Lewis H. Lazarus

Court of Chancery Denies Expedited Process in Merger of Limited Partnership Even Though Plaintiff Stated Colorable Claim

Authored by Lewis H. Lazarus
This article was originally published in the Delaware Business Court Insider | July 13, 2011

The Court of Chancery often hears applications for expedition of a plaintiff's motion to enjoin a merger transaction. While the court "has followed the practice of erring on the side of more hearings rather than fewer" (Giammargo v. Snapple Beverage Corp. (1994)), it will not schedule an expedited hearing unless the plaintiff can show good cause.

The June 10 opinion in In Re K-Sea Transportation Partners L.P. Unitholders Litigation illustrates that, even where a plaintiff can state a colorable claim, the court will not schedule an expedited hearing if the plaintiff fails to show "a sufficient possibility of a threatened irreparable injury, as would justify imposing on the defendants and the public the extra (and sometimes substantial) costs of an expedited preliminary injunction proceeding," (citing Giammargo).

The K-Sea case also illustrates that when parties to agreements governing limited partnerships, limited liability companies or other alternative entities modify or eliminate fiduciary duties, a Delaware court will enforce the agreements as written. Courts will not undo what one party now believes is a bad bargain through the application of fiduciary duties or the implied covenant of good faith and fair dealing.

PARTNERSHIP ACQUISITION

K-Sea involved the acquisition of a Delaware partnership. The acquirer sought to acquire the limited partnership by merger for either cash or a combination of cash and the acquirer's stock. Representatives of the board of directors of target's general partner negotiated the terms of the merger agreement. A special committee approved the transaction.

The plaintiffs argued that the special committee's approval did not comply with the K-Sea Limited Partnership Agreement (LPA) for two reasons. First, the special committee failed to consider separately an $18 million payment to the general partner for its incentive distribution rights (IDRs). Second, the members of the special committee were not independent because shortly before the beginning of merger negotiations with the acquirer, the target granted them each 15,000 phantom units that would immediately vest upon a change of control.

The plaintiff-unitholders also challenged the disclosure provided the common unitholders in the registration statement.

  More ›

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Lewis Lazarus Authors Article on Plaintiffs' Pleading Burden in the Court of Chancery

Lewis H. Lazarus
This article was originally published in the Delaware Business Court Insider | June 15, 2011

A plaintiff who pleads successfully that a transaction under attack is governed by the entire fairness standard of review instead of business judgment generally stands a good chance of defeating the defendant's motion to dismiss.  That is because when a transaction is reviewed for entire fairness, defendants bear the burden in the first instance of proving at trial the fairness of the process and price.

In two recent cases - Ravenswood Investment Co. v. Winmill and Monroe County Employees' Retirement System v. Carlson - the Court of Chancery clarifies that a plaintiff must still make well-pleaded allegations that a transaction is unfair as to process and price if its complaint is to survive dismissal at the pleadings stage.

Ravenswood involved claims that defendant directors' adoption of a performance equity plan violated fiduciary duties by seeking to dilute the minority stockholders' percentage interest in non-voting Class A shares (only Class B shares had voting rights).  The court noted that the entire fairness standard applied because "where the individuals comprising the board and the company's management are the same, the board bears the burden of proving that the salary and bonuses they pay themselves as officers are entirely fair to the company unless the board employs an independent compensation committee or submits the compensation plan to shareholders for approval."

Because the directors employed no such protective measures, the court held that the entire fairness standard of review applied.  Still, citing Monroe County, the court held that the plaintiff "bears the burden of alleging facts that suggest the absence of fairness."

The court dismissed the plaintiff's complaint because it found he had failed to make well-pleaded allegations that the defendant directors' adoption of the performance equity plan was unfair.  Critical to the court's reasoning was that dilution occurs upon the adoption of any options plan; the question is whether the manner in which the options were issued unfairly diluted the stockholders.

As the defendants in their motion to dismiss did not challenge the plaintiff's claim for unfair issuance of the options, the court found that the plaintiff's allegation of dilution did not suffice to state a claim for unfairness in the adoption of the performance equity plan.

