M&A Litigation Declines as Court of Chancery Confirms Narrow Path for Success--Comstock, Larkin and Nguyen
Delaware court decisions over the past two to three years have evidenced a strong trend toward greater deference to directors and stockholders in M&A matters. The trend has been reflected not only in procedural matters (such as the court's unwillingness to approve previously typical disclosure-only settlements) but also in generally relaxed substantive legal standards (including, for example, application of the deferential business judgment review in post-closing actions for damages so long as the transaction was approved by shareholders in a fully informed vote, even if in a pre-closing action for injunctive relief Revlon or "entire fairness" was applicable). A consequence of this trend has been that defendant directors now have a clear road map for several routes to early dismissal of claims against them.
As a result, there has been a significant decline in M&A-related litigation. Cornerstone has reported that, in the first half of 2016, 64% of announced M&A transactions (valued over $100 million) were challenged in litigation, down from over 90% in each year from 2010 through 2014. Further, litigation is more frequently being brought outside Delaware, in jurisdictions viewed as potentially more plaintiff-friendly--with 26% of M&A lawsuits having been brought in Delaware over the nine-month period from September 2015 through June 2016, down from over 60% involving Delaware corporations in prior periods.
Volume of M&A Litigation
Percentage of Announced Public M&A Deals Challenged in Litigation
2010 - 2014
2015 Jan-Jun 2016
Source: Cornerstone Research: Shareholder Litigation Involving Acquisitions of Public Companies
Fried Frank M&A/PE Quarterly Copyright 2016. Fried, Frank, Harris, Shriver & Jacobson LLP. All rights reserved. Attorney Advertising.
>> ETE-Williams Heightens Focus on Deal Certainty--Advance Planning to Lower Risk of Non-Satisfaction of Closing Conditions Page 3
>> In Our View, Dell Has Not Increased the Risk of an Appraisal Award Higher than the Merger Price--But Highlights that a "Meaningfully" Competitive Sale Process Is the Key to Reducing the Risk Page 3
>> In Appraisal Case Involving Unusual Business Uncertainty, the Court of Chancery Rejects Sole Reliance on the Merger Price Despite "Robust" Sale Process--DFC Global Page 4
>> Other Items of Interest Page 5
M&A/Private Equity Partners
Abigail P. Bomba Andrew J. Colosimo Warren S. de Wied Aviva F. Diamant Steven Epstein Christopher Ewan Arthur Fleischer, Jr.* Andrea Gede-Lange Randi Lally Mark Lucas Scott B. Luftglass Philip Richter Steven G. Scheinfeld Robert C. Schwenkel David L. Shaw Peter L. Simmons Matthew V. Soran Steven J. Steinman Gail Weinstein*
Washington, DC Jerald S. Howe, Jr. Brian T. Mangino Brian Miner
London Dan Oates Graham White
Frankfurt Dr. Juergen van Kann Dr. Christian Kleeberg
M&A Litigation Jurisdictions
Percentage of Litigation Brought in Delaware
Source: Cornerstone Research: Shareholder Litigation Involving Acquisitions of Public Companies
The Delaware Court of Chancery's decisions this past quarter--Miami v. Comstock (8/24/16), Larkin v. Shah (8/25/16), and Nguyen v. Barrett (9/28/16)--have broadened the court's trend, underscoring the likelihood of early dismissal of damages claims against directors in the context of transactions that were approved by the shareholders (based on the Delaware Supreme Court's seminal 2015 Corwin decision).
Comstock. Although Revlon duties applied pre-closing, the court applied business judgment review in the post-closing damages action based on the fact that the shareholders had approved the transaction--even though apparently serious allegations relating to the sale process and the proxy disclosures were raised.
Larkin. Larkin indicates that, in the context of non-controller transactions, the weight of authority of Court of Chancery decisions now favors the application of business judgment review (rather than entire fairness) even in the context of wellpled claims of unexculpated breaches by a board of its duty of loyalty--that is, claims that the board was not independent and disinterested or acted in bad faith.
