Court of Chancery Holds Business Judgment Protections Announced in Kahn v. M&F Worldwide Corp. Extends to Conflicted One-Side Controller Transactions

Stockholders of Martha Stewart Living Omnimedia, Inc. (MSLO) brought suit in the Court of Chancery against Martha Stewart, alleging that Stewart, as controlling stockholder of MSLO breached her fiduciary duties by negotiating greater consideration for herself to the detriment of the minority stockholders  of MSLO during the course of a merger with Sequential Brands Group, Inc. (“Sequential”).  The stockholders also brought suit against Sequential under an aiding and abetting theory.

Much of the litigation was over the appropriate standard the Court should use to review the merger.  Stewart claimed the business judgment rule was appropriate because there was no conflicted transaction, but even if there was, the procedural safeguards – that the transaction was recommended by a properly-empowered and independent special committee of the Board and a nonwaivable condition that the merger be approved by a majority of the minority stockholders, were fully complied with.  The stockholders sought entire fairness review.

Sequential entered into negotiations with MSLO, who in turn formed a special committee to assist in contemplating a merger.  Sequential requested the ability to simultaneously negotiate with Stewart while also negotiating the merger with MSLO’s special committee; the committee granted that request. Relevant to the merger, Stewart was party to several other agreements with MSLO, including: an employment agreement, an IP agreement, and a license agreement.

Sequential and MSLO eventually entered into a merger agreement where the stockholders of MSLO were entitled to $6.15 per share or shares of Sequential common stock equal to the shareholders’ shares in MSLO.  On the same day, Sequential entered into, and extended, certain agreements with Stewart.  The license agreement was extended for three more years, but otherwise remained the same as did the IP agreement, other than Stewart forfeiting the use her name in new businesses. The employment agreement changed slightly, but in no material way, according to the Court.

The Court found there was no conflicted transaction, noting that a conflicted transaction will either have the controlling stockholder on the buy and sell side of the transaction, or the controlling stockholder will extract “different consideration or derive some unique benefit from the transaction…”  Neither of these two scenarios arose under the merger. Stewart was plainly only on the sell side of the transaction, and received the same $6.15 per share merger consideration that other stockholders received.  The Court found that the plaintiffs failed to distinguish the “new” side deals from the “old” side deals in any meaningful way that could support the assertion that Stewart extracted additional consideration that otherwise was afforded to MSLO shareholders.

The Court rejected Plaintiffs’ characterizations of the merger negotiations.  They claimed that after entering into negotiations with Stewart, the offering price dropped from $6.20 per share to $6.15 per share.  Initially, Sequential did offer $6.20 per share; however, after a period of due diligence, but before entering into negotiations with Stewart, that offer dropped to $5.75 per share.  After entering into negotiations with Stewart, that offer increased to $6.15 per share.  The merger consideration actually increased after Sequential began negotiations with Stewart.

The Court answered the additional question of when the dual safeguards of a special committee and a majority of the minority vote need be implemented to secure review under the business judgment rule. Plaintiffs urged the safeguards need be implemented at the outset of discussions between the target and third party, while Stewart argued the safeguards need be applied before any actual agreement between the third party and the controller is reached. The Court ended up in the middle, finding that the necessary time for the safeguards is “where the controlling stockholder actually sits down with an acquirer to negotiate for additional consideration.”  The Court found that both a properly-empowered and independent special committee of the Board and a nonwaivable condition that the merger be approved by a majority of the minority stockholders, were fully complied with at the appropriate time.  As such, the business judgment rule applied, and having failed to plead a claim for waste, the claims against Stewart and Sequential failed. The Court granted the motions to dismiss.

Read the full Opinion here.

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