Page 1 Fried Frank Inside Change of Control Protections in Significant Non-Debt Commercial Agreements—The Importance of a “Dead Hand” Provision Page 5 Court Facilitates Fiduciary Duty Claims by Creditors When Entire Fairness Applies—Quadrant v. Vertin Follow-on Decision Page 8 The MLP Cycle and General Partner Liability in Dropdowns—Perspective on El Paso Page 10 Delaware Supreme Court Decisions— Independent Directors in Controller Transactions; Annual Meeting Dates Page 15 Delaware General Corporation Law Amendments—Fee-Shifting Bylaws Prohibited; Forum Selection Bylaws Permitted Page 16 Other Delaware Decisions—UAM, Molycorp, Citrix, ADT Page 18 Recent Delaware Appraisal Decisions— The More Things Change, The More They Stay The Same Page 21 Appraisal Update—Statistics and Dell Page 32 Authors Steven Epstein Arthur Fleischer, Jr. Peter S. Golden Brian Mangino Philip Richter Robert C. Schwenkel John E. Sorkin Gail Weinstein M&A QUARTERLY A quarterly roundup of key M&A developments 2nd Quarter 2015 Fried Frank M&A Quarterly Copyright © 2015. Fried, Frank, Harris, Shriver & Jacobson LLP. All rights reserved. Attorney Advertising. Shareholder Activism Update – DuPont and Samsung Shareholder Activism Update (continues on next page) DuPont Proxy Contest Victory Nelson Peltz’s Trian Fund has lost the proxy contest it waged to elect nominees to the E.I. du Pont de Nemours and Co. board. The battle pitted the activist considered to have the most successful record in reaching settlements with target boards against a $68 billion market cap company (the largest U.S. company to date to be the subject of a proxy contest that went to a vote). Peltz had waged a two-year campaign—criticizing the company’s performance, advocating a splitup of the company, and ultimately seeking to elect himself and three other nominees to the 12-person board. DuPont’s success appears to have been primarily attributable to its having pursued an aggressive growth plan that was well-articulated and effectively communicated to shareholders. Factors that supported a potential win for Trian: n Both ISS and Glass Lewis had recommended that shareholders vote to elect Peltz to the board. n Peltz has an operational background that provided him with considerable credibility among institutional investors in his past activist approaches. n Peltz had been viewed as never having “lost” an activist campaign. The keys to DuPont’s success were: n DuPont proactively took action to effect a program to enhance value for shareholders—splitting off one business and increasing stock buybacks. n Because DuPont had an independent, state-of-the-art board and a credible CEO, the company was able to position the battle as a debate about the competing visions the company and Trian had as to how best to enhance stockholder value. n DuPont effectively communicated to the market the strengths of its program and the weaknesses of Peltz’s proposed program. Management engaged in ongoing, thoughtful outreach to shareholders to communicate the program. Additional factors supporting DuPont’s success: n DuPont’s stock had performed well, regularly outperforming the S&P 500 Index and Page 2 Shareholder Activism Update (continued from previous page) Shareholder Activism Update (continues on next page) other metrics of corporate profitability before Peltz’s campaign. (While companies with good or bad performance are targeted by activists, it is often more difficult for an activist to succeed if the company’s performance has been good.) n Peltz had only a 3% stake in DuPont. In addition, his campaign did not attract other activists or new institutional investors to the stock. Thus, he had no significant natural base of support for the campaign. n While ISS recommended election of a part of Peltz’s slate of nominees, it did not endorse his full slate and declined to take a position on his substantive plan to splitup the company. n An S&P report putting DuPont on a credit negative outlook—partly because of concerns that Peltz’s proposed plan to split up the company would weaken its business diversity and reduce its operating scale—substantiated to the market DuPont’s contention that Peltz’s plan could have significant potential negative consequences for the company. Activist campaigns against very large cap companies: In 2014, approximately 30% of the issuers subjected to activist campaigns had a market capitalization of over $1 billion. In recent years, there have been several activist campaigns against companies with a market capitalization over $50 billion—Time Warner (2006), Target (2009), eBay (2014), PepsiCo (2015), GM (2015) and DuPont (2015). Of these, only DuPont and Target involved a proxy contest that went to a vote. In DuPont, the activist failed to win the election of any of its nominees; in Target, the activist failed to win the election of three of its five nominees. Notably, the typical shareholder base of very large blue-chip companies may tend to favor support for the company. There is often a large base of retail shareholders that may be pro-management, as well as more long-term institutional investors (with index-type qualities) that sometimes are not readily influenced by activists. In the DuPont/Trian battle, retail shareholders and institutions that manage index funds represented about half of the shares that were voted. The four largest shareholders (Vanguard, BlackRock, State Street and BONY—the first three of which manage index funds), owning a combined 18% of the outstanding stock, voted with DuPont. The retail shareholders, owning 30% of the shares (about half of which were voted), voted overwhelmingly with DuPont. The DuPont victory underscores the effectiveness that a proactive approach can have: n Proactive approach. The best defense to shareholder activist pressure (both before and after an activist approaches the company or commences a proxy contest) is to develop and communicate a strong, coherent, consistent and compelling message about the company’s growth and value-creation strategy, specific plans, and timing—and then to deliver on the strategy. If the board is independent and respected, shareholders may be less likely to be supportive of an activist that, by definition, will be less familiar with the company and may be perceived as potentially self-interested. Moreover, obviously, activists will have less reason to target, or to continue a battle with, a company that is functioning well. Notably, shareholders have tended to support “short slates” proposed by activists—generally based on the view that the addition of a few “fresh” voices on the board can “shake things up” while not presenting the risks associated with turning over control of the board to the activist. In the DuPont situation, other factors dominated—a successful company, with a respected board and management and a proactive plan for growth. n Tone is important. Before or after an approach by a shareholder activist, it is important that a company have a clear and consistent tone, in its communications and its actions, that conveys that the board’s paramount interest is in doing what is in the company’s best interests. n Flexibility is required. Each activist situation will be unique. Whether aggressive resistance to, or productive engagement with, the activist is the appropriate path for the company will depend on the circumstances. In each situation, the nature and history of the particular activist, the specific concerns expressed, and the company’s situation must be taken into account. Further, the company must be flexible in changing gears as developments occur. n Know the activist and its agenda. In all cases, it will be important for the company to understand the activist’s Page 3 Shareholder Activism Update (continues on next page) Shareholder Activism Update (continued from previous page) history, typical modus operandi, strengths and weaknesses, and specific concerns and suggestions relating to the company. n Know the shareholders and their concerns. A company should make every effort to know what the views, concerns and voting histories (with respect to the company and to activist situations) of its major stockholders are. Large institutional shareholders are increasingly focusing on and making a judgment about individual activist situations. Notably, BlackRock, DuPont’s largest shareholder and the apparent swing vote in the contest, in other proxy contests over the past year supported management in one case and supported the activist in another case. n Co-opt the activist’s agenda to the extent possible. Any parts of an activist’s agenda that the company deems to be advisable can be effected by the company itself, thereby reducing or eliminating the raison d’etre for the activist’s nominees to the board to be elected or for the activist to otherwise remain involved. In DuPont, for example, the company included on its slate of nominees for the board two persons who had been pursued by Peltz to be part of his slate. We note also that activists should carefully consider the selection of their nominees—while not always acceptable to the activist, the proposal of independent nominees (i.e., not affiliated with the activist) can sometimes be a route to settlement with the company or support from other shareholders. n Even a poorly performing company can mount a successful defense. In response to the result in the DuPont situation, market commentators have suggested that it is only “strong” companies like DuPont (i.e, well-performing companies with an independent board and respected management) that can be successful in the face of an activist’s proxy challenge. In our view, even a failing company with a weak board and management can prevail in an activist challenge (including a proxy contest) if the company is proactive in the response—whether by co-opting the parts of the activist’s agenda with which they agree or by creating their own agenda for a turnaround. If, for example, an activist seeks to replace the board or management, the board itself can re-constitute the board or strengthen management if it deems those moves to be prudent. A company in this situation will, however, be under significant pressure to make definitive moves on a quick timetable. n Critical development for the company. Virtually all activist situations will be a major endeavor for a company— with significant distraction, time, expense and effort involved. It is critical to prepare in advance for a possible approach. Once an approach is made, the company must seek to stay “ahead of events” as much as possible. n Prepare. Companies should prepare for a potential activist approach, even when the company does not believe that an approach is likely. Company’s “message”. Establish, and update on an ongoing basis, the company’s “message”—including successes, challenges, and plans for addressing challenges and ensuring growth. The company’s message should be clear, consistent and compelling. The message should be communicated as often as possible. PR/communications team. Establish a public relations and shareholder communications team that is responsible for establishing and updating the company’s “message” and for ongoing shareholder outreach. Through a thoughtful shareholder outreach plan, the company should seek to understand shareholders’ concerns and to communicate the company’s vision and plans. Response team. Designate a small team that is responsible for preparing management and the board for the potential of an activist approach, establishing a process to be followed if an approach is made, and coordinating the actual response if an approach is made. Value creation. Consider the potential, if any, for additional value creation—such as operational improvements (cost-cutting; revenue enhancement; etc.); sale or spin-off; separation of businesses; assets that could be monetized; unused borrowing capacity/optimization of refinancing opportunities; acquisitions; additional dividends or stock repurchases if there is excess cash; acquisition of related businesses with higher multiples; etc. Activist Challenge to Samsung in Korean Court In what may be the first significant campaign by a U.S. activist targeting a major company outside North America and Europe, Paul Singer’s hedge fund, Elliott Associates, is opposing the announced $8 billion all-stock merger of Samsung Page 4 Electronics C&T with an affiliated company. Elliot sued in a Korean court to enjoin C&T shareholders from voting on the proposed merger. On July 1, 2015, the court dismissed the claim. The shareholder vote on the deal is scheduled for July 17, 2015. Market observers have considered the merger of Samsung Electronics C&T (the construction and trading subsidiary of the Korean corporate giant Samsung Group) with Cheil Industries, a holding company through which the Lee family has controlled Samsung, to be part of an effort by the Lee family to tighten its control over the various Samsung businesses. Through the merger, Chiel would acquire C&T’s minority stake in Samsung Electronics, expanding the Lee family’s ownership stake in Samsung Electronics (which is considered the “crown jewel” of the Samsung group). Elliott acquired a 7.1% stake in C&T, making it the third largest stockholder of C&T. Elliott has stated that the merger price significantly undervalues the company. Elliott has also sought to block C&T’s sale of US $607 million of common treasury shares to a current major C&T stockholder, which is apparently designed to increase shareholder support for the merger. C&T is now seeking to delist its depositary receipts in the UK, presumably in an effort to limit its exposure to lawsuits by foreign investors. There have been reports that hundreds of small stakeholders have stated their opposition to the proposed merger on a public web forum and some are offering to make Elliot their proxy at the shareholder meeting. The response has been considered unusual as, in Korea, where consensus is highly valued and Korea’s large family-controlled conglomerates yield enormous power are generally respected as pillars of the economy. Activism Statistics It has been estimated that the 50 largest activist funds currently have approximately $220 billion in total assets under management (compared to about $9 billion at the end of 2010). According to a June 2014 Prequin Report on Hedge Fund Activists: 32% of activist hedge funds have a global focus (without focusing on one area over others); 41% focus their activities primarily on North America; 15% focus primarily on the Asia-Pacific region; and 8% focus primarily on Europe. We note that, activist situations outside the U.S. will vary significantly based on the legal and regulatory regime, corporate structures, and culture of the specific country, as well as the characteristics of the specific activist and company involved. Please see our previous memoranda on shareholder activism issues, including: n Shareholder Activism Spreads Globally (March 6, 2014) n Shareholder Activism in M&A—Checklists … and The Future (July 10, 2014) n New Activist Weapon—The Rise of Delaware Appraisal Arbitrage: A Survey of Cases and Some Practical Implications (June 18, 2014) n The Allergan Aftermath: Lessons Learned and New Ideas for Bidders, Activists, and Targets (Dec. 1, 2014) n Valeant Fails In Its Effort to Acquire Allergan—What is the Future of the Bidder-Activist Collaboration Model? (Nov. 19, 2014) n Bidder-Activist Collaboration to Buy Allergan Expands Reach of Activists in M&A—Will the Model be Followed? (May 9, 2014) Shareholder Activism Update (continued from previous page) Page 5 Change of Control Protections in Significant Non-Debt Commercial Agreements—The Importance of a “Dead Hand” Provision Parties to significant commercial agreements may not currently be well protected against the risk of being forced to continue to partner with a counterparty after a change in control of the counterparty’s board (for example, through a proxy contest). Change of control protections can be especially important in certain commercial agreements—such as a major joint venture, critical supplier or key product licensing agreement—where the company’s counterparty has been selected based on factors such as the ability to collaborate and to execute; trustworthiness in the marketplace; a compatible corporate culture; competitive position; and other similar factors. Through these provisions, companies seek to protect themselves against involuntarily having to partner with, for example, their competitors; shareholder activists who may have an agenda inconsistent with the objectives of the venture; or other parties that the company would not want to partner or collaborate with, rely on, or share its intellectual property with. Accordingly, these types of agreements routinely include a right of the company (and/or its counterparty) to change the terms, obtain additional rights, or terminate the agreement upon a change of control of the other party, including through a merger, the acquisition by a third party of a significant percentage of the counterparty’s outstanding stock, or a change in control of the counterparty’s board of directors (a “board change of control provision”). However, because board change of control provisions in commercial agreements have generally not included a “dead hand” feature, these provisions may well not provide the protection that parties have sought (and that they generally assume they have). We recommend that parties to these types of agreements consider including a dead hand feature to