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M&A Litigation Update: Standard of Deal
Review, Appraisal Rights, D&O Fiduciary
DutiesImplications of Recent Delaware Case Law for Planning, Negotiating and Drafting Deal Documents
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THURSDAY, OCTOBER 18, 2018
Presenting a live 90-minute webinar with interactive Q&A
Michael D. Allen, Director, Richards Layton & Finger, Wilmington, Del.
Samuel T. Hirzel, Partner, Heyman Enerio Gattuso & Hirzel, Wilmington, Del.
Ryan D. Stottmann, Partner, Morris Nichols Arsht & Tunnell, Wilmington, Del.
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2018 M&A Litigation Update:Standard of Deal ReviewStrafford WebinarOctober 18, 2018
Michael D. Allen
▪ Standards of Review
- Limits of Corwin
- Controlling Stockholder Transactions
- When Is a Less than 50% Holder a Controlling Stockholder?—Bashoand Tesla
- MFW Update—Other Cases
6
Overview of Discussion Topics
7
Standards of Review: Limits of Corwin
▪ Corwin v. KKR Fin. Hldgs. LLC, 125 A.3d 304 (Del. 2015) – absent a controllingstockholder, the business judgment rule applies following informed stockholderapproval of a transaction.
▪ Singh v. Attenborough, 137 A.3d 151 (Del. 2016) – informed stockholder approvalin transactions that do not include a controlling stockholder “irrebuttably” invokesthe business judgment rule and precludes judicial review absent extremeallegations sufficient to state a claim for waste.
▪ Subsequent Court of Chancery decisions have characterized the standard ofreview under Singh as the “irrebuttable business judgment rule.” See, e.g., City ofMiami Gen. Emps.’ v. Comstock, 2016 WL 4464156 (Del. Ch. Aug. 24, 2016).
8
Limits of Corwin
▪ Corwin will not apply where stockholders are improperly coerced.
‐ In re Saba Software, Inc. Stockholder Litigation, 2017 WL 1201108 (Del. Ch.Mar. 31, 2017) – Court of Chancery declines to apply Corwin wherestockholders were coerced due to de-registration of stock and due tomaterial non-disclosures.
‐ Sciabacucchi v. Liberty Broadband Corp., 2017 WL 2352152 (Del. Ch. May 31,2017) – Court of Chancery declines to apply Corwin where stockholderswere coerced into voting to approve a stock issuance in connection with amerger because the stockholder approval of this matter was a condition toconsummation of beneficial merger transaction.
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Standards of Review: Limits of Corwin - Coercion
▪ In addition to alleging “voter coercion” in certain cases, plaintiffs have begunbringing post-closing disclosure claims in an attempt to prevent the application ofCorwin and subject change of control transactions to enhanced scrutiny.
▪ In order to do so, “a plaintiff . . . must first identify a deficiency in the operativedisclosure document, at which point the burden would fall to defendants toestablish that the alleged deficiency fails as a matter of law in order to secure thecleansing effect of the vote.” In re Solera Hldgs., Inc. S’holder Litig., 2017 WL57839, at *8 (Del. Ch. Jan. 5, 2017).
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Limits of Corwin - Disclosure
▪ In light of several recent decisions, practitioners should take care to provide fulldisclosure in proxy statements, 14D-9s and other solicitation materials.
• The failure to disclose the reasons that a company’s Chairman and founderabstained from voting in favor of a merger was found material where his basis fordoing so was his disappointment with the merger price (and with management fornot running the business in a manner that would have commanded a higher price)and his belief that it was an inopportune time to sell the company. Appel v.Berkman, 180 A.3d 1055 (Del. 2018).
• Corwin was found inapplicable where a 14D-9 failed to disclose whether conflictedofficers and directors who received post-transaction employment with theacquirer led key portions of merger negotiations. van der Fluit v. Yates, 2017 WL5953514 (Del. Ch. Nov. 30, 2017).
• The Delaware Supreme Court overturned a Court of Chancery dismissal underCorwin, finding that disclosure deficiencies related to, among other things, thefounder’s potential unwillingness to partner with other potential acquirers duringthe auction process prevented the stockholder vote from being fully informedunder Corwin. Morrison v. Berry, 2018 WL 3339992 (Del. 2018)
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Limits of Corwin - Disclosure
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▪ In Lavin v. West Corp., 2017 WL 6728702 (Del. Ch. Dec. 29, 2017), in holding that astockholder-plaintiff had established a valid primary purpose in its demand to inspectthe books and records related to the acquisition of West Corporation (“West”) byApollo Global Management, the Court of Chancery rejected West’s argument thatCorwin precluded a Section 220 demand because any possible breaches of fiduciaryduties that plaintiff sought to investigate were cleansed by stockholder approval of theacquisition.
▪ West contended that the inspection demand was invalid because the West stockholdersapproved the transaction and, accordingly, any lawsuit for alleged breach of fiduciaryduties (other than one for waste) would lack merit.
▪ The Court rejected West’s use of Corwin in the context of Section 220, stressing that amerit-based defense was improper and noting that Delaware courts had rejectedsimilar attempts to invoke merit-based defenses. The Court explained that astockholder “need not prove that wrongdoing or mismanagement actually occurred.”That is, the viability of a demand does not turn on the ultimate likelihood a claim willsucceed.
Limits of Corwin – Section 220
13
Standards of Review: Controlling Stockholder TransactionsWhen Is a Less than 50% Holder a Controlling Stockholder?—Basho
and Tesla
▪ Stockholders owning more than 50% of a Delaware corporation’s voting stock orotherwise exercising control over the corporation owe fiduciary duties of loyalty,care, and disclosure to the corporation and its minority stockholders, and indealing with the corporation must act in good faith and in a manner that does notoppress the corporation and its minority stockholders.
▪ Where a stockholder is not a majority stockholder, plaintiffs must either show thatthe minority stockholder actually dominated and controlled the corporation, itsboard or the deciding committee with respect to the challenged transaction orthat the minority stockholder actually dominated and controlled the majority ofthe board generally.
14
Controlling Stockholder Transactions—When Is a Less than 50% Holder a Controlling Stockholder?—Basho and Tesla
▪ In Basho Techs. Holdco B, LLC v. Georgetown Basho Inv’rs, LLC, 2018 WL 3326693 (Del.Ch. July 6, 2018), holders of junior series of preferred stock and common stock of BashoTechnologies, Inc. (the “Company”) brought breach of fiduciary duty claims againstGeorgetown Basho Investors, LLC (“Georgetown”), a significant senior preferredstockholder, and certain directors in connection with a Series G financing round (the“Series G Financing”) and certain subsequent transactions.
▪ The Court found that Georgetown exercised effective control over the decision by theCompany to consummate the Series G Financing due to the confluence of:
• Use of its contractual rights to cut off access to sources of financing other thanGeorgetown;
• Efforts taken to spread misinformation regarding Georgetown’s intentions and thestatus of negotiations;
• Interference with the CEO and other members of management;• Influence over the Company’s financial advisor; and• Insistence on the Series G Financing, unwillingness to negotiate and use of
threats.
▪ Accordingly, the Court found that the entire fairness standard of review applied to theSeries G Financing. 15
Controlling Stockholder Transactions – Basho Technologies
▪ Applying the entire fairness standard of review, the Court held that Georgetown and itsdirector designees had failed to prove that the Series G Financing was entirely fair.
▪ The Court also rejected defendants’ equitable defense that one of the plaintiffs hadacquiesced to the Series G Financing because he had voted in favor of it as a director.
• The Court noted the director’s numerous objections to the Series G Financing(which objections he submitted in writing for inclusion in the minutes), as well asGeorgetown’s conduct that resulted in the directors being forced into a choicebetween approving an unfair offer or destroying the Company.
▪ The Court also applied the entire fairness standard of review to the post-financingtransactions, which transactions the Court found were more likely than not to havecontributed to the Company’s failure.
• The Court characterized the post-financing transactions as having been motivatedby Georgetown’s desire to pursue a near-term sale and extract value for itselfthrough its senior securities at the expense of the Company’s long-termprospects.