This was so because the plaintiff alleged that "(1) the Performance Equity Plan only authorizes the Board to grant stock options with an exercise price not lower than the market value as of that event, (2) the Defendants already control all of the Company's voting rights through their ownership of its Class B shares, and (3) even if all options authorized under the plan were to be granted to the Defendants they would not obtain a majority interest in the Class A shares... ."

The court noted that although it was true that the Class A shares could vote to approve a merger, the plaintiff made no allegation in his complaint that the adoption of the performance equity plan impaired those voting rights.  The court declined to comment on whether such an allegation may have sufficed to sustain this claim.

The Ravenswood court relied upon the court's holding in Monroe County.  That case involved a challenge to an intercompany agreement that required the plaintiff's company to purchase services and equipment from its controlling shareholder on terms in conformity with (for services) or the same as (for equipment) what the controlling shareholder charged its other affiliates.  The parties agreed that the arrangement the plaintiff attacked was governed by the entire fairness standard of review.

They disagreed as to whether the plaintiff's pleading sufficed to survive a motion to dismiss.

As summarized by the court: "Delaware law is clear that even where a transaction between the controlling shareholder and the company is involved such that entire fairness review is in play, plaintiff must make factual allegations about the transaction in the complaint that demonstrate the absence of fairness. (citations omitted).  Simply put, a plaintiff who fails to do this has not stated a claim.  Transactions between a controlling shareholder and the company are not per se invalid under Delaware law. (citation omitted).  Such transactions are perfectly acceptable if they are entirely fair, and so plaintiff must allege facts that demonstrate a lack of fairness."

In reviewing the complaint, the court found no allegations that the price at which the controlling stockholder provided the services and equipment was unfair.  Instead, the court found that plaintiff's allegations addressed only alleged unfair dealing.

In the absence of an allegation that the company could have obtained the services or equipment on better terms from a third party or any specific allegation of the worth of the services or equipment relative to what the company paid, the court found that the complaint did not make sufficient factual allegations that the intercompany agreement transactions were unfair.  Because the plaintiff chose to stand on its complaint in response to the defendants' motions to dismiss rather than to amend, the court dismissed plaintiff's complaint with prejudice under Court of Chancery Rule 15(aaa).

Together, these two cases clarify that a plaintiff cannot survive a motion to dismiss simply by alleging that a transaction involving a controlling stockholder is unfair.  A plaintiff instead must make particular factual allegations suggesting why the transaction was unfair.  A plaintiff who cannot make such allegations and who stands on a conclusory complaint, as in Ravenswood, may find that its claims are dismissed with prejudice.

Lewis H. Lazarus (llazarus@morrisjames.com) is a partner at Morris James in Wilmington and a member of its corporate and fiduciary litigation group.  His practice is primarily in the Delaware Court of Chancery in disputes, often expedited, involving managers and stakeholders of Delaware business organizations.  The views expressed herein are his alone and do not necessarily reflect the firm or any of the firm's clients.
 

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Chancery Decisions Highlight Importance of Independent and Disinterested Directors in Company Sale Transactions

Lewis H. Lazarus
This article was originally published in the Delaware Business Court Insider | May 25, 2011
 
Two recent decisions from the Court of Chancery — In re Orchid Cellmark Inc. Shareholders Litigation and In re Answers Corp. Shareholders Litigation — illustrate how parties may reduce deal risk by ensuring that the directors responsible for managing a sale process are disinterested and independent.  At the same time, while the court in both cases rejected challenges to the transactions based on allegedly excessive deal protection terms, the court also signaled that providing much more than the parties did in Orchid may break the court’s proverbial back.

Independence and Disinterest

The court decided each of these cases following an expedited preliminary injunction hearing at which the plaintiffs sought to enjoin the transactions based in part on an allegedly inadequate sales process.  In this Revlon Inc. v. MacAndrews & Forbes Holdings Inc. context, the court is called upon "to assess carefully the adequacy of the sales process employed by a board of directors."  A primary inquiry in assessing a transaction is whether the directors responsible for the negotiations are independent and disinterested.

