AIRGAS: POISON PILLS AND THE ALLOCATION OF POWER BETWEEN THE BOARD AND STOCKHOLDERS
Following the 2010 year-end discussion in Bloomberg Law Reports® of several cases involving shareholder rights plans,1 Chancellor Chandler, on February 15, 2011, released a landmark 153-page post-trial opinion shortly before retiring from the bench.2 The case involved a takeover fight between Air Products & Chemicals Inc. and Airgas, Inc. Air Products had launched an all-shares, all-cash tender offer, periodically increasing its offering price, and Airgas responded by stating in public filings that the offering price was inadequate. For almost one year, the Airgas board defended against the offer, relying on its shareholder rights plan to thwart the takeover attempt. Eventually, the combatants came to a crossroads where Air Products had made a “best and final” offer of $70 per share and the Airgas board had concluded that the offer was inadequate and that its value in a sale transaction was at least $78.00 per share. The Court of Chancery was asked to order Airgas to redeem its poison pill and other defenses and to allow Airgas’s stockholders to decide for themselves whether they wanted to accept the $70.00 offer.
The court addressed the fundamental question of the allocation of power between directors and stockholders and who gets to decide when and if the corporation is for sale. The court framed the inquiry as follows: “Can a board of directors, acting in good faith and with a reasonable factual basis for its decision, when faced with a structurally non-coercive, all-cash, fully financed tender offer directed to the stockholders of the corporation, keep a poison pill in place so as to prevent the stockholders from making their own decision about whether they want to tender their shares—even after the incumbent board has lost one election contest, a full year has gone by since the offer was first made public, and the stockholders are fully informed as to the target board’s views on the inadequacy of the offer? If so, does that effectively mean that a board can ‘just say never’ to a hostile tender offer?”3
The court held that “a board cannot ‘just say no’ to a tender offer” because, under Delaware law, a board must first pass through two prongs of exacting judicial scrutiny by a judge who will evaluate the actions taken by, and the motives of, the board. Only a board of directors found to be acting in good faith, after reasonable investigation and reliance on the advice of outside advisors, which articulates and convinces the court that a hostile tender offer poses a legitimate threat to the corporate enterprise, may address that perceived threat by blocking the tender offer and forcing the bidder to elect a board majority that supports its bid.
After going through the 25-year history of Delaware precedent on the use of poison pills, the court “conclude[d] that, as Delaware law currently stands, the answer must be that the power to defeat an inadequate hostile tender offer ultimately lies with the board of directors. As such, I find that the Airgas board has met its burden under Unocal to articulate a legally cognizable threat (the allegedly inadequate price of Air Products’ offer, coupled with the fact that a majority of Airgas’s stockholders would likely tender into that inadequate offer) and has taken defensive measures that fall within a range of reasonable responses proportionate to that threat.”4
The court stated that it had “a hard time believing that inadequate price alone (according to the target’s board) in the context of a non-discriminatory, all-cash, all-shares, fully financed offer poses any ‘threat’—particularly given the wealth of information available to Airgas’s stockholders at this point in time—[but] under existing Delaware law, it apparently does.”5 Inadequate price has become a form of “[s]ubstantive coercion” which “has been clearly recognized by our Supreme Court as a valid threat.”6 Accordingly, the court was “constrained by Delaware Supreme Court precedent to conclude that defendants have met their burden under Unocal to articulate a sufficient threat that justifies the continued maintenance of Airgas’s poison pill.”7
The Chancellor was clear that this case “does not endorse ‘just say never.’”8 Rather, it endorses “Delaware’s long-understood respect for reasonably exercised managerial discretion, so long as boards are found to be acting in good faith and in accordance with their fiduciary duties (after rigorous judicial fact-finding and enhanced scrutiny of their defensive actions).”9
FINANCIAL ADVISOR CONFLICT CLAIMS—DEL MONTE
The Court of Chancery in 2011 continued to express concern for potential conflicts of interest involving financial advisors. Most prominently, perceived conflicts involving the advisor to Del Monte Foods led to an injunction and, ultimately, a $90 million settlement, and an interim attorneys’ fee award of $2.75 million as well as an attorneys’ fee award of $22.3 million in a final order and judgment approving the settlement.
