Delaware Mitigates Litigation Risk In Going Private Transactions

SMART SUMMARY

• Recent amendments to the Delaware General Corporation Law afford safe-harbor protections for sponsors taking part in going private transactions, welcome clarifications that should (in the long run) reduce litigation risks.
• The amendments demonstrate Delaware's commitment to remaining a top jurisdiction for blue-chip corporate law and M&A.

Recent Delaware law developments should reduce litigation risks for sponsors engaged in going private transactions. First, for controlling stockholder "going private" transactions where a private equity sponsor may seek to squeeze out minority stockholders, Section 144 of the Delaware General Corporation Law (the "DGCL") now provides a safe-harbor to potentially insulate such transactions from stockholder challenge and judicial review. Second, the Delaware Supreme Court recently reaffirmed the high bar for establishing "aiding and abetting" claims against a third-party acquiror. More detail can be found here.

The Going Private Safe Harbor

Controlling stockholder "going private" transactions are generally subject to the entire fairness standard of review under Delaware law. Entire fairness is Delaware's most onerous standard of judicial review and typically requires the defendants to prove that the transaction was entirely fair to the corporation and its minority stockholders both in terms of the price and the process that was followed. For the last decade, Delaware law provided a path for controlling stockholders to shift the standard of review in a going private transaction from entire fairness back to the deferential business judgment standard of review if, among other things, the controller conditioned the transaction from the very outset on approval by both a fully-empowered committee of disinterested and independent directors (including the power to reject the transaction) and a fully-informed, uncoerced minority stockholder vote. Kahn v. M&F Worldwide Corp., 88 A.3d 635 (Del. 2014) ("MFW"). A shift in the standard of review from entire fairness to business judgment would mean that a post-closing litigation challenging such transactions could be dismissed at the pleading stage, without the burden and expense of discovery. But the path to shifting the standard of review under MFW was fraught with risk for potential foot-faults, including around timing for when the MFW protections were invoked, and many motions to dismiss by defendants who sough to implement the MFW framework were denied. The new DGCL safe harbor still requires the "twin" protections of approvals by both disinterested directors and disinterested stockholders for going-private transactions, but the statute simplifies the process and provides greater clarity for parties seeking to avail themselves of the safe harbor protections, which should reduce litigation risks for sponsors who undertake going private transactions in their controlled portfolio companies.

Aiding and Abetting Liability Continues to be a High Bar

Aiding and abetting claims against third-party buyers have always been difficult in Delaware. In In re Mindbody, Inc. Stockholder Litigation, 332 A.3d 349 (Del. 2024), the Delaware Supreme Court reaffirmed that principle, reversing the Court of Chancery's judgment that a private equity sponsor aided and abetted a breach of fiduciary duty by the target's CEO in a going private transaction because the sponsor had a contractual right to review the target's proxy filings and was aware of actions by the CEO that rendered statements in the proxy misleading. The Court affirmed that the "knowing participation" element of an aiding and abetting claim requires "substantial assistance" in the form of "active participation." Thus, the mere awareness of a fiduciary's breach of his disclosure duty upon review of the draft proxy, without more (e.g., actively participating in the drafting), did not rise to the level of active participation necessary to trigger aiding and abetting liability. The Mindbody decision is a welcome reassurance for buyers that customary contract rights under a merger agreement, such as the right to review a draft proxy statement, standing alone, are not a sufficient basis for aiding and abetting liability under Delaware law.

Bottom Line

The bottom line is that Delaware's corporate law continues to evolve and develop to strike an optimal balance between managerial freedom and stockholder rights, demonstrating its commitment to maintaining its status as the premier jurisdiction for corporate transactions.

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