A Delayed Look at the Delaware Supreme Court Decision in 'In re Match Derivative Litigation': Director Independence

The Delaware Supreme Court’s recent decision in In re Match Group, Inc. Derivative Litigation (April 4, 2024) addressed two issues of significance to transactions of Delaware corporations involving their controlling shareholders.

• First, in a transaction with a controlling shareholder (referred to here as a controller) that is not a freeze-out (i.e., it is not a transaction in which the controller takes the company private), is it sufficient to have either an independent committee or an unaffiliated shareholder vote to change the standard of review from entire fairness to business judgment? The court answered no, it requires both. The court’s decision in Kahn v. M&F Worldwide Corp. (2014) (MFW), which imposed the combination of these procedural safeguards, applies to all types of controller transactions.
• Second, under MFW, does the independent committee have to be composed exclusively of independent directors? The court answered yes, there can be no interested directors on the committee.

En passant, the court also offered additional guidance on the determination of director independence, which may have received less attention than its two rulings on the application of entire fairness. This note will focus on the independence determination, an issue important in and of itself.

Background

For the factual background of the case, and some definitions, please see Appendix A.

For context here, suffice it to state that IAC InterActiveCorp (Old IAC) was the controller of Match Group Inc. (Old Match), a leading online dating website, with Barry Diller being the controlling shareholder of Old IAC. (Claims in the case against Diller personally were recently dismissed a second time. See In re Match Group, Inc. Derivative Litigation (Del. Ch. Oct. 2, 2024).) Old Match separated from Old IAC in a reverse spinoff transaction. In that transaction, Old IAC distributed to its shareholders all its businesses other than Old Match, and at the same time, Old Match, through a merger transaction, became a wholly owned subsidiary of Old IAC. The minority shareholders of Old Match received a minority interest in Old IAC, renamed Match Group Inc. and now a highly leveraged company.

Old Match formed a special committee to negotiate with Old IAC in the hope that the directors’ determinations could obtain the benefit of MFW. The former minority shareholders of Old Match challenged their treatment in the separation transaction. The Old Match shareholders disputed the reliance on MFW, inter alia, because of the lack of full independence of the special committee.

The independence ruling

As noted, the Delaware Supreme Court ruled that in order to obtain the benefit of MFW, all members of a special committee acting on behalf of the company and negotiating opposite the controller must be independent.

One of the directors appointed to the special committee of Old Match was Thomas McInerney. The Delaware Court of Chancery determined that Mr. McInerney lacked independence. But contrary to the ultimate ruling of the Supreme Court, it held that this was not fatal to the application of MFW because a majority of the committee was still independent. While reversing the Chancery Court on the application of MFW, the Supreme Court agreed that the plaintiffs had adequately alleged that Mr. McInerney lacked independence. In doing so, the Supreme Court took account of these factors:

• McInerney worked at Old IAC for 13 years, including seven years as the CFO.
• Over the period of his employment, as alleged by the plaintiffs, he earned more than $55 million.
• When Mr. McInerney announced that he was leaving Old IAC, he stated he was “more than grateful to Barry Diller for the opportunities he and IAC have given me,” and Mr. Diller said of Mr. McInerney that he held “total respect for [McInerney’s] ability, trustworthiness and decency.”
• McInerney had served as a director of various Old IAC-affiliated companies since 2008, including Old Match.
• It was alleged that Mr. McInerney earned more than $4.5 million from serving on the Old IAC-affiliated boards.

In holding that the plaintiffs adequately pleaded lack of independence, the Supreme Court offered these observations:

• Long-standing business affiliations, particularly those based on mutual respect, are of the sort that can undermine a director’s independence.
• Directors who owe their success to another will conceivably feel as though they owe a “debt of gratitude” to that individual.

The court summed up the alleged independence disqualifying relationship of Mr. McInerney with Old IAC and Mr. Diller as one of “personal ties of respect, loyalty, and affection.”

