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The business judgment rule is a common-law principle that generally prohibits courts from questioning the propriety of actions taken by corporate directors and officers, provided those actions are taken in good faith, with honest judgment, and in the lawful and legitimate furtherance of corporate purposes. This doctrine is based on a recognition that courts are ill equipped to evaluate what are essentially business judgments; there is no objective standard by which to measure the correctness of many corporate decisions (which involve the weighing of various considerations); and corporate directors are charged with the authority to make those decisions. Hence, absent fraud or bad faith, courts respect such business determinations and refrain from subjecting them to judicial scrutiny.
Recently, the Manhattan Commercial Division declined to offer such deference to a going-private transaction and allowed the case to proceed to discovery and further litigation. See Macomb County Retiree Health Care Fund v MSC Industrial Direct Co., Inc., 2025 NY Slip Op 51839(U) [Sup Ct, NY County 2025] [hereinafter MSC]. MSC involved a shareholder derivative action challenging a conversion of shares within MSC Industrial Direct Co., Inc. The plaintiff alleged that the transaction was a conflicted controller transaction in which the Jacobson/Gershwind family, as controlling shareholders, extracted an unfair 22.5% premium not provided for in the company's Certificate of Incorporation. The court denied the defendant-shareholder's motion to dismiss, holding that the allegations in the First Amended Complaint (FAC) were sufficient to establish a reasonably conceivable set of facts that the transaction was subject to the "entire fairness" standard of review rather than the business judgment rule.
The Court of Appeals has held that, in reviewing challenges to going-private mergers, courts should apply the business judgment rule as long as certain shareholder-protective conditions are present. See Matter of Kenneth Cole Productions Inc., 27 NY3d 268, 271 [2016] [hereinafter Kenneth Cole]. Specifically, "in controller buyouts, 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 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." Id. at 277. If a plaintiff alleges a "reasonably conceivable set of facts" showing that any of the shareholder-protective conditions are not met, then the entire fairness standard should be applied. See id. at 278. The entire fairness standard requires the transaction to be viewed as a whole to determine if there was a fair process and fair price to the minority shareholders. However, even with this avenue of recourse, as demonstrated in Kenneth Cole, plaintiffs were still bound by the application of the business judgment rule. Id.
The court in MSC found that the FAC demonstrated that the procedural safeguards required in controller buyouts were not satisfied. First, the FAC alleged that the transaction was not conditioned from inception on approval by an independent special committee and a majority of informed minority shareholders, as required by Kenneth Cole. Instead, the controlling shareholders allegedly undermined the process by collaborating with a conflicted special committee chairman to disempower the board and push through a transaction that diluted the minority shareholders' interest. Second, the FAC also alleged that the special committee was not independent, as its members had longstanding personal financial and professional ties to the controlling shareholders, compromising their ability to act independently. Furthermore, the special committee was not empowered to freely select its advisors or reject the transaction, as the financial advisor was pre-selected and incentivized to recommend a premium transaction, and the special committee members faced structural coercion due to their dependence on the controlling shareholders for their board positions and compensation. Third, the FAC alleged that the defendants breached their fiduciary duties of care and loyalty by failing to adhere to the company's Certificate of Incorporation, which required a one-for-one conversion of shares without a premium. The FAC even detailed how the special committee failed to meet its duty of care by not adequately considering non-premium transactions and by relying on conflicted advisors. Finally, the proxy statements provided to minority shareholders were alleged to be materially misleading, as they omitted critical information about the Certificate of Incorporation's provisions and the special committee's conflict of interest, rendering the minority shareholders' vote uninformed.
The significance of MSC lies in its application of the entire fairness standard of review to a controller transaction. On one hand, the court's decision underscores the importance of adhering to the procedural safeguards established in Kenneth Cole for going-private mergers and similar transactions. It highlights the necessity for independent and empowered special committees, informed minority shareholders votes, and adherence to corporate governance documents to ensure fairness in transactions involving controlling shareholders. On the other hand, the court's decision also demonstrates the court's willingness to deny application of the business judgment rule when plaintiffs present well-pled allegations of breaches of fiduciary duties and violations of corporate charters, allowing such claims to proceed to discovery and further litigation.
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