In Orchid, the court noted that five out of the six directors were independent. Its board formed a special committee to negotiate the transaction.  That committee included two independent directors and a third newly elected director who had been nominated by the company’s largest shareholder.  In addition to the independence of the special committee, the court also found no reason to doubt the independence or credentials of the special committee’s financial adviser.

Likewise, in Answers, although the plaintiffs raised questions about the independence of two of the directors, the court found that those directors did not lead the negotiations.  Moreover, four out of the seven directors who approved the transaction were disinterested and independent.  Finally, the court held that the company’s financial adviser’s independence and qualifications were not seriously challenged.  The independence of the directors and their advisers were significant factors in the court’s decision in both cases to uphold the reasonableness of the boards’ decision making.

Deal Protection Terms

The court noted that deal protection terms such as termination fees, expense reimbursements, and no-talk and no solicitation clauses are standard.  The issue is whether cumulatively they are impermissibly coercive or preclusive of alternative transactions.  In Answers, the court observed that the break-up fee of 4.4 percent of equity value was at the upper end of the "conventionally accepted" range.

However, the court stated that this is not atypical in a smaller transaction.  The court also rejected the plaintiffs’ challenge that the court should measure the break-up fee in reference to enterprise value on the ground that "Our law has evolved by relating the break-up fee to equity value."

In Orchid, the parties' deal protection included not only standard no-shop and termination provisions, but also a top-up option, matching rights and an agreement to pull the company’s poison pill, but only as to the buyer.  The court held that top-up options are standard in two-step tender offer deals.  As to the termination fee, the court found it appropriate in reference to the equity value of the target and again rejected the plaintiffs' effort to measure the termination fee in reference to enterprise value.  The court also recognized that the matching and informational rights might have a deterrent effect on a hypothetical bidder, but it found those provided in the merger documents would not preclude a serious bidder from stepping forward.

The court also found that the selective pulling of the pill was not impermissibly preclusive of alternative bids.  The court reasoned that the merger agreement enables the board to redeem the pill if it terminates the merger agreement.  Termination is permitted if the board receives a superior offer and withdraws its recommendation that the stockholders tender their shares.  The court observed that the termination fee that would be owed if the board terminates the merger agreement for a bidder who makes a superior offer and then pulls the pill would be no greater than if the company accepts a superior offer or terminates the merger agreement for some other reason.

Finally, because "a sophisticated and serious bidder would understand that the board would likely eventually be required by Delaware law to pull the pill in response to a Superior Offer," the court ruled that the deterrent effect of these provisions likely was minimal.

In so holding, the court stated that deal protection measures evolve and cautioned that at some point incremental protection may prove too much:

"Deal protection measures evolve.  Not surprisingly, we do not have a bright line test to help us all understand when too much is recognized as too much.  Moreover, it is not merely a matter of measuring one deal protection device; one must address the sum of all devices.  Because of that, one of these days some judge is going to say 'no more' and when the drafting lawyer looks back, she will be challenged to figure out how or why the incremental change mattered.  It will be yet another instance of the straw and the poor camel's back.  At some point, aggressive deal protection devices — amalgamated as they are — run the risk of being deemed so burdensome and costly as to render the 'fiduciary out' illusory."

Together, these two cases demonstrate the value of a disinterested and independent decision-making body running a sale process.  Also, while the court rejected claims that the deal protection at issue was preclusive or coercive, the court also cautioned that counsel must be careful not to make an alternative transaction too burdensome or costly, lest any fiduciary out be deemed illusory.  Counsel should carefully evaluate the context of each transaction in determining appropriate deal protection, lest an added straw of protection is found to be the one that breaks the court’s proverbial back.

Lewis H. Lazarus (llazarus@morrisjames.com) is a partner at Morris James in Wilmington and a member of its corporate and fiduciary litigation group.  His practice is primarily in the Delaware Court of Chancery in disputes, often expedited, involving managers and stakeholders of Delaware business organizations.  The views expressed herein are his alone and not those of his firm or any of the firm's clients.
 