Some prior Delaware case law on director independence

Much of the prior case law on director independence arose in the context of “demand futility.” Plaintiffs in demand futility cases argue that a shareholder derivative lawsuit should be allowed to proceed without the otherwise required predicate of a demand on the board to act because of a lack of director independence by at least a majority of the board. The standard most often applied by the court to assess director independence derives from the Martha Stewart Living Omnimedia case — whether the director is “so ‘beholden’ to an interested director … that his or her ‘discretion would be sterilized’” (quoting Aronson v. Lewis (Del. 1984). Other variants, with substantially similar import, exist as well, such as “whether a director is, for any substantial reason, incapable of making a decision with only the best interests of the corporation in mind” (utilized in In re Oracle Derivative Litigation).

In the Supreme Court

The following chart summarizes a number of Delaware Supreme Court decisions in the area of director independence.

In the Chancery Court

The Delaware Chancery Court has also instructively addressed independence in various cases. These are a few:

‘Tornetta v. Musk’

In Tornetta v. Musk (Del. Ch. Jan. 2024), the Chancery Court’s decision earlier this year invalidating Elon Musk’s incentive pay package at Tesla, the court considered the independence of each of the members of the Tesla board who approved these compensation arrangements. The court applied the sterilization standard from Martha Stewart Living Omnimedia. Of the directors that the court found to clearly lack independence, one enjoyed a decades-long personal relationship with Musk, with more than $1 billion invested in Musk-controlled entities, and another was a longtime friend of Musk with whom he repeatedly vacationed with their respective families. Other directors had fewer compromising ties to Musk (in one case, none), which the court characterized as falling along a spectrum.

Something new?

All the Delaware court decisions addressing director independence can be said to turn on a commonsense analysis, but where reasonable minds can sometimes differ. Factors such as longtime personal relationships, close business ties and the creation of opportunity for outsized financial gain have long been seen as compromising independence. In many cases, as the court said in Tornetta v. Musk, the relationships will fall along a spectrum and the determination of independence or lack thereof will necessarily turn on the particular constellation of facts and the inclinations of the judicial decisor.

The Supreme Court’s independence determination in Match, however, can be seen as additive to the legal mix in this area. The court’s observation that the independence-compromising relationship of Messrs. McInerney and Diller was one of “respect, loyalty, and affection” seemingly introduces new elements for courts and practitioners to consider when assessing director independence. Also, the court’s remark that independence may be compromised where a director owes their professional success to an individual suggests that the effects of circumstances that undermine independence may in some cases linger long after the circumstances themselves have dissipated. Neither of these points constitutes a radical departure from the independence jurisprudence of the Delaware courts or the common sense on which it rests. Nevertheless, the Match decision may, if only slightly, lower the bar in appropriate cases for plaintiffs alleging the absence of director independence.

Lessons learned

As most director independence cases appear to involve demand futility, it is instructive to have two significant cases this year, Match and Tornetta v. Musk, that address independence at the stage of board or committee determinations. Given the subjective line drawing in which the courts rendering decisions in this area must engage, it is fair to ask whether a decision to sue a controller is affected by personal, business and financial relationships in the same way as a decision to approve a controller transaction. Based on the interchangeable use of precedent in the recent cases and others, it does not appear that the courts make any such distinction. But there is one important procedural difference. In demand futility cases, when independence is first raised as a concern, the script has already been written and implemented and the board and the controller are left to deal with facts that are already in place. In contrast, when an issuer begins its consideration of a controller transaction, it has the opportunity to structure a committee or other group of board independents that, based on the guidance offered by judicial precedent, should withstand challenge.

Clearly, it would be best to populate the special committee representing the company in a controller transaction with directors who are, and always have been, socially and financially insulated from the controller. By the very nature of controlled companies, however, a majority of the members of the board are likely to have some relationship with the controller. The board must therefore draw a line between directors with a soft relationship with the controller whose independence of judgment can be defended and directors who will likely fail the independence test. These guidelines suggest themselves.