Nguyen. The court indicated that, in a post-closing action, the court may view as having been waived disclosure claims that were not first brought and pursued pre-closing. In addition, the court clarified that there will be a higher burden of proof for plaintiffs with respect to disclosure claims brought in a post-closing action for damages than in a pre-closing action for injunctive relief--namely, that, post-closing, to avoid dismissal at the pleading stage, plaintiffs would have to allege facts from which there is reasonable inference that (i) the misrepresentation or omission in the disclosure was material (as would be required in a pre-closing injunctive action), and (ii) the board breached its duty of loyalty in connection with the inadequate disclosure (i.e., that the board was not independent and disinterested or that it knowingly and intentionally misrepresented or omitted material information).
In our Briefings, we also discuss:
Related practice points, including the heightened importance of disclosure, the burden of proof with respect to disclosure in a Corwin context, and when disclosure claims made for the first time after closing might or might not be deemed by the court to have been waived;
The validity of post-signing passive market checks; Plaintiffs' exposure for reimbursement of target company expenses in complying with an injunction that is later
overturned; and The continued importance of board and banker compliance with best practices notwithstanding the courts' recent trends.
ETE-Williams Heightens Focus on Deal Certainty--Advance Planning to Lower Risk of Non-Satisfaction of Closing Conditions
In Energy Transfer Equity v. Williams (6/24/16), the Delaware Court of Chancery held that ETE was not obligated to close the merger pursuant to which it had agreed to acquire Williams. The court's holding was based on the failure of a mutual condition to closing that ETE's counsel deliver an opinion that the transaction should be regarded by the tax authorities as a tax-free exchange. Although ETE had "bitter buyer's remorse" and wanted to exit the transaction for reasons unrelated to the tax opinion issues, the court concluded that (i) ETE's tax counsel in good faith believed that it could not issue the tax opinion and (ii) ETE had not influenced its counsel not to deliver the opinion.
In response to ETE, merger parties likely will intensify their focus on deal certainty. Although a number of unusual characteristics of the ETE-Williams transaction led to both the issue in the case and the
judicial result, ETE highlights that merger parties should understand and seek to redress the risks of (and detriment from) non-satisfaction of closing conditions. Depending on the facts and circumstances, it may advantage a company (particularly a target company--and even more so if the company is foregoing an alternative transaction) to take an aggressive approach in narrowing closing conditions when negotiating a merger agreement. Attention should be paid to each condition, including conditions that have been considered to be customary and have not typically been the subject of dispute. As ETE underscores, this evaluation is particularly important if: (i) a condition involves receipt of an opinion from the counterparty's own advisor; (ii) there is a novel deal structure; or (iii) the nature of the transaction or market or other condition may give rise to issues that could result in failure of a condition. The issues in ETE were exacerbated by the facts that only an opinion delivered by ETE's one named tax counsel could satisfy the tax opinion condition and there was no alternative presented to remedy a failure of receiving the opinion.
In our Briefing, we also discuss:
The importance of due diligence to identify, evaluate and deal with the potential risks of a deal not being consummated; The need for specificity with respect to the "efforts" obligation; The possiblity of providing for "back-up" alternative transaction structures; Alternative formulations for tax opinion conditions to seek to avoid the ETE situation; and The likelihood that, in response to ETE, target companies may become more aggressive in seeking to achieve
agreements that come closer to a true "hell-or-high-water" standard than in the past.
In Our View, Dell Has Not Increased the Risk of an Appraisal Award Higher than the Merger Price--But Highlights that a "Meaningfully" Competitive Sale Process Is the Key to Reducing the Risk
In Appraisal of Dell Inc. (May 31, 2016), the Delaware Court of Chancery awarded an appraisal amount that was 30% higher than the price that was paid in the $25 billion merger in which Michael Dell (the founder and CEO of Dell) and private equity firm Silver Lake Partners took Dell private. In the merger, Mr. Dell obtained 75% ownership of the company. The court utilized a discounted cash flow (DCF) analysis to appraise Dell's "fair value" for appraisal purposes (i.e., the going concern value of Dell just prior to the merger, excluding the value of any expected synergies), having concluded that, in this case, the merger price was not a reliable indicator of fair value.
