Tuesday, March 26, 2024

Chancery erred in applying MFW framework to cleanse merger

By Anne Sherry, J.D.

The Delaware Supreme Court, sitting en banc, restored a challenge to a squeeze-out merger. While the chancery court was right to dismiss a coercion claim, it erred when it assessed the failure to disclose certain conflicts of interest and management fees. Those disclosure failures meant that the minority stockholders were not adequately informed, and that the transaction was not eligible for the safe harbor of the MFW framework (City of Dearborn Police and Fire Revised Retirement System (Chapter 23) v. Brookfield Asset Management Inc., March 25, 2024, Valihura, K.).

In 2020, a subsidiary of Brookfield Asset Management proposed to acquire the remaining outstanding shares of TerraForm Power, Inc. (Brookfield already owned 62 percent of TerraForm). The subsidiary conditioned its proposal on the approval of an independent special committee and a majority of the minority stockholders. Under the Court of Chancery’s 2013 MFW decision, the business judgment rule applies to a controller-led transaction that employs these two cleansing devices.

The plaintiffs challenged the merger, but the chancery court granted the defendants’ motion to dismiss. The court held that the plaintiffs failed to adequately allege coercion under MFW or that the special committee breached its duty of care by failing to disclose conflicts of interest.

Reviewing this dismissal de novo, the Supreme Court agreed with chancery that the plaintiffs did not state a claim for coercion. The plaintiffs theorized that Brookfield’s presentation of a “no growth” projection for TerraForm amounted to an implicit threat to let TerraForm “wither on the vine” if the special committee recommended against the transaction. But this theory rested on attenuated and unreasonable inferences.

However, the merger proxy’s failure to disclose conflicts of interest and a non-ratable upside for Brookfield rendered it misleading—and the stockholder vote not fully informed. Chancery had considered immaterial an undisclosed conflict of interest centering around Morgan Stanley, which both advised the TerraForm special committee and had $470 million in holdings in Brookfield.

The high court called chancery’s analysis “problematic.” Chancery had concluded that the conflict was not material because of the small size of Morgan Stanley’s stake in Brookfield relative to its overall portfolio, but the materiality determination has to consider the perspective of the stockholder. Delaware law prioritizes transparency in the special committee’s reliance on advisors, and it was reasonably conceivable that Morgan Stanley’s holding nearly half a billion dollars in Brookfield would be material to a stockholder assessing the advisor’s objectivity.

Similarly, the fact that another advisor had represented Brookfield in the past and concurrently represented a Brookfield affiliate should have been disclosed. This ongoing relationship raised the concern that the advisor would not want to push Brookfield too hard.

Furthermore, the proxy was deficient in its failure to disclose certain management fees Brookfield expected to realize from the merger. Knowing that Brookfield expected to gain $130 million in management fees would have helped stockholders evaluate whether Brookfield paid a fair price and whether the special committee leveraged the added value.

The case is No. 241, 2023.