What Revlon Doesn't Require
In re Family Dollar Stores, Inc. (Del. Ch. Dec. 19, 2014)
C&J Energy Services Inc. v. City of Miami General Employees' and Sanitation Employees' Retirement Trust(Del. Dec. 19, 2014)
Refresher: Revlon duties
Under Revlon, Inc. v. MacAndrews & Forbes Holdings, Inc.("Revlon"), when a Delaware corporation's board of directors considers a transaction that constitutes a sale of corporate control, the court will require a board to "maximiz[e] … the company's value at a sale for the stockholders' benefit" and to "get the highest value reasonably attainable for the shareholders." The Delaware courts have consistently held that Revlon does not create one standard methodology pursuant to which a board must run a sale process. Rather, they recognize that every situation is fact-specific, and that in carrying out the sale process directors must simply have been "adequately informed and acted reasonably" when aiming to achieve stockholder value.
Background: C&J and Dollar Store
In both C&J and Family Dollar, the Supreme Court and Court of Chancery, respectively, call out the important difference between judicial review of the decisions of a conflict-free, independent board and those of a board where independence has been called into question. The agreement included a standard "fiduciary-out" pursuant to which C&J could consider superior offers and, upon payment of a termination fee, terminate the agreement with Nabors. No competing bids emerged either before or after the agreement with Nabors was signed, yet stockholders of C&J sued to enjoin the stockholder vote on the Nabors deal, alleging that the C&J board breached its Revlon duties by failing to actively solicit third party bidders. Although the Chancery Court granted the injunction, the Supreme Court quickly reversed and permitted the vote to go forward.
In Dollar Store, rendered by the Delaware Court of Chancery, Family Dollar Stores, Inc. ("Family Dollar") and Dollar Tree, Inc. ("Dollar Tree") entered into a merger agreement pursuant to which Dollar Tree would pay a mix of cash and stock for Family Dollar valued at $74.50 per share of Family Dollar stock. The merger agreement included a requirement for Dollar Tree to divest up to 4,900 of its stores to clear antitrust approval (a divestiture commitment which, according to the board's legal and investment banking advisors, yielded a 95% chance of antitrust approval), and, as in C&J, included a "fiduciary-out" pursuant to which Family Dollar's board could entertain a "superior proposal" that was "reasonably likely to be completed on the terms proposed." Unlike in C&J, however, an unsolicited third party bidder emerged when Family Dollar was approached by Dollar General, Inc. ("General") with a bid to acquire Family Dollar for cash at a price of $78.50 per share and divestiture commitment of 700 stores. After being refused by Family Dollar's board, General subsequently increased its offer to $80 per share and a 1,500 store divestiture commitment, which Family Dollar's board again refused based upon it and its advisors' judgment that the chances of antitrust approval for the deal were no greater than 40%. General then sued to enjoin Family Dollar's stockholder vote to approve the Dollar Tree merger, claiming Family Dollar's board had breached its Revlon duties, in part, by not properly negotiating with General. The Court of Chancery declined to issue an injunction and the vote proceeded.
(1) Maximizing the value of your family dollar: more money (but more problems)
The Court in Family Dollar emphasizes that Revlon does not require a board to accept the bids of, or even engage in active negotiations with, a competing bidder solely because that bidder offers a higher price. To the contrary, the Court noted that:
In short, the Board's decision reflects the reality that, for the Company's stockholders, a financially superior offer on paper does not equate to a financially superior transaction in the real world if there is a meaningful risk that the transaction will not close for antitrust reasons.
Thus, despite a higher offer, Family Dollar's board complied with its Revlon duties to "get the highest value reasonably attainable for the shareholders" (emphasis added) because the lower bid from Dollar Tree was all but certain to be attainable, while the higher bid from General was unlikely to be attainable at all. It is easy for even the most responsible board of directors, eager to do right by its stockholders and to abide by its fiduciary duties, to mistake a higher offer for a better offer. After all, Revlon requires the "highest value." However, when more money comes with more problems (in this case, likely and unavoidable antitrust problems) more is not necessarily better.
