When a court reviews contested business transactions of a Delaware corporation, they typically rely on one of two standards of review: the “business judgment rule” or the “entire fairness standard.” The business judgment rule is the default standard of review, where the plaintiff has the burden of proof and which sets forth a presumption that “in making a business decision[,] the directors of a corporation acted on an informed basis, in good faith, and in the honest belief that the action was in the best interest of the company.” In essence, it precludes courts from second-guessing the decisions of independent and disinterested directors that have acted with care by focusing on the reasonableness of such persons’ decisions. That being said, if the presumption of the business judgment rule is overcome by the plaintiffs, a director or controlling stockholder breaches a fiduciary duty, or the transaction involves the self-dealing of a director or controlling stockholder (rendering, in each such instance, the business judgment rule inapplicable), then the entire fairness standard applies, shifting the burden of proof to the corporation. To overcome this burden, a corporation must prove that both the process and the price that was achieved were fair to the corporation’s stockholders. Unlike the deferential business judgment rule, the entire fairness standard is onerous and meant to apply to transactions that have conflicts in which the majority of the board is interested, a director has self-dealing financial incentives adverse to those of the company, or a conflicted director or stockholder “controls or dominates the board.” Demonstrating that the transaction was approved either by a special committee of independent directors or by an informed vote of the majority of the disinterested stockholders are some of the ways in which defendants can overcome the entire fairness standard of review.
The recent Delaware Chancery Court decision, In re BGC Partners, Inc. Derivative Litigation, underscores, among other things, the complex analysis that a court must go through in making a decision under the entire fairness standard. In BGC Partners, the defendants overcame the scrutiny of the standard by demonstrating that it appointed an independent special committee, which ultimately approved the transaction. This decision highlights, however, the critical importance of interested directors and controlling stockholders ensuring the transaction processes are fair and reasonable through the appointment of the independent special committee while also ensuring strong records are kept throughout such process to support the price of the deal. Even with the more rigorous and exacting analysis under the entire fairness standard, BCG Partners reinforces that defendants can still prevail under this scrutiny.
At trial, the plaintiffs challenged the fairness of BGC Partners’ acquisition of Berkeley Point Financial from an affiliate of Cantor Fitzgerald, where BGC purchased the entity for $875 million and simultaneously invested $100 million in a Cantor affiliate’s mortgage-backed securities business. More specifically, the plaintiffs alleged that the controlling stockholder of both BGC and Cantor caused BGC to carry out an overpriced deal that was beneficial to him and detrimental to BGC stockholders. Although such stockholder initiated the deal, had a financial incentive to cause BGC to overpay for the acquired entity, overstepped in identifying members for the special committee advising on the deal, and the consummation of the deal and its final resolution remained somewhat shrouded, the Delaware Chancery court still found that the evidence the defendants presented at trial prevailed over plaintiffs’ allegations.
The court first reviewed whether the transaction was fair as to process. Then, the court looked to factors based on Delaware precedent: timing and initiation, structure, negotiations, and approval, noting that, while there were some “defects in the process”, it was ultimately fair.
The court’s analysis concerning the second factor, transaction structure, warrants further review, as the composition of the board’s special committee and such committee’s advisors was far from perfect and appears to have had the potential to sway the court’s decision in favor of the plaintiffs. As the court noted, composition of a special committee is “‘of central importance’ when evaluating the fairness of its process,” and such committee must be fully empowered to reject or approve the proposed transaction. Further, a “critical factor in assessing the reliability and independence of the process employed by a special committee is the committee’s financial and legal advisors and how they were selected.” The actual selection of the special committee and its advisors were not a procedural strength in this case, as the controlling stockholder played a not-insignificant role in selecting such persons, which raised the question as to whether such committee members were truly independent. As the plaintiffs alleged, such stockholder, co-opted an ineffective and powerless special committee and such committee’s advisors. While the court noted this was a flawed process, it did not prove to be fatal: the majority of the committee members were, in fact, independent throughout the transaction, the committee and its advisors spent ample time reviewing the transaction and negotiated an arms-length deal, and both the committee and its advisors conducted thorough analyses to ensure the transaction made financial sense, ultimately voting to approve it.
The court then reviewed whether the transaction was fair as to price, which “relates to the economic and financial considerations of the transaction,” including relevant factors such as assets, market value, earnings, prospects, and any other elements that affect the intrinsic or inherent value. The central question, of course, is whether the $875 million paid by BGC was a fair price. The court reviewed the analyses conducted by both parties’ experts, ultimately concluding that such analyses created a “fairness range” extending from $805 million to $1.164 billion. As the $875 million clearly falls within that range, the court deemed the price for BGC to be fair.
Among other things, this decision highlighted the importance of the special committee process, particularly concerning appointing a committee that is both independent and knowledgeable. Further, the special committee should have its own independent advisors that, through the completion of a fairness opinion presented to the special committee, add yet another layer of insulation from the controlling stockholder or interested director(s) as to the fairness of the transaction. In addition to this layered approach, the controlling stockholder or interested director(s) should remove themself from the selection process of both the committee and its advisors. Moreover, the committee and its advisors should ensure they conduct thorough analyses and be given meaningful authority to negotiate the terms of the deal, so it is apparent that the insulation from the controlling stockholder or interested director(s) is not illusory. Although ultimately the defendants prevailed in BGC Partners, had the controlling stockholder overstepped further in the special committee process, it’s possible the transaction would have been deemed unfair.
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- In re Walt Disney Co. Derivative Litig., 906 A.2d 27, 52 (Del. 2006) (quoting Aronson v. Lewis, 473 A.2d 805, 812 (Del. 1984).
- Krasner v. Moffett, 826 A.2d 277, 287 (Del. 2003).
- Aronson v. Lewis, 473 A.2d 805, 812 (Del. 1984).
- Telxon Corp. v. Meyerson, 802 A.2d 257, 264 (Del. 2002).
- In re BGC Partners, Inc. Derivative Litig., No. 2018-0722-LWW, 2022 WL 3581641, at *1 (Del. Ch. Aug. 19, 2022).
- Id. at *18.
- Id. at *20.
- Id. at *22.
- Id. at *28.
- Id. at *41.