Del Monte Foods entered into a merger agreement for $19 per share cash with a newly formed entity owned by three private equity firms—KKR, Centerview Partners and Vestar Capital Partners. The plaintiffs sought to enjoin the transaction.
The court found that “[u]ntil discovery disturbed the patina of normalcy surrounding the transaction,’” there were only two Board decisions that invited serious challenge: first, allowing KKR to team up with Vestar, the high bidder in a previous solicitation of interest, and second, authorizing Barclays Capital, the financial advisor to Del Monte, to provide buy-side financing to KKR.”10 Discovery then revealed the deeper problem—namely, that “Barclays secretly and selfishly manipulated the sale process to engineer a transaction that would permit Barclays to obtain lucrative buy-side financing fees.”11 According to the court, Barclays did not disclose the behind-the-scenes efforts of its Del Monte coverage officer to put Del Monte in play; it did not disclose its explicit goal of providing buy-side financing to the acquirer; and it did not disclose that it had steered Vestar into a joint bid with KKR in violation of confidentiality agreements that prohibited Vestar and KKR from discussing a joint bid without written permission from Del Monte.12
The court found that the plaintiffs had established a reasonable probability of success on the merits of a claim for breach of fiduciary duty against the individual defendants, aided and abetted by KKR. The directors failed to provide the serious oversight that would have checked Barclays’ misconduct. “Barclays’ deal-specific, buy-side conflict tainted the advice it gave and the actions it took.”13
OPENLANE: WRITTEN CONSENTS, OMNICARE AND THE ABSENCE OF A FIDUCIARY OUT
In In re OPENLANE, Inc. Shareholders Litigation,14 the Court of Chancery upheld the use of written consents by a majority of stockholders shortly after the target company board entered into a merger agreement. Two other notable aspects of the opinion are the court’s treatment of the lack of a fiduciary out (given the continuing uncertainty about the vitality of the Delaware Supreme Court’s opinion in Omnicare), and the court’s reliance on a board’s “impeccable knowledge” of the company to satisfy its duty under Revlon, even in the absence of “any [other] traditional value maximization tool.”15 This opinion reinforces the principle that “‘[t]here is no single path that a board must follow in order to maximize stockholder value, but directors must follow a path of reasonableness which leads towards that end.’”16
The buyer, KAR, agreed to acquire OPENLANE for $210 million in cash plus any excess cash over necessary working capital at closing. The plaintiffs alleged that the OPENLANE board engaged in a flawed sales process because it only contacted three potential buyers (including KAR), failed to perform an auction or an adequate market check, failed to obtain a fairness opinion, relied on its financial advisor’s nine-month old financial analysis and locked up the deal with a no solicitation clause that lacked a fiduciary out, coupled with the board’s ownership of a majority of the voting power of the stock.
The court declined to enjoin the merger, even though it noted that “the Board’s decision-making process was not a model to be followed.”17 The court held: “if a board fails to employ any traditional value maximization tool, such as an auction, a broad market check, or a go-shop provision, that board must possess an impeccable knowledge of the company’s business for the Court to determine that it acted reasonably.”18 In this regard, the court observed that OPENLANE appears to be one of the “few corporations that is actually ‘managed by’ as opposed to ‘under the direction of’ its board of directors.”19 Moreover, OPENLANE was a small public company with more in common with a private company. Accordingly, the court found that “the record supports the conclusion that this is one of those few boards that possess an impeccable knowledge of the company’s business.”20 However, it was careful to observe that the smallness of a company does not modify core fiduciary duties. Even so, where a small company is managed by a board possessing an impeccable knowledge of the company’s business, the court may consider the size of the company in determining what is reasonable and appropriate. In addition to the board members’ impeccable knowledge of the company, the board held over 59 percent of OPENLANE’s outstanding stock, and the board and OPENLANE’s current executives held over 68 percent. Thus, the board’s ownership interests suggested that the board was motivated to get the best price reasonably available—another helpful fact in defeating the injunction motion.