ensure the effectiveness of the board change of control provision. Key Points n Board change of control provisions without a dead hand feature are likely not effective. A board change of control provision in a commercial agreement most likely will not be effective if it does not include a dead hand feature because (as discussed below) a counterparty’s board can unilaterally avoid the triggering of the change of control protections by approving a dissident slate. Thus, companies should consider including a dead hand feature to obtain protection against being forced to “partner” with a party that takes control of a counterparty’s board in a proxy contest. n Dead hand board change of control provisions are not like “dead hand poison pills”. Dead hand board change of control provisions are substantively different from, and should not be confused with, “dead hand poison pills” (which have been invalidated by the Delaware courts). n Dead hand board change of control provisions in debt agreements have been under attack but are legally permissible. Similar provisions—board change of control provisions in debt (so-called “dead hand proxy puts”, which contemplate the acceleration of debt upon a change of control of the borrower’s board)—have been under attack, but, in our view, are legally permissible under most circumstances. Dead hand board change of control provisions in non-debt commercial agreements should be equally defensible. n Dead hand board change of control provisions are best adopted on a “clear day”. Dead hand change of control provisions are best adopted on a “clear day” (i.e., when the company is not facing an actual or realistically potential proxy contest)—although, in our view, they are legally permissible under most circumstances even when not adopted on a clear day. n Reciprocity may be requested. We note that, depending on the type of agreement and the leverage of the parties, a counterparty may require that a dead hand board change of control provision be reciprocal. Change of Control Protections (continues on next page) Page 6 Change of Control Protections (continues on next page) Change of Control Protections (continued from previous page) Board change of control provisions without a dead hand feature are likely not effective. In significant commercial agreements where one or both parties are sensitive to who the counterparty is (for example, a major joint venture agreement), one or both of the parties typically will have the right to revise the terms, add restrictions on the counterparty, or terminate the agreement if a majority of the board of the other party is no longer comprised of “continuing directors”. These provisions often do not include a “dead hand” feature. n Definitions. “Continuing directors” are those directors who were on the board when the agreement was entered into or replacement directors who were approved by a majority of those directors or their approved replacements. A “dead hand” feature in a board change of control provision provides that any director elected as a result of an actual or threatened proxy contest would not be considered a “continuing director” for purposes of the provision. Thus, a board would, in effect, be disabled from approving a dissident slate for the purpose of avoiding a triggering of the board change of control provision. n Without dead hand, approval of dissident slate can avoid triggering change of control provision. A continuing director requirement without a dead hand feature will often not be effective. The dead hand feature is needed because, without it, an existing board may be required by a court to—or otherwise may in any event— approve a dissident slate in order to avoid a triggering of the board change of control provision. Under recent case law relating to board change of control provisions in debt agreements, a board was required to approve a dissident slate to avoid the triggering of a change of control provision (see SandRidge, Del. Ch. 2012). Generally, it may be expected that a board could be required by a court to approve a dissident slate if the triggering of the change of control provision would have a material adverse effect on the company, such that stockholders would be dissuaded from voting to replace directors. For example, approval likely would be required if a triggering of the change of control provision would give the counterparty the right to terminate the agreement and the agreement was both material to the company and irreplaceable or replaceable only at a material cost. (Approval would not be required if, under unusual circumstances relating to the characteristics of the nominees, doing so would constitute a breach of the directors’ fiduciary duties.) In any event, as a practical matter, boards usually ultimately approve a dissident slate before losing a proxy contest. n Dead hand makes change of control provision effective. Thus, without a dead hand, the protection of a board change of control provision can be eliminated by actions of the board of the party experiencing the board change of control—meaning that the counterparty’s protection was only illusory. With the dead hand, however, the board’s approval of a dissident slate would be irrelevant for purposes of the board change of control provision because dissident nominees would be considered to be non-continuing directors irrespective of the approval. The dead hand feature thus is necessary to conform a board change of control provision to what may well be the parties’ expectations. Notably, in none of the other types of change of control provisions included in agreements (i.e., those triggered by a merger or acquisition of stock) is a party afforded a right or opportunity to avoid the triggering of the change of control protection for the other party upon the occurrence of the change of control event. Dead hand board change of control provisions are not like “dead hand poison pills”. Dead hand board change of control provisions are substantively different from, and should not be confused with, “dead hand poison pills”. A “dead hand poison pill” is a shareholder rights plan (“poison pill”) in which a company’s board, after a change in control of the board, is disabled from redeeming the plan for a specified period after election of the new board. Dead hand poison pills have been invalidated by the Delaware courts because their impact is to restrict directors in carrying out their fiduciary duty in determining whether to redeem a poison pill. Importantly, however, while both dead hand board change of control provisions and dead hand poison pills include a dead hand feature, there are critical differences between them. n Pill is adopted unilaterally by company for its own interests. First, a poison pill is adopted by a company’s board, acting unilaterally, for the company itself, and the interests being served are the company’s, not a counterparty’s. By contrast, a board change of control provision in a commercial agreement is the product of negotiation with a counterparty and is intended to meet the objectives and protect the interests of the counterparty and/or both parties. Page 7 Change of Control Protections (continues on next page) n Pill triggering is economically catastrophic. Second, the triggering of a poison pill is economically catastrophic. By contrast, the triggering of a board change of control provision in a commercial agreement can result in the affected company losing, or having to replace, the benefits of the agreement—the significance of which will vary depending on the circumstances. n Pill cannot be redeemed. Third, a dead hand poison pill cannot be redeemed either by the board or through negotiation with a counterparty to avoid its being triggered. By contrast, the triggering of a commercial agreement can potentially be avoided through re-negotiation with, or waiver by, the company’s counterparty. Dead hand board change of control provisions in debt agreements have been under attack but are legally permissible. There has been recent judicial criticism of dead hand change of control provisions in debt agreements (see Pontiac v. Ballantine (“Heathways”) (transcript), Del. Ch. Oct. 8, 2015). These provisions—so-called “dead hand proxy puts”—contemplate the acceleration of debt upon a change of control of the board of the borrower and include the dead hand feature that disables the borrower’s board from approving a dissident slate to avoid a triggering of the put. In Healthways, in denying a motion to dismiss, in an oral ruling from the bench, Vice Chancellor Laster ruled that the Healthways Inc. directors could have liability for a breach of the duty of loyalty, and the bank lender could have aiding and abetting liability for the breach, for including a dead hand proxy put in the company’s credit agreement. n Widespread misinterpretations of Heathways. The Vice Chancellor emphasized that the dead hand feature was added to the longstanding board change of control provision at a time that the borrower was “in the shadow” of a realistically potential proxy contest. The court was skeptical that the “primary driver” for inclusion of the provision was protection of the bank’s legitimate commercial interests as opposed to the potential entrenchment effect for the directors. (The inherent entrenchment effect arises because shareholders may be dissuaded from changing the composition of the board, as the change could trigger the put, which, unless waived by the bank, would result in a need to refinance the company’s debt.) The Vice Chancellor emphasized that, without a record developed as to the negotiations between the parties and the board’s deliberations with respect to the provision, the court could not determine the motivation for its inclusion. Further, the Vice Chancellor stated his view that a bank could protect itself more effectively by adding covenants to the credit agreement. The Vice Chancellor’s comments have been widely interpreted (misinterpreted, in our view—see our memorandum, “Dead Hand Proxy Puts—What You Need to Know,” June 5, 2015) as invalidating dead hand proxy puts in debt. In recent remarks made during the settlement hearing for the Healthways case, Vice Chancellor Laster characterized Healthways as “probably one of the more frequently misrepresented or misunderstood rulings of mine.” The Vice Chancellor confirmed that: “[Healthways] was a contextual ruling based on the facts of th[at] case applying the reasonably conceivable standard [applicable at the motion to dismiss stage of litigation].” Because the Vice Chancellor’s remarks were made orally from the bench during a settlement hearing, they have not been widely received and, in any event, do not carry the imprimatur of a definitive resolution of the issues addressed. However, the remarks confirm that dead hand proxy puts will be evaluated by the courts based on the facts and circumstances of each case. n Plaintiff’s bar campaign against proxy puts. Nonetheless, since Healthways, the plaintiffs’ bar has been conducting a campaign against dead hand proxy puts in debt of pubic companies. We expect that further judicial clarification of the validity of dead hand proxy puts will be forthcoming and will put an end to the campaign. In any event, though, under Healthways, it is clear that dead hand proxy puts are legally permissible under most circumstances. In our judgment, board change of control provisions in non‑debt commercial agreements should be at least as readily understood as having commercial rather than entrenchment motivations given (i) the importance, for legitimate commercial reasons, of protection against a board change of control in light of the more “personal” nature of the arrangements, as noted above, which can impact both parties to an agreement and (ii) the difficulty in providing the same protection by other means such as additional covenants. Change of Control Protections (continued from previous page) Page 8 Dead hand board change of control provisions are best adopted on a “clear day”. If a dead head feature were adopted, or added to an existing board change of control provision, at a time when the company was facing an actual or realistically potential proxy contest, a court might be skeptical that the primary motivation for inclusion of the provision was the legitimate commercial interests of one or both of the parties as opposed to the potential entrenchment of the directors. Thus, adopting the provision on a “clear day”—i.e., when a company does not face an actual or realistically potential proxy contest—should, as a legal matter, tend to support the validity of the provision (while the converse would tend to create a higher bar for establishing the validity of the provision). If a dead hand is adopted when the company faces an actual or realistically potential proxy threat, the board should be advised as to (and should consider specifically) the effects of the provision, including the possible entrenchment effect. These factors should be less important in the case of immateriality of the provision—i.e., the relative unimportance of the agreement or its being readily replaceable without significant additional cost. Conclusion Companies should consider the desirability of including a dead hand feature in the board change of control provisions of their significant non-debt commercial agreements where composition of the counterparty’s board is important to the company (such as, for example, a major joint venture, critical supplier, or key product licensing agreement). While none of the other change of control provisions routinely included in these types of agreements affords the counterparty a right or opportunity to avoid the triggering of the change of control protection for the other party upon the occurrence of the change of control event, a board change of control provision does provide that opportunity unless a dead hand feature is included—because, without the dead hand, except in extreme circumstances, a board will most likely be required to (or otherwise will) approve a dissident slate to avoid triggering the change of control protection. It should, of course, be kept in mind that, depending on the importance of the protection to the counterparty and the counterparty’s negotiating leverage in the transaction, the counterparty may require that the provision be reciprocal. Change of Control Protections (continued from previous page) Court Facilitates Fiduciary Duty Claims by Creditors When Entire Fairness Applies—Quadrant v. Vertin Follow-on Decision The Delaware Chancery Court’s previous decision in Quadrant Structured Products Co. v. Vertin (issued Oct. 1, 2014) confirmed that, except in egregious circumstances (described below), decisions made by directors of an insolvent corporation will generally be reviewed under the business judgment rule. Thus, as the court acknowledged, derivative claims by creditors against directors of insolvent corporations have limited “potency”—and, as a result, we note, are not likely to be frequently made. In this follow-on decision (issued May 4, 2015), Vice Chancellor Laster, answering questions of first impression, held that creditors bringing fiduciary duty claims against directors of an insolvent corporation do not need to establish that the corporation was either “continuously” or “irretrievably” insolvent, as long as it was insolvent when the challenged action was taken. Thus, although the previous decision is likely, as a practical matter, to limit the frequency of creditors’ derivative claims for directors’ breaches of fiduciary duties, this follow-on decision will facilitate the claims that are brought (which, as noted, will likely present more egregious fact situations). Key Points n Business judgment deference will almost invariably apply to directors’ decisions seeking to maximize the value of an insolvent corporation. As established initially in the Delaware Supreme Court’s 2007 Gheewalla decision, and confirmed in Quadrant, directors’ decisions made as part of an effort to maximize the value of an insolvent corporation will almost invariably be accorded business judgment deference—even if the plan does Court Facilitates Fiduciary Duty Claims (continues on next page) Page 9 Court Facilitates Fiduciary Duty Claims (continued from previous page) not affect stockholders and creditors equally. The court’s rationale has been that a value maximization plan has the potential to enhance value for all residual claimants (which, after insolvency, includes both stockholders and creditors), even if the plan favors some residual claimants above others. Thus, creditors’ fiduciary duty claims generally will not be an effective vehicle for creditors to challenge a business plan to maximize the value of an insolvent corporation because a board’s decision will be accorded business judgment deference. n Entire fairness review will apply to directors’ decisions that constitute “actual wealth transfers.” By contrast to claims with respect to value maximization plans, creditors’ derivative fiduciary claims that seek to restore to the company “actual wealth transfers” to a controller will be reviewed under an entire fairness standard, as the court deems a controller to stand on both sides of these transactions. In Quadrant, the payment of excess fees to the controller and the company’s not exercising its right to defer interest payments to the controller were considered to be “actual wealth transfers” to the controller that would not be subject to business judgment deference. n No “continuous” or “irretrievable” insolvency requirement. The court held that creditors making derivative fiduciary duty claims against the board of an insolvent company do not need to establish that a corporation was either “continuously” or “irretrievably” insolvent in order to maintain a derivative suit. Thus, creditors can maintain a derivative suit if the corporation was insolvent at the time of the challenged action—even if not “continuously” insolvent from the time of the challenged action through the end of the derivative litigation. In addition, insolvency will be tested on a balance sheet basis (liabilities exceeding the fair market value of the assets)—not a standard of “irretrievable” insolvency, with the company having no reasonable prospect of returning to solvency. The court rejected the defendants’ contention that the creditor lost its ability to sue because the company had been restored to solvency after the challenged action by the board. The court also rejected the defendants’ position that a creditor should be required to demonstrate that the company had no reasonable prospect of returning to solvency. Finding a genuine issue of fact as to the corporation’s solvency, the court denied the defendants’ motion for summary judgment. n Significance of the ruling—facilitates creditors’ fiduciary duty claims that are subject to entire fairness review. The significance of Quadrant is that, in those cases where entire fairness review will apply (i.e., when there are “actual wealth transfers” to a controller), creditors’ derivative claims challenging those actions will be facilitated because the creditors will not need to prove continuous or irretrievable insolvency of the corporation to avoid summary judgment against them. Notably, Vice Chancellor Laster observed that the decision reflects the view of “one trial judge” and that “the Delaware Supreme Court may well disagree.” n General principles. Vice Chancellor Laster summarized the following principles that apply to creditors’ derivative claims against directors of distressed companies since Gheewalla: n Derivative claims only: Creditors cannot bring direct claims for breach of fiduciary duty, whether a corporation is solvent or insolvent. After a corporation becomes insolvent, creditors gain standing to assert claims derivatively for breach of fiduciary duty. n Actual insolvency is required. There is no legally recognized “zone of insolvency” for fiduciary duty claims—the only “transition point that affects fiduciary duty analysis is insolvency itself”. n No special duty is owed to creditors. Directors of an insolvent corporation do not owe particular duties to creditors, but continue to owe fiduciary duties to the corporation for the benefit of all of its residual claimants (which, after insolvency, includes creditors). “[The directors] do not have a duty to shut down the insolvent firm and marshal its assets for distribution to creditors, although they may make a business judgment that this is indeed the best route to maximize the firm’s value,” the court stated. n No concept of “deepening solvency”. Delaware courts do not recognize the theory of “deepening insolvency”— that is, “[d]irectors cannot be held liable for continuing to operate an insolvent entity in the good faith belief that they may achieve greater profitability, even if their decisions ultimately lea to greater losses for creditors.” n Stock ownership by directors does not create a conflict of interest. As in the case of a solvent corporation, “common stock ownership [by directors]” or directors’ “ow[ing] duties to large common stockholders” do not, standing alone, give rise to a conflict of interest. Court Facilitates Fiduciary Duty Claims (continues on next page) Page 10 Remaining Issue In Quadrant, the court accorded business judgment review even though the court viewed the board as not independent, there was a controller that was the sole stockholder, and the board had taken actions that the court found stated nondismissible claims for direct transfers of value from the insolvent corporation to the controller. The court’s basic rationale appeared to rest on the premise that maximization of value has the potential to benefit all corporate constituencies, even if disproportionately. The question is whether there is any point at which a board’s plan to maximize the value of an insolvent corporation would be so disproportionate in terms of the ratio of risks and benefits to the company’s creditors, stockholders (if applicable), or controller that the court might find that the plan had crossed the line from being a value maximization plan to having been a transfer of value to the controller. The closer an insolvent company is to being able to cover the creditors’ claims, the less potential there is for the creditors to benefit, even theoretically, from a high-risk value maximization plan, and the more potential there is for them to be disadvantaged by the plan—while the upside for the controller increases because more of whatever additional value may be captured will be for the controller’s account. The Quadrant opinion does not address to what extent the company had or lacked sufficient funds to cover the creditors’ claims. It remains to be seen whether the court might reach a different conclusion in a case like Quadrant if the company is very close to being able to cover the creditors’ claims—so that the creditors would stand to receive not just a disproportionate (that is, disproportionately low) benefit from a high-risk value maximization plan but no benefit at all. Please see our memorandum, Quadrant v. Vertin: Duty to Maximize Value of an Insolvent Enterprise, published on The Harvard Law School Forum on Corporate Governance and Financial Regulation, Oct. 9, 2014. Court Facilitates Fiduciary Duty Claims (continued from previous page) The MLP Cycle and General Partner Liability in Dropdowns—Perspective on El Paso (The following is based in part on our articles on this subject published by Transaction Advisors, May 2015; and the Harvard Law School Forum on Corporate Governance and Financial Regulation, June 4, 2015.) Recent developments have prompted predictions of the death of the master limited partnership (MLP) structure. Commentators have focused on (i) the announcement in summer 2014 by Kinder Morgan, which pioneered the use of the MLP structure in the 1990s, that it would be consolidating its MLPs into a single traditional C corporation and (ii) the decision by the Delaware Chancery Court, in El Paso Pipeline Partners Derivative Litigation (April 20, 2015), holding— for what we believe was the first time—the general partner of an MLP liable for the MLP’s having overpaid for assets purchased from its parent company in a typical “dropdown” transaction. We expect, however, that, notwithstanding these developments, MLPs will continue to be the prototype structure for businesses, such as midstream MLPs, characterized by very long-life assets, limited exposure to new competitive capacity, limited commodity price exposure, essential service protection and generally definable and manageable risks. Key points. In our view: (a) Roll-ups of MLPs will not necessarily become common. Although we expect that there will be consolidation in the MLP industry (such as, most recently, the Crestwood consolidation of its two MLPs in May 2015), we anticipate that in most cases the partnership form will be retained. We expect that a roll-up into corporate form will occur only when, for some large, mature MLPs, it provides significant advantages in terms of tax, financing or simplicity of governance. (b) MLP general partners will not be more likely than in the past to have liability. Due to the unusual facts of the El Paso case, we do not believe that the decision suggests that the court will be more likely than in the past The MLP Cycle (continues on next page) Page 11 The MLP Cycle (continued from previous page) to find liability of MLP general partners (or their bankers) in connection with dropdown transactions. El Paso appears to be an outlier in the line of cases in which general partners of MLPs have, as far as we know, never before been held liable in connection with dropdown transactions—even when their process was poor or the assets purchased were overpriced. (c) We expect that an MLP cycle will develop. Notably, some have speculated that in a few years, when the tax benefits from the Kinder Morgan rollup have been diminished, Kinder Morgan itself is likely to spin assets off into one or more new MLPs which would acquire assets from Kinder Morgan in dropdown transactions—at which point the process will have come full circle, with an expansion of MLPs, poised for the next cycle. Roll-ups of MLPs will not necessarily become common The MLP structure eliminates the double taxation problem faced by traditional corporations, allowing all profits to be passed along to investors as dividends (with investors subject to tax on the distributions). In 2009, there were 66 MLPs, worth a combined $160 billion. Five years later, there were well over 100 MLPs, worth more than $500 billion combined. In 2013 alone, 19 new MLPs were formed. When Kinder Morgan announced that it was abandoning the MLP structure, it had become an over $100 billion company with a complicated structure that included four very large entities—two Kinder Morgan MLPs, the El Paso MLP that it had acquired in 2012 and the Kinder Morgan parent company. Each of these entities had been significantly underperforming their peer groups. Kinder Morgan’s purported objectives in effecting a “roll-up” of the MLPs were to (i) simplify its structure; (ii) achieve a lower blended cost of capital in a corporate form by being able to obtain significantly higher leverage (i.e., a higher proportion of low cost debt financing), and a lower cost of equity capital by being able to provide a lower yield to investors receiving corporate dividends rather than the yield required for MLP distributions; and (iii) achieve tax savings for the new corporation through a step-up in its basis in the acquired assets (with, we note, the savings “paid for” in advance by the MLP unit holders as the transaction was treated as a taxable sale of the underlying MLP assets by them). Notably, the corporate structure also eliminated the incentive distribution rights (IDRs) payable to the MLP general partners (through the equivalent of a buyback of those rights). As is typical, the Kinder Morgan IDRs resulted in about half of the total cash distributions from the MLP going to the parent company rather than to the MLP unit holders – negatively affecting the marketability of the MLP units. Certainly, there are negative pressures on MLPs: n Need to sustain growth. Most importantly, as MLPs grow larger, they ultimately face the same essential bind that Kinder Morgan did—the difficulty of sustaining past growth levels through acquisitions as the IDRs reach a “tipping point” at which a majority of the dividends are being paid to the parent company rather than to investors, resulting in a high cost of capital that constrains capital expenditures and acquisitions. We note, however, that this issue can be addressed through direct, without a roll-up, repurchase or amendment of the IDRs, paid for with member units. n Kinder Morgan performance. The market reacted positively to Kinder Morgan’s roll-up. On announcement, there was an increase in market value of about 20% or more. Since then, Kinder Morgan has continued to outperform its peers—while, as noted, the Kinder Morgan entities were underperforming their peers prior to the roll-up. n Oil and gas price decline. The recent decline in oil and gas prices is having a dramatic effect on the oil and gas industry; however, its impact on MLPs will generally depend on the type of MLP. Midstream MLPs should generally not be directly affected since they typically are paid a fixed price based on the quantity of product they store, treat or transport. They would be negatively affected by a reduction in the quantity of product—however, at least over the near- and mid-term, quantity is not expected to decrease significantly. They also would be negatively affected by any increased credit risk of their customers—at the same time, unless oil fields are shut in or abandoned (both unlikely), there will be a need for the product to find a way to the marketplace. The midstream MLPs in many cases provide the only economically viable access to the market. As an essential service for the producer from an The MLP Cycle (continues on next page) Page 12 The MLP Cycle (continued from previous page) operational and bankruptcy perspective, a producer’s contracts with an MLP generally should continue in place unchanged and should be assumed in any bankruptcy of a producer, protecting the MLP with respect to both preand post-petition obligations. Thus, unlike upstream or downstream MLPs, midstream MLPs (which provide an essential service and act essentially as “toll takers”) are typically not significantly affected by volatility in oil and gas prices. n Interest rate or tax changes. We note that an increase in interest rates would increase MLP capital costs (principally debt costs) and increase the appeal of competitive yield-based assets, including bonds. The government’s review of the corporate tax code with a focus on structures that deprive the U.S. Treasury of revenue could affect MLPs. (As part of this review, last year the IRS temporarily discontinued the issuance of private letter rulings with respect to new MLP formations. Resumption of private letter rulings is expected once the IRS adopts a new rule regarding qualifying activities for forming MLPs. A new rule was proposed May 15, 2015). However, despite these pressures, we are aware of only one other roll-up announced since the Kinder Morgan roll-up—i.e., the Williams “creeping” roll-up, consisting of the merger in early 2015 of the Williams MLP with another affiliated MLP, which Williams announced in May 2015 was to be followed by an acquisition of the merged MLPs by the Williams parent company. There were press reports after the announcement of the Williams roll-up that there was likely to be litigation challenging the general partner’s approval of the roll-up. Our view is that, without highly unusual facts such as those in El Paso (most importantly, contemporaneous statements by conflict committee members that they did not believe the transaction was in the best interests of the MLP), claims challenging an MLP’s approval of a conflict transaction (whether a dropdown or a roll-up) will not result in liability for the MLP general partner or its conflict committee members or bankers. In any event, the Williams roll-up is probably unlikely to occur as, on June 22, 2015, Energy Transfer Partners (ETP) announced an unsolicited bid, at a 32.4% premium, to acquire the Williams parent company (and has not indicated any intention to abandon the MLP structure). Both Williams and ETP have partially consolidated paarts of their affiliated MLP structures recently. It is expected that consolidation among MLPs will continue-because of the uncertain price environment, the potential for slower growth, the desire to achieve critical mass, and the desire for diversification among midstream geographic and product categories. Notably, there has also been speculation that in a few years, when the tax benefits from the Kinder Morgan roll-up have been diminished, Kinder Morgan itself is likely to spin assets off into one or more new MLPs which would acquire assets from Kinder Morgan in dropdown transactions. If so, the process will have come full circle, with MLPs expanding—and the industry poised for the next cycle. We note that in the next cycle, to address any investor concerns relative to the IDR drag on growth, there may be changes in the general partner’s incentive structure. MLP general partners will not be more likely than in the past to have liability Vice Chancellor Laster found, in El Paso, that the general partner of the El Paso MLP was liable to the MLP for $171 million that, in the court’s judgment, the MLP had overpaid for liquefied natural gas (LNG) purchased from the El Paso parent company for a total of $1.4 billion. The Vice Chancellor was extremely critical of the conduct of the conflict committee of the general partner’s board, as well as the conduct of the committee’s investment banker. In our view: n Unusual facts. Due to the unusual facts, the decision is an “outlier” in the line of cases in which general partners of MLPs have, as far as we know, never before been held liable in connection with dropdown transactions (whether their process was poor or the assets were overpriced). n Fiduciary duties are inapplicable. By law, an MLP general partner’s fiduciary and common law duties to an MLP can, and typically are, eliminated by contract and replaced with a contractually established low standard of responsibility to the MLP. In connection with dropdowns and other “conflict” transactions, the standard usually is (as it was in El Paso) simply that a committee of the general partner’s independent directors subjectively believes in good faith that the dropdown is in the best interests of the MLP. The El Paso decision has been characterized The MLP Cycle (continues on next page) Page 13 Practice Notes n A conflict committee must satisfy the contractual standard. Legal counsel should advise a conflict committee and its banker as to what the applicable standard for approval of a conflict transaction under the MLP’s