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'Material Adverse Change' Clauses Protect Against Loss of Customers and Suppliers

Lewis H. Lazarus and Jason C. Jowers
This article was originally published in the Westlaw Journal Delaware-Corporate | May 4, 2011

In the article, Lewis H. Lazarus and Jason C. Jowers discuss the need for transactional and litigation attorneys who negotiate or litigate material adverse change clauses to focus on the particular language at issue as differences in phrasing could affect whether a seller is protected from a buyer's claim of breach.

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Ignoring Chancery Court's Guidance on How to Act in Merger Transactions Could Jeopardize Deals

Lewis H. Lazarus
This article was originally published in the Delaware Business Court Insider | May 04, 2011

The Delaware Court of Chancery, mindful of its role as a pre-eminent business court, works hard to communicate its expectations of officers and directors and their advisers.  That facilitates predictability.  Companies can be bought or sold with reduced risk that proposed transactions will be enjoined.  The corollary is that when advisers and their boards do not follow the rules, they put their clients’ transactions at risk.  Two recent cases illustrate that the Delaware Court of Chancery will not hesitate to enjoin a transaction where parties ignore clear guidance from prior opinions.

In its Feb. 14 decision in In re Del Monte Foods Co. Shareholders Litigation, the Court of Chancery enjoined a merger transaction from closing for 20 days and voided the deal protection terms that would have made a competing bid more expensive during that time period.  It did so because of conflicts of interest by the seller’s investment adviser.  The conflict arose because the seller’s investment adviser worked with the buyer to develop its merger proposal without telling the board, in apparent violation of a confidentiality agreement arising out of a previous failed effort to sell the company.  It then sought a role in providing buy-side financing.  All this while acting as financial adviser to the seller.

In enjoining the transaction the court relied on In re Toys "R" Us Inc. Shareholder Litigation, a 2005 case in which the court held that generally "it is advisable that investment banks representing sellers not create the appearance that they desire buy-side work, especially when it might be that they are more likely to be selected by some buyers for that lucrative role than by others."

Here the court found the investment adviser failed to disclose its conversations with prospective buyers or that it sought from the beginning to provide financing to the buyers.  This prevented the board from taking steps to protect the integrity of the process.  It also caused the seller to incur greater fees because once it was disclosed that the investment adviser sought to provide buy-side financing, the conflict required the board to obtain a new investment banker to opine on the fairness of the transaction.  Thus, while "the blame for what took place appears at this preliminary stage to lie with Barclays, the buck stops with the Board," the court said in Del Monte.

The remedy the court fashioned was unique — voiding the deal protection terms while enjoining the closing to permit a 20-day go-shop — but reflects the traditional equity power of the court to fashion a remedy tailored to the breach.  The court had no problem voiding the contractually bargained-for deal protection terms where the buyer knowingly participated in the board’s breach of fiduciary duty.  In so doing, the Del Monte court emphasized, "After Vice Chancellor [Leo] Strine’s comments about buy-side participation in Toys 'R' Us, investment banks were on notice."

Three weeks later, in its March 4 decision in In re Atheros Communications Inc. Shareholders Litigation, the Court of Chancery enjoined another transaction where the board failed to disclose the nature and amount of the investment adviser’s fee.  In Atheros the court found that stockholders voting on a proposed merger transaction would find it important to know that the investment adviser who rendered the fairness opinion upon which the board relied would receive 98 percent of its fixed fee only if a transaction closed.  The court was not troubled by the contingent fee per se, but rather by the fact that more than 50 times the portion that was otherwise due would be received only if a transaction closed.  As the court held, "the differential between compensation scenarios may fairly raise questions about the financial adviser’s objectivity and self-interest."

An additional factor justifying the court’s entry of injunctive relief was that the board did not disclose how soon in the process the seller’s CEO, who actively participated in negotiating the transaction price, knew that he would be staying on and receiving compensation from the buyer.  The court thus required additional disclosure on this point, finding that information that the CEO knew he would receive an offer of employment from the buyer at the same time he was negotiating the offer price would be important to a reasonable stockholder in deciding how to vote.

Both of these cases demonstrate the vitality of the court’s observation in Del Monte, cited in Atheros, that "because of the central role played by investment banks in the evaluation, exploration, selection, and implementation of strategic alternatives, this court has required full disclosure of investment banker compensation and potential conflicts."

