Fixing Freeze-outs

Abstract

Freezeout transactions, in which a controlling shareholder buys out the minority shareholders, have occurred more frequently since the stock market downturn of 2000 and the Sarbanes-Oxley Act of 2002. While freezeouts were historically executed as statutory mergers, recent Delaware case law facilitates a new mechanism--freezeout via tender offer--by eliminating entire fairness review for these transactions. This Article identifies two social welfare costs of the current doctrinal regime. First, the tender-offer-freezeout mechanism facilitates some inefficient (value-destroying) transactions by allowing the controller to exploit asymmetric information against the minority. Second, the merger-freezeout mechanism deters some efficient (value-increasing) transactions because of the special committee's veto power against the deal. These negative wealth effects are unlikely to be resolved through private contracting between the controller and the minority in the corporate charter. Rather than advocating patchwork reforms to correct these problems, this Article proposes a return to first principles of corporate law in the freezeout context. The result of this re-grounding would be a convergence in judicial standards of review for freezeouts and the elimination of the efficiency loss that is inherent in the existing doctrine.