governing documents is and what is required to satisfy it. The court stated that a standard that requires a belief as to the best interests of the MLP is not satisfied by a belief as to the best interests of the limited partners of the MLP (who are the common unit holders of the MLP). In earlier litigation in this case, the court had stated that the best interests of the MLP can include the interests of all of the MLP’s constituencies, such as its employees, customers, general partner, and incentive distribution rights holders, as well as the limited partners. The court found that the El Paso committee was “fixated myopically” on whether the dropdown would be accretive and therefore permit increased cash distributions to the limited partners. As a result, the court found, the committee considered whether the dropdown was in the best interests of the limited partners and “failed to carry out their known contractual obligation to determine whether the [dropdown] was in the best interests of El Paso MLP.” n A dropdown transaction should be valued based on all relevant factors—accretion alone is probably insufficient. This is an important practical point arising from the decision as it does not relate to the unusual facts of the case and is applicable to all dropdowns. As discussed above, the El Paso committee had concluded that the dropdown would be immediately accretive and that, therefore, the MLP could increase its cash distributions to the limited partners. We note that an MLP’s units trade based largely on yield and expectations as to yield growth and the primary objective for MLPs is to grow cash distributions over time. While the court acknowledged the importance of accretion, it viewed accretion as “focused on short term profits” and thus a “separate inquiry” from “valuation”. The court stated that valuation of a dropdown should take into consideration the fairness of the price and the potential for adding to the MLP’s long-term value—not just the The MLP Cycle (continued from previous page) by some as the latest in a line of cases highlighting the Chancery Court’s recent heightened scrutiny of directors and their financial advisors in connection with conflict-of-interest transactions. Importantly, however, those cases arose in the corporate context relating to fiduciary duties of directors (and bankers’ potential liability for aiding and abetting directors’ breaches of their fiduciary duties). El Paso in no way expands the concepts of the duty of care or loyalty into the MLP arena when they have been eliminated by contract. Of course, some level of diligence is required. Clearly, a committee cannot form its subjective belief about a dropdown arbitrarily or whimsically or without any foundation or understanding. For example, a committee must know what the price being paid is (a fact that the court determined the El Paso committee did not know). Further, the court suggested that some amount of negotiation with respect to the dropdown may be required. Certainly, we would counsel a committee to approach evaluation of a dropdown with reasonable diligence. However, El Paso does not suggest a change in the legal standard applicable to an MLP general partner’s directors or its conflict committee. n Court applied the contractual standard without expansion. The court in El Paso approached the case as a breach of contract case (not a duty of care or loyalty case) and applied the contractual standard as written, without expanding it. The court confirmed that, as previous cases have held, the “subjective belief” component of the standard does not include any requirement of objectivity or reasonableness; and the “good faith” component requires that the committee members did not have personal or other improper motivations and did not exhibit “conscious disregard” of their known duties, which would constitute “bad faith”. n The court reviewed the committee’s and the banker’s conduct because there was “convincing” evidence that the committee did not actually have the belief about the dropdown that it purported to have. The court explained that its review of the committee’s process was required because there was “convincing” evidence that contradicted the committee members’ testimony as to what they actually subjectively believed about the dropdown. Specifically, there were numerous contemporaneous emails among the committee members, before and during their deliberations, in which the committee members stated their views that the dropdown assets were both undesirable (as they were in the declining LNG market and the MLP already was overexposed in that market) and overpriced. In determining whether the committee’s subjective belief was what the committee said it was, the court stated: “Trial judges … are not telepaths [and therefore], where, as here, the Committee members testified that they believed the [dropdown] to be in The MLP Cycle (continues on next page) Page 14 the best interests of El Paso MLP, the trial judge must make credibility determinations about each defendant’s subjective beliefs … [and the] objective facts therefore [are] relevant to the extent they permit an inference that the defendants lacked the necessary subjective belief.” n The court determined that the committee did not believe that the proposed dropdown was in the best interests of the MLP. Notably, with respect to the testimony, the court found that “the defense witnesses … had few specific recollections of the [d] ropdown”; “the Committee members and their financial advisor had no explanation for what they did” to evaluate the dropdown; “the few explanations they had were conclusory or contradicted by contemporaneous documents”; and their testimony as to the belief they had about the dropdown being in the best interests of the MLP “seemed over-prepared and artificial.” In the court’s view, the committee exhibited “conscious indifference” to its contractual obligation to determine whether it believed that the dropdown was in the MLP’s best interests. It is important to note the extreme nature of the facts here. For example, the committee did not know important information about the revenues arising from the assets being acquired, nor even the price that was being paid for the assets. Thus, the committee appeared to lack even the most basic information necessary for any foundation upon which a belief could have been formed. Moreover, every objective fact strongly indicated that the dropdown was not in the MLP’s best interests. Thus, the court concluded from its review of the committee’s and the banker’s evaluations of the dropdown that the emails reflected the committee members’ actual subjective belief about the dropdown. n The committee’s and its banker’s conduct. It is instructive that liability has been rarely found in other dropdown cases—including with respect to those relating to the nine El Paso MLP dropdowns completed from its IPO in 2008 through this transaction in 2010 that were challenged in separate litigations. In those cases, which involved the same committee directors, advised by the same banker and legal counsel and with the same lead negotiator as in this case, and covering similar claims relating to process and pricing, the court granted summary judgment to the defendants. What differentiates El Paso from other dropdown cases are that (i) as noted, there were emails among the committee members that contradicted their testimony that they believed that the transaction was in the best interests of the MLP; and (ii) the committee’s and its banker’s conduct was so egregious that it led the court to conclude that the committee “never learned enough about [the transaction] to make that determination.” The court emphasized that no one factor or set of factors would have led to the court’s result, but that “the number of problems reached a tipping point”. “At some point, the story is no longer credible,” the court commented. We note that, given the distinguished record and long experience of the directors and the banker involved, it is hard to understand how the process went so wrong. However, the court found that the committee lacked even basic knowledge about the transaction (including the amount paid and whether it was more or less than amounts paid in their other recent transactions for interests in the same assets); and that the banker deliberately “manipulated” its accretion that is in the best interests of the limited partners. We note that a court might not criticize a focus on accretion as the primary relevant factor if a committee has considered the extent to which accretion is the most important factor for the MLP as a whole and has considered the other relevant factors. n Possible Changes to Current Practice With Respect to MLP Agreements. We do not view El Paso as requiring any changes to usual current practice with respect to the drafting of MLP limited partnership agreements. However, in light of the decision, in drafting an MLP agreement, one could consider changing the typical standard for the conflict committee’s approval of a dropdown transaction: (i) to provide that the standard is the “best interests of the MLP or of the common unit holders of the MLP” or to define “best interests of the MLP” as being, or as including, “the best interests of the common unit holders”; and/or (ii) to provide that accretion should be considered the exclusive consideration (or the primary consideration) in determining the best interests of the MLP. The MLP Cycle (continued from previous page) The MLP Cycle (continues on next page) Page 15 financial analyses to justify the dropdown (in the court’s view, so that the banker could “collect its [fully contingent] fee”). n Issue of potential aiding and abetting liability for bankers. While not addressed by the court, we note that, although in the context of corporate boards the court has recently expanded the concept of aiding and abetting liability for bankers, it is likely to be significantly more difficult to prevail on a secondary liability theory in the case of MLPs. Under Delaware law, there is no such concept as aiding and abetting liability for a breach of contract— as opposed to a breach of fiduciary duties—which duties, as discussed above, are generally not applicable in the case of MLPs. Moreover, in dropdown situations, as in El Paso, because the banker advises the committee, and the committee members have no contractual duties as they are not parties to the limited partnership agreement, there are no contractual duties for the committee members to breach and so there can be no aiding and abetting by the banker of a breach by the committee. Nevertheless, bankers should be aware of the generally greater focus recently on bankers’ conduct, particularly since Vice Chancellor Laster’s rulings in Rural/Metro (2014) and Del Monte (2012), in which, in the corporate context, the court was highly critical of the bankers’ conduct (and, in Rural/Metro, found the banker liable for $76 million for aiding and abetting the directors’ breach of fiduciary duties). While in our view this increased focus in the corporate context will not increase the risk of liability in the partnership context, it can, of course, evoke judicial criticism, with associated reputational risk. The MLP Cycle (continued from previous page) Delaware Supreme Court Decisions—Independent Directors in Controller Transactions; Annual Meeting Dates Cornerstone Therapeutics (May 14, 2015)—Comfort for independent directors of controlled companies. In a move consistent with the Delaware courts’ recent general inclination for early dismissal of M&A-related litigation, the court reversed the Chancery Court’s 2014 Cornerstone holding. The court held that in every type of case (including a controlling stockholder squeeze-out merger) where shareholders are seeking monetary damages for alleged breaches of fiduciary duty by a disinterested, independent director who is protected by an exculpation provision in the company’s charter, the director must be dismissed at the pleading stage if the plaintiff has not sufficiently plead nonexculpated claims—ie., claims for duty of loyalty violations. Claims of duty of care violations (which are exculpated) would not be sufficient. This pleading standard will apply regardless of the judicial standard of review that applies— whether Revlon, Unocal, entire fairness or the business judgment rule. Thus, in controlling stockholder freeze-out mergers, for example, an independent, disinterested director should no longer have to be involved in prolonged litigation to establish at trial that he is not liable for damages, as that is already apparent at the peading stage due to the company’s exculpation provision. The result was not unexpected, particularly given the Chancery Court’s own reluctance about its ruling, which the Chancery Court had expressed was required by Supreme Court precedent. Practice Point: We note that, with claims against a company’s independent, disinterested directors in controller transactions more likely to be dismissed at the pleading stage, the parties may be less inclined to comply with the MFW prerequisites to obtain review under the business judgment rule. Hill v. Opportunity Partners (July 2, 2015)—Guidance on drafting of advance notice bylaws. Affirming the Chancery Court’s decision, the court required that Hill adjourn its June 9 annual meeting for 21 days in order to provide Opportunity Partners (a 5.5% stockholder, affiliated with activist investor Bulldog Investors) the opportunity to present its shareholder proposals and director nominations. The court emphasized the plain language Delaware Supreme Court Decisions (continues on next page) Page 16 Delaware General Corporation Law Amendments— Fee-Shifting Bylaws Prohibited; Forum Selection Bylaws Permitted The Governor of Delaware recently signed into law amendments to the Delaware General Corporation Law that (i) ban fee-shifting—i.e., prohibit charter and bylaw provisions that shift the responsibility for litigation-related fees to the losing party in the litigation and (ii) permit Delaware exclusive forum selection—i.e., allow charter and bylaw provisions that specify Delaware (or Delaware and other states) as the exclusive forum for litigating claims against the corporation. These laws will become effective August 1, 2015. Fee-Shifting Prohibited Fee-shifting will be prohibited for lawsuits involving “an internal corporate claim”. “Internal corporate claims” are defined as “claims, including claims in the right of the corporation, (I) that are based upon a violation of a duty by a current or former director or officer or stockholder in such capacity, or (II) as to which this title confers jurisdiction upon the Court of Chancery.” Thus, the ban likely applies to breach of fiduciary duty litigation (including derivative actions) (covered by I above) and appraisal cases (covered by II above). However, federal securities class actions not involving a breach of fiduciary duty claim (e.g., alleging only a claim of material misstatement or omission) appear possibly to not be covered. We note that plaintiffs presumably can add fiduciary duty claims to bring their litigation within the definition. We note also that the federal securities laws do not permit fee-shifting charter or bylaw provisions. The bill was proposed in response to the Delaware Supreme Court’s ATP Tour decision last year, holding that feeshifting bylaws adopted by non-stock corporations were valid and enforceable—and raising the issue whether they would also be valid if adopted by stock corporations. The bill was opposed by corporations and the Chamber of Commerce—whose emphasis has been on discouraging the increasing prevalence of shareholder litigation. The of the company’s advance notice bylaws—which provided a window for the submission of shareholder proposals and director nominations based on the date of the company’s notice or public disclosure of the annual meeting date. The court ruled that it was the company’s disclosure of the actual meeting date that was relevant for calculating the advance notice window, not its earlier disclosure of an anticipated meeting date. Practice Points: n Disclosure of an anticipated meeting date will likely not be considered to be public disclosure of a meeting date for purposes of standard advance notice bylaws. n If, as in the case of Hill’s bylaws, a corporation’s advance notice bylaws are pegged to the current year’s meeting date, the company should announce the specific meeting date once it has been set (and not rely on disclosure in the prior year’s proxy statement of the anticipated meeting date for the follwing year as having provided notice of that meeting date). Further, the date should be set (and announced) before notice of the meeting is given under DGCL Section 222 (whichh requires that the notice be given not more than 60 days before the meeting date). n It may be preferable for a corporation’s advance notice bylaws not to be pegged to the current year’s meeting date. Rather, the notice period could be pegged to the anniversary date of the corporation’s prior annual meeting or the mailing of the prior year’s definitive proxy statement. n We note that, while it was not relevant to the court’s decision, the company had miscalculated the window period even under the company’s own interpretation of the bylaws. In our experience, it is not uncommon for companies to miscalculate the advance notice window period—creating an issue when shareholder submissions made within the disclosed period