The plaintiffs had also alleged allegations that the deal was improperly “locked-up” because (i) the board controlled a majority of the target’s stock; (ii) holders of a majority of the stock submitted written consents a day after the merger agreement was executed; and (iii) the merger agreement contained a no-solicitation clause without a fiduciary out provision. However, unlike the situation presented in Omnicare, here, the merger was not a fait accompli. There was no voting agreement under which stockholders had promised to vote for the merger, as was the case in Omnicare; rather, the record “merely suggest[ed] that, after the Board approved the Merger Agreement, the holders of a majority of shares quickly provided consents.”21 Similarly, the court held that the no-solicitation clause was not preclusive because the board was free to terminate the entire merger agreement if OPENLANE’s shareholders did not consent to the merger within twenty-four hours.
The court also addressed the lack of a fiduciary out in footnote 53. The court noted that the Delaware Supreme Court’s Omnicare decision could be read to require a fiduciary out. Nevertheless, the court rejected the argument that the lack of a fiduciary out required the Court of Chancery to enjoin the transaction. Citing Omnicare, the court held that “hostile bidders are on notice that Delaware courts may not enforce a merger agreement that lacks a fiduciary out if they present a board with a superior offer.”22 Thus, although the court noted that “it is not surprising that another suitor has not emerged,” the lack of a fiduciary out does not prevent a topping offer from emerging.23 “Enjoining a merger when no superior offer has emerged is a perilous endeavor because there is always the possibility that the existing deal will vanish, denying shareholders the opportunity to accept any transaction.”24 Here, there was no competing offer—importantly, none that was arguably superior—and that suggested to the court that caution should be exercised before enjoining a transaction with no viable alternative.
REVLON—SPLIT MERGER CONSIDERATION
In In re Smurfit-Stone Container Corp. Shareholder Litigation,25 Vice Chancellor Parsons considered “a question that has not yet been squarely addressed in Delaware law; namely, whether and in what circumstances Revlon applies when merger consideration is split roughly evenly between cash and stock.”26 The court decided that a merger consisting of 50 percent cash and 50 percent stock was subject to Revlon, and, in the circumstances of the case, the directors “satisf[ied] their obligations under Revlon.”27
The court examined precedent in this area relating to what percentage of merger consideration could be cash without triggering Revlon, including In re Lukens Inc. Shareholders Litigation,28 and In re Santa Fe Pacific Corp. Shareholder Litigation.29 While the 50 percent cash consideration was closer to the situation presented in Lukens (where the court assumed that Revlon would apply), the court recognized the conclusion was not “free from doubt.”30 The court held, echoing recent opinions on the application of Revlon, that because “there [wa]s no ‘tomorrow’ for approximately 50% of each stockholder’s investment in Smurfit-Stone,” Revlon applies to “a transaction that constitutes an end-game for all or a substantial part of a stockholder’s investment in a Delaware corporation.”31
DERIVATIVE LITIGATION—A LANDMARK AWARD OF DAMAGES
In In re Southern Peru Copper Corp. Shareholder Derivative Litigation,32 Chancellor Strine, in a post-trial opinion, ordered a controlling stockholder (the “controller”) of a NYSE-listed mining company, Southern Peru Copper Corporation (“SPC”) to pay $1.263 billion in damages (an amount the court subsequently revised to $1.347 billion), plus interest, in connection with a merger in 2005 where Southern Peru Copper acquired Minera Mexico, S.A. The controlling stockholder of SPC proposed that SPC buy the controller’s 99.15 percent stake in Minera. A Special Committee of SPC ultimately approved SPC’s acquisition of 99.15 percent of Minera’s stock in exchange for 67.2 million newly issued shares of SPC stock. On that day, the 67.2 million shares had a market value of $3.1 billion. When the merger closed five months later, the value of these shares had grown to $3.75 billion.