(2) Independence buys you freedom
In both C&J and Family Dollar, the Supreme Court and Court of Chancery, respectively, call out the important difference between judicial review of the decisions of a conflict-free and independent board and those with respect to which independence has been called into question. The Court is hesitant to second-guess the otherwise reasonable decision-making processes of an independent and conflict free board, and although a change of control transaction might implicate Revlon duties, as the Court in Family Dollar notes, "when the record reveals no basis to question a board's motivations, the Court understandably will be more likely to defer to the board's judgment in determining how to conduct a corporate sale process." In his C&J opinion, Chief Justice Leo Strine noted that the facts in the case, as with many cases in which Revlon duties apply, were quite different from Revlon (the case) itself, and thus the results of Revlon shouldn't determine the results of every case in which Revlon duties are implicated: "Revlon involved a decision by a board of directors to chill the emergence of a higher offer from a bidder because the board's CEO disliked the new bidder…the majority of C&J's board is independent, and there is no apparent reason why the board would not be receptive to a transaction that was better for stockholders than the Nabors deal." Likewise, in Family Dollar, the court noted that "the record here demonstrates that the Board was properly motivated to maximize value for Family [Dollar]'s stockholders. Ten of the eleven members of the Board are outside directors whose independence has not been called into question… None of the ten outside directors will serve as a director in the combined entity if the Merger is approved." With no good reason to question the motivation of the board as anything other than maximizing the value for its stockholders, the courts in both C&J and Family Dollar limited their inquiries to whether the board in question was "adequately informed and acted reasonably" to achieve that end. Thus, the more independent and free from conflicts a board is, the more freedom it has to craft a sale and decision-making process, and the more deference it will get in a judicial review of that process, even when Revlon applies.
(3) Market Checks Can be Passive (No Aggressive Solicitation Required)
Both C&J and Family Dollar explicitly reject the notion that Revlon requires an auction or otherwise requires a board to actively shop the Company, either before or after a definitive agreement has been signed with a prospective buyer. In C&J, Chief Justice Strine specifically rejected the notion that the C&J board breached its Revlon duties by forgoing an active auction process and relying instead on the passive market check of a "fiduciary-out" in its acquisition agreement with Nabors:
Revlon made clear that when a board engages in a change of control transaction, it must not take actions inconsistent with achieving the highest immediate value reasonably attainable. But Revlon does not require a board to set aside its own view of what is best for the corporation's stockholders and run an auction whenever the board approves a change of control transaction… In prior cases…this sort of passive market check was deemed sufficient to satisfy Revlon. But as the years go by, people seem to forget that Revlon was largely about a board's resistance to a particular bidder and its subsequent attempts to prevent market forces from surfacing the highest bid.
The Court's discussion of the passive market check, or "fiduciary-out" in Family Dollar spanned multiple pages, and the Court noted that "taking into consideration the constraints of Section 5.3(c) of the Merger Agreement, the Board acted reasonably in my opinion to maximize value for Family [Dollar]'s stockholders in accordance with its fiduciary obligations under Revlon when it came to the conclusion, as reflected in the minutes, "that the Revised Dollar General Proposal is not reasonably expected to lead to a Company Superior Proposal that is reasonably likely to be completed on the terms proposed." Thus the board need not have engaged General in its competing offer, let alone solicited competing offers from unidentified third parties, and the "constraints" contained in the fiduciary-out it negotiated with Dollar Tree did not dilute its effect as a Revlon-compliant market-check mechanism, but rather informed the Court's analysis of the universe of potential board action to be considered in determining whether the board, in considering other offers, acted "reasonably." These decisions highlight the importance of a carefully drafted fiduciary-out provision which allows the board an effective passive market check.
The Latest in "Appraisal Arbitrage"
In Re Appraisal of Ancestry.com, Inc. (Del. Ch. Jan. 5, 2015)
Merion Capital LP v. BMC Software, Inc. (Del. Ch. Jan. 5, 2015)
As a refresher, "appraisal arbitrage" is a trading strategy pursuant to which an investor purchases stock in an acquisition target following public announcement of the deal but prior to closing, with the specific intention of seeking appraisal rights in order to capitalize on potentially undervalued deals. This arbitrage opportunity gained traction in 2007, when the Chancery Court's opinion in In re Appraisal of Transkaryotic Therapies, Inc. clarified that any beneficial holder of a company's stock could seek appraisal rights regardless of when the shares were acquired, provided that the total number of dissenting shares was less than the total number of shares not voted or voted against the deal by the record holder of such shares. Notably, the Delaware legislature amended the appraisal statute in 2007 to allow the beneficial holder of shares to seek appraisal rights directly. Previously, only the record holder of shares, large depositaries such as Cede & Co., could seek appraisal rights at the direction of beneficial holders. The court's two recent opinions clarify that the 2007 amendments did not impose a "share-tracing" requirement to shares acquired after the record date for determining stockholders entitled to vote on a transaction.
In Ancestry.com, hedge fund Merion Capital initiated appraisal action, through Cede & Co. acting on its behalf as nominee record holder, for Ancestry.com stock purchased after the record date for the related cash acquisition.Ancestry.com argued that Merion Capital, as mere beneficial owner of the stock, should only be permitted appraisal rights if it could prove that the specific prior owners of its shares had not voted to approve the merger. Arguing a "share-tracing" requirement as a necessary corollary to the 2007 Delaware appraisal statute amendments, Ancestry.comcontended that Merion (as beneficial owner of the shares, rather than Cede & Co as nominee) should be required to prove that it did not vote its shares in favor of the acquisition. In addition, because the shares were acquired after the record date, Ancestry.com argued that Merion Capital should also prove that the prior beneficial owners of the shares did not vote in favor of the acquisition. The Court rejected both arguments, holding that the party seeking appraisal (whether record or beneficial owner) is only required to show that the record owner of the shares beneficially owned would have available sufficient shares not voted in favor of the transaction.