are then not within the period as prescribed by the bylaws. Delaware Supreme Court Decisions (continued from previous page) Delaware General Corporation Law Amendments (continues on next page) Page 17 Delaware General Corporation Law Amendments (continues on next page) bill was supported by shareholder groups and the plaintiffs’ bar—whose concern has been that fee-shifting would discourage even meritorious stockholder claims. In the year after the ATP decision, over 30 Delaware public companies (and about ten public non-Delaware companies) adopted fee-shifting bylaws. (Notably, 40% of these corporations were majority-controlled companies that, at the time the fee-shifting bylaws were adopted, were entering into a merger or reorganization transaction.) Stockholders generally and the major proxy advisory firms have been strongly against fee-shifting bylaws. Delaware corporations that have adopted fee-shifting bylaws should consider removing the bylaw or, as applicable, amending the bylaw to track the language of the new law. Please see our prior article, Confirmation of Delaware Corporations’ Expansive Powers With Respect to Bylaws, M&A Quarterly, 4th Q 2014. Forum Selection Permitted Many Delaware corporations have adopted forum selection for litigation relating to “internal affairs” in order to limit duplicative, multi-jurisdictional litigation (particularly with respect to lawsuits challenging mergers). The new law essentially codifies the court’s 2013 Boilermakers Local v. Chevron decision, which upheld the validity of forum selection bylaws for internal corporate claims. The law prohibits bylaw or charter provisions that designate only a state other than Delaware as an exclusive forum. (The decision, thus implicitly overrules the court’s 2014 Providence v. First Citizens BancShares decision, which upheld a forum selection bylaw that designated North Carolina, the state in which the Delaware corporation was headquartered, as the exclusive forum.) The law does not expressly prohibit selection of a forum other than Delaware as an additional forum for bringing internal corporate claims. We note that forum selection provisions still may be challenged as having been adopted in an inequitable manner or as operating unreasonably under the circumstances that apply. We recommend that companies consider adoption of forum selection bylaws, keeping in mind that: If a forum will be selected, Delaware must be designated, but the state where the corporation is headquartered may be designated in addition. It is preferable, when possible, that forum selection bylaws be adopted on a “clear day” (i.e., when the company is not facing a transaction process or other anticipated litigation)—although, the court has upheld the validity of forum selection bylaws when not adopted on a clear day. The company should have conversations with its major stockholders on the subject and take into account the views of the major proxy firms. In our experience, shareholders generally have not reacted strongly against the adoption of exclusive forum bylaws. There is nonetheless some uncertainty as to the proxy advisory firms’ likely recommendations. ISS now reviews all bylaws that affect shareholders’ litigation rights (including exclusive forum bylaws) on a case-by-case basis. ISS’s policies adopted for the 2015 proxy season increase the subjectivity with which these bylaws will be reviewed. Under this policy, when evaluating any bylaw affecting stockholders’ litigation rights, ISS will take into account such factors as: the company’s stated rationale for the bylaw; any disclosure by the company of past harm to the company from shareholder lawsuits that were unsuccessful or were brought outside the jurisdiction of incorporation; the breadth of application of the bylaw (i.e., to which types of lawsuits it would apply and the definition of key terms); and related governance features (such as the stockholders’ ability to repeal the bylaw and their ability to hold directors accountable through annual election of directors and majority voting). Significantly, however, ISS has also indicated that it will apply to bylaws that are adopted without shareholder approval its new policy against a board’s unilateral adoption of any bylaw that “materially diminishes” stockholder rights. Factors ISS will consider when applying this new policy are: the board’s rationale for adopting the bylaw without shareholder ratification; disclosure by the company of any significant engagement with shareholders regarding the bylaw; the level of impairment of shareholders’ rights cause by the bylaw; the board’s track record with regard to unilateral board action on charter or bylaw amendments or other entrenchment provisions; the company’s ownership structure and existing Delaware General Corporation Law Amendments (continued from previous page) Page 18 Delaware General Corporation Law Amendments (continued from previous page) governance provisions; whether the bylaw was adopted prior to or in connection with the company’s initial pubic offering; the timing of the bylaw adoption in relation to a significant business development; and other factors ISS deems appropriate to determine the impact of the bylaw on shareholders. Glass Lewis’s policy is that, if a board adopted a forum selection bylaw in the past year without stockholder approval, the firm will consider recommending against the governance committee chair. Further, if a company that completed in initial public offering within the past year and the board unilaterally adopted a forum selection charter or bylaw provision prior to the IPO, the firm will recommend voting against the governance committee chair. Other Delaware Decisions—UAM, Molycorp, Citrix, ADT Court confirms company does not breach a board seat agreement when it agrees to seat a stockholder’s designee subject to reasonable conditions not specified in the agreement—Partners Healthcare Solutions Holdings v. Universal American (June 17, 2015). The Delaware Chancery Court granted summary judgment to defendant Universal American Corp. (“UAM”) and rejected the contentions of one of UAM’s largest stockholders, Partners Healthcare Solutions Holdings (“Partners”), that UAM had breached a board seat agreement by imposing conditions on the seating of Partners’ designee to the UAM board that were not specified in the agreement. Partners, a subsidiary of a private equity firm, acquired its stake in UAM through, and the board seat agreement had been entered into in connection with, UAM’s acquisition of a subsidiary of Partners (the “Portfolio Company”). The dispute relating to the seating of Partners’ board designee arose at the same time that UAM and Partners were involved in a separate fraud litigation arising from the acquisition of the Portfolio Company (because of the significant decline in its performance immediately after the merger). The facts were not typical in that the ongoing simultaneous fraud litigation between the parties created an unusual type of conflict of interest and confidentiality issue relating to the board designee’s selection of legal counsel (and may also have created animus that prevented the parties from resolving the board seat issue without litigation). The decision confirms that a company will not be in breach of a board seat agreement when it agrees to seat a stockholder’s designee but the board, in the exercise of its fiduciary duties, imposes reasonable conditions relating to conflicts of interest and confidentiality of company information that were not provided for in the board seat agreement. At the same time, the decision does not alter the basic rights of private equity firms or other stockholders under board seat agreements to have their board designees seated, to recover damages incurred if the company breaches the agreement, or to be reimbursed for legal fees to the extent the agreement so provides. Depending on the circumstances, where a board seat agreement is silent with respect to certain conditions, we expect that a court also would likely uphold a board’s imposing reasonable conditions (i) that are applicable to all directors or (ii) for which the company has a strong legitimate need and which do not have a disabling or significant negative effect on the stockholder’s designation rights. In our experience, parties to board seat agreements usually avoid disputes by specifying in the agreement the conditions that will apply to seating the designee and, in any event, usually can resolve issues that arise under these agreements without resorting to litigation. (Please see our memorandum, “Court Confirms Company Does Not Breach a Board Seat Agreement When It Agrees to Seat a Stockholder’s Designee Subject to Reasonable Conditions Not Included in the Agreement,” published in Law360, June 23, 2015.) Directors appointed by private equity firms did not violate fiduciary duties by facilitating PE firms’ demand registration at a time the company faced a cash crunch— In re Molycorp (May 27, 2015). The Delaware Chancery Court dismissed claims against the private equity firms that owned 44% of Molycorp and against the Molycorp directors appointed by them. The court found that the allegations pleaded provided no reasonably Other Delaware Decisions (continues on next page) Page 19 Other Delaware Decisions (continues on next page) Other Delaware Decisions (continued from previous page) conceivable basis on which to rule that they had an obligation to delay the exercise of contractual demand registration rights that permitted them to sell Molycorp shares in a secondary offering. The minority stockholder plaintiffs had contended that the directors (many of whom held significant equity stakes in the PE firms) had violated their fiduciary duties by favoring the PE firms’ (and thus their own) interests over the company’s interests by failing to delay the demand registration so that the company could have raised cash through a company registration—when the company faced a cash shortfall and the price of the stock had been inflated due to a market bubble in the price of the rare earth metal the company produced and sold. The Molycorp IPO in July 2010, and a secondary offering by Molycorp in February 2011, had yielded disappointing results. In May 2011, potential financing and joint venture arrangements for Molycorp fell through. At that time, the firms exercised their demand registration rights. When the offering was held, in June 2011 (the “June Offering”), the stock price had been elevated due to a spike in the price of rare earth oxides. By September 2011, when Molycorp tried to raise cash through the issuance of convertible notes, the rare earth oxide bubble had burst. The court ruled that the plaintiffs had failed to state a claim. The court emphasized: Registration rights agreement. The court emphasized that the plaintiffs did not challenge the registration rights agreement as being unfair or invalid. The private equity firms exercised contractual rights that they had fairly secured. Alleging that they “exercised rights that benefited themselves but were fairly extracted and disclosed in public filings…does not itself state a claim that the [firms] took advantage of Molycorp and its minority shareholders,” the court concluded. Facts contradicting a cash crunch. Without reaching the issue of whether a cash shortfall would satisfy the “materially detrimental” provision in the registration rights agreement (that would permit the company to delay a demand registration), the court expressed skepticism that there even was a significant cash crunch. The plaintiffs alleged that Molycorp could not meet its core operating budget through June 2013 and could not proceed with its strategy to increase its production starting in late 2010. The court noted that “a developing company almost certainly will have budget issues”; that Molycorp had raised $233 million in a June 2011 convertible note offering; and that there was no basis on which to infer that, as of May 2011, the defendants knew that Molycorp could not make another successful offering after the June Offering. The court also noted that the pleadings did not allege that Molycorp had a “pressing need to fund its business” during the months at issue or that other financing avenues would be unavailable in the future. Inability to predict the future. Most importantly, the court emphasized, the plaintiffs had not plead that the director defendants knew, or had reason to know, how Molycorp’s stock price would move. The court stated: “A director is not liable for failing to predict the movement of stock prices, and a stockholder is generally allowed to sell her shares.” The court noted that the defendants were not “guarantors” and, moreover, that Molycorp’s stock price rose based on a typical commodity boom-bust cycle and did not fall substantially until September 2011 (months after the secondary offerings, during which time the company conceivably could have raised additional funds). Entire fairness will be applied to board decisions granting compensation to nonemployee directors unless “meaningful” limit is specified in the stockholder-approved compensation plan— Calma v. Templeton (April 30, 2015) (“Citrix”). Based on Citrix (and a 2012 Chancery Court decision, Seinfeld v. Seger), unless a “meaningful” limit on equity awards to non-employee directors was included in the company’s equity compensation plan under which the awards were made, the awards, if challenged, will be reviewed by the court under an entire fairness standard because of the inherent conflict of interest of directors in granting compensation to themselves. Citrix establishes that a per-director limit in a plan that is not specific to non‑employee directors and that is significantly higher than the awards (or the total compensation) that have been made to non-employee directors in the past will not be deemed by the court to be meaningful limits. Page 20 In Citrix, the plan specified that no director could receive awards covering more than one million shares in any given year. One million shares had a value of $55 million, based on Citrix’s stock price at the time the claim was filed. The court noted that the board’s longstanding practice had been to grant total compensation to non-employee directors of, at its highest, less than $400,000 per director. The court reasoned that stockholder approval of a compensation plan with “a compensation plan with multiple classes of beneficiaries and a single generic limit on the amount of compensation” did not constitute “stockholder ratification” of the awards to non-employee directors and noted that the company did not seek or obtain stockholder approval of “any action bearing specifically on the magnitude of compensation to be paid to its non-employee directors” (emphasis in original). We note that, as a practical matter, for a company to achieve business judgment review of equity awards to nonemployee directors under Citrix, the company would have to establish either (i) separate limits for non-employee directors in the company’s equity compensation plan or (ii) a separate plan for non-employee directors. A company will, of course, want to consider how proxy firms and stockholders will react to a proposed compensation plan. (We note that ISS has a new equity plan scorecard to evaluate equity compensation plans.) Confirmation of basic principles relating to corporation’s repurchase of its stock from a dissident stockholder—Ryan v. ADT (April 28, 2015). A stockholder of ADT Corp. sought to bring a derivative action against the ADT board, challenging the appointment to the board of a person representing a hedge fund (which owned 5% of the stock and had advocated stock repurchases) and the subsequent repurchase of the hedge fund’s shares at an allegedly inflated price. The court ruled that demand on the defendant directors was not excused and granted their motion to dismiss. The court commented that, under the wellestablished Aronson test, a plaintiff demonstrates demand futility (and so is excused from making a pre-suit demand on the company’s board) by pleading particularized facts that create a reasonable doubt as to whether (i) the directors made the challenged decision with disinterestedness and independence or (ii) the challenged decision was otherwise the product of a valid exercise of business judgment. The court noted that the Aronson line of cases covers the possibility of non-disinterestedness not only based on conflicts of interest in the classic sense of self-dealing, but also when directors’ sole or primary motivation may have been entrenchment. In this case, however, the court concluded that the alleged facts did not support a reasonable inference that the director defendants perceived an actual threat of removal and were motivated to avoid it. Alleged facts were too speculative to reasonable create an inference of an entrenchment motive. The particularized facts alleged were (i) that the chairman of the board stated that C (a major stockholder) “likely” would make a stockholder proposal to elect one or more nominees to the company’s board and (ii) that the pitch materials received from two investment banks stated that C “could or might become aggressive and run a proxy contest or other activist campaign.” The court viewed these facts, standing alone, without even an “actual threat” having been made or “preliminary steps” having been taken by C, as too speculative to reasonably create an inference of an entrenchment motive. In addition, the court noted, the