16
Controlling Stockholder Transactions – Basho Technologies
▪ As to remedies, the Court held that Georgetown and its director designees were jointlyand severally liable for $17,490,650 plus pre- and post-judgment interest for the SeriesG Financing.
• The award was calculated based on the difference in value between the plaintiffs’equity before and after the Series G Financing, using the Section 409(a) valuationsas a guidepost (including certain discounts, such as a 20% discount in recognitionof the onerous terms of the Series G Financing).
▪ With respect to the post-Series G Financing transactions, the Court held thatGeorgetown and its director designees were jointly and severally liable for $2,778,228plus post-judgment interest.
• The award was calculated based on the diminution in value of the plaintiffs’shares from the time of the Series G Financing to the date of judgment; the Courtnoted that the award was warranted by the egregious manner in whichGeorgetown operated the Company after obtaining control.
17
Controlling Stockholder Transactions – Basho Technologies
▪ In addition to referencing examples of broader indicia of control, the Court alsoenumerated a non-exclusive list of examples of sources of influence that wouldcontribute to a finding of control over a particular transaction or decision including:
• Relationships with particular directors that compromise their disinterestedness orindependence;
• Relationships with key managers or advisors who play a critical role in presentingoptions, providing information and making recommendations;
• Exercise of contractual rights to channel the corporation to a particular outcome;
• Existence of commercial relationships that provide a stockholder with leverageover the corporation, such as status as a key customer or supplier; and
• Lending relationships in which a lender exercises outsized influence.
18
Controlling Stockholder Transactions – Basho Technologies
▪ The Court stressed that a finding of control depends upon the totality of the facts andcircumstances, considered in the aggregate and not on any one factor.
▪ In particular, the Court stated:
“Lest sensitive readers fear that this decision signals heightened risk for venturecapital firms who exercise their consent rights over equity financings, I reiteratethat a finding of control requires a fact-specific analysis of multiple factors. IfGeorgetown only had exercised its consent right, that fact alone would not havesupported a finding of control. The plaintiffs proved that Georgetown andDavenport did far more.”
19
Controlling Stockholder Transactions – Basho Technologies
▪ In In re Tesla Motors, Inc. S’holder Litig., 2018 WL 1560293 (Del. Ch. Mar. 28, 2018),appeal refused, 184 A.3d 1292 (Del. 2018), the Court held that the plaintiff-stockholderspled sufficient facts to show it was reasonably conceivable that Elon Musk acted as aconflicted controller with respect to the acquisition (the “Acquisition”) of SolarCityCorporation (“SolarCity”) by Tesla, Inc. (“Tesla”), and denied the defendant’s motion todismiss under Corwin.
▪ Musk owned 22.1% of Tesla’s stock at the time of the Acquisition and was Tesla’s largeststockholder. Musk also served as Chairman of the Tesla Board, CEO of Tesla, and ChiefProduct Architect of Tesla. Simultaneously, Musk was SolarCity’s largest stockholder(21.9%) and Chairman of SolarCity’s board.
▪ The Court held that despite Musk only owning a minority stake in the voting power ofTesla, the plaintiffs’ allegations supported a reasonable inference that Musk actuallydominated and controlled Tesla and Tesla’s Board with respect to the Acquisition.
• The Court determined that it need not express an opinion as to whether Muskacted as a controlling stockholder over Tesla and Tesla’s Board generally becauseenough allegations were pled to raise a reasonable doubt that Musk acted as acontrolling stockholder with respect to the Acquisition.
20
Controlling Stockholder Transactions – Tesla Motors
▪ The Court found the following allegations, when considered together, supported areasonable inference that Musk was a controlling stockholder:
• Musk displayed an ability to influence the stockholder vote at Tesla.
₋ Particularly, Musk previously forced the founder and then-CEO out of Teslaand subsequently had himself appointed as CEO.
₋ Musk’s 22.1% block of Tesla’s stock positioned him as a potential roadblockfor Tesla to transact any significant business, as Tesla’s bylaws containedseveral supermajority voting requirements that required 66 2/3 percent oftotal voting power for approval.
• Tesla’s Board failed to implement safeguards to prevent Musk’s control over Tesla’sconsideration and negotiation of the Acquisition.
₋ Notably, although Musk recused himself from voting on the Acquisition,Musk brought the proposal to acquire SolarCity to Tesla’s Board three times,Musk led the Board’s discussion of the Acquisition, and Musk engaged thefinancial and legal advisers for the Acquisition.
₋ Tesla’s Board never considered forming a committee of disinterestedindependent directors to consider the Acquisition.
21
Controlling Stockholder Transactions – Tesla Motors
• Musk had strong connections with the members of the Tesla Board and a majorityof Tesla’s Board was “interested” in the Acquisition.
▪ Two of the five directors who approved the Acquisition were notindependent directors based on Tesla’s public filings.
▪ A third director, Jurvetson, who approved the Acquisition was gifted the firstever Tesla Model S and the second ever Tesla Model X by Musk himself.Further, Jurvetson’s venture capital firm owned 3.3% of SolarCity’soutstanding common stock and Jurvetson personally owned 417,450 sharesof SolarCity common stock.
• Tesla acknowledged Musk’s significant influence at Tesla in Tesla’s public filings.
▪ Notably, one Tesla filing stated that Tesla is “highly dependent on theservices of Elon Musk,” and if Tesla were to lose his services, it could disruptTesla’s operations.
▪ Further, Musk had publicly stated that Tesla is “his company” and that Tesla,SolarCity, and SpaceX form a pyramid on top of which he sits.
22
Controlling Stockholder Transactions – Tesla Motors
23
Standards of Review: Controlling Stockholder TransactionsMFW Update—Other Cases
▪ The entire fairness test is the default standard of review for challenges toconflicted controlling stockholder transactions.
▪ In Kahn v. M&F Worldwide Corp., 88 A.3d 635 (Del. 2014) (“MFW”), the DelawareSupreme Court held that the business judgment standard of review applies to atwo-sided controlling stockholder merger when it is conditioned, ab initio, on:
• Negotiation and approval by an independent, fully functioning and dulyempowered special committee that fulfills its duty of care; and
• The uncoerced, fully informed vote of a majority of the minoritystockholders.
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Controlling Stockholder Transactions – MFW Update
▪ Thus, under the MFW framework, in controlling stockholder buyouts, the businessjudgment standard of review will be applied if and only if:
• The controlling stockholder conditions the transaction on the approval ofboth a special committee and a majority of the minority stockholders fromthe outset;
• The special committee is independent;
• The special committee is empowered to freely select its own advisors and tosay no definitively;
• The special committee meets its duty of care in negotiating;
• The vote of the minority is fully informed; and
• There is no coercion of the minority.
25
Controlling Stockholder Transactions – MFW Update
▪ In two recent cases, the Court of Chancery has held that the conditions for MFW weresatisfied where the initial overture by the controlling stockholder did not expresslycondition the transaction on a favorable recommendation from a special committeeand approval by the majority of the disinterested stockholders.
• In In re Synutra Int’l, Inc. S’holder Litig., 2018 WL 705702 (Del. Ch. Feb. 2, 2018)(ORDER), aff’d, __ A.3d __, 2018 WL 4869248 (Del. Oct. 9, 2018), the Court ofChancery held that MFW applied where the board considered a “preliminary non-binding proposal” that did not condition a potential transaction on both afavorable special committee recommendation and approval of the majority of theminority, because a follow-up letter, sent before the board had substantivelyevaluated the proposal, reaffirmed its initial offer and expressly conditioned thetransaction on the approval of the special committee and a majority of theminority stockholders.
• The Delaware Supreme Court, sitting en banc, affirmed the Court of Chancery’sholding in Synutra, concluding that the ab initio requirement of MFW is satisfiedwhen “the controller conditions its offer on the key protections [of MFW] at thegermination stage of the Special Committee process, when [the SpecialCommittee] is selecting its advisors, establishing its method of proceeding,beginning its due diligence, and has not commenced substantive economicnegotiations[.]” 26
Controlling Stockholder Transactions – Synutra & Olenik
• In a dissenting opinion in Synutra, Justice Valihura disagreed with the adoption ofa “when the negotiations begin” test by the Majority to determine when the abinitio requirement is satisfied. Instead, she suggested that the Court apply aclearer test by requiring the dual protections of MFW to be present in thecontroller’s initial formal written proposal.