1. The determination of independence will be made by a judge in hindsight. In deciding whether a director is independent, the board should adopt the mindset of a trier of fact looking back at a completed transaction in which it may be alleged that the controller has received a materially disproportionate benefit.
2. If a director has realized substantial, quantifiable financial benefit as a result of their relationship with the controller, the director’s independence will likely be questioned. A benefit that is outsized compared to the director’s other assets or income is suggestive of nonindependence.
3. All personal and business relationships between the controller and a director should be considered. Plaintiffs alleging and courts addressing nonindependence tend to consider the cumulative consequence of such relationships.
4. The length of time of the relationship is not necessarily dispositive. It could be a factor, however, when viewed in combination with other touch points between the controller and the director.
5. Even a relationship transpiring years before a proposed committee appointment can be relevant if it was transformative for the director.
6. Social relationships that entwine not only the controller and the director but their families as well may be relevant to the analysis of independence.
7. Public expressions of mutual respect and admiration, coupled with a business relationship, should be considered.
8. Service by the director on numerous boards of entities affiliated with the controller, especially where the director cumulatively receives a substantial amount of consideration, should be considered but may not be dispositive.
9. Common views regarding business, finance and politics can be safely ignored.
10. Common philanthropic activity, without more, should also not be of concern.
11. A long-standing but casual relationship between the director and the controller will probably not support a challenge to independence.

A note on director independence and independent directors

The rules of the New York Stock Exchange and the Nasdaq Stock Exchange prescribe independence requirements for boards of directors and various director committees. For companies listed on the New York Stock Exchange, for example, for a director to be deemed independent, the board of directors must “affirmatively determine[] that the director has no material relationship with the listed company (either directly or as a partner, shareholder or officer of an organization that has a relationship with the company).” Item 407(a) of SEC Regulation S-K requires public companies to provide disclosure regarding the independence of their directors and persons nominated for election as directors, typically under the applicable stock exchange standards. The disclosure must include a description of any transactions, relationships or arrangements that were considered by the board in determining that a director is independent.

The director independence standards of the stock exchanges focus on the independence of a director from the company on whose board he or she serves and its senior management. The standards, and the decisions that a board makes in applying those standards, will in many instances overlap with the independence decision-making process that a board is often called upon to make under state law principles. A director who has a close relationship with a senior executive will likely not be independent either for stock exchange purposes or under the Delaware jurisprudence discussed above. For example, in a recent SEC enforcement action, the SEC obtained an order on consent against a purportedly independent director who failed to disclose to the board a close personal relationship with a senior executive, including frequently vacationing with the executive and the executive’s spouse and paying for the executive and his spouse on several such international vacations. (SEC v. James R. Craige (SDNY Oct. 1, 2024))

The state law principles are broader in their scope of application, however. In certain instances, a director who is independent for stock exchange and SEC purposes may fail the test of independence in respect of a particular transaction because of his or her interest in the transaction or because of a common interest with other independent directors on the board. Indeed, in many of the Delaware cases described above, directors who no doubt were categorized as independent in a company’s SEC filings were found by the court to lack independence in the roles that they were tasked with fulfilling in the particular case.

Appendix A

The separation transaction in brief

IAC/InterActiveCorp, founded and controlled by Barry Diller, is a holding company for various online brands and services. In 1999, IAC acquired Match Group Inc., a leading online dating website. Fast forward to 2019 and IAC determined to separate Match from the rest of IAC’s businesses. It proposed to do so in a separation transaction that included a so-called reverse spinoff coupled with a merger. In a classic spinoff, the business to be separated from a company is distributed by the company to its shareholders. In a reverse spinoff, the business to be separated from the rest of the company remains behind and the rest of the company’s businesses are spun off to shareholders.

