Freezeout Doctrine: Going Private at the Intersection of the the Market and the Law
New York Law School
Business Lawyer, May 2007
NYLS Legal Studies Research Paper No. 06-07/15
Delaware's fiduciary doctrine governing going private transactions by controlling stockholders is presently in disarray. Controllers generally select between single step cash-out mergers and tender offers followed by short-form mergers to do these freezeouts, and they are subject to very different equitable standards depending on the format selected. Further disarray arises because the courts' longstanding commitment to strict scrutiny in freezeouts is in tension with the popular disfavor towards private class-action litigation. This disarray threatens minority investors' interests in freezeouts, and capital market values more broadly. First, the disparities in freezeout doctrine have encouraged controllers to arbitrage the legal standards for freezeouts in their self-interest. The operation of a fair price requirement in one format and not the other has been particularly important in this regard. Second, recently proposed judicial reforms to freezeout doctrine would leave minorities in freezeouts stranded in a limbo between the market and the law - without adequate protections of either kind.
Delaware's Chancery Court has become sensitive to this doctrinal disarray and has proposed fundamental reforms. In a recent trilogy of opinions it has attempted to unify freezeout doctrine. However, these cases also indict equity's longstanding commitment to reviewing freezeouts for Entire Fairness (fair dealings and fair price on the controller's part). They propose that minorities' claims of unfairness in freezeouts should be dismissible on the pleadings if the controller's deal received the seemingly freely given approval of disinterested directors and stockholders (Dual Ratification).
The Article reviews the foundations of both lines of freezeout doctrine and proposes alternative standards for reform. It agrees with the recent cases that unifying freezeout doctrine is a positive objective; but it rejects the view that strict judicial oversight is gratuitous because minorities would be adequately protected by Dual Ratification. As envisioned in the recent cases, the latter would operate merely as a simulacrum of arms'-length dealings, and thus systematically advantage controllers over minorities. Entire Fairness should continue to apply as a standard of conduct and standard of review in all freezeouts, with one exception. Deferential judicial review (consistent with the business judgment rule) should apply to a freezeout only if prior to accepting the controller's offer, the target company's independent directors conducted an auction or market check to ascertain if better offers were available. Recent federal legislative and regulatory changes will make it easier for public companies to establish independent committees to oversee such auctions or market checks. Only in this situation will real market forces operate in freezeouts to ensure genuine arms'-length dealings between controllers and minority shareholders. Thus only in this situation should the courts presume the fairness of the controller's freezeout.
Keywords: going private, freezeout, fiduciary, controlling stockholder, minoirity stockholder, Entire Fairness, fair price, cash-out merger, self-dealing, Weinberger, Kahn v LynchAccepted Paper Series
Date posted: December 18, 2006
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