In the derivative suit that followed, the parties agreed that the appropriate standard of review was entire fairness. The court found the value of the SPC stock to be given in the exchange to be easily discernable since it was a publicly traded company, and that its actual stock market price was a reliable indicator of the value of the “give.”33 It observed that “[t]he question thus becomes what was the value of the ‘get’.”34 The court focused on the inability of the Special Committee’s financial advisor to reconcile the stand-alone value of Minera with the market value of the SPC stock requested by the controller.
The court concluded that the Special Committee’s financial advisor’s discounted cash flow analyses showed that Minera was worth far less than $3.1 billion. Yet, the Special Committee had embarked on a “relative valuation” approach which presumed that SPC’s real value was less than its stock trading price. The court described these approaches as “complicated scenarios” which obscured the fundamental fact that SPC had a proven cash value and that the use of these “relative valuation” methodologies suggested that the Special Committee believed that Minera was worth far less than $3.1 billion. The court criticized the Special Committee for not asking the controller to make a premium to market offer for SPC, and concluded for a variety of reasons that the Special Committee was not “well functioning.” The board resolution creating the Special Committee did not give the Special Committee express power to negotiate, or to explore other strategic alternatives. The Special Committee’s request for a collar around the purchase price and a majority-of-the-minority vote was rejected. Moreover, it never requested an updated fairness opinion even though SPC’s stock price steadily rose between the signing and the closing of the merger. The Special Committee never derived a stand-alone value for Minera that equaled the controller’s asking price. Ultimately, the court concluded that the merger was unfair to SPC and its stockholders and that the Special Committee, instead of pushing back on the controller, devalued SPC and topped up the value of Minera.
In fashioning a remedy, the court determined that the plaintiff’s long delay in litigating the case rendered rescission inequitable. Instead, it took the difference between the price the Special Committee would have approved had the merger been entirely fair and the price the Special Committee actually paid, which the court found to be $1.347 billion, plus simple interest on that amount since the date of the merger. In addition, the court awarded attorneys’ fees and expenses in the amount of 15 percent of the judgment or $304,742,604, plus post-judgment interest until such fee award is satisfied.
MASSEY ENERGY CO.—LOSS OF STANDING AND DENIAL OF INJUNCTIVE RELIEF
In another notable opinion, Chancellor Strine (then Vice Chancellor Strine), denied a motion to enjoin a merger between two mining companies in In re Massey Energy Co. Derivative & Class Action Litigation.35 There, Massey Energy Company entered into a merger with Alpha National Resources, Inc. following the tragic, massive West Virginia mine explosion in April 2010 which killed 29 miners. The plaintiffs sought to enjoin the merger because the Massey board did not negotiate to have the pending derivative claims transferred into a litigation trust for the exclusive benefit of the Massey stockholders. They argued that the merger was unfair because it resulted in Alpha being able to acquire Massey without paying fair value for the economic value of the derivative claims.
The court, in denying its motion to preliminarily enjoin the merger, found, as a matter of black letter law (Lewis v. Anderson), that the derivative claims would pass to Alpha in the merger unless the merger itself was merely a fraudulent attempt to deprive the Massey stockholders of their derivative standing, or the merger was a mere reorganization that otherwise did not affect the Massey stockholders’ relative ownership in the resulting corporate enterprise. Because the merger was not a mere reorganization and because it appeared highly doubtful that plaintiffs could prove a fraudulent attempt by the board to deprive them of their standing, it seemed likely that Alpha would control the derivative claims—forcing the plaintiffs to have to prove demand excusal as to Alpha, not Massey stockholders, and obtain leave to proceed in a double derivative action on behalf of Alpha.
