Court ruling confirms way to reduce litigation risk

Delaware’s top court upheld an earlier ruling that the ‘business judgment rule’ should be applied to certain going private transactions.

Private fund advisors and other asset managers with a controlling stake in a public company can delist that company with less exposure to litigation risk if they undergo certain precautionary measures, a Delaware Supreme Court ruling has confirmed.

The court affirmed that controlling stockholders, which gain the approval of both a special committee of independent directors and the majority of the minority stockholders in a going private transaction, can invoke a “business judgment” test of care should a plaintiff challenge the transaction. The business judgment test is Delaware's most forgiving standard of review for defendants, according to a Clifford Chance client alert.

Typically a controlling stakeholder will condition a take-private agreement with only one of the two approval methods: a special committee or minority shareholder vote. When only one approval method is offered any plaintiff challenge is subject to “the entire fairness standard”, a more rigorous standard of review for defendants under Delaware law.

Legal sources say firms intending to make use of the court decision should be aware of the downsides.

“Having a deal conditioned on both a minority stakeholder vote and independent special committee increases the chance of a deal being blocked, particularly because the minority stockholder vote is considered a bit more of a wild card” said Kaye Scholer M&A partner Diane Holt Frankle.

And independent directors who sit on special committees sometimes have unrealistic views of value or other motivations to resist a going-private proposal, the Clifford Chance alert said.