Fixing MFW: Fairness and Vision in Controller Self-Dealing

Abstract

The legal regime governing controlling shareholders relies on the court’s ability to police conflicted transactions under the stringent “entire fairness” standard of review. This review involves both implicit valuation—evaluating the transaction process, and explicit valuation—assessing the fairness of the transaction’s financial terms. Our research reveals a critical flaw in this regime: courts cannot reliably engage in valuation when the transaction involves an entrepreneur’s idiosyncratic vision for the company. As a result, there is a gaping hole in Delaware's framework for policing the fairness of controller transactions.

Delaware courts have developed guardrails to avoid judicial valuation by rewarding controllers that implement procedural protections for minority shareholders with more favorable review. Nonetheless, we describe how these guardrails have been failing more and more often, forcing judicial valuation to the forefront of trials and negating the informed input of shareholders. To address this shortcoming, we propose reforms to the doctrinal framework that would enable courts to avoid valuation when the interested parties have endorsed the transaction and its price. We also offer guidance for judicial review of controller self-dealing transactions where necessary that respects the competency of courts. Our modified framework represents an important advancement in the legal treatment of controlling shareholder transactions. It would safeguard minority shareholders from expropriation by controllers while simultaneously encouraging visionary entrepreneurs to engage in value-creating activities, thereby promoting both fairness and innovation in Delaware corporate law.