Posts tagged M&A

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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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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Justice Jacobs and Others Analyze Hostile Takeovers in Developed and Emerging Markets

In the most recent issue of the Harvard International Law Journal, John Armour, Justice Jacobs and Curtis Milhaupt analyze how hostile takeovers arise under similar circumstances in different countries and how countries enact substantially different regulatory responses to hostile takeovers.  The article focuses primarily on hostile takeovers in the United States, United Kingdom and Japan, but also considers the possible trajectory of hostile takeovers in emerging markets like China, India and Brazil.

 

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Court Of Chancery Explains Disclosure Rules For Adviser Fees

In re Atheros Communications Inc. Shareholder Litigation, C.A. 6124-VCN (March 4, 2011)

This decision outlines what must be disclosed to shareholders asked to approve a merger.  As to the financial adviser giving a fairness opinion, the disclosures should include whether its fee is contingent on a closing and if so, how much of the fee is contingent. The amount of the fee should  also be disclosed.

The decision also held that when the CEO learned he would be employed by the acquiror, that should have been disclosed as well.

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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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Court Of Chancery Validates Top Up Options

Olson v. ev3, Inc., C.A. 5583-VCL (February 21, 2011)

In recent years, top up options have been frequently used to speed up a merger by avoiding the time-consuming and expensive process of soliciting proxies to approve a merger after a successful tender offer.  This decision explains how such an option works and why they are permitted under Delaware law.

The decision is also important is pointing out certain perils in the way top up option rights are structured.  The option needs to comply with the provisions of the DGCL  governing stock options.

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Court Of Chancery Explains Categories Of Damages

Pharmaceutical Product Development Inc. v. TVM Life Science Ventures VI, LP,  C.A. 5688-VCS (February 16, 2011)

Agreements sometimes try to limit any damages from a misrepresentation or contract breach by excluding consequential or special damages.  This decision notes that is hard to do because what falls into what category of damages is not always clear.  Better to limit damages some other way such as by the amount paid to the seller.

The opinion is also noteworthy as an example of the far-reaching scholarship the Court undertook to understand the science involved in the dispute.  Litigants should not underestimate the Court of Chancery in such matters.

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Court Of Chancery Creates Unique Remedy

In re Del Monte Foods Company Shareholders Litigation, C.A. 6027-VCL (February 14, 2011)

This is an important decision if only for the creative remedy that the Court came up with to deal with the breach of faith by a target's investment bank.  In effect, the investment bank was willing to sell out its client to get a piece of the buy-side financing.  The Court enjoined the deal for 20 days to let a competing bid emerge while at the same time not killing a deal that the target's stockholders might want.

The decision gives guidance to advisers on the proper conduct they should be expected to follow.

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Court of Chancery Discusses "Best and Final" Offer

Air Products & Chemicals, Inc. v. Airgas, Inc., C.A. No. 5249-CC  (January 20, 2011)

This is another decision in the Airgas takeover battle.  In this decision, Chancellor Chandler addressed Air Products' motion to compel Airgas' compliance with the protective order and Airgas' motion in limine to preclude Air Products from offering evidence that its $70 offer was indeed its "best and final" offer.  With respect to the motion to compel, Air Products sought to reduce Airgas' designation of large chunks of deposition testimony and documents as "Litigators' Eyes Only" ("LEO").  The Court found that Air Products was itself somewhat responsible for the large designation of deposition testimony as LEO since it had not segregated LEO and non-LEO subject matter when deposing Airgas witnesses.  The Court ordered Air Products to indicate the testimony that it did not believe should be LEO and then Airgas to respond within 5 hours of receipt of each transcript.  Additionally, the Court ordered Airgas to produce a non-LEO version of an institutional shareholder letter setting forth that shareholder's opinion of the fair value of Airgas based on publicly available information. Finally, the Court refused to order Airgas to re-review documents previously produced and designated LEO given the rapidly approaching supplementary evidentiary hearing, but held Air Products could specify LEO documents it thought should be de-designated.

In its motion in limine, Airgas sought to preclude Air Products from offering documentary evidence that its $70 offer was its "best and final" offer because it had refused to produce internal analyses or valuations that the Air Products board relied upon in deciding to make its $70 offer. The Court had previously ordered in a December 23, 2010 opinion that the parties conduct limited discovery on Air Products' "best and final" offer.  This discovery was limited to documents relating to the decision to make the final offer and limited depositions of people directly involved with that decision.  The Court rejected Airgas's reliance on cases where defendants blocked discovery on privilege grounds to support its motion in limine.  According to the Court, those cases involved situations where a party shielded evidence and then relied on that evidence at trial to meet its burden of proof on an issue central to resolution of the case.  Air Products' characterization of its $70 offer was not an issue central to resolution of the case.  Resolution of the case would depend upon whether Airgas' board had a good faith, honest belief that the $70 offer posed a "threat" to Airgas. The Air Products board's knowledge of Air Products' internal valuations of Airgas was not relevant to that inquiry. The Court was careful to point out, however, that there could be circumstances where a buyer's view of a target's value might be relevant to a fairness inquiry. In this case, Air Products was not required to prove the fairness of its offer or whether the offer was more or less than its internal valuations of Airgas. Accordingly, the Court the denied Airgas' motion in limine.

