In HomeFed Corp. S’Holder Litig., C.A. No. 2019-0592-AGB (Del. Ch. July 13, 2020), Bouchard, C., the Delaware Court of Chancery denied the defendants’ bid to dismiss shareholders’ claims for breach of fiduciary duties, which arose out of a majority shareholder’s purchase of the remaining shares of HomeFed Corporation. Rather than deferring to the company’s business judgment, the court found that the complaint demonstrated the majority shareholder’s failure to adhere to the letter of the law established by the Delaware Supreme Court in Kahn v. M&F Worldwide Corp. (MFW). The decision implies that once a majority shareholder engages in direct, substantive negotiations with minority shareholders regarding the terms of sale, no subsequent processes or protections may allow the transaction to receive the benefit of the business judgment standard.
In HomeFed Corp., Jefferies Financial Group, Inc., the holder of a 70% interest in the company, commenced negotiations with the largest minority shareholder, BMO, regarding the terms of a merger. Under a shareholder agreement between HomeFed and Jeffries, the majority shareholder was prohibited from acquiring additional shares unless it obtained the prior approval of a special committee of independent directors and an affirmative vote of the majority of disinterested shareholders. Several months after these initial discussions, in December 2017, the board was notified of a potential transaction, and a special committee was formed. Negotiations between Jefferies and the special committee broke down, and the majority shareholder indicated that it was no longer interested in the acquisition. Despite this representation, Jeffries directly negotiated with minority shareholders regarding the merger, in which Jefferies obtained the support of 70% of disinterested shareholders for a 2:1 exchange ratio. Jefferies announced the proposed terms in February 2019, and the company reauthorized the special committee. Despite the reauthorization of the special committee, Jefferies continued direct discussions with BMO, in which Jefferies told BMO that the minority shareholders must accept the 2:1 exchange ratio or it would walk away from the deal. BMO agreed, and Jefferies completed negotiations with the special committee. The terms of the merger received the support of the special committee and a majority of disinterested shareholders. Litigation subsequently ensued, in which it was alleged that Jefferies and various directors breached their fiduciary duties.
The Court of Chancery rejected the defendants’ reliance on MFW to defeat the fiduciary duty claims. Under MFW, the court will apply the business judgment rule to a squeeze-out merger by a controlling shareholder if the deal is conditioned ab initio upon the approval of an independent special committee, which satisfied its duty of care, and the uncoerced, informed vote of a majority of the minority shareholders. A plaintiff can avoid this deferential standard and obtain the right to propound discovery by pleading facts in the complaint, upon which the court can reasonably infer that one or both of these conditions have not been met. In HomeFed Corp., the court found that Jefferies’ substantive negotiations with minority shareholders before Jefferies committed to the protections set forth in MFW proved fatal, as the procurement of the minority shareholders’ consent to a 2:1 exchange ratio critically undermined the role and authority of the special committee.
HomeFed Corp. demonstrates the Delaware courts’ commitment to fairness in a squeeze-out merger through adherence to process. The defendants sought to avoid judicial scrutiny through the use of a special committee, but their efforts in furtherance of the merger, which preceded the special committee’s authorization, tainted the well to such an extent that subsequent negotiations with the special committee and the approval of a majority of disinterested shareholders prevented the court from analyzing the transaction through a deferential lens. In order to avoid the more rigorous, entire fairness standard, a majority shareholder must commit to the MFW protections in advance of any substantive negotiations. Otherwise, the pressure imposed upon the majority shareholders by the MFW protections for the benefit of minority shareholders are of little consequence.