That guidance means that practitioners and advisers would be well-served to avoid conflicts, to counsel their clients to avoid them, and to disclose such conflicts promptly.  Boards must also ensure that possible conflicts on the part of management who participate in the sale negotiations are properly managed by the board and fully disclosed.  As these cases demonstrate, it is the board’s responsibility to manage the sale process and failure to follow clear guidance from the case law imperils prompt closing of potential transactions.

Lewis H. Lazarus (llazarus@morrisjames.com) is a partner at Morris James in Wilmington and a member of its corporate and fiduciary litigation group.  His practice is primarily in the Delaware Court of Chancery in disputes, often expedited, involving managers and stakeholders of Delaware business organizations.  The views expressed herein are his alone and not those of his firm or any of the firm's clients.
 

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Directors Designated By Investors Owe Fiduciary Duties to the Company as a Whole and Not to the Designating Investor

This article was originally published in The Delaware Business Court Insider | 2011-03-23

Investors who make substantial investments often demand a seat on their company’s board of directors.  That is a reasonable request as it permits the investor to have a representative on the board of directors with a voice in management of the company.  It is well-settled that directors elected by stockholders of a Delaware corporation owe fiduciary duties to the company and all its stockholders once they serve on the board.  Thus, they may make decisions in the exercise of their fiduciary duty that are different than what is in the best interest of designating investor. The Court of Chancery’s recent decision in Air Products and Chemicals, Inc. v. Airgas, Inc., 2011 WL 519735 (Del. Ch. Feb. 15, 2011) reflects this issue.

Air Products had sought to acquire control of Airgas since October, 2009.  When Airgas rebuffed its inquiries, Air Products launched a hostile tender offer.  One of the conditions of its tender offer was that Airgas lift its poison pill.  The poison pill made it prohibitively expensive for Air Products to proceed.  Airgas refused to lift the pill on the ground that the Air Products offer was inadequate.

Frustrated by its inability to proceed with a tender offer, Air Products nominated three directors to the Airgas board.  It stated that its nominees would be impartial in their evaluation of the Air Products tender offer, although they would be replacing Airgas directors who had voted to maintain the Airgas poison pill. Air Products succeeded and its three nominees were elected by the Airgas stockholders to the Airgas board.  Once they were on the board of Airgas, the Air Products designees obtained their own legal and financial advisors. Based in part on the advice of their advisors and on their own assessment of the business plans of Airgas, these Air Products nominated directors determined that the Air Products offer was inadequate and voted with their colleagues to maintain the Airgas poison pill.

In so acting, these directors acted consistently with Delaware law.  As stated in Phillips v. Insituform of N. Am., Inc., 1987 WL 16285, at *10 (Del. Ch. Aug. 27, 1987) the “law demands of directors … fidelity to the corporation and all of its shareholders and does not recognize a special duty on the part of directors elected by a special class to the class electing them.” 

While the Airgas directors’ conflict arose in a highly-publicized battle for control of a public company, issues also arise in privately held companies where investors often condition their investment on the receipt of preferred stock and board representation. 

For example, in In re Trados Incorporated Shareholder Litigation, 2009 WL 2225958 (Del. Ch. July 24, 2009), the Court of Chancery sustained a complaint on behalf of a class of stockholders who complained that directors designated by preferred stockholders, constituting a majority of the board, had interests that diverged from the interests of the common stockholders in approving a sale transaction.  This divergence arose because the preferred stockholders received a substantial portion of their liquidation preference from the sale, while common stockholders received nothing.  The preferred stockholder designated directors also held interests in entities which held preferred stock of the selling company.  Those relationships bore on the court’s decision to treat the preferred stock designees as having interests potentially different from, and in conflict with, the interests of the common stockholders.  As a result of this finding, the court denied a motion to dismiss because the plaintiffs’ allegations were sufficient to rebut the presumption of the business judgment rule.

These cases teach that directors designated by particular stockholders or investors owe duties generally to the company and all of its stockholders. Where the interests of the investor and the company and its common stockholders potentially diverge, the directors cannot favor the interests of the investor over those of the company and its common stockholders. 

