth Cole Productions, Inc. Company founder, Kenneth Cole, owned approximately 70% of the equity and 90% of the voting power of Kenneth Cole Productions. The remainder of the equity was publicly-held and traded on the New York Stock Exchange.
Cole desired to re-acquire full ownership of the company by purchasing the minority shareholder interests in a going-private merger at a price of $15.00 per share. Though Cole conditioned the offer on both the approval of a special committee of the board and a majority of the minority shares, he advised the board that he would not support an alternatively structured deal and that a decision to reject the merger by the special committee and/or minority shareholders would not adversely affect his relationship with the company. The board established a special committee to evaluate the transaction, with two representatives elected by “Class A” shares (of which Cole held 46%) and two from “Class B” (of which Cole held 100%). The special committee approved the transaction at a slightly increased price of $15.25 per share. Over 99% of the minority shares were voted in favor of the merger.
A shareholder litigation followed which was dismissed at both the trial and intermediate appellate court levels for failure to state a claim. In appealing to the Court of Appeals, plaintiffs petitioned the court to subject the transaction to the test of entire fairness rather than applying the business judgment rule as Cole asserted. The Court of Appeals ultimately pursued a hybrid solution, holding that the business judgment rule should apply so long as the protective provisions articulated in MFW were followed, and that entire fairness would apply only if the MFW conditions were not met. The Court stated that MFW properly balances the rights of the minority shareholders against “the interests of directors and controlling shareholders in avoiding frivolous litigation and protecting independently-made business decisions from unwarranted judicial interference.” As the Court of Appeals found that plaintiffs did not sufficiently allege that any of the six MFW conditions had not been met, it applied the business judgment rule and upheld the dismissal of the lawsuit, thereby ushering in the MFW era in New York.
If you are considering the purchase, sale or merger of a business, or any other corporate transaction, you should be advised and represented by legal counsel.