The following diagram illustrates the structurally complex Match reverse spinoff transaction:

The diagram and this appendix adopt terminology used by the court, repeated here:

Old IAC was a public company, of which in 2019 Mr. Diller beneficially owned 15.5% of the equity and 43.1% of the voting power. Old Match was also a public company with a dual class structure, whose equity and voting power were split between Old IAC and the public shareholders in the percentages of 24.9% (equity)/98.2% (vote) and 75.1% (equity)/1.8% (vote), respectively.

The separation transaction proceeded through these steps:

• Old IAC created New IAC and transferred to New IAC all its businesses other than the Match business.
• Old IAC issued $1.5 billion of its stock and contributed the proceeds to New IAC.
• Old Match declared a cash dividend of $850 million, of which $680 million went to Old IAC, as its majority owner, which Old IAC then contributed to New IAC.
• Old Match spun off New IAC to its shareholders.
• Old IAC formed a merger subsidiary that merged into Old Match, as a result of which Old Match became a wholly owned subsidiary of Old IAC, and Old IAC changed over to a single class structure.
• Old IAC was renamed Match Group Inc. and New IAC was renamed IAC/InterActiveCorp.
• In the merger, Old Match’s minority shareholders gained an additional 2% of the Match business but in a highly leveraged company.
• Old IAC’s shareholders received most of the interest in New Match as well as shares in New IAC, which was cash-rich with little to no debt.

Old IAC was the controller of Old Match. There was enough here to at least suggest that Old IAC received benefits in the merger not shared by the minority, public shareholders of Old Match. Traditional Delaware corporate jurisprudence, developed largely in the context of so-called take-private or freeze-out transactions, would require the merger to be reviewed under the heightened standard of entire fairness unless the MFW exception, so called after the Delaware Supreme Court case of Kahn v. M&F Worldwide Corp. (2014), were available. If the MFW exception applied, the merger would be reviewed under the much lower business judgment standard, which essentially defers to the judgment of the board.

Enter ‘MFW’

MFW is available to limit the standard of review of a controller transaction from entire fairness to business judgment if two requirements are satisfied:

1. The transaction must be negotiated from beginning to end on behalf of the company — here, Old Match — by an independent committee of the company’s board.
2. The transaction must be approved by an uncoerced, fully informed majority of the shareholders other than the controller — here, a majority of the public shareholders of Old Match.

Old Match sought to comply with MFW. It duly appointed an independent committee of its board to negotiate with Old IAC. It also conditioned the merger transaction on the approval of a majority of Old Match’s public shareholders, which it obtained. The merger and the reverse spinoff closed but were challenged in Delaware Chancery Court by certain public shareholders of Old Match.

Despite some reservation on the composition of the independent committee of the Old Match board, the Chancery Court found that a majority of the committee was independent. It therefore ruled that the MFW procedures had been followed and dismissed the case.

In the Delaware Supreme Court

On appeal, New Match (Old IAC) advanced two arguments in support of the case dismissal. First, it argued that MFW did not apply to a controller transaction in which the controller did not take the company private. In all other controller transactions, it was sufficient in order to obtain business judgment review that the transaction be approved by either an independent board committee or a vote of the majority of unaffiliated shareholders. Second, it maintained, even if MFW applied, Old IAC complied with MFW, as it obtained approval of the separation transaction by both an independent committee and an unaffiliated shareholder vote of Old Match.

After a comprehensive review of its precedent, the court ruled that MFW applies to all controller transactions. Where a controller sits opposite the company at the bargaining table, it is effectively negotiating with itself. Delaware law therefore requires both an independent committee serving as a surrogate for the company on the other side of the negotiating table and an unaffiliated shareholder vote. Otherwise, the heightened entire fairness scrutiny will apply to the transaction.

For reasons discussed above, the Chancery Court found that one of the directors on the independent committee was in fact not disinterested. The Chancery Court nonetheless held that the conditions of MFW were satisfied because a majority of the committee was independent. The Supreme Court reversed and ruled that in order to fulfill the independent committee requirement of MFW, the entire committee must be independent.