• In Olenik v. Lodzinski, 2018 WL 3493092 (Del. Ch. July 20, 2018), the Court ofChancery explained that the MFW protections must be in place at the outset ofnegotiations (which typically begin when a proposal is made by one party that, ifaccepted, would constitute a binding agreement); however, such protections maybe agreed to after discussions between the parties that are merely “exploratory innature.”
• The Olenik case is still in the appeals process.
27
Controlling Stockholder Transactions – Synutra & Olenik
▪ In IRA Trust FBO Bobbie Ahmed v. Crane, 2017 WL 7053964 (Del. Ch. Dec. 11, 2017),the court dismissed claims alleging that directors of NRG Yield, Inc. (“Yield”) breachedtheir fiduciary duties in connection with the approval of a reclassification of Yield’sshares that went into effect in May 2015.
▪ The court held that the recapitalization was a conflicted controller transaction thatwould be presumptively subject to the entire fairness standard of review(notwithstanding that it was nominally a pro rata transaction).
• Yield had two classes of voting stock, Class A and Class B, each of which wasentitled to one vote per share. NRG Energy, Inc. (“NRG”) initially heldapproximately 65% of Yield’s voting power through its ownership of all of Yield’sClass B Shares, which were never offered to the public, and public stockholdersinitially held approximately 35% of Yield’s voting power through their ownershipof Class A shares.
• In response to increasing dilution of its voting control as a result of Yield’sissuance of Class A shares to fund various acquisitions, NRG proposed arecapitalization pursuant to which Yield would issue non-voting common stock toClass A stockholders, on a pro rata basis, which could be used to fund futureacquisitions, thereby discontinuing dilution of NRG’s voting control.
28
Controlling Stockholder Transactions – Crane
• Ultimately, the recapitalization resulted in an issuance of new classes of stock withvery limited voting rights to the holders of both Class A shares and Class B shares.
▪ The Court found that the defendants complied with the MFW framework, which shiftedthe standard of review from entire fairness to business judgment.
• NRG’s proposal was conditioned from the beginning on the approval of a majorityof the outstanding shares of Yield not affiliated with NRG (i.e., a majority of Yield’soutstanding Class A shares). Additionally, Yield’s board delegated to its standingconflicts committee the authority to evaluate and negotiate the proposal. Theindependence of the three members of the conflicts committee was neverchallenged.
▪ Because the court found that the defendants successfully implemented the MFWframework, the reclassification was subject to the business judgment rule. As theplaintiff had made no effort to plead facts sufficient to overcome the businessjudgment rule, the court granted the defendant’s motion to dismiss.
▪ Court distinguishes Williams v. Geier due to this transaction being before the court on amotion to dismiss and without discovery.
29
Controlling Stockholder Transactions – Crane
This presentation and the material contained herein are provided as general informationand should not be construed as legal advice on any specific matter or as creating anattorney-client relationship. Before relying on general legal information or deciding on legalaction, request a consultation or information from a Richards, Layton & Finger attorney onspecific legal needs.
31
Samuel T. Hirzel, Esq. Heyman Enerio Gattuso & Hirzel LLP
[email protected](302) 472-7315www.HEGH.law
8 Del. C. Section 262 provides the statutory process for a judicial determination of the fair value of the shares of a Delaware corporation that is a party to certain types of M&A transactions. AKA “dissenters rights.”
8 Del. C. Section 262 has two main components: (1)Perfection of Appraisal Rights, and (2) Valuation.
33
Stockholder does not vote in favor of the merger, continues to hold stock through closing, and demands appraisal. See In re Appraisal of Dell Inc., 143 A.3d 20 (Del. Ch. May 11, 2016) (finding that 83% of shares that pursued appraisal through trial were not entitled to appraisal based on inadvertent failures in the “Byzantine” system of “daisy chain” authorizations in connection with voting beneficially owned shares)
Stockholder may withdraw demand and receive the merger consideration for 60 days after the effective date of the merger if they have not commenced or joined an appraisal action.
Stockholder does not need to separately file a petition to become part of a quasi-class.
Typical course of litigation: fact discovery & expert discovery culminating in a “battle of the experts” (and their foundations) at trial.
Claims of breach of fiduciary duty in connection with the transaction giving rise to the appraisal may be pursued together with the appraisal. Entire fairness turns on fair process and fair price, creating significant overlap on the price component.
34
The appraisal petitioner is entitled to a proportionate share of the “fair value in the going concern on the date of the merger” but is not entitled to elements of value “arising from the accomplishment or expectation of the merger,” e.g., synergies.
DGCL grants the Court significant discretion to determine the “fair value” of the shares and “take into account all relevant factors.” DFC Glob. Corp. v. Muirfield Value Partners, L.P., 172 A.3d 346, 364 (Del. 2017) (“Section 262(h) unambiguously calls upon the Court of Chancery to perform an independentevaluation of ‘fair value’ at the time of a transaction. It vests the Chancellor and Vice Chancellors with significant discretion to consider ‘all relevant factors’ and determine the going concern value of the underlying company.”)
35
Historical preference for discounted cash flow analysis (“DCF”) based valuations using contemporaneous management projections, but comparable transactions and comparable company analyses are also historically accepted approaches. In recent cases, the Court has let appraisal respondents walk away from projections that were prepared for the deal and not used in the ordinary course of business.
The Delaware Supreme Court historically rejected any presumption in favor of the negotiated deal consideration as evidence of “fair value” in an appraisal action even if it was the result of an arms’-length negotiation. Golden Telecom, Inc. v. Global FT Ltd., 11 A.3d 214 (Del. 2010) (“Requiring the Court of Chancery to defer—conclusively or presumptively—to the merger price, even in the face of a pristine, unchallenged transactional process, would contravene the unambiguous language of the statute and the reasoned holdings of our precedent. It would inappropriately shift the responsibility to determine ‘fair value’ from the court to the private parties. Also, while it is difficult for the Chancellor and Vice Chancellors to assess wildly divergent expert opinions regarding value, inflexible rules governing appraisal provide little additional benefit in determining ‘fair value’ because of the already high costs of appraisal actions.”). See also DFC Glob. Corp. v. Muirfield Value Partners, L.P., 172 A.3d 346, 364 (Del. 2017).
A number of recent cases, however, have given this data-point far greater weight absent evidence of a tainted process.
36
Costs—appraisals are expensive.
Fees—fee shifting is rarely granted. No corporate benefit or common fund doctrine. Petitioners fund their own case.
Time—it could take years for resolution.
Security – Petitioner is an unsecured creditor and bears the company’s credit risk.
Uncertainty—the appraised value could be higher or lower than the merger consideration.
37
Trends
Observed trend of “event driven” funds buying into and filing appraisal actions. See Charles R. Korsmo & Minor Myers, Appraisal Arbitrage and the Future of Public Company M&A, 92 Wash U. L. Rev. 1551 at Figures 1 & 3 (2014-15) (see next two slides).
Observed increase in the number of appraisal petitions filed since 2012.
M&A and defense bar lobbies against appraisal arbitrage as “unseemly.”
Possible slow down in filing rate in 2017.
Transkaryotic decision
In re Appraisal of Transkaryotic Therapies, Inc., 2007 WL 1378345 (Del. Ch. May 2, 2007) (opening the door for investors to buy into an appraisal action by upholding appraisal rights for shareholders who acquired shares after the record date). Reaffirmed in Merion Capital LP v. BMC Software, Inc., 2015 WL 67586 (Del. Ch. Jan. 5, 2016) and In re Appraisal of Ancestry.com, Inc., 2015 WL 66825 (Del. Ch. Jan. 5, 2015).
