Erie County Employees Retirement System v. Blitzer, 28 N.Y.3d 268 (2016)

In reviewing going-private mergers, the business judgment rule applies if the merger is conditioned from the outset on approval by both a special committee of independent directors and an uncoerced majority of the minority shareholders; otherwise, the entire fairness standard applies.

Summary

The New York Court of Appeals addressed the standard of review for going-private mergers. The court adopted the Delaware Supreme Court’s framework from MFW, holding that the business judgment rule applies if the merger is conditioned on approval by an independent special committee and an uncoerced majority of the minority shareholders. If these conditions aren’t met, the entire fairness standard is applied, placing the burden on the directors to show fair process and fair price. The court affirmed the dismissal of the plaintiff’s complaint, finding the conditions for the business judgment rule were met.

Facts

Kenneth Cole Productions (KCP) had two classes of stock, with Kenneth Cole holding the majority voting power. Cole proposed a going-private merger, offering to buy the remaining Class A shares. The KCP board formed a special committee to negotiate the terms. Cole’s offer was conditioned on approval by the special committee and a majority of the minority shareholders. The special committee negotiated the price, eventually recommending $15.25 per share, which the minority shareholders approved with 99.8% in favor. Shareholders sued, alleging breach of fiduciary duty.

Procedural History

Shareholders filed class actions in the trial court. The trial court granted the defendants’ motions to dismiss, finding no breach of fiduciary duty. The Appellate Division affirmed, holding that the entire fairness standard did not apply. The Court of Appeals granted leave to appeal.

Issue(s)

1. Whether the entire fairness standard should apply to the going-private merger.

2. Whether the business judgment rule should apply to the going-private merger.

Holding

1. No, because the court adopted the Delaware Supreme Court’s framework in MFW, which outlines the conditions for the business judgement rule.

2. Yes, because the conditions for the business judgement rule, as outlined in MFW, were met.

Court’s Reasoning

The court reviewed the history of freeze-out mergers and the standards of review applied, noting the inherent conflict of interest when a controlling shareholder seeks to take a company private. The court discussed the business judgment rule, which generally defers to directors’ decisions absent fraud or bad faith. The court specifically adopted the standard from MFW (Kahn v. M&F Worldwide Corp.), which states that the business judgment rule applies if the merger is conditioned from the outset on approval by both an independent special committee and an uncoerced majority of the minority shareholders. The court reasoned that this structure creates a situation akin to an arm’s-length transaction, protecting minority shareholders while respecting the board’s decisions. The court examined the facts under the MFW standard and found the complaint did not adequately allege that any of the six conditions were absent. The court emphasized the plaintiff’s failure to show that the special committee was not independent, lacked the ability to negotiate a fair price, or that the minority shareholders were coerced.

Practical Implications

This decision provides a clear framework for evaluating going-private mergers, which can provide more predictability to parties involved in these transactions. It confirms that, if structured correctly, these mergers can be reviewed under the business judgment rule. This means that if a merger satisfies the conditions set forth in MFW (an independent special committee, the committee is empowered to freely select its own advisors and to say no definitively, and an informed, uncoerced majority of the minority vote), courts will defer to the board’s decision, reducing the risk of shareholder litigation. Companies engaging in going-private mergers should carefully structure the process to meet these conditions. Plaintiff’s attorneys must allege specific facts to show any of the conditions were not met to avoid dismissal.