MFW: Past, Present, and Future

In the 2013 Delaware Chancery case In re MFW Shareholders Litigation, then-Chancellor Strine faced the issue of whether a controller buyout that was both negotiated by a special committee and approved by a majority of the minority stockholders would avoid the onerous burdens of proving entire fairness ordinarily associated with such transactions. Before MFW, Kahn v. Lynch had held that approval by either a special committee or a majority of the minority would shift the burden to prove entire fairness—ordinarily on the controller—onto the challenging stockholder. However, no case before MFW had addressed what resulted if a controller implemented both protections.

Chancellor Strine answered that question by holding that a controller who implemented both protections at the beginning of negotiations would receive the protection of the business judgment rule. Combined with the widespread use of § 102(b)(7) exculpatory clauses, the business judgment rule places a heavy burden on a plaintiff to plead that a board made its decision in bad faith or acted disloyally, making it significantly more likely that the transaction is protected from substantive judicial review. The Delaware Supreme Court affirmed, using the term “ab initio” for the requirement that the protections be implemented before the beginning of negotiations. Since then, the MFW framework has been expanded from freeze-out mergers to all controller transactions. However, figures no less than Strine himself and former Delaware Supreme Court Justice Jack Jacobs have recently questioned the expansion of MFW.

Application and Evolution of MFW

Delaware courts have issued several decisions applying—and greatly expanding—the MFW framework. This case law reveals two important insights. First, Delaware courts have expanded MFW far beyond the freeze-out merger context and, in fact, to any transaction involving a controller. Second, Delaware courts have imposed exacting requirements for MFW’s ab initio requirement.

Delaware Courts Have Held That the MFW Framework Applies to Any Controller Transaction

• In In re Ezcorp Inc. Consulting Agreement Derivative Litigation, the Chancery Court drastically expanded the reach of MFW. The Chancery Court held that the MFW framework applies not only to squeeze-out mergers, but to any transaction in which the controller receives a nonratable benefit.
• In IRA Trust FBO Bobbie Ahmed Ex rel. Class A Stockholders of NRG Yield, Inc. v. Crane, the Chancery Court applied MFW to a stock reclassification, holding that that there was “no principled basis” for concluding that “the MFW framework should apply to squeeze-out mergers but not to other forms of controller transactions.”

Delaware Courts Have Taken a Strict Approach to MFW’s Ab Initio Requirement

• In Flood v. Synutra, the Delaware Supreme Court held that MFW’s dual protections must be in place “before economic negotiations” begin; this prevents a controller from offering to implement MFW’s protections in exchange for economic concessions from minority stockholders.
• In In re HomeFed Corp. Shareholder Litigation, the controller proposed a transaction to acquire the remaining stock at a 2:1 exchange ratio for the controller’s stock. The board constituted a special committee to evaluate the proposal, but “paused its process” when the controller said it had lost interest in the deal. But over the next eleven months, the controller allegedly “repeatedly” discussed a potential transaction with the company’s two largest minority stockholders. After gaining their support, the controller formally proposed a transaction at the same 2:1 exchange ratio conditioned on MFW’s dual protections. The Court of Chancery denied the motion to dismiss a stockholder’s challenge to the deal, finding it plausible that MFW’s requirements had not been implemented ab initio.

MFW Present and Future

Some argue that MFW’s expansion has placed undue burdens upon controllers. Two former Delaware Supreme Court Justices—including the author of the MFW Chancery decision—recently lamented “MFW creep” in a paper. L. Hamermesh, J. Jacobs, L. Strine, Optimizing The World’s Leading Corporate Law: A 20-Year Retrospective and Look Ahead, U. of Penn. Inst. for Law & Econ Research Paper No. 21-29 (Nov. 2021). MWF’s dual protections, Strine and Jacobs argue, were never intended to be applied in all controller transactions, but only in the squeeze-out-merger context. They contend that in other controller transactions, approval by an independent and disinterested special committee or a majority of the minority suffices for business judgment review.

Although Strine and Jacobs have made their positions clear, the Delaware Supreme Court has not opined on the expansion of MFW to the non-merger context. Until the Delaware Supreme Court clarifies the reach of MFW, boards and lawyers advising them should strongly consider implementing MFW’s dual protections in any controller transaction. By taking these precautions, boards can increase the likelihood that, if challenged, the transaction will be subject to the deferential business judgment rule.