2007 statutory amendment fixes interest at 5% + Federal Reserve discount rate
38
The Union Illinois 1995 Inv. Lim. P’ship v. Union Fin. Grp., Ltd., 847 A.2d 340 (Del. Ch. 2004) (Then Vice Chancellor Strine appraising company at merger price less synergies, noting: As I perceive [my discretion under Section 262], I am free to consider all non-speculative elements of value, provided that I honor the fair value definition articulated by the Delaware Supreme Court…. that evidence may include facts bearing on the market value of the subject company. This includes the transaction that gives rise to the right of appraisal, so long as the process leading to the transaction is a reliable indicator of value and merger-specific value is excluded. More generally, our case law recognizes that when there is an open opportunity to buy a company, the resulting market price is reliable evidence of fair value. Or, as then-Vice Chancellor, now Justice Jacobs, aptly put it: ‘The fact that a transaction price was forged in the crucible of objective market reality (as distinguished from the unavoidably subjective thought process of a valuation expert) is viewed as strong evidence that the price is fair.’”)
Highfields Capital, Ltd. V. AXA Fin., Inc., 939 A.2d 34 (Del. Ch. Aug. 17, 2007) (finding fair value, in part, based on merger price less synergies, noting: “Typically, Delaware courts tend to favor a DCF model over other available methodologies in an appraisal proceeding.However, that metric has much less utility in cases where the transaction giving rise to appraisal was an arm's-length merger…” and “a court may derive fair value in a Delaware appraisal action if the sale of the company in question resulted from an arm's-length bargaining process where no structural impediments existed that might prevent a topping bid.”)
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Global GT LP v. Golden Telecom, Inc., 993 A.2d 497, 507-08 (Del. Ch. Apr. 23, 2010)(then VC Strine rejects deal price as evidence of fair value, and enters an appraisal in excess of deal price, but notes: “It is, of course, true that an arms-length merger price resulting from an effective market check is entitled to great weight in an appraisal” citing Union Ill. 1995 Inv. Ltd. P'ship v. Union Fin. Group”)).
Golden Telecom, Inc. v. Global GT LLP, 11 A.3d 214 (Del. 2010) (affirms Chancery opinion above holding that the statutory mandate requires the Court of Chancery to perform an independent evaluation of fair value and grants the court with significant discretion to consider “all relevant factors” and noting that “Requiring the Court of Chancery to defer—conclusively or presumptively—to the merger price, even in the face of a pristine, unchallenged transactional process, would contravene the unambiguous language of the statute and the reasoned holdings of our precedent. It would inappropriately shift the responsibility to determine “fair value” from the court to the private parties.”)
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Huff Fund Investment P’ship v. CKx, Inc., 2013 WL 5878807 (Del. Ch. Nov. 1, 2013) aff’d 2015 WL 631586 (Del. Feb. 12, 2015) (VC Glasscock using deal price as a “reliable indicator of value” where “neither party has presented as reasonable valuation method” due to the “unpredictable nature of the income stream from the Company’s primary asset.”).
In re Appraisal of Ancestry.com, Inc., 2015 WL 399726 (Del. Ch. Jan. 30, 2015) (VC Glasscock deferring to the deal price after conducting DCF analysis and finding a valuation close to the deal price).
Merlin Partners LP v. AutoInfo, Inc., 2015 WL 2069417 (Del. Ch. Apr. 30, 2015) (VC Noble rejecting DCF based on management projections that were not used in the ordinary course of business, but that were prepared for the investment bankers in favor of the negotiated merger price).
LongPath Capital, LLC v. Ramtron Int'l Corp., 2015 WL 4540443 (Del. Ch. June 30, 2015) (VC Parsons relying on the deal price after finding projections unreliable and concluding fair value was below deal price due to synergies not available to an appraisal petitioner).
Merion Capital LP v. BMC Software, Inc., 2015 WL 6164771 (Del. Ch. Oct. 21, 2015) (VC Glasscock relying on deal price generated in the market after a “vigorous” sales process as evidence of fair value after the Court conducted its own DCF analysis and lamented wildly divergent expert opinions).
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In re ISN Software Corp. Appraisal Litig., 2016 WL 4275388 (Del. Ch. Aug. 11, 2016) (VC Glasscock awarded 2.5 x deal price paid in a cash out merger using DCF in connection with the appraisal of a privately held software company following a merger approved without the benefit of a financial advisor or fairness opinion. Although the company did not have long-term management projections used in the ordinary course of business, the Court found the projections relied on by respondent’s expert, subject to corrections to certain assumptions, to be reliable given the subscription based business model, customer retention, and inelastic demand for the company’s product.)
Dunmire v. Farmers & Merchants Bancorp of W. Pennsylvania, Inc., 2016 WL 6651411 (Del. Ch. Nov. 10, 2016) (C Bouchard rejected market price absent an auction, absent majority of the minority approval, where buyer and seller were controlled by the same family, rejected “wildly divergent” expert valuations, and conducted its own independent discounted net income valuation to arrive at an appraised value of 11% over the deal price in connection with the appraisal of a closely held community bank).
Merion Capital L.P. v. Lender Processing Servs., Inc., 2016 WL 7324170 (Del. Ch. Dec. 16, 2016) (VC Laster found no reason to depart from merger price following a reliable sale process and reliable projections. The court’s own DCF valuation came out 4% above the merger price and gave the court comfort as to the reliability of merger price. The court also rejected the respondent’s synergies argument as unsupported by any evidence).
In re PetSmart, Inc., 2017 WL 2303599 (Del. Ch. May 26, 2017) (VC Slights recognized that the Court’s statutory obligation to consider “all relevant factors” did not end with its finding that the merger price was a reliable indicator of fair value and needed to consider the reliability of a DCF or any other valuation method it could use to reach its final determination of fair value. The court found that a DCF valuation would not be reliable because management had not historically created long-term projections and the projections that were created for the sales process were too aggressive to be reasonable and reverted to deal price).
42
DFC Glob. Corp. v. Muirfield Value Partners, L.P., 172 A.3d 346 (Del. Aug. 1, 2017)
Delaware Supreme Court again refused to establish a presumption in favor of tying fair value to deal price.
The Chancery Court should continue to exercise its discretion to determine fair value, but while doing so it should also explain why it was accorded a certain weight to its indicators of value, including the deal price.
Found that the Court of Chancery’s decision to afford only one-third weight to the deal price was “not rationally supported by the record” explaining: “Although there is no presumption in favor of the deal price . . . economic principles suggest that the best evidence of fair value was the deal price, as it resulted from an open process, informed by robust public information, and easy access to deeper, non-public information, in which many parties with an incentive to make a profit had a chance to bid.”
43
44
In re Appraisal of Dell, Inc., 2015 WL 4313206 (Del. Ch. July 30, 2015)
VCL concluded that the deal price resulting from the MBO was a relevant factor but that respondent failed to show that it was the best evidence of the company’s fair value.
The Court found that the MBO process would not subject directors to liability, but suffered multiple imperfections as a “price discovery tool.”
Vice Chancellor Laster appraised Dell at 28% over the deal price exclusively using a traditional DCF.
45
Dell, Inc. v. Magnetar Global Event Driven Master Fund LTD, 177 A.3d 1 (Del. Dec. 14, 2017)
Delaware Supreme Court reverses and remands on the ground that the Court of Chancery failed to give adequate consideration to the deal price – effectively requiring the lower court to explain away deal price when departing from deal price in appraisal actions.
Delaware has “long endorsed” the “efficient market hypothesis” which “teaches that the price produced by an efficient market is generally a more reliable assessment of fair value than the view of a single analyst, especially an expert witness who caters her valuation to the litigation imperatives of a well-heeled client.”
On remand, the Court of Chancery is empowered to find fair value equal to deal price without further proceedings, but is not required to do so, so long as the court “explain[s] that weighting based on reasoning that is consistent with the record and with relevant, accepted financial principles.”
46
In re Appraisal of AOL Inc., 2018 WL 1037450 (Del. Ch. Feb. 23, 2018)
VC Glasscock reads DFC and Dell to mean “in distilled form, provide that the statute requires that, where a petitioner is entitled to a determination of the fair value of her stock, the trial judge must consider ‘all relevant factors,’ and that no presumption in favor of transaction price obtains.”
