New York’s highest court recently adopted a more lenient standard for reviewing certain types of corporate transactions between companies and controlling shareholders, similar to that adopted two years ago by Delaware’s highest court.
Under the entire fairness standard, defendants generally must show the fairness of both the deal process and the purchase price. Cases under an entire fairness standard usually do not get decided until after discovery or trial.
Under the business judgment standard, the inquiry is focused on whether the decision makers on the transaction were not acting in good faith. Cases decided under the business judgment standard are much more prone to dismissal at an early stage and often allow defendants to avoid discovery.
Earlier New York decisions involving interested-party transactions between a controlling shareholder and the controlled company applied the entire fairness review.
The recent decision in In re Kenneth Cole Productions, Inc., Shareholder Litigation, however, held that the transaction merited review under the business judgment standard because certain key conditions were met, including that: (1) the deal was negotiated and approved for the company by a special committee of independent directors and (2) it was approved by a majority of minority shareholders.
The New York court, adopting the Delaware court’s approach, found that inherent conflicts of interest were allayed where the following conditions were present in going-private mergers: (i) the controlling shareholder conditions the procession of the transaction on the approval of both a special committee and a majority of the minority stockholders; (ii) the special committee is independent; (iii) the special committee is empowered to freely select its own advisors and to say "no" definitively; (iv) the special committee meets its duty of care in negotiating a fair price; (v) the vote of the minority is informed; and (vi) there is no coercion of the minority.
The Court of Appeals’ adoption of the Delaware reasoning is likely to signal a greater acceptance of this conditional business judgment standard in going-private mergers in the remainder of the nation.
Thus, parties contemplating controlling shareholder transactions should pay careful attention to this line of authority, as it may provide a way to avoid, or at least cut short, the deal-challenge litigation that follows nearly every M&A transaction.