Conflicts also are likely to arise over the use of confidential information supplied to the designated directors.  Designating directors who owe their livelihood or materially benefit from relationships with the designating investor sharpens the likelihood of conflicts of interest. Companies, investors and directors and their counsel should consider carefully the implications of directors designated by particular stockholders serving on boards of Delaware corporations. 
 

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Court Of Chancery Re-affirms Board's Use Of Poison Pill To Block Inadequate Tender Offer

Air Products and Chemicals, Inc. v. Airgas, Inc., C.A. No. 5249-CC / In re Airgas Inc. Shareholder Litigation, C.A. No. 5256-CC (February 15, 2011)

The Court of Chancery denied an application by Air Products and Chemicals, Inc. to force the board of Airgas, Inc. to redeem its poison pill so as to allow the stockholders of Airgas to decide whether to tender into Air Products' all-cash, all-shares offer.  The Court in this 153-page opinion carefully applies Delaware Supreme Court precedent in holding that the Airgas board reasonably believed that the Air Products offer was inadequate and that its decision to maintain its pill was a reasonable response to that threat.  A major factor in upholding the reasonableness of the Airgas board's actions was that three directors nominated by Air Products supported the decision to maintain the pill.  While some have questioned the continued vitality of doctrine that allows the board to maintain a poison pill in the circumstance of an all-cash, all-shares and fully financed offer, this decision re-affirms Delaware's director-centric approach to corporate governance.  The description in the opinion of the process followed by the Airgas board serves as a primer for how a board might defend against a tender offer it believes is inadequate.

 

 

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Delaware Supreme Court's Determination That Record Does Not Permit Interlocutory Review of Court of Chancery's CNX Gas Decision Leaves for Another Day Questions Concerning Standard of Review in Two-Step Unilateral Freeze-out Transactions

  In re CNX Gas Corp. Shareholders Litig., Consol. C.A. No. 5377-VCL (July 5, 2010)

The standard of review applicable to two-step unilateral freeze-out transactions remains uncertain following the Delaware Supreme Court’s decision[1] to deny interlocutory review of the Court of Chancery’s decision[2] to refrain from enjoining a majority shareholder’s tender offer even though the Court of Chancery had certified the Injunction Decision for interlocutory review[3]. In the Interlocutory Appeal Decision, the Court outlined its views of conflicts in the Court of Chancery’s determination of the appropriate standard of review as a factor that would justify interlocutory appeal. Although the Supreme Court declined interlocutory review, for practitioners seeking guidance among the competing standards, the Court of Chancery’s Interlocutory Appeal Decision provides a clear overview.

 

Three Choices

 

The Court of Chancery will apply one of three standards of review to a unilateral two-step freeze-out transaction: (i) entire fairness unless the transaction is structured to simulate arms’ length third party approvals by both the board and the stockholders (“Cox Communications[4] test” or “Unified Standard”)[5]; (ii) no substantive review as long as the transaction is subject to a non-waivable majority of the minority condition; the controlling stockholder promises to consummate a short-form merger at the same price if it obtains more than 90% of the shares; the controlling stockholder makes no retributive threats; and the independent directors have free rein and adequate time to react to the tender offer (“Pure Resources[6] test” or “Hybrid Standard”); and (iii) no substantive review for entire fairness unless the transaction is structurally coercive (“Siliconix[7] test”).

 

Standard of Review May Determine Outcome

 

As the Court noted in its Interlocutory Appeal Decision, the standard the court applies may be outcome-determinative.  Thus, the Court of Chancery in its Interlocutory Appeal Decision states that the outcome in Siliconix would have differed because had either the Hybrid or Unified Standard applied, the Siliconix defendants would have failed both tests, primarily because the controlling stockholder did not commit to a cash-out merger on the same terms as the tender offer.  The Interlocutory Appeal Decision also noted similar deficiencies in other cases that preceded and followed Siliconix and were not substantively reviewed, but would not have passed muster under the Hybrid or Unified standards.

