Posts in M&A

Court Of Chancery Again Denies Injunction Despite Breach Of Duty

In re Delphi Financial Group Shareholder Litigation,  C.A. 7144-VCG (March 6, 2012)

For the second time in a month, the Court of Chancery has denied an injunction against a merger despite serious breaches of duty by the lead merger negotiator.  Here the controlling stockholder refused to vote for the transaction unless he received a "bonus" in the form of more for his stock than the other stockholders were to receive on a per share basis.  This odd demand arose out of some equally odd provisions in the certificate of incorporation where the controller had agreed to equal treatment in any merger but now sought to take back that provision.  That was wrong, the Court held.  However, the deal was too good to enjoin when there was no other deal on the table and none likely to arise later if an injunction stopped the show.  Hence, out of concern for the minority stockholders, the Court let the deal go through and left the stockholders with a damage claim.

While some commentators have argued that such a result is wimpy, they do not seem to worry about the impact on stockholders of killing a deal that represents the golden goose.  The threat of a damage remedy should be enough to deter such conduct in the future,  just as it does in other contexts.

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Court Of Chancery Explains Priority Rule In Merger Litigation

Dias v. Purches, C.A. 7199-VCG (March 5, 2012)

It is often thought that the jurisdiction where suit is first-filed will obtain priority over later filed actions.  As this decision makes clear, that is not true when the litigation involves a representative action and Delaware corporate law applies.  For in that case, the Delaware courts will apply the doctrine of forum non conveniens that gives only slight weight to where the first suit was filed.  More important in class or derivative actions is Delaware's interest in applying its corporate law to Delaware entities.

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Court Of Chancery Declines Injunction Despite Probabililty Of Success

In re El Paso Corp. Shareholder Litigation,  C.A. 6949-CS (February 29, 2012)

This is the now-famous decision finding several breaches of fiduciary duties by the negotiators of a merger, but declining to kill the deal that would have given stockholders a large premium.  The opinion is, as usual for its author, entertaining to read.  More importantly, however, it is once again proof that money may deaden any sense of fiduciary duty, particularly any sense of when there is a conflict of interest.

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Court Of Chancery Instructs What Deal Protection Provisions Are Acceptable

In re Micromet Inc. Shareholders Litigation, C.A. 7197-VCP (February 29, 2012)

This is an excellent primer on what deal protection provisions are acceptable, particularly when the board must have the right to change its recommendation to stockholders when a superior proposal surfaces.  It is permissible to require a board to wait a short time before changing its recommendation to allow the first acquiror to match a new proposal.  However, once that matching right period passes, the board must be free to act promptly.

This opinion also provides a good analysis of the scope of any pre-deal market check and the board's role in limiting the scope of any effort to shop a deal.

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Court Of Chancery Explains Good Faith And Fair Dealing

Winshall v. Viacom International Inc.,  C.A. 6074-CS (November 10, 2011)

This is another case where a party tried to re-do a contract by claiming that the failure to give it more than it bargained for constituted a violation of the covenant of good faith and fair dealing.  In rejecting that claim, the Court again explains the tight limits of that covenant.  It just can not be used to make a new deal.

Affirmer, del Sup. 39, 2013 (October 7, 2013).

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Court Of Chancery Again Interprets The Step Transaction Doctrine

Coughlan v. NXPB, C.A. 5110-VCG (November 4, 2011)

It is sometimes important to decide if a series of transactions are to be coupled together to be treated as one.  The so-called step transaction doctrine does that when applied.  Here the Court used the step transaction to interpret an agreement that gave the selling stockholders the right to a bump up in the merger consideration and certain protections if company assets were sold before all the additional consideration was paid.  This somewhat lenient application of the doctrine may signal its greater acceptance by the Court.

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Court Of Chancery Suggests The Disclosure Of Free Cash Flows

Gaines v. Narachi, C.A. 6784-VCN (October 6, 2011)

What should be disclosed in a proxy is not always clear. This decision notes the reasons and the precedent to disclose free cash flows used to do a discounted cash flow analysis by an investment bank giving the fairness opinion.