Significantly, the Court held that Air Products' public announcement of its $70 offer as its "best and final" offer meant Air Products had irrevocably represented to the Court it would not seek judicial relief for any additional offers. Bidders should keep this in mind when characterizing offers as "best and final".

 

 

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Court Of Chancery Permits Discovery On Offer Strategy

Air Products & Chemicals, Inc. v. Airgas, Inc., C.A. 5249-CC (December 23, 2010)

In this latest chapter of the Airgas takeover saga, the bidder may have bitten off more than it wanted.  In the past, the Court of Chancery has recognized an immunity from having to disclose a party's strategy in an on-going takeover fight.  Known as the "business strategy" privilege, the idea is that litigation should not be used to gain a negotiating advantage.  Here the bidder asked for sensitive discovery and the Court, while granting that request, also permitted discovery on whether the bidder's self-proclaimed "best and final" offer was in fact the best it would do to acquire Airgas.

Given that the bidder had told the Court its offer was its best and final, it had better be true.

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Court of Chancery Interprets Conflict of Interest Provision of LLC Agreement

In re Atlas Energy Resources, LLC Unitholder Litigation, C.A. No. 4589-VCN (October 28, 2010)

This case is another example of the care practitioners must take in drafting LLC agreements. In this decision, Vice Chancellor Noble applied the Kahn v. Lynch entire fairness standard of review to a merger between a publicly traded LLC and its controlling unitholder.  Plaintiffs, LLC unitholders, alleged the controlling unitholder breached its fiduciary duties to minority unitholders by negotiating an unfair merger through an unfair process.  Plaintiffs also alleged that the directors and officers of the LLC breached their fiduciary duties by agreeing to the merger.

The controlling unitholder argued that it was not liable for breach of fiduciary duty because the LLC Agreement provided that if a conflict of interest arose between the LLC and controlling unitholder, it could be resolved by certain actions that had occurred here.  Plaintiffs argued that the conflict of interest at issue was between the controlling stockholder and minority unitholders and thus the LLC Agreement conflict of interest provision was inapplicable. The Court agreed and found the merger between the LLC and its controlling unit holder subject to the entire fairness standard of review.  In the absence of anything in the LLC Agreement addressing a conflict of interest between the controlling unitholders and minority unitholders, the Court saw no reason not to apply the reasoning of Kahn v. Lynch.  As is typical in cases where the entire fairness standard of review applies, the Court denied the controlling unitholder's motion to dismiss.

The Court did, however, grant the motion to dismiss of the LLC directors and officers. The LLC Agreement provided that the directors and officers did not owe fiduciary duties to the LLC or its members. Thus, unlike the provision governing conflicts of interest, this provision of the LLC Agreement expressly eliminated fiduciary duties of directors and officers to members. Under the LLC Agreement, the officers and directors were subject to a subjective good faith standard.  This standard of good faith is narrower than the good faith standard under Delaware law.  Applying this subjective standard of good faith, the Court found that Plaintiffs had failed to state a claim that the directors and officers believed they were acting against the best interests of the LLC's unitholders in negotiating the merger.

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Court Of Chancery Clarifies Termination Fee Calculation

In re Cogent Inc. Shareholder Litigation, C.A. 5780-VCP (October 5, 2010)

A termination fee must be reasonable.  That is well known.  But how to calculate the fee to test its reasonableness is sometimes misunderstood.  This decision explains how to do so.

The preferred approach is to calculate the fee based on the equity value of the transaction. That is the amount needed to buy the equity, usually market value.  Normally, the equity value is less than the enterprise value that includes the equity value and the value of the debt, less cash.

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Supreme Court Clarifies Unocal/Moran Relationship

Versata Enterprises Inc v. Selectica Inc. , C.A. 193, 2010 (October 4, 2010)

This is the most important clarification of Delaware law under the Unocal and Moran decisions in several years and is worth a close study.  The Supreme Court upheld the Court of Chancery decision that a 5% poison pill was valid under the Unocal tests and not preclusive under Moran despite the presence of a staggered board.

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Court Of Chancery Enforces Stockholder Representative Agreement

Aveta Inc. v. Bengoa, C.A. 5074-VCL (September 20, 2010)

In this continuation of a long saga, the Court held that when a stockholder representative is designated to act for the stockholders in calculating a post merger adjustment, then the stockholders are stuck with what their representative does.  Big surprise.

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