 

Cases Differ in What Constitutes “Inherent Coercion”

 

The Interlocutory Appeal Decision also identified conflicts in the case law concerning whether inherent coercion is present when a controlling stockholder tenders to buy the stock held by minority stockholders. The Court noted that certain cases pre- and post-Siliconix held that unlike in a cash-out merger by a controlling stockholder, a controlling shareholder’s tender offer was not coercive as long as the majority shareholder did not unduly pressure the minority such as by threatening to de-list if the tender offer failed. But the Court of Chancery in other cases found no distinction between the inherent coercion that the Delaware Supreme Court has recognized in single-step freeze-out transactions by controlling stockholders and that present when a majority shareholder tenders for the shares it does not own. Compare Siliconix and Pure Resources. The Court also noted that the Injunction Decision, Cox Communications and Pure Resources may conflict with Kahn v. Lynch Communication Systems Inc., 638 A.2d 1110 (Del. 1994) over the effect that protective devices such as independent director or majority of minority approval may have on the standard of review. Lynch held that the possibility of retribution if the stockholders defied the wishes of the majority stockholder required the application of the more searching entire fairness standard of review even if the transaction were negotiated with a committee of independent directors and approved by a majority of fully informed minority stockholders. By contrast, Pure Resources, Cox Communications and the Injunction Decision would allow for the application of business judgment review if the controlling stockholder’s transaction is negotiated and approved by disinterested and independent directors and a fully informed majority of the minority stockholders.

 

Cases Differ in Role of the Board in Responding
to a Tender Offer by a Controlling Stockholder

 

The Court also pointed out a conflict in the proper role of the board under the past decisions.  The Siliconix line of cases holds that the target board has no necessary role, the Pure Resources line of cases provide for an advisory role, and the Injunction Decision holds that the target board has the same role responding to a controlling stockholder’s tender offer as it does in responding to a third-party tender offer.  The Court emphasized that its holding in the Injunction Decision was grounded on its understanding of the board-centric foundation of Delaware corporate law with which the Siliconix line of cases was inconsistent.

 

Court Cites Scholarly Research Finding that Stockholders
Receive Greater Consideration in Single-Step Freeze-outs

 

Finally, the Court cited scholarly work indicating that stockholders receive greater consideration in single-step freeze-outs and in negotiated two-step freeze-outs than in unilateral two-step freeze-outs.  The Court thus concluded that:

All else equal, a legal regime that makes it easier for controllers to freeze out stockholders will increase the number of transactions but result in lower premiums. Conversely, a legal regime that imposes greater procedural requirements will enable target stockholders to receive higher premiums but reduce the overall level of transactional activity. Either approach is legitimate and defensible. Either approach could result in the greatest aggregate benefits for stockholders, depending on the typical premium and overall level of deal activity.

Interlocutory Appeal Decision at *12.

 

Supreme Court Declines Interlocutory Appeal
So Foregoing Differing Approaches Will Remain

 

            Notwithstanding the Court of Chancery’s delineation of the conflicts in the lower court concerning the proper standard to apply, on July 8, 2010 the Delaware Supreme Court determined in its discretion that the application for interlocutory review should be denied “based upon the current state of the record.” CNX Gas III at *1. In the absence of definitive guidance, practitioners would be well-advised to review the Court’s Interlocutory Appeal Decision for a concise statement of the standards of review that may apply to unilateral two-step freeze-out transactions with controlling stockholders.

 

  

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Court of Chancery Holds Jilted Suitor May Recover Damages Even After Target Pays Termination Fee and Expense Reimbursement

NACCO Industries Inc. v. Applica Incorporated, C.A. No. 2541-VCL (December 22, 2009)

In this decision, the Court's newest Vice Chancellor, the Hon. J. Travis Laster, substantially denied a motion to dismiss a complaint filed by a jilted suitor who sought damages from the target and the winning bidder.  The complaint alleged that the target violated no-shop and prompt notice provisions of a merger agreement between plaintiff and the target that the target later terminated in favor of a superior proposal from the defendant winning bidder.  Plaintiff alleged that the winning bidder violated Delaware law by fraudulently misstating its intentions in filings required by the Securities Exchange Act of 1934 ("the Exchange Act).  The Court of Chancery upheld plaintiff's claims for breach of contract, tortious interference with contract, fraud, and civil conspiracy for fraud.  Although the Court emphasized that its decision was required under the plaintiff-friendly standard the Court applied in analyzing a motion to dismiss a complaint at the pleadings stage, the opinion has three critical lessons for practitioners concerning (i) the potential inadequacy of termination fee and expense reimbursement provisions to preclude a damages claim, (ii) the viability of state law claims arising out of misstatements in public filings required as a matter of federal law, and (iii) the relation of prior injunction proceedings to later claims for damages.