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Chancellor Explains How Representations And Warranties Work

GRT, Inc. v. Marathon GTF Technology Ltd., C.A. 5571-CS (July 11, 2011)

One of the more misunderstood aspects of merger agreements is how their representations and warranties are intended to work.  Do they continue after closing?  What is the limit on when litigation may be filed over any breach?  This decision answers those questions and is therefore essential reading for those who deal in these agreements.

Of particular importance is the decision's holding that a 1 year limitation of litigation is binding  and may cut off claims for breach of the representations and warranties.

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Unliquidated Derivative Claims Continue to Have Little Value

This article was original published in The Delaware Business Court Insider | 2011-07-06

On May 31, Vice Chancellor Leo E. Strine Jr. issued an opinion denying a motion for preliminary injunction to halt a merger between Massey Energy Company and an affiliate of Alpha Natural Resources Inc. One of the critical issues in the opinion was the value of the derivative claims Massey had against certain current and former directors and officers arising out of Massey's compliance with federal mining safety regulations.

Massey's attitude toward federal mining safety regulations arguably manifested itself in the Upper Big Branch mine disaster, which resulted in the loss of 29 lives. In his opinion, Strine found that the plaintiffs had probably stated a Caremark claim against the directors of Massey and criticized the board of Massey for failing to assess the value of the derivative claims but ultimately refused to enjoin the merger, concluding that the derivative claims did not have the value plaintiffs believed.

While this result has received some negative commentary, is it really a surprise? In fact, the court's analysis is consistent with prior analyses addressing the value of derivative claims in the context of a merger. The fact that the party here is more infamous than many others did not change the analysis under Delaware law.

The plaintiffs valued the derivative claims based on the "aggregate negative financial effect on Massey that the Upper Big Branch Disaster and its Fall-Out has caused." According to the plaintiffs' expert, these damages range from at least $900 million to $1.4 billion. The court, however, rejected this theory, in large part because the computation of the value of the derivative claims was far more complicated than the plaintiffs' theory.

First, even though the plaintiffs had stated a viable Caremark claim against the directors, because of the business judgment rule and the exculpatory provisions in Massey's certificate of incorporation, in order to obtain a monetary judgment against the directors, they would have to prove that the directors acted with scienter — a difficult standard to meet, particularly with independent directors.

Second, the court also found that even as to the autocratic former leader of Massey, Don Blankenship, who was arguably responsible for Massey's approach to mining safety, meeting this standard would be difficult. The court noted that there is a large gap between pushing the limits of federal regulations while accepting minimal loss of life and knowingly endangering the mine itself by putting its very operations at risk. Moreover, Blankenship was not directly in charge of any specific mine, and tying his policies directly to any disaster would be challenging.

Third, proving that the directors acted with scienter may entitle the corporation to a monetary judgment from the directors, but it would simultaneously expose the company to third-party civil liability and potential criminal liability, and potentially deprive the directors of the ability to rely on insurance coverage, all of which would harm the company.

Fourth, after the merger, Alpha will continue to have to address direct claims against Massey from its lost and injured miners, regulatory consequences of the company's mining safety approach, and other elements of the "Disaster Fall-Out." To the extent possible, Alpha will have every incentive to shift that liability to the former directors.

Fifth, it is impossible to determine the potential derivative liability of the directors until Massey's direct liability is determined. Indeed, it is not even in the interest of Massey's stockholders to press their claims of derivative liability now, before third-party civil and criminal adjudication, lest the plaintiffs expose the company to additional liability.

Sixth, the plaintiffs' expert put no value on the ability of the company or its stockholders to collect on a potential $1 billion judgment. The company's insurance policy, even assuming it is available to cover claims against the former directors, is only $95 million. While this is no small amount, it is, as the court put it, "not material in the context of an $8.5 billion merger."

While the vice chancellor was quick to note that the Massey board's approach to valuation of the derivative claims was less than ideal, because of the factors noted above, he found that the plaintiffs had not persuaded him that the merger was unfairly priced because of the failure to value separately the derivative claims. Was this conclusion so unprecedented, however, to justify criticism of the valuation?

