In Gesoff v. IIC Industries Inc., 902 A.2d 1130 (Del. Ch. 2006), the Delaware Court of Chancery held that defendants failed to prove that the IIC Industries, Inc. (“IIC”) merger was a product of fair dealing or that the merger consideration was fair, and therefore, failed to prove the entire fairness of the merger transaction. Consequently, the Court awarded money damages to the plaintiffs amounting to $14.30 per share – $3.80 per share more than the merger price. In doing so, the Court issued a reminder that boards that disregard the clear guidelines as to how a going-private merger can withstand judicial scrutiny expose themselves and others to substantial damages awards.
Defendant IIC was a Delaware corporation with its principal place of business in New York City. Defendant CP Holdings (“CP”), which owned 80% of IIC, is an English holding company with its principal place of business in Watford, England. The only business of IIC was to act as an intermediate holding company of certain overseas assets, including a Hungarian corporation that operates hotels and spas in Eastern Europe and an Israeli corporation that distributes tractors and heavy equipment.
In 2000, CP decided to take IIC private and remove the minority stockholders. A report prepared by Paul Filer, CP’s Finance Director, described the potential benefits to CP of removing IIC as an intermediate holding company. That report attached a “separate paper on the mechanics of removing the minority.” The information in that separate document, which was provided by IIC’s and CP’s U.S. lawyer, Samuel Ottensoser, stated that they expected the minority stockholders to demand $16.20 per share. In May 2001, Filer presented a more comprehensive report to the Board of Directors of CP regarding a goingprivate transaction, which included a quote from investment bankers Jesup & Lamont. The report showed CP was presently required to pay $13 per share for IIC shares on the open market. Subsequently, the CP Board authorized a bid approach to the IIC Board at $13 per share, which was envisioned to be in the form of a tender offer followed by a shortform merger pursuant to Section 253 of the Delaware General Corporation Law.
The IIC Board decided to appoint a special committee in order to comply with Delaware law. The special committee, however, consisted of only one IIC director, Alfred Simon, because he was the only in- Consequences Of A Defective Special Committee Directed To Negotiate Going Private Transaction dependent director capable of performing the necessary work. The consent appointing Simon to the special committee authorized him to make a recommendation on the proposed transaction. Simon had no real authority to choose either his own lawyer or his own financial advisor. In fact, Filer met with Jesup & Lamont before Simon retained them as the bankers for the transaction and before Simon decided to retain Jesup & Lamont, Filer sent them a draft engagement letter telling them that they would have the engagement soon. Ottenoser was presented to Simon as the choice of the conflicted IIC board, and CP’s choice, for counsel. Although Simon pressed Ottenoser about his conflict of interest in representing IIC and CP on the one hand and the special committee on the other, Ottenoser said there was no conflict.
The evidence presented at trial illustrates that there was an entirely inadequate negotiation between Simon and CP. Particularly troubling was that Filer and Ottenoser exchanged emails discussing how it perceived the negotiation process with the special committee – CP would make a “lowish bid,” Jesup & Lamont would recommend a slightly higher bid, CP would meet that new price, Jesup & Lamont would approve it and then CP would make its tender offer. As if following a script, the negotiations followed this pattern. During the negotiations, Filer received much of Jesup & Lamont’s work for the special committee and shared it with CP. Without knowledge of this, Simon approved a $10.50 per share tender offer. Shortly thereafter, the events of September 11, 2001, occurred and the tender offer was unsuccessful. After the tender offer closed, CP proceeded to acquire the remaining minority shares of IIC through a long-form merger pursuant to Section 251 of the DGCL. Filer told Simon the price would remain the same, even though it should be lower as a result of September 11. Relying on information from Filer, Simon decided to recommend the merger without receiving a new fairness opinion or conducting any additional formalities on behalf of IIC’s minority stockholders. Simon did not attend the IIC board meeting approving the merger, but instead gave his proxy to Filer to vote in favor of the transaction.
Plaintiff Richard S. Gesoff filed both a class action alleging that the merger between IIC and CP was the product of unfair dealing and produced an unfair price and an appraisal action pursuant to Section 262 of the Delaware General Corporation Law. The defendants argued that the merger was entirely fair because any unfair dealing did not affect the fairness of the merger price. They also argued that the events of September 11th depressed the value of IIC and made the price paid more than fair. The defendants relied on their expert report to assert that the fair appraisal value of IIC was somewhere between $6.22 and $12.98. Only Simon argued that IIC’s exculpatory charter provision, modeled after Section 102(b)(7) of the Delaware General Corporation law, protected him from personal liability.
After a full trial, the Delaware Court of Chancery held that the merger was the result of unfair dealing and produced an unfair price. In its opinion, the Court focused on the special committee, because the question of whether the merger was the result of unfair dealing hinged on the special committee’s negotiations with CP. The Court found an abundance of flaws with the special committee. First, the Court held that the composition of a special committee is of fundamental importance and should preferably have more than one member, which was not the case here. Second, the Court stated that the special committee should be given a clear mandate and have the power to say “no” to a transaction. Simon’s mandate was unclear and certainly did convey to Simon that he could veto a merger. Additionally troublesome, Simon did not appreciate the difference between the tender offer and merger transactions. Third, a special committee should have access to independent legal and financial advisors, however, in this case, the special committee’s legal counsel was hopelessly conflicted and its financial advisor was selected by CP and disloyal to the special committee during the negotiations. As a result of these flaws, the Court found the merger was the result of unfair dealing.
The Delaware Court of Chancery also found that the price paid was unfair. The Court rejected the defendants’ argument that September 11 depressed the value of IIC so much that the price paid was fair, finding that the defendants failed to prove that September 11 materially affected the value of IIC, which was based wholly overseas.
Exercising its discretion to fashion a suitable remedy because this was a consolidated entire fairness and appraisal action, the Delaware Court of Chancery determined the value of IIC by weighing the reports of both side’s experts, conducting its own discounted cash flow (DCF) analysis and testing the results of its financial analysis. Applying this process and, for the most part, employing defendants’ expert reports, the Court concluded that IIC was worth $14.30 per share.
Finally, the Delaware Court of Chancery found that Simon had breached his duty of care, but not his duties of loyalty or good faith, and was therefore protected from personal liability by IIC’s exculpatory charter provision pursuant to Section 102(b)(7). The Court concluded that Simon was not personally conflicted, did not receive a personal benefit from the transaction and did not work together with Filer and the other defendants to squeeze out IIC’s minority stockholders at an unfair price.
[T]he special committee should be given a clear mandate and have the power to say “no” to a transaction. Simon’s mandate was unclear and certainly did not convey to Simon that he could veto a merger.
[A] special committee should have access to independent legal and financial advisors, however, in this case, the special committee’s legal counsel was hopelessly conflicted and its financial advisor was selected by CP and disloyal to the special committee during the negotiations.