plaintiff’s allegation that the directors sought to maintain their compensation was insufficient to establish an entrenchment motive, absent allegations that the compensation was extraordinary or excessive, or that there was some other basis on which to conclude that the compensation “unduly influenced the directors’ decisionmaking.” Business judgment rule applies to stock repurchase. With respect to the second prong of the Aronson test, the court confirmed that, without particularized facts alleging fraud or unfairness rising to the level of corporate waste, a corporation’s repurchase of its stock at a premium over market from a dissident stockholder is entitled to protection of the business judgment rule. Other Delaware Decisions (continued from previous page) Page 21 Recent Delaware Appraisal Decisions—The More Things Change, The More They Stay The Same There has been much ado about the Delaware Chancery Court’s recent reliance on the merger price to determine fair value in appraisal cases. The Delaware statute defines fair value of a company as its going concern value immediately prior to the merger, excluding value arising from the merger itself. In the past, the court has relied on standard financial analyses of going concern value (primarily discounted cash flow (DCF) and comparable companies or transactions analyses). In a break with past practice, however, several times in recent months the court has relied primarily or exclusively on the merger price to determine fair value. We note that the court’s reliance on the merger price is still limited: n Narrow set of circumstances (two-prong test). The court has emphasized that it will rely primarily on the merger price only when both (i) the merger price is particularly reliable as an indication of value because an effective market check was part of the sale process and (ii) the financial valuation methodologies are particularly unreliable because the available inputs—projections and comparable companies or transactions—are unreliable. n Small number of cases. There have been only four cases in which the court has relied primarily on the merger price. n Factual context. The factual context in each of these cases included (i) an especially strong sale process—a public auction with competing bids in three of the four cases and, in the fourth case, a thorough public shopping of the company to obtain a white knight bidder (although no competing bid emerged); (ii) no competing bid being made after announcement of the merger; and (iii) a merger price that represented a significant premium above the unaffected stock price. The court’s approach has been consistent in the appraisal decisions this quarter. The court’s appraisal decisions this past quarter have produced varying outcomes—with the court determining fair value to be: n equal to the merger price—in Merlin v. Autoinfo (Apr. 30, 2015); n slightly below the merger price—in Longpath v. Ramtron (June 30, 2015); and n significantly above the merger price—in Owen v. Cannon (June 17, 2015). The court’s approach has been consistent, however. In AutoInfo and Ramtron, both of which involved arm’s length transactions with an effective market check and with unreliable valuation analysis inputs (as well as a merger price that represented a significant premium to the unaffected stock price), the court relied primarily on the merger price—and found fair value to be equal (or very close) to the merger price. In Cannon, which involved an interested transaction (a squeeze-out merger) with no market check (as well as a merger price well below the value indicated by third party valuations received by the company), the court relied on a DCF analysis—and its fair value determination represented a 60% premium over the merger price. It remains to be seen to what extent the court may expand its use of the merger price as the primary factor in determining fair value. As we have discussed in previous articles, the court ever expressly used the merger price to determine fair value, the court, stating that it was relying on DCF analyses, consistently determined fair value to be equal or close to the merger price in disinterested transactions in which there had been an effective market check (and often determined fair value to be significantly higher than the merger price in interested transactions without a market check). Thus, while not expressly relying on the merger price, the actual results of the court’s past appraisal decisions clearly suggest that, when there has been an effective market check, the merger price has always been a strong (albeit unacknowledged) factor in the court’s considerations. Appraisal Decisions (continues on next page) Page 22 Appraisal Decisions (continues on next page) Open issues include: n Will the court’s increased inclination to use the merger price to determine fair value expand to include any transaction with an effective market check, whether or not there are reliable inputs for a financial analysis? So far, the court has used the merger price as the primary or exclusive basis for determining fair value only in those cases involving transactions that meet both prongs of the test noted above (an effective market check and unavailability of reliable inputs for financial analyses). Yet, reliance on the merger price whenever there has been an effective market check—thus, even if, for example, the company projections are reliable—no doubt holds allure. That approach would short-cut the considerable difficulties inherent in a DCF analysis. As we have noted in previous articles, a DCF analysis can yield widely varying results depending on the selection of the numerous required inputs for the analysis. These inputs are often uncertain or subjective (including, for example, the company’s long-term projections and the appropriate discount rate). Moreover, a small change in any of them can yield a significant change in the result. Even when a DCF analysis is conducted in a cooperative, non-litigation context, there may be considerable uncertainty about the reliability of the result— and the court has often expressed frustration, most recently in Ramtron, with “litigation-driven valuations” submitted by the parties’ experts. Moreover, as noted, the results, as a practical matter, would not necessarily differ from those that now pertain. n How strong would the market check have to be for the court to use the merger price to determine fair value in a case involving an interested transaction? To date, the appraisal cases involving interested transactions have included, in the court’s view, no (or weak) market checks. Moreover, the amount by which the court’s fair value determinations (using financial valuation analyses) have exceeded the merger price has generally corresponded to the apparent strength of the sale process (even though the process is logically irrelevant to a DCF or other financial analysis of going concern value). It remains to be seen whether the court would accord to an interested transaction with an effective market check the same treatment as a disinterested transaction with an effective market check. n Would the merger price or the financial valuation take precedence in the case of a transaction in which there had been an effective market check but also reliable financial analyses—and the financial valuation exceeds the merger price? If the court were to expand its use of the merger price to all transactions with an effective market check, how would the court respond if the financial valuations—if based on reliable company projections and sufficiently comparable companies and transactions—lead to values materially in excess of the merger price? Clearly, in such a case, either the “effective market check” Appraisal Decisions (continued from previous page) Key Practice Points for Acquirors relating to adjustment of the merger price: n Establish the amount and nature of the expected cost savings. An acquiror should outline in some detail the cost savings expected from the merger. References to anticipated savings embedded, for example, in assumptions for projections or in an investment memorandum may not be sufficient. The acquiror should identify what portion of the expected savings is attributable to the merger itself. For example, executive compensation reductions that are anticipated due to the overlaps of executive positions at both companies (i.e., the merged company will not need two CEOs, two CFOs, etc.) would appear to be mergerspecific. Reductions that are anticipated due to the target’s already having implemented compensation reductions would not be mergerspecific. Reductions anticipated because the target’s compensation scale is above-market (so reductions could be achieved by the target itself without the merger, but the target might not have thought of or wanted to make those reductions) are more difficult to classify as merger-specific or not. The acquiror should consider identifying what part of its offer price is based on expected merger-specific cost savings. Internal documents, and those prepared by the company’s investment banker, should be carefully reviewed so as to be consistent with the acquiror’s views of merger-related cost savings. n Consider establishing the amount of the control premium. The merger price typically includes a control premium, all or part of which logically is merger-specific and should be excluded from the court’s determination of fair value. An acquiror should consider establishing a foundation to support a determination as to what part of the merger price is represented by a control premium. If the merger price is used to determine fair value in an appraisal proceeding, the respondent company should argue for a downward adjustment to exclude that amount. We are not aware of parties to appraisal proceedings having made this argument and the court has not addressed the issue. (Of course, the calculation of the control premium amount Page 23 Appraisal Decisions (continues on next page) Appraisal Decisions (continued from previous page) could be complex, including, for example, because part of a control premium may be attributable to merger synergies (and cannot be counted twice in determining reductions). n Seek to understand target company’s sale process. The acquiror will have a better sense of the likely appraisal risk if it understands the target’s sale process, including whether there was an effective market check. The acquiror should consider requesting information about the sale process from the target company’s general counsel and seeking to review a draft of the target’s description of the background of the transaction in its proxy statement or tender offer statement. n Seek to establish the nature and reliability of the target’s projections. The acquiror will have a better sense of the likely appraisal risk if it understands the target’s process in developing its projections. For example, the acquiror should seek to understand: Does the company prepare annual projections on a regular basis? What is the nature of those projections (1-, 3- or 5-year)? Are the projections subject to review by the board and what is the extent of the review? Were the projections utilized in the sale process prepared in the ordinary course? Are there any factors indicating that the projections utilized in the sale process were prepared other than in the ordinary course? Are there any factors indicating that the projections were modeled to be “aggressively optimistic,” were prepared in anticipation of the sale process, or do not reflect the management’s best view of the company’s future? What has management said about its confidence in the projections and how has management used the projections? Have the projections been provided to the company’s banks or other financial institutions? n We note that, if a court utilizes the merger price to determine fair value and requests adjustment proposals from the parties, the petitioner and the company may wish to consider the game theory involved in proposing a lower proposed adjustment (in the case of the company) or a nominal proposed adjustment (in the case of the petitioner) insofar as it may affect the court’s would not in fact have been effective or there would have been a “market failure” for some reason. Presumably, the course the court would choose in these circumstances would depend on the court’s view of the reason for the discrepancy between the merger price and the financial valuations. Key Points n Consistency of results in appraisal cases. The court has been, and continues to be, consistent in awarding appraisal amounts equal (or close) to the merger price in disinterested transactions in which the sale process included an effective market check—whether the court has utilized the merger price or a DCF analysis as the basis for determining fair value. The court continues to be consistent in awarding appraisal amounts that significantly exceed the merger price only in interested transactions without an effective market check. n Use of the merger price under narrow circumstances. Although the court has now relied on the merger price as the sole or primary basis for determining value in four recent cases, in each of these cases there was not only (i) an effective market check, but also (ii) the court viewed the standard financial analyses (DCF and comparables analyses) as being particularly unreliable because management projections were deemed to be unreliable for a variety of reasons and there were not sufficiently comparable companies or transactions. n Effect of increased use of the merger price. As noted, the court’s increased used of the merger price in disinterested transactions with an effective market check may not change the results in these cases. Further, in our view, the increased use of the merger price may or may not discourage appraisal arbitrage overall but, in any event, should tend to drive appraisal claims away from disinterested transactions with an effective market check (unless accompanied by indications that the market check was not in fact effective) and to those transactions with the most potential for an award significantly above the merger price. n Effectiveness of market check when there is a single bidder. The court has viewed a public auction process with competitive bidding as an effective market check that supports the court’s use of the merger price to determine appraised fair value. In Ramtron, even though no competing bid emerged during the company’s search for a white knight buyer after the company had received an unsolicited bid, the court viewed the company’s “lengthy” and “public” shopping of the company (during which it contacted every party that the company believed might be interested) to have been an effective market check. n Continued confusion about adjustments to exclude mergerspecific value. The court’s more frequent use of the merger price to determine fair value necessarily focuses more attention Page 24 Appraisal Decisions (continues on next page) on the long-neglected issue of adjustments to the merger price to exclude merger-specific value from the appraisal award (as is statutorily mandated). In AutoInfo, the court articulated a new burden of proof that has the potential to provide effective guidance to parties seeking to establish the need for an adjustment. Although inconsistent with the general approach in appraisal cases of both parties and the court itself having a burden to establish fair value, the court stated that the party arguing for an adjustment to exclude value arising from mergerspecific synergies would have the burden of establishing the merger-specific nature of the synergies and their value. We note that, nonetheless, the next appraisal decision, Ramtron, indicates that, where both parties propose an adjustment amount, the court may select the amount it considers to be more reasonable (which the court in Ramtron did without analysis or much explanation), even if the burden of proof has not been met. We note that the court still has not addressed (and parties to appraisal actions still have not raised) the issue of whether all or part of a control premium included in the merger price is merger-specific value that should be excluded. n Reliability of projections—no change in the court’s approach. The court continues to find projections to be unreliable when they are not prepared by management in the ordinary course of business. Discussion n Consistency of results in appraisal awards. Interested transactions without an effective market check. As noted, the court has been consistent in determining fair value to be significantly above the merger price only in interested transactions (i.e., transactions involving, for example, a controller or a parent-subsidiary or squeeze-out merger) without an effective market check. Moreover, the amount of the premium above the merger price represented by the fair value determination in these cases has corresponded with the extent of the market check. The premiums in cases involving interested transactions that included no market check ranged from 60% to 150%, while the premiums in cases involving transactions that included some (albeit, in each case, a weak) market check were just under 20%. Disinterested transactions with a market check. Irrespective of the valuation methodology utilized by the court, the court has been consistent in determining fair value to be not significantly above the merger price in disinterested transactions with a market check. In the disinterested transactions that