Forcing Out Minority Shareholders
By Jed Weiner
Controlling shareholder(s) seeking to force out minority shareholder(s) in a freeze-out merger and the board of directors (“Board”) controlled by such controlling shareholders should brush up on their fiduciary duties prior to embarking on this path.
MFW Framework
In the 2013 case re MFW Shareholders Litigation (“MFW”), a Delaware court provided guidance to controlling shareholder(s) on fiduciary duty compliance in connection with a freeze-out merger. This case held that a special committee’s approval of the freeze-out merger coupled with the approval of the freeze-out merger by the majority of minority shareholders would grant the controlling shareholder(s) and Board’s decision to effect the freeze-out merger the protection of the Business Judgement Rule. Under this judicial doctrine, the minority shareholder(s) shoulder the heavy burden of proving that the Board made its decision in bad faith or acted disloyally, making it much more likely the transaction will be shielded from judicial review.
Statutory Short-Form Merger
In addition to following the MFN framework, controlling shareholder(s) seeking to force out minority shareholder(s) would maintain Business Judgment Rule protection by complying with Delaware’s short-form merger statute. Under the short-form merger statute, shareholder(s) controlling 90% or more of each class of stock (“Company Stock”) of a Delaware corporation may force out minority shareholder(s) holding the remainder of the Company Stock.
The statutory short-form merger is achieved through a merger whereby a parent company owned by the controlling shareholder(s) merges with a subsidiary corporation housing the minority shareholder(s). The minority shareholder(s) receive cash consideration, based on fair market value, for their shares. Absent fraud or illegality, the minority shareholder(s) only recourse to a short-form merger is appraisal rights. No shareholder vote is required for a freeze-out merger.
Minority shareholder(s) with negotiating leverage can protect themselves from the risk of freeze-out or short form mergers by requiring the controlling shareholder(s) to forgo rights to pursue such transactions in a shareholders agreement.
For more guidance on freeze-out mergers or shareholder disputes more generally, please reach out to Jed Weiner, Head of Corporate at boutique law firm Mei & Mark LLP.