Academic journal article Journal of Corporation Law

Kahn V. M&F Worldwide Corporation: A Small but Significant Step Forward in the War against Frivolous Shareholder Lawsuits

Academic journal article Journal of Corporation Law

Kahn V. M&F Worldwide Corporation: A Small but Significant Step Forward in the War against Frivolous Shareholder Lawsuits

Article excerpt


From time-to-time, a controlling shareholder will want to eliminate the minority shareholders by buying them out in a transaction called a freeze-out merger.1 However, under Delaware corporate law, a freeze-out merger creates such a strong presumption of taint2 that, for the last 30 years, the Delaware courts have required the decision to be reviewed under its highest level of scrutiny: entire fairness, i.e., fair dealing and fair price.3 According to the Delaware Supreme Court, "[w]here a transaction involving self-dealing by a controlling stockholder is challenged, the applicable standard of judicial review is 'entire fairness,' with the defendants having the burden of persuasion."4

Empirical evidence suggests that the entire fairness standard of review does provide the required benefits for minority shareholders in freeze-out mergers. Bates, Lemmon and Linck conclude that "[m]inority claimants in freeze-out offers receive an allocation of deal surplus at the bid announcement that exceeds their pro rata claim on the firm," suggesting "that minority claimants and their agents exercise significant bargaining power during freeze-out proposals."5 Unfortunately, the application of the entire fairness standard of review in freeze-out mergers has also created unintended negative consequences. Because entire fairness makes it almost impossible for defendants to get the case dismissed prior to trial,6 the standard has made it extremely tempting for plaintiffs' attorneys, in order to earn attorney's fees, to reflexively file a class action lawsuit in a freeze-out merger without regard to the claim's merits.7 For example, in Kahn v. M&F Worldwide Corp.-the Delaware Supreme Court case that is the focus of this article-the initial lawsuit challenging the freeze-out merger was filed one day after the controlling shareholder announced its proposal to buy out the minority shareholders and several months prior to a board-approved transaction.8 As will be subsequently discussed, the process of freeze-out merger litigation then proceeds in a very predictable manner, with the final result being a settlement that allegedly benefits no one except the plaintiffs' attorneys. 9

To help remedy this overabundance of frivolous lawsuits, the Delaware Supreme Court in Kahn provided the defendants the protections of the business judgment rule as long as the freeze-out transaction utilized the court's dual protection merger structure, i.e., the use of a special independent committee in negotiating the transaction on behalf of the minority shareholders and the approval of the transaction by an informed majority of minority shareholders.10 By moving the standard of review to the business judgment rule, defendants now have the ability to seek dismissal of the suit prior to trial, thereby reducing, at least in theory, the pressure on defendants to seek a settlement automatically even if the suit is without merit.

Unfortunately, the result is mostly aspirational because while the standard of review eventually shifts to the much more lenient business judgment rule, it does little to relieve the burden on defendants to show that the freeze-out merger ultimately meets the objective of an entire fairness standard of review: "fair price."11 Each of the six requirements that the board and the controlling shareholder must meet may be subject to discovery.12 The judicial review in total still requires a level of scrutiny, in terms of both process and discovery, that must be considered the functional equivalent of entire fairness. This does not mean, however, that Kahn is without significance. As subsequently discussed, Kahn may lay the foundation for a greater judicial attack on frivolous lawsuits in the context of freeze-out mergers if new approaches are allowed to enhance Kahn's dual-protection merger structure.

This Commentary proceeds as follows. Part II describes Delaware law as it applies to freeze-out mergers prior to Kahn. …

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