Delaware courts previously have been asked to consider the value of unliquidated, contingent claims belonging to the company in the valuation context. These courts have never valued derivative claims at the full value of all potential damages, but instead have considered many of the factors Strine addressed in Massey.

For instance, in Onti Inc. v. Integra Bank Inc., petitioners in an appraisal action argued that their derivative claims should have been valued as an asset of the company in the appraisal proceeding. The stockholders' expert valued the claims at more than $19 million, while the company's expert valued the claims at negative $2.5 million. The court determined that the claims had no value. In reaching that conclusion, the court adopted the theory advanced by the company's expert, that all litigation factors should be considered, including the likelihood of success on the merits, the attorney fees necessary to obtain that result and any indemnification that the company would owe to its directors. Citing to prior precedent, the court noted that "there would be strong logic in including the net settlement value of such claims as an asset of the corporation for appraisal purposes."

Later that same year, the court took a similar approach in Bomarko Inc. v. International Telecharge Inc. The court valued the claim in that case by multiplying the probability of success by the likely amount of recovery while subtracting costs incurred to obtain that result.

More recently, in Arkansas Teacher Retirement System v. Caiafa, the Court of Chancery overruled an objection to a settlement that released claims that the board failed to ascribe any value to federal derivative claims in a merger. After noting that there is no case law supporting the proposition that the board was required to undertake a separate and discrete valuation of the derivative claims pending at the time of the challenged merger, the court reached the same result as Strine did in Massey, albeit with less analysis. That is, the court noted that the claims asserted in the federal action were difficult to win, and even those that had a higher probability of success could not have the $2 billion value the objectors claimed they did. On appeal, the Delaware Supreme Court affirmed the Court of Chancery's decision to overrule the objection for the reasons set forth in the Court of Chancery's opinion.

Given these precedents, is the result in Massey all that surprising? While some contingent claims have been given value, it is the exception, and not the rule, to assign material value to contingent derivative claims. Moreover, in the context of a merger worth billions of dollars, the likelihood is low that derivative claims have material value, particularly when reasonable defenses can be interposed.

But does this decision mean that boards can just eschew any analysis of the value of a derivative claim in the context of a merger? Probably not. The Court of Chancery certainly did not condone the practice, and had the court not been persuaded that the board otherwise acted properly, the failure to do so could have had more importance.

Further, because the exception to the derivative standing rule that entering into a merger for the purpose of extinguishing derivative claims remains viable, particularly in light of the Supreme Court's opinion in Caiafa, failure to value the claims could support the conclusion that a merger was negotiated simply to avoid liability. Finally, not all derivative claims are equal in this context. As Strine noted in Massey, if Massey had a liquidated claim against a former fiduciary reduced to a judgment but failed to get any value for this claim, he could see the substantial unfairness in failing to obtain value for that claim in a merger. Alternatively, if recovery on any derivative claim after a cash-out merger would inure solely to the benefit of the acquirer, then perhaps there would be value to the buyer in obtaining that claim.

Put simply, as with many issues of fiduciary law, the context of the situation is important. What is fairly clear, however, is that unliquidated contingent derivative claims are not ascribed much value, if any, in a merger context, unless a party can demonstrate a reasonable likelihood that the net value of the claim to the company is material.

Peter B. Ladig (pladig@morrisjames.com) is a partner at Morris James in Wilmington and a member of its corporate and fiduciary litigation group. He represents both stockholders and directors in corporate litigation. The majority of his practice is in the Delaware Court of Chancery, although he has extensive experience in the other state and federal courts in Delaware and has been involved in over 50 published decisions. 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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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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Why Do We Care About 'Poison Pills'?