In BMC Software, Merion Capital sought appraisal, through its broker, with respect to shares of BMC purchased after the record date of a going-private transaction. In this case, the broker refused to initiate an appraisal action and Merion Capital transferred record ownership of the shares into its own name and made a direct appraisal demand. BMC agreed that Merion Capital's standing for appraisal depended on a showing that its shares had not been previously voted in favor of the deal by any prior share owners. The Court disagreed with BMC's position and ruled that the Delaware appraisal statute only required Merion Capital to show that the record holder (here, Merion Capital) had not voted in favor of the deal.
These decisions, and the technical operation of the Delaware appraisal statute, further support the increasing practice (and publicity) of "appraisal arbitrage." Since 2007, the number of appraisal actions in the Delaware courts has grown every year and this practice is now a multi-billion dollar business with numerous investors and hedge funds exclusively focusing on this strategy for return. We anticipate, based on the recent recommendation of the Delaware Corporation Law Council, that the Delaware legislature will review this as an area for potential reform in the near future—specifically with respect to (i) a required minimum share ownership percentage held by any dissenting party and (ii) limitations on potential interest payable for pre-judgment settlements (see the proposed amendments here). In the interim, M&A practitioners should be aware that all acquisitions (public and private) potentially risk a time consuming and potentially expensive appraisal process and/or settlement. As a result, we may also see requests for appraisal related closing conditions in certain smaller public deals.
Books and Records – An Assist to Forum Selection
United Technologies Corp. v. Treppel (Del. Dec. 23, 2014)
A frequent precursor to public company deal litigation is the books and records request under Section 220 of the Delaware General Corporation Law. Typically employed by plaintiffs as the first step of "information gathering" for derivative litigation, a company's right to limit the potential use of requested information for claims solely in Delaware has been recently reviewed by the Delaware courts.
Faced with a books and records request relating to the rejection of a litigation demand, United Technology Corporation ("UTC") offered to provide the plaintiffs the requested information, pursuant to a binding confidentiality agreement that allowed the plaintiffs to use the information solely in connection with cases filed in Delaware. Unsurprisingly, the demanding stockholder refused to agree to such a limitation. Note that, at the time, UTC had not adopted a forum selection bylaw provision. In United Technologies Corp. v. Treppel, the Supreme Court reversed the Court of Chancery's ruling that the court lacked statutory power under Section 220 to impose a restriction on use of the information for claims brought in Delaware. The Delaware Supreme Court held that the state courts had "wide discretion to shape the breadth and use of inspections under §220 to protect the legitimate interests of Delaware corporations" and the power to impose the use restriction requested by UTC. The Supreme Court also noted that a company's interest in consistent rulings in the home state of incorporation, further fueled by the goal of reducing expenses from duplicative lawsuits, were indeed legitimate interests to be reviewed and protected by the courts and could be taken into account by the Court of Chancery in reviewing proposed restrictions in Section 220 disputes. The Supreme Court did not rule on the merits of UTC's request in remanding the case to the Court of Chancery for further review.
Do Merger Efficiencies Matter in Antitrust Review? Ninth Circuit Says "Yes"
The Ninth Circuit U.S. Court of Appeals last month sided with the Federal Trade Commission and required divestiture to unwind a consummated acquisition between two health care providers. In doing so, however, the court broke with long-standing precedent and accepted, in principle, a role for efficiencies in analyzing mergers.
The decision in St. Alphonsus v. St. Luke's provides valuable appellate-level insight into the treatment of merger efficiencies—long an equivocal issue before the federal courts. As the Ninth Circuit was quick to point out, prevailing Supreme Court precedent holds that "economies cannot be used as a defense to illegality."
While expressing some lingering skepticism about the efficiencies defense, the Ninth Circuit—which hears appeals of antitrust challenges to mergers and acquisitions in California, as well as Alaska, Arizona, Idaho, Montana, Nevada, Oregon and Washington State—indulged the parties' efficiencies-based arguments. This is a big step, given long-standing circuit court precedent that had rejected efficiencies as a merger defense. In doing so, the court was careful to emphasize the "linchpin" of the analysis remains whether the merger is likely to increase—not harm—competition. The court concluded, "the Clayton Act does not excuse mergers that lessen competition … simply because the merged entity can improve its operations."
It is becoming increasingly clear that evidence of merger efficiencies may be introduced to counter a prima facie merger challenge based on market shares, both before the Department of Justice and FTC and in court. St. Alphonsus provides support for such arguments. Prudent companies exploring a potential merger with a competitor should thus evaluate, analyze, and document proposed efficiencies early in the process of considering a transaction, and should pay attention to how the efficiencies may enhance competition, consulting with counsel and economic experts.