Payment of Termination Fee and Expense Reimbursement Does Not Preclude a Damages Remedy Where Jilted Suitor Can Allege Fraud Under State Law

First, the Court rejected defendants' arguments that plaintiff was not entitled to damages because the target paid a termination fee and expense reimbursement upon termination.  The Court held that if plaintiff were able to show a breach of the merger agreement between the jilted suitor and the target, it should be entitled to receive expectancy or reliance-based damages.  The Court recognized that any reliance-based recovery would have to overcome the jilted suitor's receipt of a bargained-for $4 million termination fee and $2 million expense reimbursement.  But at the pleadings stage, it was sufficient for the Court to note that the merger agreement excluded from the limitation on liability any termination arising from a willful or material breach of a representation, warranty or covenant in the merger agreement.  The Court also noted that the target's ability to terminate and pay fees without further liability required it to comply with its obligations under the no-shop and prompt notice provisions.

Exchange Act Does Not Preclude State Law Claims for Fraud

Second, the Court of Chancery explained that the mere fact that plaintiff's allegations against the winning bidder arose out of filings mandated by the Exchange Act did not deprive a state court of jurisdiction to resolve fraud claims brought solely under state law.  The Court noted that a Delaware Supreme Court decision, Rossdeutscher v. Viacom, Inc., 768 A.2d 8 (Del. 2001), and federal decisions comported with this result.  The Court's scholarly analysis of this issue at pages 31-42 culminates with emphasis on Delaware's interest in "preventing the entities that it charters from being used as vehicles for fraud."  In short, the opinion reaffirms that the Exchange Act contemplates a balance between state and federal roles and responsibilities and does not preempt fraud claims arising under state law.

Moreover, in permitting the jilted suitor to bring a fraud claim, the Court held it was entitled to rely on the bidder's statements in public filings.  Note that the Court does not require the jilted suitor to have bought securities or limit the damages to the loss it incurred as a result of its purchase of the target's stock.

Federal Decision Denying Preliminary Injunction Based on Same Claims of Alleged Falsity of Public Filings Does Not Preclude Later State Law Claim for Damages

Third, a decision rendered denying a preliminary injunction is not case dispositive.  Here an Ohio Federal District Court had denied an application by the jilted suitor to enjoin the winning bidder's merger with the target based on the same alleged misstatements that formed the basis of the jilted suitor's later state law claim.  The strength of that court's conclusion - "[c]ontrary to Plaintiff's position, the Court does not perceive any falsity in [the winning bidder's] filings when they are properly viewed alongside unfolding events." (NACCO Indus., Inc. v. Applica Inc., 2006 WL 3762090, at *7 (N.D. Ohio Dec. 20, 2006)) - did not preclude a different result on a different record and in a different procedural context.  The lesson for bidders and practitioners: Absent a binding final judgment, the parties proceed at their own risk.

Perhaps this opinion will focus the attention of transactional lawyers on the breadth of prompt notice provisions in merger agreements and the nature of their clients' intentions when acquiring stock in a target and making the filings required by the Exchange Act.  From a target's perspective, this decision reaffirms that contractual language in merger agreements concerning no-shops and prompt notice of competing proposals will be enforced when a party can plead injury from a breach.  From a bidder's perspective, this decision reinforces the importance of timely and accurate disclosure regarding a client's intentions in purchasing stock of a company that is in play.  The decision is also a reminder that a holding by a Federal district court denying an injunction on a preliminary record does not prevent a later assertion of a state law claim for fraud.  As the Court rendered the NACCO decision on a motion to dismiss it remains to be seen whether liability will be imposed on a fuller record.

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