“Where, however, transaction price represents an unhindered, informed, and competitive market valuation, the trial judge must give particular and serious consideration to transaction price as evidence of fair value. Where information necessary for participants in the market to make a bid is widely disseminated, and where the terms of the transaction are not structurally prohibitive or unduly limiting to such market participation, the trial court in its determination of fair value must take into consideration the transaction price as set by the market.”
“In sum, while no presumption in favor of transaction price obtains, a transaction that demonstrates an unhindered, informed, and competitive market value is at least first among equals of valuation methodologies in deciding fair value.”
The Court found that it was a “close question” whether the transaction was “Dell Compliant” but that process deficiencies required the Court to reject the $50 per share deal price as the sole determinate of value. The Court also found that there was and no non-arbitrary way to assign weight to the deal price in the Court’s fair value determination.
Notwithstanding the decisions in DFC and Dell, both parties continued to advocate for the use of financial metrics rather than transaction price, and the Court ascribed full weight to the DCF valuation of $48.70 per share and used the $50 per share transaction price as a reality check – about a 2.6% haircut to the appraisal petitioners.
47
Verition Partners Master Fund Ltd. v. Aruba Networks, Inc., 2018 WL 922139 (Del. Ch. Feb. 15, 2018).
Applying Dell and DFC, and the Delaware Supreme court’s endorsement of market evidence, VC Laster uses 30 day average unaffected stock price of $17.13 in the face of a merger price of $24.67 as “a possible proxy for fair value.”
VC Laster rejects DCF analyses based on the guidance of DFC and Dell.
VC Laster rejects the transaction price because the synergies analysis “requires exercises of human judgment analogous to those involved in crafting a discounted cash flow valuation.”
“Fortunately for a trial judge, once Delaware law has embraced a traditional formulation of the efficient capital markets hypothesis, the unaffected market price provides a direct route to the same endpoint, at least for a company that is widely traded and lacks a controlling stockholder.”
Verition Partners Master Fund Ltd. V. Aruba Networks, Inc., 2018 WL 2315943 (Del. Ch. May 21, 2018) (denying reargument and noting “I perceived that Dell and DFC endorsed the reliability of the unaffected market price as an indicator of value, at least for a widely traded company, without a controlling stockholder, where the market for its shares has attributes consistent with the assumptions underlying the efficient capital markets hypothesis. As a result, I believe that trial courts now can (and often should) place heavier reliance on the unaffected market price. From my standpoint, this aspect of the Dell and DFC decisions represented a change in direction for Delaware appraisal law. Before Dell and DFC, my conceptual framework for approaching the determination of fair value called for regarding the trading price with skepticism, while having relatively greater confidence in the contemporaneous views of management and other sophisticated parties and placing relatively greater reliance on management projections prepared in the ordinary course of business. This skeptical approach to market prices did not flow from any personalvalue judgment on my part, but rather from how Delaware Supreme Court decisions had treated the unaffected trading price as avaluation indicator.”
Oral Argument has not yet been set in the Delaware Supreme Court, but this is one to watch.
48
In re Appraisal of Solera Holdings, Inc., 12080-CB (Del. Ch. July 30, 2018)(Chancellor Bouchard awards deal price less synergies and appraises the company at 3.4% below deal price)
Norcraft Companies, Inc. v. Blueblade Capital Opportunities LLC, C.A. No. 11184-VCS (Del. Ch. July 27, 2018) (VC Slights awards a premium of 2.5% above deal price relying on a DCF and rejecting merger price less synergies where there was no pre-signing market check, Seller fixated on one buyer, lead negotiator was conflicted, and deal protection measures undermined post-signing go-shop).
Both cases considered deal price under Dell and DFC, but found that it was not an appropriate valuation on the facts.
Both cases also rejected unaffected stock price and rejected it as not supported by the record.
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Deal price less synergies has been a risk since 2004.
Appraisal actions are still being filed -- rate remains relatively high through 2017 compared to historical levels.
While there is still no presumption, the writing is on the wall that the Delaware Supreme Court expects good reasons (like bad process) for departing from the deal price.
No longer just about different WACC or plugging more appropriate projections than those used by financial advisors.
We may see less appraisal in arm’s length public company deals without viable (or close to viable fiduciary duty claims).
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Remains viable for non-arms length deals (controlling stockholder, MBO, Squeeze outs). But note the impediments to stockholder litigation under MFW.
Changes from signing to close could still result in appraisal bumps.
Disclosure deficiencies identified in discovery could undermine process-based defenses.
Expansion of appraisal discovery.
Lack of fee shifting mechanisms available in fiduciary duty cases under common fund and corporate benefit doctrine.
51
Owen v. Cannon, 2015 WL 3819204 (Del. Ch. June 17, 2015) (Chancellor Bouchard awarding a 60% premium over deal price and rejecting post-hocprojections in favor of contemporaneous management projections).
ACP Master, Ltd. v. Sprint Corp. (“Clearwire”), 2017 WL 3421142 (Del. Ch. July 21, 2017) (Court found the price paid in Sprint/Nextel’s 2013 acquisition of Clearwire to be entirely fair and that fair value was 50% below merger price because of “massive synergies” based on DCF analysis based on management projections prepared in the ordinary course of business and rejecting projections prepared by the buyer’s management in connection with competitive bidding).
In re Dole Food Co., Inc. S’holder Litig., 2015 WL 5052214 (Del. Ch. Aug. 27, 2015) (Court awarded a 20% premium based on strong findings of fraud by buyer / chairman and CEO. Court concluded that the decision likely renders the appraisal proceeding moot).
52
Criticism of Corwin v. KKR Fin. Holdings LLC, 125 A.3d 304 (Del. Oct. 2, 2015) as based on untested hearsay proxy statements without the benefit of discovery.
Use of discovery obtained in appraisal actions to plead plenary breach of fiduciary duty claims appears to be a strategy that plaintiffs could pursue to avoid a pleading-stage dismissal under Corwin, before any discovery can be obtained.
53
In July 2018, Dell announced that it is going public again. Although the transaction is complicated by Dell’s 2016 acquisition of EMC for $67B and the use of a tracking stock, it has been suggested that the $109 per share transaction signals that perhaps Vice Chancellor Laster’s original appraisal, and not the going private deal price, better reflects fair value with the benefit of hindsight.
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Schoenfeld, Matthew, From Corwin to Dell: The Cost of Delaware Turning a Blind Eye
The author, of Burford Capital, suggests that the ramifications of Delaware’s clampdown on shareholder litigation in Corwin and Dell is based on a fallacy that the practices being promoted are reflective of actual fair dealing and that these decisions will lead to lower deal premia and higher agency costs, CEO wage growth, greater industry specific concentration, declining competition, lower labor market mobility, wage stagnation and income inequality.
Available at https://papers.ssrn.com/sol3/papers.cfm?abstract_id=312251
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Heyman Enerio Gattuso &
Hirzel LLP
Samuel T. Hirzel, Esq. [email protected](302) 472-7315www.HEGH.law
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This presentation was prepared solely for general informational and educational purposes. It does not create an attorney-client relationship with the author or Heyman Enerio Gattuso & Hirzel LLP. It should not be construed as legal advice or used as a substitute for legal counselling. This presentation reflects the personal views of the author and those views are not necessarily the views of Heyman Enerio Gattuso & Hirzel LLP or its clients.
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mnat.com
2018 M&A Litigation Update
Presented by Ryan D. Stottmann
Presented on October 18, 2018
59
Key 2018 Delaware Rulings• Busted Deal/Material Adverse Effect Provisions
• Akorn. Inc., v. Fresenius Kabi AG, et al.
• Anti-takeover Provision and the Delaware General Corporate Law
(“DGCL”)§203
• Siegman I & II
• Matador
• Chesapeake
• KCG
• USG
• Waiver of Stockholder Appraisal Rights
• Manti Holdings, LLC et al. v. Authentix Acquisition Co.