have included an effective market check, Appraisal Decisions (continued from previous page) decision whether to reject both proposals as not satisfying the burden of proof or to select what it views as the more reasonable between the two proposals. Key Practice Points from Cannon: n Stockholders agreement should have prevented the squeeze-out merger. The petitioner argued that the merger violated the stockholders’ agreement among the petitioner and the other two stockholders. That agreement required that all three stockholders approve any “agreements or transactions valued in excess of [$10,000]” and “any material changes in the business of the Company.” The court declined to resolve the issue for various reasons. We note, however, that the stockholders’ agreement could have been drafted more clearly to prevent a squeeze-out merger or other forced buyout of any of the stockholders by the other two (or to provide certain protections in that event). n Valuations and offers to purchase prior to a squeeze-out. The company’s credibility was damaged by its several offers to purchase the petitioner’s stock at prices, in each instance, significantly below the value of the petitioner’s shares indicated by third party valuations the company had received. Key Practice Point for Bankers relating to DCF analysis: n No liquidity discount to cost of capital size premium. In AutoInfo, the court indicated that, in a DCF analysis for appraisal purposes, the weighted average capital cost (WACC) component of the capital asset pricing model (CAPM) should generally be calculated without applying any “marketability” or “illiquidity” discount to the equity size premium derived from the Ibbotson tables. The court indicated agreement with the position, taken in Gearrald v. JustCare (2012), that, as “the ‘liquidity effect’ contained within the size premium” relates to the company’s ability to obtain capital at a certain cost, it is therefore related to the company’s intrinsic value as a going concern, and should therefore be included in the calculation of its cost of capital in a DCF analysis for appraisal purposes. Page 25 Appraisal Decisions (continues on next page) n Hypothetical corporate-level tax rate for Subchapter S corporation. According to the court in Cannon, determining the corporate-level tax rate to calculate the company’s projected free cash flows, a hypothetical rate must be determined for an S corporation that “treats the S corporation shareholder … as receiving the full benefit of untaxed dividends, by equating [his] after-tax return to the after-dividend return to a C shareholder.” n Appraisal Decisions (continued from previous page) the court has determined fair value to be equal (or close) to the merger price. In the disinterested transactions in which the court did not comment on the sale process (although, we note, in each of these there appeared to be no, or only a weak, market check), the court has determined fair value to be above, but not significantly above, the merger price (specifically, premiums of 9% and 16% above the merger price, and, in one case with an unusual fact situation, 14% below the merger price). (See the Charts below.) n Methodology to determine fair value. The Delaware appraisal statute defines fair value for appraisal purposes as going concern value of a company immediately preceding the merger, excluding any value arising from the merger itself. Use of the merger price. The court now primarily or exclusively relies on the merger price to determine fair value when (i) the merger price is a particularly reliable indication of value because it has been established through a sale process that included an effective market check and (ii) the standard financial valuation analyses (DCF and comparables analyses) are particularly unreliable because (a) the available company projections (the primary input for a DCF analysis) are unreliable and (b) there are not sufficiently comparable transactions or companies (for meaningful input to a comparables analysis). All of the recent cases meeting these parameters have involved disinterested transactions. Use of DCF analysis. In the case of interested transactions, and in the case of disinterested transactions in which either prong of the two-part test noted above has not been satisfied, the court has relied primarily or exclusively on a DCF analysis to determine appraised fair value. As noted, in these cases, notwithstanding the potential inherent in a DCF analysis for wide variability of the results, and notwithstanding the logical irrelevance to a DCF analysis of the nature of the transaction or the sale process, the court’s results have been significantly above the merger price in the case of interested transactions and not significantly above the merger price in the case of disinterested transactions (with the amount of any premium above the merger price corresponding to the apparent strength of the sale process). n Effectiveness of market check. Prior to Ramtron, each case in which the court utilized the merger price to determine fair value after finding that there had been an effective market check involved a public auction with competing bids. In Ramtron, the court viewed the company’s aggressive public shopping of the company to find a white knight buyer to be an effective market check—even though no competing bidder emerged. Notably, the $3.10 merger price the company ultimately agreed with the unsolicited bidder, after five separate price increases, represented a 71% premium over the unaffected stock price and a 25% increase over the unsolicited bidder’s initial offer price. The court found that the non-emergence of competing bids was a result of the company’s “operative reality” rather than “any shortcomings of the process”. The court noted that no party made a competing bid even at the time that the unsolicited bidder’s offer was $0.42 below the final merger price. n Continued uncertainty about adjustments to the merger price to exclude merger-specific value. The Delaware appraisal statute mandates that any value arising from the merger itself be excluded from appraised fair value. In the cases in which the court has utilized the merger price as a basis for fair value, the court has acknowledged that merger-specific value must be “backed out”. However, the court invariably has not made adjustments—sometimes simply ignoring the issue and sometimes indicating that the parties had not argued for or established a sufficient basis for an adjustment. We have noted in previous articles the difficulties inherent in, for example, determining what is a merger-specific synergy and how to calculate the value it represents. We have speculated that these difficulties, as a practical matter, may account for the court’s reluctance to make adjustments to exclude merger-specific value when the merger price is used as the primary or sole basis for determining fair value. Further, as we have noted in previous articles, the court has not addressed (and the parties to appraisal actions have not raised) the complicated issue of whether all or part of a control premium is merger-specific value that should be excluded from a determination of fair value. AutoInfo: Court establishes a new burden on the party advocating an adjustment for merger synergies. In AutoInfo, the court has provided what appears to be new, albeit limited, guidance on this issue. The court placed on the party arguing for an adjustment a burden to establish the need for, and amount of, the adjustment. We note that, generally, the court has characterized the appraisal statute as placing a burden on both parties and on the court to Page 26 Appraisal Decisions (continues on next page) determine fair value. Thus, no presumptions have been applied by the court based on one or the other party failing to provide convincing evidence with respect to one or more parts of the determination of fair value. Rather, the court has viewed itself as having the burden of determining whether to rely on one party’s view or the other’s or, if it finds neither persuasive, then to form its own view. In AutoInfo, the court appears to have departed from that approach in connection with the issue of adjustments to the merger price when it is used as the basis for fair value. In AutoInfo, the respondent company’s expert had argued that a downward adjustment should be made to the merger price to exclude the cost savings the acquiror anticipated from eliminating public company costs and reducing executive compensation. These savings were reflected in the base case projections the acquiror had developed and used internally. Following its usual course, the court did not make any adjustment to exclude merger-specific synergies. The court stated that the record had not established precisely the nature of the anticipated cost savings (thus, according to the court, it could not be determined whether they were merger-specific) or the reliability of the estimated amount of the savings. The court, in effect, established a presumption against an adjustment for anticipated cost savings unless the company demonstrates that the anticipated savings are merger-specific and that the court can have confidence in the amount. It remains to be seen how rigorous a standard the court will apply in determining whether a record sufficiently supports an adjustment being made to the merger price. Given the court’s strong reluctance to date to make any adjustments when the merger price has been used to determine fair value, and given that the court rejected any adjustment in AutoInfo even though the record (while not fully developed) appeared to be sufficient to indicate that some adjustment would be required, we expect that the court may continue to apply a restrictive standard. Ramtron: Court chooses between parties’ proposed adjustments (selecting only a nominal adjustment). In Ramtron, the court rejected the respondent’s two proposed methods of determining an adjustment to exclude mergerspecific synergies (both of which indicated a $0.34 per share adjustment of the $3.10 merger price). We note that; if the company had the benefit of the court’s discussion of adjustments in AutoInfo, it may have been possible for the company to have developed a more acceptable methodology. (Please see the accompanying Practice Points). With little discussion, the court characterized the petitioner’s proposed nominal adjustment ($0.03 per share) as “better conform[ing] to the evidence adduced at trial”—even though, the court stated, that adjustment “may understate” the merger-specific synergies. The court noted the petitioner’s testimony that, in addition to “positive synergies” anticipated from the merger (such as cost savings), significant “negative synergies” (i.e., negative effects on revenue, as well as transaction costs— in the range of 10-15% of revenue) were also expected. Therefore, the court appeared to believe that the petitioner’s nominal adjustment (although likely too low) made more sense than the respondent’s proposed significant adjustment (which, the court noted, represented more than 10% of the merger price). Notwithstanding the burden of proof established in AutoInfo, the court in Ramtron simply selected what it viewed as the more reasonable of the two proposals, without regard to the burden of proof. In our view, it may be that the court will take this approach only in limited situations—such as where, as was the case in Ramtron, significant negative synergies are anticipated, both parties propose adjustment amounts, one amount does not take into account the negative synergies, and the other amount is nominal. n Reliability of projections—No change in the court’s approach. The court generally views as reliable projections that are prepared by management in the ordinary course of business. These are viewed as reliable because management ordinarily has the best first-hand knowledge of a company’s operations and, when prepared in the ordinary course, the projections typically reflect management’s best estimate of the company’s future performance and are not tainted by distorting influences or post-merger hindsight. The court has viewed management projections as unreliable when they: n were prepared outside the ordinary course of business; n were prepared by a management team that never before prepared similar projections; n were prepared in anticipation of litigation or an appraisal action, or with some other motive (for example, to protect their jobs or to increase the apparent value of the company in a sale process); n were viewed by management itself as unreliable; and/or n were based on unusual company or industry factors that were so speculative as to make forecasting nearly impossible. Appraisal Decisions (continued from previous page) Page 27 Appraisal Decisions (continues on next page) AutoInfo and Ramtron: Unreliable projections. In Ramtron and AutoInfo, the court rejected use of a DCF analysis to determine fair value in part because the court deemed the management’s projections to be unreliable. In Ramtron, the court deemed the projections to be unreliable because they were prepared by a new management team (with the CEO, CFO and all other senior management having been at the company for less than two years); the team used a new methodology (that they appeared to view, without confidence, as a “new and unfamiliar process”); and the company had previously only ever prepared short-term forecasts (which the company itself had recently characterized as having limited reliability). Further, the court found that the projections, prepared while the company was in the process of trying to defend against a hostile takeover bid, were prepared in anticipation of possible future disputes and seeking white knights; in addition, the projections did not accord with the reality of the business in numerous respects. Moreover, the company itself did not rely on the projections in the ordinary course of its business (having prepared other projections for managing the company’s finances, including providing information to the company’s bank). Importantly, the court criticized the parties’ “litigation-driven” valuations, including the petitioner’s “eyebrow-raising DCF”—which relied on projections the expert had presumed were overly optimistic and yet still yielded a result two cents below the merger price. In AutoInfo, the court found that the company’s projections were unreliable because management had been specifically directed to “paint an ‘aggressively optimistic’ picture” for the purpose of generating more interest in, and a better price for, the company in its sale process. In addition, management had never before prepared projections; “had no confidence in its ability to forecast” the company’s future performance; and “perceived its attempt [to forecast] as ‘a bit of a chuckle and a joke’.” Cannon: High bar for company to disavow its projections. In Cannon (an interested transaction), the court and both of the parties utilized a DCF analysis to determine fair value. The court rejected the company’s attempt to disavow the projections that had been prepared by the company’s president in favor of projections later created by the company’s expert. The expert’s projections, which had been prepared in anticipation of a mediation of the parties’ dispute with respect to the forced buyback of the petitioner’s shares, projected less growth in the company than the projections that the company had prepared earlier in anticipation of offering to buy back the petitioner’s shares. The court deemed the expert’s projections to be unreliable because they were prepared in anticipation of litigation. While the president’s projections had been prepared for the purpose of determining the offer price for the contemplated forced buyback of the petitioner’s shares (either through his agreement or a squeeze-out merger), the petitioner did not argue that they were unreliable on this basis, but argued instead that the president’s projections were more reliable than the expert’s revised projections. The court agreed, finding that the following factors supported the reliability of the president’s projections: (i) although the projections had not been prepared by a management team but by the president alone, the president had a thorough knowledge of the company and its prospects and other management input was obtained through weekly discussions with the president about results, developments and prospects; (ii) the president had, over a three year period, updated and revised the projections to reflect actual results and new developments; and (iii) the president had submitted the projections to financing sources (here, the court emphasized that the court will place great weight on projections that have been provided to financing sources, as it is a federal felony to knowingly obtain funds from a financial institution by false or fraudulent pretenses or representations); and (v) it was unlikely that the president’s projections were too high as he had an incentive to make the projections as low as possible since they were prepared for the purpose of setting the price for the buyback of the petitioner’s shares. The court rejected the respondent’s arguments that, based on principles discussed in previous appraisal decisions, the projections prepared by its president were unreliable. The court distinguished the previous decisions as follows: n CKx. In Huff v. CKx, the court viewed the company’s projections as unreliable because a projected increase in licensing fees under a