The Delaware Court of Chancery ruled that the business judgment rule may be applicable to reviews of transactions involving third parties.
In In re Martha Stewart Living Omnimedia, Inc. Stockholder Litigation, C.A. No. 11202-VCS (Del. Ch. Aug. 18, 2017), former shareholders of Martha Stewart Living Omnimedia, Inc. ("MSLO") brought claims against Martha Stewart for breach of fiduciary duty as controlling stockholder of MSLO, and against a third-party buyer, Sequential Brands Group, Inc. ("Sequential"), for "aiding and abetting that breach." The class action lawsuit was instituted in connection with Sequential's acquisition of MSLO, from which former stockholders received $6.15 per share. The plaintiffs alleged that Ms. Stewart leveraged her position as controller to secure greater consideration for herself than was paid to the other stockholders. Pursuant to the Sequential-MSLO transaction, as approved by the MSLO board and stockholders, Ms. Stewart would remain involved with the company, serve as Chief Creative Officer and receive, among other benefits, a $1.8 million annual salary and potential bonus.
The Court determined that at the pleadings stage, the challenged transaction should be reviewed under the business judgment rule rather than the entire fairness standard. This ruling represents the first time that the business judgment rule has been applied to single-side controller transactions at the pleadings stage pursuant to the framework established in Kahn v. M&F Worldwide Corp. ("MFW"), which was decided in the context of a controller who stood on both sides of a transaction. The Court found that a controller who is negotiating an offer from a third party does not have the same ability to set deal terms as the controller would if standing "on both sides of the transaction." The Court applied the business judgment rule to this particular case and found that business judgment review is appropriate in a one-sided controller transaction, pursuant to the MFW framework, where an independent special committee and majority of the minority stockholder vote requirement are established before the controller and the third party begin negotiations for disparate or non-ratable consideration.
The plaintiffs alleged that Ms. Stewart's "side deals" with the third party diverted consideration from minority stockholders. The Court rejected that argument. Based on the timeline of events in the publicly disclosed proxy filed with the U.S. Securities and Exchange Commission, and not the misstated timeline of events in plaintiffs' complaint, the Court found that Stewart and Sequential had complied with the MFW framework.
In a Cadwalader memorandum on the implications of the case, attorneys noted that this portion of the Court's opinion followed in the wake of several other Delaware decisions that could make it difficult for litigants to "persuade a court of its arguments to the extent they are contradicted by contemporaneous evidence or SEC-filed materials on which the litigants themselves rely."
In ruling that the minority stockholders failed to establish that Ms. Stewart's "side deals" amounted to a conflict of interest, the Cadwalader attorneys explained, the Court made clear that not all disparate consideration for a controller stockholder results in a conflict of interest with minority stockholders. In fact, the Court said that Stewart's deals "enabled stockholders to realize premium value for their shares."
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