The court found that while the Massey board’s failure to address the value of the derivative claims was regrettable in view of the economic impact the disaster had on Massey, the record did not support the inference that the derivative claims were material in comparison to the overall value of Massey as an entity. The court noted the absence of any substantial argument from the plaintiffs that the derivative claims were material in the context of the $8.5 billion Alpha merger—even though the court found that they were likely to survive a motion to dismiss. Moreover, the plaintiffs had not seriously contended that the sale process was flawed. Nor was there any probability of success on the merits of any disclosure claims. In denying injunctive relief, the court also found that a later award of monetary damages could make Massey and its current stockholders whole, possibly through a direct action against the directors if the plaintiffs could prove the directors acted in bad faith to approve a sale at a materially unfair price because the merger did not reflect the value of the derivative claims. Pursuing an appraisal under a similar theory, although also a difficult route, was another potential path to monetary relief which precluded a finding of irreparable harm.
NO DERIVATIVE STANDING FOR AN LLC CREDITOR, EVEN IN INSOLVENCY
In an opinion which highlights yet another significant distinction between Delaware alternative entities and Delaware corporations, the Delaware Supreme Court in CML V, LLC v. Bax36 held that a creditor of a Delaware limited liability company lacks derivative standing to pursue claims on behalf of the limited liability company, even in insolvency.37
CML V, LLC, a junior secured creditor of JetDirect Aviation Holdings, LLC, sued the LLC’s managers derivatively for breach of fiduciary duty stemming from allegations of misguided acquisitions and self-dealing. In analyzing whether the plaintiff had standing to assert such claims, the court first turned to 6 Del. C. § 18-1002 of the Delaware Limited Liability Company Act (the “LLC Act”), which it held was “unambiguous and limits derivative standing . . . exclusively to ‘member[s]’ or ‘assignee[s].’”38 The plaintiff argued, unsuccessfully, that Section 18-1001 of the LLC Act should be read to not limit standing to those groups listed in Section 18-1002 and that the LLC Act merely “rephrase[d] the language of Section 327 of the Delaware General Corporation Law” (the “DGCL”).39 Using statutory construction arguments, the court held that this was not a reasonable interpretation and that it was not absurd or unreasonable to interpret the LLC Act in a different manner from the DGCL.40
INSIDER TRADING CLAIMS UNDER DELAWARE LAW—BROPHY REVISITED AND REAFFIRMED
In Kahn v. Kohlberg Kravis Roberts & Co.,41 the Delaware Supreme Court, en banc, reversed the Court of Chancery’s dismissal of a derivative action. In that case, two shareholders of Primedia, Inc. sued the company, its directors and officers, and Kohlberg Kravis Roberts & Co. (“KKR”) for alleged breaches of fiduciary duty stemming from KKR’s purchase of Primedia preferred stock which eventually was redeemed by the company. The plaintiffs alleged that KKR possessed material, non-public information when it made the purchases—a so-called Brophy claim.42 In response to the complaint, Primedia moved to dismiss and when that motion failed, formed a special litigation committee (the “SLC”) comprised of two new directors. The SLC moved to dismiss, and the Court of Chancery granted the motion.