This article was originally published in the Delaware Business Court Insider | June 08, 2011
 
Why do so many people care about whether the Delaware courts will continue to uphold the "poison pill" defense to a hostile takeover?  After all, comparatively few lawyers practice merger and acquisition law. Few companies are subject to hostile takeover threats, especially in recent years.  And who really stays up at night worrying about the fight between the two largely unknown companies that were the participants in Delaware's latest hostile takeover battle and the weapon of choice among defenders in such battles, the poison pill?

Yet, since the Feb.15 Court of Chancery decision in the Air Products case, there have been almost too-many-to-count blog postings, journal articles and symposia about that decision and its upholding of a poison pill. Who cares?
  More ›

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Court Of Chancery Explains Revlon Application In Mixed Consideration Offers

In re Smurfit-Stone Container Corp. Shareholder Litigation, C.A. 6164-VCP (May 20, 2011, revised May 24, 2011)

When does the Revlon doctrine apply when a takeover offer involves a mix of cash and stock?  After all, at least one Supreme Court decision suggests that if the stockholders will continue as part of a mix of all minority stockholders in the acquiring company, they may still be able to get a control premimum later and so Revlon does not apply.  This decision explains that even when the stockholders are being asked to take stock for some but not all of their shares that they still will lose the ability to get a control premimum for those shares to the extent they are sold for cash. Hence, Revlon applies and the board is required to get the best price possible for the stockholders in that transaction.

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Court Of Chancery Accepts Deal Protection Terms

In re Orchid Cellmark Inc. Shareholders Litigation, C.A. 6373-VCN (May 12, 2011)

In another decision reviewing whether deal protection agreements are impermissibly preclusive, the Court noted: " one of these days some judge is going to say "no more"..."   This decision and its recent companion decision,  In Re Answers Corporation Shareholders Litigation, C.A. 6170-VCN (April 11, 2011),  list many deal protection measures that the Court has accepted.

Since the Delaware Supreme Court's split decision in Omnicare, Inc. v. NCS Healthcare Inc., 818 A.2d 914 (Del. 2003) rejecting a lock up agreement with the majority owner, the Delaware courts have not overturned such deal protection measures in merger agreements.  Maybe this decision is a warning.   After all, the Chancellor's recent decision in Air Products and Chemicals Inc. v. Airgas Inc., 16 A.3d 48 (Del. Ch. 2011)  also expressed some doubts that Delaware should be so protective of a Board's power to block a takeover.  We shall see.

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The Viability of the Disclosure Only Settlement

This article was originally published in the Delaware Business Court Insider | May 11, 2011
 
For corporations facing stockholder litigation challenging a proposed business combination, negotiating a settlement in which the corporation agrees to provide additional disclosures without any increased consideration can be an efficient means of avoiding the risk of litigation.  The benefit created by the additional disclosures means the plaintiff’s lawyer can apply for a fee while the corporation and its directors get a release of all claims.

Some recent decisions of the Court of Chancery, however, have cast some doubt on the ability of a "disclosure only" settlement to serve as the sole consideration for a settlement or a substantial fee.  Practitioners on both sides should be aware of these developments when negotiating a settlement of litigation challenging transactions.

Although the Court of Chancery has not recently issued a written opinion refusing to approve a "disclosure only" settlement, there is precedent for doing so — e.g., the Delaware Court of Chancery's 2006 opinion in In re SS & C Technologies Inc.  The issue most recently came to light in Scully v. Nighthawk Radiology Holdings Inc., a much discussed case in which the court appointed special counsel to report on whether the settlement in that case was collusive and improper.

There, the plaintiffs sought expedited proceedings to enjoin a merger between Nighthawk Radiology Holdings Inc. and another party based solely on claims of inadequate disclosures.  The court denied the motion, in part, because the court felt the disclosure claims were not meritorious and, indeed, would not support a "disclosure only" settlement.  The corporation then reached a "disclosure only" settlement with the plaintiffs in a parallel proceeding in Arizona and agreed to present the settlement for approval to that court.  The Court of Chancery viewed this as an attempt to avoid its earlier admonition that a disclosure only settlement would not be adequate consideration to support a release for defendants, and appointed special counsel to investigate the matter.

