A New York state court adopted the business judgment rule for going-private mergers that are conditioned on the approval of both an independent committee and a majority-of-the-minority vote. Kenneth Cole bought out his eponymous fashion company in 2012, with the blessing of an independent committee and 99.8 percent of the minority shareholders. Deferring to the defendants' business judgment, the New York Court of Appeals dismissed an institutional shareholder's breach-of-duty claims (In the Matter of Kenneth Cole Productions, Inc., Shareholder Litigation, May 5, 2016, Stein, L.).
Entire fairness or business judgment? The court could have extended the entire-fairness standard that applies to freeze-out mergers, Alpert v. 28 Williams St. Corp., to going-private mergers. Alternatively, it could adopt the test articulated by the Delaware Supreme Court in Kahn v. M&F Worldwide Corp. MFW, a case of first impression, involved a going-private merger that required the approval of two factions: a properly empowered, independent committee and an informed, uncoerced majority of minority shareholders. Although it had previously applied the entire-fairness standard to deals that involved only one of those protections, the Delaware court likened the MFW deal's dual-protection structure to an arm's-length transaction and applied the deferential business judgment rule.
Specifically, the Delaware high court said the business judgment rule applies to a controlling-shareholder buyout if and only if six criteria are met: (1) the controller conditions the deal on approval by both a special committee and a majority of the minority shareholders; (2) the special committee is independent; (3) the special committee is empowered to hire its own advisers and to definitively say no to a deal; (4) the special committee satisfies its duty of care by seeking a fair price; (5) the minority’s vote is an informed one; and (6) the minority was not coerced.
The New York court adopted this standard of review for challenges to going-private mergers. The standard reinforces the state's principles that the business judgment rule applies generally to corporate management decisions. Furthermore, it preserves the courts' ability to examine the disinterested independence of special committee members and the appropriateness and sufficiency of the committee's investigative procedures. The business judgment rule is deferential to corporate boards, but the dual protections required by the MFW test sufficiently protect minority shareholders. This compromise strikes a balance between protecting minority shareholders' rights and protecting directors and shareholders against unwarranted judicial interference, the court wrote.
Six-factor test applied. Under the MFW rule, a complaint states a claim for breach of fiduciary duty if it alleges a set of facts showing that any of the six protective conditions did not exist. First, the plaintiff conceded that Cole conditioned the merger on dual approval. Second, even though Cole and/or his personally selected directors seeded the special committee, that was not enough to rebut the presumption of the committee's independence. Third, the complaint did not allege that the committee lacked the freedom to hire its advisers or veto Cole's offer.
Fourth, although the complaint alleged that the special committee could have gotten a higher price, it failed to allege any basis to conclude the committee failed to meet its duty of care by, for example, engaging in unfair conduct or failing to conduct meaningful negotiations. Fifth, the complaint lacked any specific challenges to the information provided to minority shareholders in advance of the vote. Sixth and finally, the plaintiff did not allege any coercion in relation to the shareholder vote. Because the plaintiff did not sufficiently and specifically allege that any of the six MFW conditions were absent from the Kenneth Cole merger, the court dismissed the complaint.
The case is No. 54.
Attorneys: Lee D. Rudy (Kessler Topaz Meltzer & Check, LLP) for Erie County Employees Retirement System. Andrew W. Stern (Sidley Austin LLP) for Michael J. Blitzer.
Companies: Erie County Employees Retirement System; Kenneth Cole Productions, Inc.
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