On appeal, the Delaware Supreme Court held that the lower court had erred in dismissing the complaint on the SLC’s motion, and that to successfully bring a Brophy claim, a plaintiff need not “show that the corporation suffered actual harm.”43 The court further held that, “[e]ven if the corporation did not suffer actual harm, equity requires disgorgement of that profit.”44 The court then rejected the defendants’ argument that Brophy was “outdated” given the pervasive regulation of insider trading under the federal securities laws.45 Further, the opinion rejects the reasoning of another Court of Chancery decision which limited recovery under Delaware law to ancillary costs incurred by the corporation as a result of the insider trading.46 Thus, even where a corporation is not harmed directly from an insider profiting from the misuse of confidential corporate information, the corporation maintains a disgorgement remedy “irrespective of arguably parallel remedies grounded in federal securities laws.”47
INTERIM ATTORNEYS’ FEE AWARDS
The Court of Chancery considered the appropriateness of an interim award of attorneys’ fees in a number of cases this year. In In re Del Monte Foods Co. Shareholders Litigation,48 Vice Chancellor Laster awarded $2.75 million in interim fees following his entry of an order temporarily enjoining the acquisition of Del Monte by a consortium of sponsors, including KKR. The court had determined that discovery showed that Del Monte’s investment bank had not fully disclosed its role in providing buy-side financing, and that these and other disclosures merited significant fees. The court awarded $1.6 million for “uncovering Barclays’ surreptitious activities,” $950,000 for disclosures relating to the bankers’ fairness opinions, fees and relationships, and $200,000 for disclosures about the executives’ incremental compensation for the merger.49 While the court had enjoined the stockholder vote for 20 days pending supplemental disclosures and declared the no-shop clause unenforceable during that time, it declined to award interim fees for the benefits conferred by the injunction and deferred that decision. The parties later agreed to settle the claims for approximately $90 million. On December 1, 2011, the court entered an Order and Final Judgment awarding $22.3 million in attorneys’ fees.
However, in two later decisions, Vice Chancellor Noble denied requests for interim fee awards. In Frank v. Elgamal,50 the plaintiff challenged the acquisition of American Surgical Holdings, Inc. by AH Holdings, Inc., an affiliate of Great Point Partners I, L.P., a private equity fund. The plaintiff alleged breaches of fiduciary duty, unfair price and process, inadequate disclosures, and aiding and abetting by Great Point and its affiliates. American Surgical filed definitive proxy materials containing supplemental disclosures that effectively mooted the plaintiff’s disclosure claims. Although the price and process claims remained viable, the plaintiff requested $450,000 as an interim fee award. The court observed that “[i]nterim fee awards are generally disfavored,”51 but that interim awards may be appropriate where the plaintiff has achieved the benefit sought by the claim that has been mooted or settled and that benefit is not subject to reversal or alteration as the remaining portion of the litigation proceeds. While arguably these circumstances were present, the court, in its discretion, chose to wait to rule until the plaintiff’s remaining claims have been litigated. The court expressed concern that piecemeal consideration of fee applications may decrease confidence in the court’s fee award because “full appreciation of the benefits brought about by the Plaintiff’s counsel can best – and perhaps only – be accurately achieved when the work is done and all the benefits have been bestowed.”52
In In re Novell, Inc. Shareholder Litigation,53 plaintiffs sought an interim award of $3 million in fees on the basis that the consolidated actions caused Novell to make corrective disclosures. The court, however, again exercised its discretion to defer ruling on the application until the remaining claims have been litigated.
Ms. Valihura is a litigation partner resident in the Delaware office of Skadden, Arps, Slate, Meagher & Flom LLP. Mr. Brown is a litigation associate in the Delaware office of Skadden, Arps. The views expressed herein are solely those of the authors.
This document and any discussions set forth herein are for informational purposes only, and should not be construed as legal advice, which has to be addressed to particular facts and circumstances involved in any given situation. Review or use of the document and any discussions does not create an attorney-client relationship with the author or publisher. To the extent that this document may contain suggested provisions, they will require modification to suit a particular transaction, jurisdiction or situation. Please consult with an attorney with the appropriate level of experience if you have any questions. Any tax information contained in the document or discussions is not intended to be used, and cannot be used, for purposes of avoiding penalties imposed under the United States Internal Revenue Code. Any opinions expressed are those of the author. The Bureau of National Affairs, Inc. and its affiliated entities do not take responsibility for the content in this document or discussions and do not make any representation or warranty as to their completeness or accuracy.
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