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Busted Deal: Akorn v. FreseniusAkorn, Inc., v. Fresenius Kabi AG, et al. (Del. Ch. Oct. 1, 2018)
• Longest Opinion in Court of Chancery history
• First Delaware decision allowing a party to walk from a merger on the basis of
Material Adverse Effect (“MAE”)
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Akorn v. Fresenius• Brief Background
• In April 2017, Fresenius agrees to buy Akorn for $4.75 billion and the parties sign a
Merger Agreement
• Akorn had just announced Q1 results and reaffirmed 2018 full-year guidance
• During Q2, Akorn’s performance “fell off a cliff” and continued declining through the
summer and into the fall
• In October/November 2017, Fresenius receives anonymous whistleblower letters
alleging issues with Akorn’s regulatory and quality compliance
• Fresenius launches investigation, and Akorn’s performance continues to deteriorate
• In late April 2018, Fresenius terminates Merger Agreement
• Akorn then files suit seeking to specifically enforce Merger Agreement
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Akorn v. Fresenius• Four Breaches:
1. Akorn’s breach of General MAE provision
2. Akorn’s breach of Regulatory Compliance Representations
3. Akorn’s breach of Ordinary Course Covenant
4. Fresenius’ s non-material breach of Hell-or-High-Water Covenant
• Failure of General MAE Condition
• Fresenius’s obligations to close were conditioned on the absence of a Material
Adverse Effect, which is a defined term that begins with a general and self-referential
description of an event that has “a material adverse effect on the business, results of
operations or financial condition of the Company and its Subsidiaries,” and then
contains a number of exceptions and carve-outs to allocate risk between the seller and
buyer.
• Recommend Court’s discussion on pages 122-127 regarding the various categories of risks
and how they are typically allocated among the seller and buyer
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Akorn v. Fresenius• Materiality of the Effect
• Buyer faces heavy burden
• Short-term hiccup is not enough, must view from the long-term perspective of a
reasonable acquirer
• The effect must substantially threaten the overall earnings potential of the seller in a
durationally-significant manner
• Court has previously used the example of a decline in earnings of 50% over two
consecutive quarters
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Akorn v. Fresenius• Findings on MAE Materiality
• Akorn suffered dramatic declines in financial performance
• EBITDA declined 51% over prior year; Similar declines over 5-year span (see chart)
• Court noted that Akorn’s performance during Q1 2017 (right before signing the
Merger Agreement) did not exhibit this downturn; Only began after merger signing
Source: Opinion p. 136
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Akorn v. Fresenius• Findings on MAE Materiality (cont’d)
• Downturn was durationally-significant as it persisted for one year with no signs of
abating
• Court rejected argument that the downturn was due to “industry headwinds” and thus
was an exception to an MAE because that risk is allocated to the buyer. Akorn’s
underperformance was substantially worse than industry median and peers
• Court also rejected argument that Fresenius knowingly accepted the risks that led to
an MAE based on info it learned in diligence or general industry knowledge. The
Court relied on the specific allocation of risks set out in the definition of an MAE
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Akorn v. Fresenius• Breach of Regulatory Compliance Representations
• So-called “bring down” issue, meaning that Akorn’s reps and warranties were
required to be true as of signing and as of closing. If reps were not true at closing,
buyer could refuse to close unless the deviation would not constitute an MAE. Buyer
could also terminate the Merger Agreement if the breach of reps could not be cured
by the outside date
• Akorn made a variety of representations regarding its regulatory compliance (p. 160)
• Court analyzed whether the difference between Akorn’s represented condition and its
actual condition was so great that it would reasonable be expected to result in an
MAE
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Akorn v. Fresenius• Findings on Regulatory Compliance
• Qualitative significance of regulatory issues
• Court found overwhelming evidence of widespread regulatory violations and pervasive
compliance problems, including large-scale data integrity issues
• Court concluded that Akorn represented itself as an FDA-compliant company when it
actually had persistent, serious violations of FDA requirements and a disastrous culture of
noncompliance
• Quantitative significance of regulatory issues
• The Court noted it would cost tens-to-hundreds of millions to remediate the regulatory
defects, amounts material to a reasonable prospective buyer
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Akorn v. Fresenius• “Sandbagging”
• The Opinion contains an interesting and detailed discussion regarding the state of Delaware
law on so-called “sandbagging,” or claiming reliance on a representation when you had
reason to suspect that the representation was inaccurate when made
• Akorn asserted that Fresenius knew about the risk of regulatory non-compliance and signed
the Merger Agreement regardless
• The Court found that the parties had allocated risk regarding regulatory compliance via a
specific representation and that Fresenius was entitled under Delaware law to rely on that
representation regardless of what it uncovered in due diligence
• The Opinion notes that parties could have drafted the representation with carve-outs for
items disclosed in due diligence or attached a schedule of specific data integrity issues not
covered by the representation
• No Cure
• Finally, the Court concluded that Akorn could not have cured its regulatory problems by the
outside date, even if that date was extended from April 2018 to October 2018
• The Court found that problems would not be fixed until at least 2021
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Akorn v. Fresenius• Breach of Ordinary Course Covenant
• This type of covenant ensures that the buyer is getting at closing what it thought it
was buying at signing.
• Consists of a broad affirmative covenant to use commercially reasonable efforts to
carry on its business in all material respects in the ordinary course of business, and
then sixteen categories of prohibited acts.
• Side note: Pages 213-214 contain an overview of the hierarchy of different types of
“efforts clauses” – ranging from “best efforts “(highest standard) to “good faith efforts”
(lowest standard). “Commercially reasonable efforts” falls closer to the lower standard
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Akorn v. Fresenius• Findings on Ordinary Course
• Court relied on the Supreme Court’s Williams/ETE opinion, noting that Akorn was
required to take all reasonable steps to maintain operations in the ordinary course, and
that Akorn breached that obligation in multiple ways
• Court found that Akorn cancelled regular audits, did not maintain a sufficient data
integrity system, and submitted FDA filings that were based on fabricated data
• Court found that the breaches were material because they “changed the calculus of the
acquisition for purposes of closing.” Court also noted that the failure to act in the
ordinary course cost Akorn a year of what could have been meaningful remediation
efforts
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Akorn v. Fresenius• Fresenius Potential Breaches
• Reasonable Best Efforts Covenant
• Court found that the parties agreed to use reasonable best efforts to consummate the
transaction they agreed to in the Merger Agreement, and not to “merge at all costs and on any
terms”
• The inquiry in a best efforts covenant is whether a party had reasonable grounds to take the
action that it did and sought to address problems with its counterparty
• The Court found that the whistleblower letters coupled with Akorn’s dismal performance
gave Fresenius good cause to evaluate its rights under the Merger Agreement, ultimately
concluding that Fresenius wanted to live by the Merger Agreement and do what it was
obligated to do while at the same time protecting its own contractual rights and terminating
the transaction if it was able
• The Court distinguished cases like IBP and Hexion where the parties did not raise
concerns before filing suit, did not work with counterparties and appeared to have
manufactured issues as part of buyer’s remorse
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Akorn v. Fresenius• Fresenius Potential Breaches
• Hell-or-High-Water Covenant
• Fresenius agreed to take all actions necessary to secure antitrust approval, without any
mitigating efforts obligation
• Court found that Fresenius as a general matter diligently pursued antitrust approval, except
for a one-week time period in February 2018, during which Fresenius considered an option
that would have pushed closing from April to June, however the Court found that Fresenius
reversed course after a week and the merger stayed on track for an April closing
• The Court found that Fresenius “technically” breached the Hell-or-High-Water covenant for a
period in February, but the breach was not material
• Thus, in April when Fresenius purported to terminate the Merger Agreement, it was not itself
already in breach of the agreement
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Akorn v. Fresenius• Takeaways
• The Opinion is extremely fact specific – some may say this is an extension of MAE
law; others will say it is simply an application of existing law to extreme facts
• VC Laster found the buyer’s conduct in this case “markedly different” from the way
buyers acted in prior MAE cases like IBP and Hexion, where buyers were perceived
to have second thoughts after cyclical trends or industry-wide effects negatively
impacted their own business and who filed litigation to escape their bargain without
first consulting with the sellers
• The Court seemed to place a lot of weight on Fresenius’s dual-track efforts of both (i)
consulting with Akorn about the issues that came up while (ii) simultaneously continuing to
move forward with the transaction.