The decision has raised two concerns: (i) that, even when the sale process has been robust, with directors meeting all of their fiduciary duties, the appraisal award may exceed the merger price--exacerbating the uncertainty that has surrounded appraisal outcomes; and (ii) due to some broad language in the decision, that the court will be taking a new direction, rejecting the merger price as a basis for determining "fair value" in all appraisal cases involving financial buyers.
In our view, the decision is consistent with the court's recent approach in appraisal cases. While the court regarded the Dell sale process as well-crafted for fiduciary duty purposes, it viewed the process, for appraisal purposes, as insufficient to outweigh the factors that undermined the reliability of the merger price as an indicator of "fair value." In our view, the decision underscores the court's consistent position that it will base appraised "fair value" on the merger price only when the court believes that the merger price is the best indicator of fair value.
The decision also serves as a reminder that the extent to which the court will view a sale process as having been sufficiently competitive to establish that the merger price is the best indicator of appraised fair value will depend on the facts and circumstances--and that the court will take into account its view of the underlying reality of the sale process based on real-world factors.
We do not believe that the court will reject the merger price as a basis for fair value in all cases involving financial buyers but, rather, that a buyer's use of an "LBO pricing model" will be one factor taken into account in evaluating whether the merger price is the best indicator of appraised fair value--and we expect that it would be unlikely to ever be a significant factor where a truly competitive market check has taken place.
In our Briefing, we also discuss:
The courts' skepticism that the merger price in a management buyout (an "MBO"--i.e., an LBO with a significant management buyout component) is a reliable indicator of "fair value" for appraisal purposes; and
The features present in Dell (not all of which are always present in MBOs--and none of which necessarily is present in strategic transactions or in LBOs without a significant management buyout component) that heightened the court's skepticism in this case.
In Appraisal Case Involving Unusual Business Uncertainty, the Court of Chancery Rejects Sole Reliance on the Merger Price Despite "Robust" Sale Process--DFC Global
DFC Global (7/8/16) is notable for the Court of Chancery's refusal to rely solely on the merger price to determine "fair value"-- notwithstanding the court's view of the sale process as "apparently robust."
The court viewed the merger price as less than fully reliable as an indicator of "fair value" because of the very high degree of business and financial uncertainty that faced the target company leading up to, and at, the time of sale.
In our Briefing, we also discuss:
That, as would be expected in the context of a robust sale process, (i) there were not a large number of shares that sought appraisal and (ii) the court's determination of "fair value" was only slightly above the merger price--with the result that the appraisal award resulted in an additional cost to the buyer that represented only a de minimis percentage increase (0.3%) in the transaction value. ; and
Related issues and practice points pertaining particularly to financial buyers.
Other Items of Interest
Delaware judges confirm a "new approach to judicial scrutiny" and "a narrowing of the more exacting standards" in M&A matters. In a panel discussion before the International Bar Association, reported in The M&A Lawyer, Vice Chancellor Joseph R. Slights, III (a new member of the Court of Chancery), former Justice of the Delaware Supreme Court Jack Jacobs, and former Chief Justice of the Delaware Supreme Court and Vice Chancellor Myron T. Steele, confirmed that (in the words of Justice Jacobs) there has been "a major shift in the way the courts are viewing M&A transactions" over the past two to three years. Vice Chancellor Slights described the change as a "convergence..., a narrowing of the more exacting standards of review toward business judgment review." Justice Steele explained that the courts' approach has been "coordinated" to also provide increased deference to stockholders in M&A matters, based on the fact that 70% of public stockholders are institutional stockholders who the courts view as "well advised, very sophisticated and... capable of making independent judgments of their own without judicial oversight." Justice Jacobs confirmed that one objective underlying the new approach is to establish "structures that would basically discourage litigation and also simplify planning."