While the special counsel in Nighthawk ultimately concluded that no collusion was present, the healthy skepticism of "disclosure only" settlements expressed by the Court of Chancery should be noted. Courts appear to be scrutinizing closely "disclosure only" settlements as part of a Delaware court’s independent duty to ensure that a settlement is fair and reasonable — e.g., the Chancery Court's 2005 opinion In re Cox Communications Inc. Shareholders Litigation.  That skepticism is most clearly manifested in recent decisions analyzing fee requests in which disclosures were part of the benefit created.

For instance, on April 30's In re Sauer-Danfoss Inc. Shareholder Litigation, Consol, the Court of Chancery considered a request for $750,000 by plaintiffs’ attorneys who claimed they caused the corporation to issue corrective disclosures before the transaction was ultimately abandoned.  After first determining that the plaintiffs were entitled to credit for only one of the purported 11 additional disclosures, the court began its discussion of the fee to which the plaintiffs were entitled by noting that "all supplemental disclosures are not equal."  When quantifying the fee award for additional disclosures, the court "evaluates the qualitative importance of the disclosures obtained."  While one or two meaningful additional disclosures might merit an award of $500,000, prior precedent in contested fee cases reveals that less meaningful disclosures yield much lower awards.  With that in mind, the court awarded $80,000, in large part because the disclosures were not particularly meaningful and the plaintiffs had not actively litigated the case after filing, instead seeking to negotiate a settlement.

The court used three recent opinions to support its conclusion that an award of only $80,000 was sufficient under the circumstance. In the 2006 case In re Triarc Companies Shareholders Litigation, the court awarded $75,000 in fees and expenses for the additional disclosure that the chairman of the special committee thought the deal price was inadequate where the plaintiffs had done nothing after the disclosure mooted the claims in the amended complaint to create any benefit.

In the 2009 Chancery Court case In re BEA Systems Inc. Shareholders Litigation, the court awarded fees and expenses of $81,297 where supplemental disclosures were made before discovery, preliminary injunction briefing and hearing, but the injunction was denied.

Finally, in 2010's Brinckerhoff v. Texas Eastern Products Pipeline Co., the Chancery Court awarded fees and expenses of $80,000 to an objector to a settlement who settled his objection in exchange for additional disclosure from the corporation as Form 8-K.

The consistent thread throughout these opinions, including the recent Sauer-Danfoss decision, is that non-meaningful disclosures that were agreed to after little work by plaintiffs will not merit substantial fee awards.

What effect, then, does the court’s reluctance to award large fees for additional disclosures combined with the court’s criticism of "disclosure only" settlements have on class action and derivative litigation going forward?

First, it may provide a disincentive for plaintiffs firms to continue to file litigation in Delaware challenging transactions.  The data showing a decrease in the number of lawsuits filed in the Court of Chancery has been readily available for some time now.  While smaller fee awards and higher criticism of "disclosure only" settlements cannot be the sole basis for the decrease in filings in the Court of Chancery, it likely plays some role.

Second, the use of the "disclosure only" settlement may become a thing of the past due to the risk for both sides.  Plaintiffs may not be willing to enter into a "disclosure only" settlement because they know they are at risk they will not be awarded a substantial fee.  Defendants may not be willing to enter into a "disclosure only" settlement because they do not want to put at risk their global release if the settlement is rejected as unfair.

To be clear, there is nothing in the Court of Chancery’s current jurisprudence to suggest that a "disclosure only" settlement is per se impermissible.  What is clear, however, is that to the extent that the parties to stockholder litigation challenging a business combination believed they could settle a case for the relatively inexpensive cost of making additional information available to the stockholders, that path must be followed carefully while keeping in mind the authorities cited above.

Peter B. Ladig (pladig@morrisjames.com) is a partner at Morris James in Wilmington and a member of its corporate and fiduciary litigation group.  He represents both stockholders and directors in corporate litigation.  The majority of his practice is in the Delaware Court of Chancery, although he has extensive experience in the other state and federal courts in Delaware and has been involved in over 50 published decisions.  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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