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Delaware Supreme Court Clarifies That “ab initio” for MFW Purposes Means before the Start of Substantive Economic Negotiations
October 16, 2018 Download PDF
In Flood v. Synutra International, Inc., the Delaware Supreme Court affirmed the Court of Chancery’s holding that the controlling shareholder satisfied MFW’s “ab initio” requirement by conditioning the deal on the required procedural protections before substantive economic negotiations had begun, even if that was not until his second offer letter. Therefore, the business judgment rule applied to the transaction, leading to the dismissal of plaintiff’s claims. In the majority opinion written by Chief Justice Strine, the court stated that determining when substantive economic negotiations begin is imprecise and could lead to close cases.
Liang Zhang and his affiliates owned 63.5% of Synutra International, Inc. In January 2016, Mr. Zhang sent a letter to the board of Synutra proposing to buy the remaining shares of the company at $5.91 per share. The letter did not include as preconditions to the offer the MFW procedural protections (i.e., that the transaction be conditioned “ab initio” on (1) approval by an independent, fully empowered special committee and (2) approval by an uncoerced and fully informed vote of a majority of the minority shareholders). One week after receipt of the letter, the board formed a special committee to consider the offer. Two weeks after the initial offer, Mr. Zhang sent a second proposal with the same economic terms, but this time conditioning his offer on the MFW procedural protections. After receiving the second proposal, the special committee retained independent legal and financial counsel. After an eight-month long process, the parties agreed to a price of $6.05 per share. Plaintiff brought fiduciary duty and related claims challenging the transaction, and the defendants moved to dismiss.
In affirming the Chancery Court’s dismissal of plaintiff’s claims and holding that business judgment review applied, the decision’s key takeaways are as follows:
- As long as the controller conditions his or her proposal on MFW’s procedural protections before any substantive economic negotiations, the transaction satisfies the “ab initio” requirement. The court explained that “ab initio” is not a bright line and includes, not only the literal start of the transaction, but also the early stages of a multi-stage process up until substantive economic negotiations commence. Here, when Mr. Zhang sent his second proposal (which contained the conditions required by MFW), the special committee had not yet retained independent legal or financial counsel. Indeed, only after seven months of diligence, including by its financial advisors, did the special committee begin negotiating with Mr. Zhang over price. The court also held that substantive economic negotiations did not commence when the company waived the conflicts of its corporate counsel, allowing it to represent Mr. Zhang in connection with the transaction. The court noted that the key purpose of MFW was to ensure that controllers could not use the MFW conditions as “bargaining chips” during economic negotiations, and because Mr. Zhang’s second proposal was made prior to commencing substantive economic negotiations, the “ab initio” requirement was satisfied.
- Due care claims must be based on a defect in the special committee process, not merely on the committee’s ability to procure a fair price. Here, Synutra’s special committee was comprised of independent directors, and the committee received extensive advice and information from its independent legal and financial counsel. Accordingly, the special committee acted with due care. The court thus dismissed the plaintiffs claim that the Special Committee was grossly negligent merely because price was ostensibly inadequate.
Justice Valihura, in a rare dissent from the majority opinion, argued that “ab initio” should be applied as a bright line test to mean the initial formal written proposal, especially since the controller determines the timing of when to commence the transactional process. The dissent was wary of the imprecise, fact-intensive definition of “ab initio” adopted by the majority, especially as applied at the pleadings stage of litigation.
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