• This case is a reminder to pay attention to the construction of the “material adverse
effect” definition to ensure it is properly tailored to the buyer/seller’s business and
that it appropriately allocates post-signing risks.
• The Opinion is a veritable treatise on how post-signing risk can be categorized, allocated,
carved-out, etc.
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DGCL Section 203Section 203 of the DGCL (8 Del. C.§203)
• Colloquially known as the “anti-takeover statute”
• Added to the DGCL in the late 1980’s during the hostile takeover boom
• Vice Chancellor Glasscock recently described the purpose of Section 203 as “to prevent coercive
takeovers that deny value to independent stockholders of the type endemic to its era, the late
1980’s.”
•Section 203 generally prohibits “business combinations” with an “interested stockholder” (generally
a holder of 15% or more of a corporation’s voting stock) for a period of three years following the time
at which the stockholder became an interested stockholder, unless one of 3 safe harbors is met.
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Section 203
The Three Statutory “Safe Harbors”
1.Prior to the time the interested stockholder became such, the board of directors approved the
business combination or the transaction that resulted in the stockholder becoming an interested
stockholder;
2.Upon consummation of the transaction by which the interested stockholder became such, the
interested stockholder owned at least 85% of the outstanding stock; or
3.After the time the interested stockholder became such, the business combination is approved by the
board and by stockholders at a meeting by 2/3 vote of the voting stock which is not owned by an
interested stockholder.
Other Carve Outs
•If the corporation’s original charter expressly opts out of Section 203; if an amendment to the charter
or bylaws to opt out is adopted by majority vote of stockholders; or if a stockholder becomes
interested inadvertently and immediately divests itself below the interested threshold.
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Section 203
Key Definitions
•“Business combination”
• Broadly defined
• Includes mergers and consolidations with an interested stockholder, transactions resulting in the
issuance of company stock to an interested stockholder, or dispositions of 10% or more of
company assets to an interested stockholder.
• “Interested stockholder”
• The direct or indirect owner of 15% or more of the voting stock of a corporation (as well as any
affiliate or associate of such an owner).
• An affiliate or associate of a corporation who was, within the prior three years, the owner of
15% or more of the corporation’s voting stock.
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Section 203Key definitions
•“Owner”
• For purposes of calculating ownership, a person is considered to be the owner of stock:
• That it beneficially owns;
• That it has the right to acquire or vote; or
• With respect to which it has an agreement, arrangement or understanding for the purpose of
acquiring, holding, voting or disposing of such stock
•Key issue: What constitutes an “agreement, arrangement or understanding” with respect to the
acquiring, holding, voting or disposing of stock?
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Section 203
Potential scenarios:
•Buyer reaches out to large 15%+ stockholder in a company to gauge interest or support in
a potential transaction.
• Could discussions or understandings between the buyer and large stockholder be deemed an
“agreement, arrangement or understanding” for purposes of Section 203, such that the large
stockholder’s holdings are attributed to the buyer and the buyer becomes an interested
stockholder?
•Private equity buyer wants members of management who collectively hold more than
15% of the company’s stock to roll their stock or enter into voting agreements in support
of the transaction.
• Will the discussions among the PE firm and management rise to the level of an “agreement,
arrangement or understanding”?
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Section 203 Cases
Siegman v. Columbia Pictures Entertainment, Inc., 576 A.2d 625 (Del. Ch. 1989)
(“Siegman I”)
•In connection with Sony’s acquisition of Columbia, Sony entered into an option agreement with
Coca-Cola, Columbia’s 49% stockholder, for the purpose of acquiring Coca-Cola’s stock of
Columbia. The option agreement was contingent on Columbia and Coca-Cola board approval.
•In denying a request to preliminarily enjoin the transaction, the Court of Chancery found, if the
Columbia board had not approved the option agreement before it was executed, the entry into the
option agreement likely would have caused Sony to become an “interested stockholder”
notwithstanding the contingent nature of the agreement.
•The Court noted that nothing in Section 203 “limits the Act to non-contingent contracts.”
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Section 203 Cases
Siegman v. Columbia Pictures Entertainment, Inc., 1993 WL 10869 (Del. Ch.
1993) (“Siegman II”)
•Over three years later, on summary judgment motions, the Court found that there were material
issues of fact as to when Sony became an interested stockholder. In particular, the Court considered
whether Sony became an interested stockholder of Columbia the day before the Columbia board
approved the merger agreement.
•Defendants argued that the language in the option agreement stating that it was contingent upon
approval of the Columbia board was not determinative, but was “strong evidence” that “no
‘agreement, arrangement or understanding’ came into being until the contingencies were removed”
unless the facts would demonstrate that the language was a “sham or mere window dressing”
•The Court stated that “the critical factual issue here . . . is whether the agreement was truly
contingent.”
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Section 203 Cases
Matador Capital Management Corp. v. BRC Holdings, Inc., 729 A.2d 280 (Del.
Ch. 1998)
•In connection with ACS’s acquisition of BRC, Esping, a 20% stockholder of BRC, entered into a
stock tender agreement for the purpose of selling her shares to ACS in the merger. The stock tender
agreement was requested by ACS, but was negotiated solely by BRC and its agents.
•The Court determined that such a stock tender agreement was not an agreement, arrangement or
understanding between ACS and Esping prior to the time that the BRC board approved the merger.
Instead, the agreement was only an agreement between BRC and Esping.
•“In the circumstances of this case, it would make a mockery of Section 203 to enjoin a transaction
negotiated by the BRC board in which Mrs. Espings’s agreement to tender was given as an
accommodation to the BRC board in order to satisfy one of ACS’ demands on it.”
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Section 203 Cases
Chesapeake Corp. v. Shore, 771 A.2d 293 (Del. Ch. 2000)
• As part of a strategy to acquire Shorewood Packaging Corporation (“Shorewood”), Chesapeake
Corporation (“Chesapeake”) entered into a stock purchase agreement with Ariel Capital
Management (“Ariel”), a firm that owned more than a 20% interest in Shorewood, pursuant to
which Chesapeake agreed (i) to purchase 14.9% of Shorewood’s stock from Ariel and (ii) to pay
Ariel an additional amount if Chesapeake or another bidder acquired Shorewood at a higher price
than Chesapeake had paid Ariel for its shares.
• Shorewood argued that the second prong of the agreement distorted Ariel’s economic incentives
with respect to the shares it retained, incentivizing it to support a change-in-control transaction,
with Chesapeake or a third party, even where it believed the company was worth more under
management’s current strategic plan. Shorewood argued these economic incentives constituted an
“agreement, arrangement or understanding for the purpose of … voting” the shares retained by
Ariel, such that Chesapeake should be deemed to own Ariel’s other shares for purposes of Section
203 and was thus an “interested stockholder.”
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Section 203 Cases
Chesapeake (cont’d)
•The Court acknowledged that the arrangement could create incentives but that Ariel’s interests would
not be aligned with Chesapeake’s in all instances:
• “Given the broad language of the statute, it is plausible that an agreement could create such substantial
economic incentives for the seller with respect to purchased shares that the agreement could also, as a
practical matter, constitute an ‘agreement, arrangement or understanding for the purpose of ... Voting’ other
shares still held by the seller. But for that to be the case, there should be persuasive evidence showing that the
agreement essentially renders it economically irrational for the seller to, in almost all likely circumstances, do
anything other than vote his remaining shares in lockstep with the buyer.”
•The Court found that Ariel’s agreement with Chesapeake did not approach this level of
incentivization, noting that it did not “render [Ariel’s] legal right to vote its remaining shares a
pretext.”