Justice Slights summarized the substantive changes as: (i) "[L]ay[ing] down in various stark and direct terms the importance of ... the qualified decision-maker" and "laying out...a pretty clear game plan or road map as to how to structure those transactions in a way that will ultimately allow the court to give deference to the judgment of the board
making the decision"; and (ii) clarifying that Revlon is a preclosing remedy only and that, when it applies, "perfection is not expected," there is "a range" of conduct that is acceptable, "there is no mandatory go-shop, [and] the market check that is expected doesn't have to follow any particular blueprint." Justice Jacobs predicted that "the next chapter of challenges" will relate to what disclosure is necessary to support business judgment review of a stockholder-approved transaction in a Revlon context. Reflecting some of the complexity that is likely to arise under the new approach, he predicted that "the disclosure is going to have to show that in fact the board made reasonable efforts to get the highest bid."
New FTC guidance on how to value LBOs under HSR.
The Hart-Scott-Rodino Act requires that certain transactions
valued in excess of a size-of-transaction threshold (currently
$78.2 million) be notified to the Federal Trade Commission
and Department of Justice and endure a waiting period prior
to closing. The value of a transaction under the HSR rules
does not necessarily match the stated purchase price. In
general, the HSR size-of-transaction is based on the portion
of the total consideration that is paid to equity holders of the
target. Thus, the portion of the consideration used to pay off
the target's existing debt can be excluded when calculating
the size-of-transaction. These rules remain unchanged.
However, the FTC recently retracted a prior interpretation
providing that the portion of the purchase price funded through
new debt incurred by the target in connection with financing of
the acquisition could be excluded for purposes of determining
Delaware Court of Chancery applied entire fairness review in a post-closing action for damages challenging a merger agreement that extinguished certain derivative claims against a majority of the target board. In Riverstone National, Inc. Stockholder Litigation (July 28, 2016), the court found that the extinguishment of claims relating to alleged usurpation of corporate opportunities by a majority of the board provided the directors with a material personal benefit, rendering them not "disinterested." The Court emphasized, however, that, standing alone, conclusory allegations that a potential derivative suit against directors was extinguished by
a merger should not provide a basis for entire fairness review of the merger. By contrast, in Riverstone, the court explained, the pleadings alleged "facts with respect to individual directors [comprising a majority of the board] showing the existence of a chose-of-action against the directors which, if brought as a claim, would have survived a motion to dismiss; that the director[s] at the time of negotiating and recommending the merger [were] aware of the potential action; that the potential for liability was material to the director[s]; and that the directors obtained and recommended an agreement that extinguished the claim[s] directly by contract."
Fried Frank M&A/PE Round-Up
Fried Frank's M&A practice advises clients on some of the largest and most complex US and global deals, providing counsel to a full spectrum of companies on sophisticated transactions that are often multi-jurisdictional and, in some cases, transformational. With over eighty attorneys in four offices, our team has deep experience advising public and private companies, special committees, audit committees, and boards of directors in complex negotiated and contested situations, including negotiated mergers, hostile takeovers and takeover defense, proxy contests and financial adviser representations, and restructuring transactions.
Highlights of our recent work include representations of:
New Mountain Capital
In its US$2.3 billion sale to Zhongwang USA
In its US$1.4 billion acquisition of Interactive Intelligence Group
In its acquisition of Convey Health Solutions, Inc.
Special Committee of NorthStar Asset Management Group Inc. (NSAM)
In its merger with Colony Capital, Inc. and NorthStar Realty Finance Corp. (NRF)
to form a REIT with US$58 billion AUM
In its agreement to sell its Material Handling and
Port Solutions business to Konecranes for US$1.3 billion
In its acquisition of BASF's polyolefin catalyst business
Awards and Accolades:
M&A partner Philip Richter was recognized in The National Law Journal's 2016 "M&A and Antitrust Trailblazers" feature for his leading role on several major deals for clients such as NorthStar Asset Management, Media General, International Rectifier, and Terex.
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