In C&J Energy Services, Inc. v. City of Miami General Employees’ and Sanitation Employees’ Retirement Trust, the Delaware Supreme Court reversed a ruling from the Chancery Court that had enjoined a shareholder vote on a merger for 30 days and imposed a mandatory go-shop period during that period. The Supreme Court’s opinion, handed down in December 2014, revisits Revlon duties thirty years after the famous decision was rendered, providing important guidance on the “road map” that a board must follow in change-of-control situation in order to fulfill fiduciary duties.
The C&J decision is of interest for boards of directors of Canadian corporations even though the legal environment governing change-of-control transactions is somewhat different north of the border. Indeed, following the BCE decision by the Supreme Court of Canada, the fiduciary duty of directors in a change-of-control context is cast broadly as the duty to act in the best interest of the corporation. In pursuing this goal, boards must follow a reasonable decision-making process in accordance with their duty of care. From this perspective, C&J reminds boards that there “is no single blueprint that directors must follow” in a change-of-control transaction, as the Ontario Court of Appeal had also emphasized in the pre-BCE case of Maple Leaf Foods Inc. v. Schneider Corp.
After having launched a strategic review, C&J Energy Services, Ltd. (C&J) entered into a merger agreement with Nabors Industries, Ltd. (Nabors) and a Bermuda company which was a subsidiary of Nabors. The merger was structured as a corporate tax inversion whereby the surviving company would be domiciled in Bermuda. Following the merger, C&J shareholders would own 47% of the shares of the surviving company and Nabors shareholders 53%. The management of C&J would lead the new company.
The merger agreement included a number of governance provisions in favour of C&J shareholders, including the power to designate a majority of the initial board, the control of the nominating committee, the right to receive pro rata consideration in the event of a sale of the company or major assets, a standstill agreement and transfer restrictions binding the sale of the shares held by Nabors. Although the board did not conduct an active market check prior to entering into the transaction, the merger agreement included a “fiduciary out” that allowed C&J to negotiate with third parties under certain circumstances, with a termination fee equal to 2.27% of the deal value.
C&J shareholders brought a class action before the Delaware Court of Chancery to enjoin the merger. They asserted that C&J’s board of directors entered into a change-of-control transaction without properly discharging its fiduciary duties. In a ruling from the bench, the Court of Chancery found that there had been a plausible violation of the board’s Revlon duties. The Court enjoined the shareholder vote on the merger for 30 days and required C&J to shop itself despite the merger agreement’s prohibition on the solicitation of other bids.
Supreme Court decision
The Delaware Supreme Court reversed the Chancery ruling less than a month after it was issued. The Court’s opinion, authored by Chief Justice Strine, includes a number of important observations on the duties of directors in change-of-control transactions. The Court reaffirmed that Revlon requires boards to seek the highest immediate value reasonably attainable in a change-of-control transaction. It also restated the Delaware principle that “there is no single blueprint that a board must follow to fulfill its duties”. When reviewing the course of action taken by the board of directors, a court will look at “whether the directors made areasonable decision, not a perfect decision”.
The Supreme Court emphasized that the Delaware case law allows a board of directors to pursue the transaction that it considers to be the most valuable to shareholders “so long as the transaction is subject to an effective market check”. Most notably, the Court remarked that the market check does not have to involve an active solicitation. A market check is effective if “interested bidders have a fair opportunity to present a higher-value alternative, and … the board has the flexibility to eschew the original transaction and accept the higher-value deal”. In this case, the Court found that there were no material barriers preventing a rival bidder from making a superior offer during the five month period following the announcement of the transaction. Moreover, the merger agreement provided for a fiduciary out which was accompanied by a termination fee that was qualified as “modest” by the Court.
Finally, the Supreme Court found that the C&J board had had no improper motive to sign a deal with Nabors. Notably, the Court did not consider that the efforts of C&J’s CEO to secure an employment package as CEO of the new entity tainted the negotiation process. Further, the Supreme Court held that the board was well-informed about C&J’s value, as were the shareholders who had the opportunity to vote on the merger.
Admittedly, the Supreme Court was called upon to issue its ruling in a rather unique setting. The appeal was filed without a formal opinion from the Court of Chancery and therefore without any detailed findings of fact. The Supreme Court was therefore required to craft its own factual recitation in the first instance as to most aspects of the process. In addition, the C&J transaction involved an unusual corporate tax inversion. Despite these unusual circumstances, however, the Supreme Court’s discussion of Revlon duties in C&J is relevant to change-of-control transactions.
For a PDF version of this post, see Legal Trends Spring 2015