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Section 203 Cases
Greenway v. KCG Holdings, Inc., et al., C.A. No. 2017-0421-JTL (June 8, 2017 and
June 9, 2017) (Transcripts)
•Involved early discussions between the buyer (Virtu) and Jefferies, a ~25% stockholder of the target
(KCG)
•Plaintiffs alleged that the buyer spent months secretly talking to and meeting with Jefferies, including
on a potential price, all behind the Board’s back. When Virtu made a proposal to KCG’s Board,
Jefferies encouraged the Board to engage with the buyer and exchanged draft voting agreements with
the buyer
•Plaintiffs alleged that this tainted the sales process, and gave the buyer the “one leg up” that Section
203 was intended to prevent.
•After a deal was announced, plaintiffs sought a preliminary injunction hearing and filed a motion to
expedite
• The defendants did not oppose some form of expedition on the Section 203 claim, suggesting the possibility of
having a full hearing on the merits before the stockholder vote.
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Section 203 Cases
KCG (cont’d)
• VC Laster initially denied the motion to expedite the Section 203 claim:
• “The point of 203 is that if you are an interested stockholder, then there’s a three-year
moratorium on certain types of transactions between the company and the interested
stockholder. It doesn’t result in a block against a meeting. It doesn’t result in setting aside a
vote. It creates a three-year moratorium . . . the consequence is that you can’t do the list of
interested transactions for a three-year period. That is a clear statutory post-meeting
consequence.”
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Section 203 Cases
KCG (cont’d)
•The next day, the Court sua sponte reconsidered its ruling:
• The Court noted that its initial analysis was that a 203 would only create a statutory moratorium
on closing; it would not invalidate the vote.
• “What I recognized after having given you my ruling . . . is that if the 203 claim is valid and the
merger then can’t close, then it creates this recursive disclosure problem, because the
stockholders would want to know going into the vote that the merger can’t close. So even
though it’s not a direct problem for the vote, it creates this feedback loop that effectively
becomes a disclosure problem.”
•The Court also described a “care-based process claim” that could exist if a board chooses
a merger but the merger is by definition not value-maximizing because it cannot close.
•The Court scheduled a pre-vote preliminary injunction hearing.
• However, the issue was ultimately mooted after the company amended the transaction to seek a
2/3 stockholder vote specifically for purposes of Section 203.
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Section 203 Cases
In re USG Corporation Stockholder Litigation, C.A. No. 2018-0602-SG (Sept.
25, 2018) (Transcript)
• The buyer (Knauf) was a 10% owner of the target (USG).
• Plaintiff alleged that Berkshire Hathaway’s 30% stake in the company should be attributed to the
buyer as a result of an alleged agreement, arrangement, or understanding reached between the
buyer and Berkshire, and Plaintiff sought a preliminary injunction against the stockholder vote
• The buyer had pursued USG for many years, USG initially rebuffed
• The buyer then approached Berkshire, seeking a commitment from Berkshire and mentioning a price of $40
per share
• The Court found that Warren Buffet provided no commitment and told the buyer to take its offer to USG
management
• The Board communicated with Buffet, who acknowledged his discussions with the buyer and
indicated support for an all cash offer and encouraged the Board to engage with the buyer.
• Later, Berkshire proposed to the buyer an option for the buyer to purchase Berkshire’s shares for
$42 and made this offer public against the buyer’s wishes. The Court described this as a
preliminary offer that was never accepted by the buyer.
88
Section 203 Cases
In re USG (cont’d)
• Ultimately, after further negotiations between the board and the buyer and threats of a proxy
contest, the buyer submitted a final bid of $44 per share.
• USG’s CEO communicated to Berkshire that $44 was the best the company could do and there
were no other prospects, and that the buyer wanted Berkshire to sign a voting agreement.
• The Board approved a merger at $44, and later that day Berkshire signed a voting agreement under
which it retained the ability to vote for a higher offer.
• In analyzing the Section 203 issues, VC Glasscock focused heavily on the history and purposes
behind the statute, quoting from the legislative synopsis and the drafters’ report
• He paraphrased Section 203 as follows:
• “Where there is an agreement, broadly defined, to provide the acquirer with control of stock held by another
for purposes of the acquisition, that stock must be aggregated with the acquirer’s own stock to determine if the
acquirer is a statutorily interested stockholder.”
89
Section 203 Cases
In re USG (cont’d)
•The Court found there “no meeting of the minds as to an agreement that ceded control of
Berkshire Hathaway’s stock to [the buyer] such that [the buyer] is a statutory owner.”
• The Court noted that Berkshire acted against the wishes of the buyer and retained an out in the
voting agreement to vote for a higher deal.
• Berkshire was aligned with the other affiliated stockholders, not the buyer, to drive a higher
price.
90
Section 203 Trends/Takeaways
• Seeing a uptick in Section 203 issues in recent years
• Stockholders seeking preliminary injunctive relief
• Stockholders sending Section 220 books and records demands in order to explore Section 203
issues
• Focus on Section 203 early and throughout the process
• Consider obtaining/providing board approval for Section 203 purposes before the transaction
is fully negotiated
• Focus on disclosures
• Make sure material facts about these types of discussions are disclosed and do not create the
misleading impression that an agreement, arrangement, or understanding was reached when it
was not
91
Waiver of Appraisal Rights• Until two weeks ago, Court of Chancery had not expressly addressed whether a
common stockholder could contractually waive statutory appraisal rights
• The Court has noted that preferred stockholders can waive their appraisal rights,
given that their rights as stockholders are largely contractual
• Any waiver or modification of preferred stock appraisal rights must be express and
clearly set forth in contract
92
Waiver of Appraisal Rights• In 2015, Vice Chancellor Glasscock noted in Riverstone that “the question of
whether common stockholders can, ex ante and by contract, waive the right to
seek statutory appraisal in the case of a squeeze-out merger of the corporation
…has not yet been answered by a court of this jurisdiction.” Halpin v. Riverstone Nat’l, Inc., 2015 WL 854724 (Del. Ch. Feb. 26, 2015)
• Riverstone was an appraisal action in which the corporation counterclaimed and
attempted to enforce a drag-along provision in a stockholders agreement that would
have effectively caused the stockholders to lose their appraisal rights
• The Court in Riverstone did not need to reach the question of whether common
stockholders “may contractually commit to a waiver of appraisal rights provided by
statute,” because the Court found that the drag-along was not properly invoked by the
company
93
Waiver of Appraisal Rights• Not aware of any case following Riverstone in 2015 in which a Delaware court
addressed the ability of common stockholders to contractually waive appraisal
rights, until two weeks ago when Vice Chancellor Glasscock once again took
up the issue, albeit in a somewhat indirect way
94
Waiver of Appraisal RightsManti Holdings LLC v. Authentix Acquisition Co., C.A. No. 2017-0887-SG (Del.
Ch. Oct. 1, 2018)
•The Court did not discuss as directly as it did in Riverstone the issue of whether a
common stockholder may waive an appraisal right conferred by statute
•Rather, the Court described the issue as whether the stockholder was “contractually bound
to refrain from seeking appraisal” – likely because that is the language used in the
stockholders’ agreement at issue
•Specifically, the stockholders’ agreement provided that, in a “Company Sale,” the parties
to the agreement “agree to consent to such a sale.” The agreement also imposed specific
duties on the stockholders, including “to refrain from the exercise of appraisal rights with
respect to such transaction.”
• The Court emphasized that demonstrating a waiver of a statutory right to appraisal requires
language evincing the clear intent to waive, and found that the agreement to refrain from
exercising appraisal rights was clear and unambiguous
95
Speakers
RYAN D. STOTTMANN
PARTNER
(302) 351-9430 T
Ryan’s litigation practice focuses on corporate and
commercial litigation in the Delaware Court of Chancery
and appeals before the Delaware Supreme Court.
He has served as lead counsel and co-counsel to
companies, stockholders and directors in appraisal and
fiduciary duty litigation, trade secrets and licensing cases,
employee non-compete and non-solicitation matters,
statutory matters arising under Delaware corporate and
alternative entity laws, and post-closing indemnification
and escrow disputes arising from merger, stock purchase
or asset purchase agreements.