material, to-be-negotiated contract was so speculative and the initial estimates of those revenues had been markedly lower than the projections provided to potential buyers and lenders. By contrast, the court noted, in Cannon, although Cannon had argued that its prospects had dimmed, it had not identified any particular line item or line of business in the projections that was so uncertain as to undermine the integrity of the overall projections. n JustCare. In Gearrald v. Just Care, the court viewed the company’s projections as unreliable because the company had never before prepared multi-year projections. The court distinguished the situation in ESG by noting that, even though the company had not generally prepared projections in the ordinary course of business, the president’s projections had been prepared (and updated and revised) over three years; that he had been confident enough in them to provide them Appraisal Decisions (continued from previous page) Page 28 to banks in connection with financing the buyout; and that they had been created in part with the assistance of a financial advisor with whom the president had reviewed the revenue growth assumptions. n Nine Systems. In In re Nine Systems, the court viewed a set of one-year projections as unreliable because the projections were inconsistent with the company’s recent performance (specifically, management had “overestimated … revenues even two months away … by more than a factor of three”). By contrast, in Cannon, the court noted, the company’s performance in the months just preceding the merger were in line with the projections. Summary of most recent cases: AutoInfo, Cannon and Ramtron AutoInfo—In this disinterested transaction involving a competitive public auction, the court: n used the merger price to determine fair value (with a DCF analysis as a double-check); n found the sale process to have been thorough; n found the management projections unreliable because they were prepared with a view to marketing the company; n imposed a new burden with respect to adjustments to the merger price to exclude merger-specific synergies; and n determined fair value to be equal to the merger price. In AutoInfo, the merger price, $1.05 per share, had been established through a public auction process conducted at arm’s length by a special committee with an independent financial advisor. The company and its financial advisor had aggressively shopped the company; the merger agreement was entered into with the bidder that had by far the highest indication of interest (although, after that bidder uncovered alleged accounting, financial and other irregularities during due diligence, the price was renegotiated to an amount slightly below the amount at which some of the other indications of interest had been); and no competing bid emerged during the almost two-month post-signing period. The court rejected the company’s projections as unreliable because management had been instructed to prepare aggressively optimistic projections as they would be used to market the company. The court rejected the petitioner’s comparable companies analysis because of the much larger size of the companies included and their different business model (store-based as opposed to the company’s agent-based model). The petitioner’s expert had argued that fair value was $2.60 per share, based one-third each on a DCF analysis, comparable company analysis using a historical-based multiple, and a comparable company analysis using a forward-looking multiple. The respondent’s expert had argued that fair value was $0.97, based on the merger price, adjusted downward to exclude cost savings arising from the merger. The court based fair value on the merger price—and also conducted its own DCF analysis as a double-check on the merger price (which yielded a result slightly below the merger price—$0.93). The court rejected any adjustment to the merger price to exclude merger-specific synergies, reasoning that the party arguing for those adjustments (the company) had a burden (that it had not met) to establish the nature and amount of the synergies alleged to be mergerspecific before any adjustment could be made. Cannon—In this interested transaction involving a squeeze-out merger at a price far below the value indicated in third party valuations received by the company (and with no market check), the court: n used a DCF analysis to determine fair value (as had both parties); n rejected the company’s attempt to disavow (and lower) its projections; and n determined fair value to be significantly higher than the merger price. In Cannon, two stockholder-directors of a Subchapter S corporation forcibly removed the third stockholder-director (the petitioner) as president and, after several failed attempts at repurchasing his shares, effected a squeeze-out merger in which his shares were cancelled. At the merger price, the petitioner would have received $26.33 million for his interest. The repurchase offers and the merger price for his interest were all far below the value indicated in third party valuations received by the company throughout the relevant periods. The court utilized a DCF analysis to determine fair value, yielding a result of $42.17 million—representing a 60% premium over the merger price. The result of the DCF analysis conducted by the petitioner’s expert was $53.46 million, while the respondents’ expert’s DCF result was $21.50 million. The difference in results Appraisal Decisions (continued from previous page) Appraisal Decisions (continues on next page) Page 29 in the DCF analyses was primarily attributable to the different projections utilized. In addition, the petitioner had tax-affected the company’s earnings in the analysis to compensate the petitioner for the loss of the tax advantage in being a stockholder of a Subchapter S corporation. The court utilized the projections prepared by the company’s new president (one of the two stockholder-directors who planned the merger), rejecting the respondents’ arguments that their expert’s more conservative projections should be used instead; and agreed with the petitioner that the Subchapter S corporation earnings should be taxaffected. Ramtron—In this disinterested transaction involving a hostile takeover bid and a thorough search for a white knight buyer (with no competing bidder having emerged), the court: n used the merger price to determine fair value; n found the management projections unreliable for a variety of reasons; n made a nominal adjustment to the merger price for merger-specific synergies (without much discussion); and n based on the nominal adjustment, determined fair value to be just below the merger price. In Ramtron, the company, after receiving an unsolicited bid, aggressively shopped the company to find a white knight buyer, while rejecting the unsolicited bid. No competing bids emerged over the three-month period and the company ultimately agreed to a merger with the unsolicited bidder. The merger price, $3.10 per share, represented a 75% premium over the unaffected stock price and, after five separate increases in the bid price, a 25% increase from the initial offer. The court rejected the management projections as unreliable because, among other things, the entire senior management team had been in place for a very short time; the projections were prepared using a new methodology; the management expressed uncertainty about their reliability and used different projections to manage the company’s finances and provide information to its bank; and the projections were prepared in anticipation of potential litigation (including an appraisal action). The court rejected the petitioner’s comparables analysis because it was comprised of only two comparable companies and the multiples for each differed significantly, making the average of the data points unreliable. The petitioner’s expert had argued that fair value was $4.96 per share (which was 274% of the unaffected stdock price, the court noted), based 80% on its DCF analysis (which yielded a result of $5.20) and 20% on its comparables analysis (which yielded a result of $3.99). The respondents’ expert had argued that fair value was $2.76, based on the merger price, adjusted downward to exclude cost savings arising from the merger. The respondent’s expert argued, in the alternative, that fair value, based on a DCF analysis utilizing management’s projections, was $3.08. The court based fair value solely on the merger price and, with little analysis or explanation, adjusted the merger price downward by the $0.03 that the petitioner proposed represented the merger-synergy savings less the merger-synergy costs. Appraisal Decisions (continued from previous page) Appraisal Decisions (continues on next page) Delaware Appraisal Decisions 2010 – June 2015: Premium Over Merger Price Date Case Appraisal amount higher than merger price Premium over merger price represented by appraisal amount Estimated additional premium over merger price represented by statutory interest Number of years from merger date to appraisal decision Sale process included market check and minority shareholder protections INTERESTED TRANSACTIONS: 6/17/15 Owen v. Cannon Yes 60% 17.6% 2.1 None 5/12/14, 6/25/14 Laidler v. Hesco Yes 86.6% 24.7% 2.5 None 9/18/13 In re Orchard Enterprises Yes 127.8% 36.1% 2.0 - 6/28/13 Towerview v. Cox Radio Yes 19.8% 26.9% 3.9 Weak 4/23/10 Global v. Golden Telecom Yes 19.5% 14.7% 2.2 Weak 2/15/10 In re Sunbelt Beverage Yes 148.8% 213.8% 12.4 None Page 30 Date Case Appraisal amount higher than merger price Premium over merger price represented by appraisal amount Estimated additional premium over merger price represented by statutory interest Number of years from merger date to appraisal decision Sale process included market check and minority shareholder protections DISINTERESTED TRANSACTIONS: 6/30/15 Longpath v. Ramtron No 0% 13.7% 2.6 Yes-strong 4/26/15 Merlin v. AutoInfo No 0% 10.5% 2.0 Yes-strong 1/30/15 In re Ancestry No 0% 11% 2.1 Yes-strong 11/1/13, 5/19/14, 2/12/15 Huff v. CKx No 0% 12.7% 2.3 Yes-strong 7/8/13 Merion v. 3M Cogent Yes 8.5% 14.3% 2.6 * 3/18/13 IQ v. Am. Commercial Lines Yes 15.6% 13.7% 2.3 * 4/30/12 Gearreald v. Just Care No (14.4%) 11.7% 2.6 * * In these cases, the court did not reach a conclusion about the strength of the market check or other protections. The court did not primarily utilize the merger price to determine the appraisal amount, but conducted a DCF analysis (see Chart below) that (as reflected above), in each case, yielded a result that was within about 15% of the merger price. Appraisal Decisions (continues on next page) Delaware Appraisal Decisions 2010 – June 2015: Valuation Methodologies Used Date Case Merger consideration (per share) Court’s valuation method/ appraised amount Petitioner’s valuation method/ proposed value Respondent’s valuation method/ proposed value INTERESTED TRANSACTIONS: 6/17/15 Owen v. Cannon $26.33M (shareholder’s whole interest) $42.17M DCF $53.46M DCF $21.5M DCF 6/25/14 Laidler v. Hesco $207.50 $387.24 DCCF $515 DCCF $205.30 DCCF (Primary) Comparable Companies Comparable Merger Price Transactions 7/18/13 In re Orchard Enterprises $2.05 $4.67 DCF $5.42 DCF $1.53 DCF (1/3) Comparable Companies (1/3) Comparable Transactions (1/3) 6/28/13 Towerview v. Cox Radio $4.80 $5.75 DCF $12.12 DCF $4.28 DCF (Primary) Comparable Companies Merger Price 4/23/10 Global v. Golden Telecom $105 $125.49 DCF $139 DCF $88 DCF 2/15/10 In re Sunbelt Beverage $45.83 $114.04 DCF ($104.16) Comparable Companies Comparable Transactions $114.04 DCF $36.30 DCF ($42.12) Asset Based ($45.83) Earlier Sunbelt Transaction Appraisal Decisions (continued from previous page) Page 31 Appraisal Decisions (continued from previous page) Date Case Merger consideration (per share) Court’s valuation method/ appraised amount Petitioner’s valuation method/ proposed value Respondent’s valuation method/ proposed value DISINTERESTED TRANSACTIONS: 6/30/15 Longpath v. Ramtron $3.10 $3.10 Merger Price $0.03- Adjustment for merger synergies $4.96 DCF- $5.20 (80%) Comparable Companies- $3.99 (20%) $0.03- Adjustment for merger synergies $3.10 Merger price $0.34- Adjustment for merger synergies 4/30/15 Merlin v. AutoInfo $1.05 $1.05 Merger Price $2.60 DCF (1/3) Comparable Companies (historicalbased multiple) (1/3) Comparable Companies (forwardlooking multpl) (1/3) $0.97 Merger price—adjusted to exclude merger synergies 1/30/15 In re Ancestry $32.00 $32.00 Merger Price ($31.79) DCF $43.05 DCF $30.63 DCF 11/1/13, 5/19/14, 2/12/15 Huff v. CKx $5.50 $5.50 Merger Price $11.02 DCF (60%) Comparable Companies/ Comparable Transactions (40%) $4.41 DCF 7/8/13 Merion v. 3M Cogent $10.50 $10.87 DCF $16.26 DCF $10.12 DCF (1/3) Comparable Companies (1/3) Comparable Transactions (1/3) 3/18/13 IQ v. Am. Commercial Lines $33.00 $38.16 DCF $45.01 DCF Comparable Companies Comparable Transactions $25.97 DCF Comparable Companies Comparable Transactions 4/30/12 Gearreald v. Just Care $40M (whole company) $34.24M DCF $55.2M DCF $33.6M DCF (2/3) Comparable Companies (1/3) In addition, please see our previous articles relating to appraisal, including: n Why Delaware Appraisal Awards Exceed the Merger Price, published on The Harvard Law School Forum on Corporate Governance and Financial Regulation (Sept. 23, 2014) n Fried Frank Discusses Proposed Appraisal Statute Amendments, Which Would Permit Companies to Reduce Their Interest Cost, published on Columbia Law School Blue Sky blog (March 30, 2015) n Over-Reaction to Use of Merger Price to Determine Fair Value, published in The M&A Lawyer (May 2015) and on The Harvard Law School Forum on Corporate Governance and Financial Regulation (May 1, 2015) n New Activist Weapon—A Look At Appraisal Arbitrage Cases, published on Law360 (August 07, 2014) n The Rise of Appraisal Arbitrage, published in Insights: The Corporate & Securities Law Advisor (July 2014) Page 32 Appraisal Update—Statistics and Dell n In 2014, a record 40 appraisal petitions were filed in Delaware (up from 28 in 2013). So far In 2015, 28 appraisal petitions already have been filed. n Appraisal actions were brought in 17% of transactions in 2014 (up from 5% in 2010 and 10% in 2011). n The value, at the deal price, of all of the dissenting shares in deals closed so far in 2015 is $1.8 billion. The amount for all deals closed in 2014 was $1.5 billion—which was more than twice the highest point over the preceding five years. (The amount for deals closed in 2013 was $720 million—which was more than five times higher than the highest point over the preceding five years.) n The Delaware Legislature was expected to act during the legislative session ended June 30, 2015 to adopt proposed amendments to the Delaware appraisal statute. Although the proposed amendments were approved by the Delaware Bar Corporate Law Council earlier this year (which typically signals ultimate adoption by the Legislature), a bill has not yet been introduced to the Delaware Assembly. n In In re Appraisal of Dell (July 13, 2015), the Delaware Chancery Court granted summary judgment to Dell, ruling that the petitioner-stockholders had lost their right to appraisal because they were not “continuous holders” of record of the Dell shares through the merger effective date, as required by the statute. As is not uncommon, the name of the record holder (Cede—the nominee for the Depository Trust Company) was changed by the beneficial owner’s custodial bank to the name of the bank’s nominee when the shares were transferred from DTC to the bank after the appraisal petition was filed. We expect that the decision will be appealed to the Delaware Supreme Court, which may reverse the ruling and adopt the alternative approach advocated by Vice Chancellor Laster in the decision. Pending further developments, the decision may immediately affect stockholders’ access to appraisal rights and the practices of custodial banks. See our memorandum dated July 14, 2015 (available on the Fried Frank website). M&A/Private Equity Group Partners: If you would like to receive Fried Frank M&A Quarterly via email, you may subscribe online at friedfrank.com/subscribe. New York Jeffrey Bagner firstname.lastname@example.org Andrew J. Colosimo email@example.com Aviva F. Diamant firstname.lastname@example.org Steven Epstein email@example.com Christopher Ewan firstname.lastname@example.org Arthur Fleischer, Jr.* email@example.com Peter S. Golden firstname.lastname@example.org Mark Lucas email@example.com Tiffany Pollard firstname.lastname@example.org Philip Richter email@example.com Steven G. Scheinfeld firstname.lastname@example.org Robert C. Schwenkel email@example.com David L. Shaw firstname.lastname@example.org John E. Sorkin email@example.com Steven J. Steinman firstname.lastname@example.org Washington, DC Jerald S. Howe Jr. email@example.com Mario Mancuso firstname.lastname@example.org Brian T. Mangino email@example.com Andrew P. Varney firstname.lastname@example.org London Alexandra Conroy email@example.com Robert P. Mollen firstname.lastname@example.org Dan Oates email@example.com Graham White firstname.lastname@example.org Paris Eric Cafritz email@example.com Frankfurt Dr. Juergen van Kann firstname.lastname@example.org *Senior Counsel A Delaware Limited Liability Partnership. The articles included in Fried Frank M&A Quarterly are general in nature and are not intended to provide legal advice with respect to any specific situation confronted by our clients or other interested persons. 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