Freezeouts (that is, transactions in which a controlling shareholder buys out the minority shareholders) pose a significant conflict of interest because the controller stands on both sides of the transaction: as a buyer and as the party who dominates the seller. As a result, Delaware courts subject freezeouts to “entire fairness” review, an enhanced form of judicial review that enables courts to engage in a de novo review of the substantive terms of the transaction (Weinberger v. UOP, 457 A.2d 701, 711 (Del. 1983)). Delaware has also promoted the use of procedural protections by relaxing entire fairness review if the controlling shareholder conditions the transaction on approval by a special committee of independent directors (“SC approval”) and approval from a majority-of-the-minority shares (a “MOM condition”). If these two conditions are met, the standard of judicial review shifts from entire fairness to deferential business judgment review, under which a court will not second guess the terms of the transaction except in very exceptional circumstances (In re MFW Shareholders Litigation, 67 A.3d 496, 500 (Del. Ch. May 29, 2013); Kahn v. M&F Worldwide Corp., 88 A.3d 635 (Del. 2014)).

In a trilogy of recent decisions (SolarCity in April 2022, BGC Partners in August 2022, and Straight Path in October 2023), the Delaware Chancery Court held for the defendant in entire fairness litigation (In re Tesla Motors, Inc. Stockholder Litig., No. CV 12711-VCS, 2022 WL 1237185 (Del. Ch. Apr. 27, 2022); In re BGC Partners, Inc. Derivative Litig., No. 2018-0722-LWW, 2022 WL 3581641  (Del. Ch. Aug. 19, 2022); In re Straight Path Commun. Inc. Consol. Stockholder Litig., No. 2017-0486-SG, 2023 WL 6399095 (Del. Ch. Oct. 3, 2023)). None of these cases were freezeouts, but they signaled to practitioners that entire fairness review was not outcome-determinative.  This trilogy of cases changed the doctrinal calculation: with entire fairness review perceived as less onerous (thereby reducing the benefits of achieving business judgment review through the dual conditions of SC approval and a MOM condition), and with perceived holdup risk increasing (thereby increasing the costs of giving a MOM condition), transactional planners may be less eager to provide MOM conditions as part of the freezeout process.

In this paper, we examine whether the incidence of MOM conditions has in fact systematically declined in recent years.  We find that it has, from 85% in the period between the Delaware Chancery Court’s decision in MFW and SolarCity, to 50% in the period after SolarCity. Although the size of the sample is small, this result holds after we control for various characteristics of the transactions. Our findings are consistent with our prior empirical research on freezeouts finding that practitioners adjust the form of their transaction in response to Delaware case law.

From a doctrinal perspective, our results are a case study on unintended consequences: after carefully constructing procedural protections for minority shareholders in a series of cases spanning over two decades, the trilogy of non-freezeout cases seems to have contributed to dismantle those protections. From a policy perspective, this effect is problematic because SC and MOM approvals help emulate an arms-length deal.

To the extent that holdup risk is deterring controllers from giving MOM conditions, we propose the MOOM alternative: approval by a majority of the original minority (i.e., approval is required from the minority shareholders at the time of the deal announcement).  Shareholders who bought after this announcement date would not be able to vote their shares. Holdup risk is therefore mitigated, while still preserving the backstopping benefits of a MOM condition.

Freezeouts matter.  Although they are a small fraction of overall deal volume, they are an important class of transaction because they involve a crucial moment in the minority shareholder’s investment, namely, exit. Prior studies suggest that there is a correlation between protections for minority investors and overall capital formation and economic development.  The intuition for these findings is that minority investors are more likely to invest in controlled companies knowing that they will receive adequate procedural protections on their exit.  From this perspective, our findings are troubling.  While other jurisdictions around the world are seeking to catch up to Delaware in protecting their minority shareholders, Delaware companies appear to be moving in the opposite direction. The MOOM condition is our proposed approach to bridge the gap between the controller’s legitimate interest in deal certainty with our collective policy interest in promoting procedural protections.

The paper is available at this link: https://ssrn.com/abstract=4965438.