Delaware Court Addresses Important Revlon Duties in Cash/Stock Mergers
On May 20, 2011, Delaware Vice Chancellor Parsons issued an opinion in In re Smurfit-Stone Container Corp. Shareholder Litigationi addressing important questions under Delaware takeover law: namely, (i) whether an acquisition transaction where the merger consideration consists of roughly 50% cash and 50% acquiror common stock triggers the duties identified in Revlon, Inc. v. MacAndrews & Forbes Holdings, Inc., 506 A.2d 173, 179 (Del. 1986) and is subjected to heightened scrutiny under Revlon and (ii) under circumstances in which Revlon is applied, may the target company's board deal exclusively with the acquiror without undertaking an auction or other market check.
Background and Arguments
The background of this case centers on the proposed merger of the target company, Smurfit-Stone Container Corporation, with a wholly owned subsidiary of Rock-Tenn Company pursuant to a merger agreement dated January 23, 2011. At the time of signing, the equity value of the transaction was approximately $3.5 billion, or $5.3 billion when including net debt and certain pension liabilities to be assumed by RockTenn following the merger. As of the date of the merger agreement, the merger consideration to be delivered in connection with the transaction was split evenly between cash and stock, with each share of Smurfit-Stone common stock receiving in the merger (i) $17.50 in cash and (ii) 0.30605 of a share of RockTenn common stock, for a value of $35 per share at the time of execution of the merger agreement. By the date of the Chancery Court hearing, the 50/50 mix of cash and stock consideration had shifted to approximately 44% cash and 56% stock due to the increase in RockTenn’s stock price since the announcement of the agreement. At the time of the hearing, it was expected that, if the transaction closed, existing RockTenn shareholders would own approximately 55% of RockTenn and that Smurfit-Stone stockholders would own approximately 45% of RockTenn on a fully diluted basis. Smurfit-Stone used a special committee of independent directors to negotiate the transaction on behalf of the Board.
Smurfit-Stone and its subsidiaries emerged from bankruptcy proceedings in June 2010. Both shortly prior to and during the bankruptcy proceedings, Smurfit-Stone explored the possibility of an investment transaction or an acquisition or strategic transaction with various third parties, but these discussions did not involve negotiation of specific deal terms and did not yield any specific proposals. None of these third parties was willing to proceed with a transaction. Upon its emergence from bankruptcy, Smurfit-Stone did not adopt various takeover defense measures, and Wall Street analysts periodically speculated that Smurfit-Stone might be a possible takeover candidate. In addition to exploration of a transaction during bankruptcy, Smurfit-Stone explored a potential transaction with a third-party after it emerged from bankruptcy but before it began discussions with RockTenn. Discussions concerning this potential third-party transaction terminated when the third party advised Smurfit-Stone that it was not able to achieve a valuation that would justify a substantially increased price from its preliminary offer of $29 per share. Shortly after discussions with the third-party terminated, RockTenn contacted Smurfit-Stone to raise the possibility of a transaction. From then forward, Smurfit-Stone did not engage in discussions with any other potential buyer. RockTenn initially proposed an all-stock, no premium transaction. After preliminary discussions with Smurfit-Stone’s advisors, RockTenn revised its proposal to a 50/50 mix of cash and stock, with the final negotiated price resulting in a 27% premium to the most recent trading price of Smurfit-Stone stock prior to announcement. The merger agreement contained mutual no-shop provisions with fiduciary outs for superior offers, matching rights in respect of superior offers and a breakup fee of approximately 3.4% of the equity value of Smurfit-Stone (and 2.8% of its total enterprise value).
Soon after announcement of the transaction, a series of putative class action lawsuits were filed by Smurfit-Stone stockholders, alleging, against the directors of Smurfit-Stone, breaches of fiduciary duty and, against RockTenn and its transaction-vehicle subsidiary, aiding and abetting the directors’ alleged breach. In addition to requesting monetary relief, the plaintiffs sought a preliminary injunction to delay the closing of the transaction. The cases were largely consolidated in Delaware, where the Chancery Court certified a shareholder class, ordered expedited discovery, and heard argument regarding the plaintiffs’ motion for preliminary injunction.
In connection with their preliminary injunction motion, the plaintiffs argued that the transaction represented a change of control of Smurfit-Stone, thereby invoking so-called Revlon duties and the associated heightened standard of review contemplated by Revlon. The plaintiffs further argued that the Smurfit-Stone board’s process for negotiating with RockTenn and considering this transaction fell short of the board’s duties under Revlon. Specifically, the plaintiffs argued that the board’s alleged failure to conduct a market check, combined with the deal protection devices agreed to in the transaction, effectively precluded the emergence of an alternative bidder and limited the board’s ability to extract from RockTenn a sufficient price for Smurfit-Stone stockholders.
The defendants argued that Revlon did not apply because, among other things, (1) even after the transaction, there would be no controlling shareholder and control of the combined entity would remain in the market; (2) Smurfit-Stone stockholders were to obtain a 45% interest in the combined entity; and (3) half the merger consideration consisted of acquiror common stock. Thus, the defendants contended that the Smurfit-Stone board’s actions should be reviewed under the deferential business judgment rule, not Revlon. The defendants also argued that even if Revlon applied, the board’s conduct was appropriate.
Revlon May Apply to a Merger with 50/50 Cash and Stock Consideration
On May 19, the Chancery Court denied the plaintiffs’ motion for preliminary injunction and allowed the transaction to proceed to stockholder vote. The court held that Revlon applied to this transaction but ultimately agreed with the defendants that the board’s conduct withstood the scrutiny Revlon required.
The Chancery Court considered the potential application of Revlon to be a novel issue “not squarely addressed” in prior opinions. In resolving the question, the court recognized the longstanding Delaware Supreme Court precedent according to which a stock-for-stock merger between two public companies without a controlling stockholder does not constitute a change of control implicating Revlon. As the court noted, in such a transaction, control remains widely held in a public marketii and the target stockholders would not be foreclosed from an opportunity to receive a control premium upon the sale or change of control of the combined company.iii The court also recognized the well-accepted conclusion that an all cash sale unquestionably triggers Revlon because it represents the final opportunity for the target stockholders to receive a control premium in connection with a sale of the business. In an all cash sale, the target company stockholders will not participate in the profits of the combined entity following the transaction.
Delaware courts have previously addressed whether Revlon applies to transactions where the merger consideration is neither all stock nor all cash in only a few cases. For example, the Delaware Supreme Court has held that Revlon does not apply to a transaction where the merger consideration consists of a 67%/33% stock and cash mix. More recently, Vice Chancellor Lamb determined that a transaction with a 38%/62% stock and cash mix, which resulted in public stockholders of the target owning approximately 12% of the acquiror, also triggers the application of Revlon duties.iv
In Smurfit-Stone, Vice Chancellor Parsons followed Vice Chancellor Lamb’s prior ruling and held that the plaintiffs are likely to prevail on their argument that Revlon applies to the Smurfit-Stone transaction. Even though the target’s stockholders would retain a 45% interest in the combined entity and there was no controlling stockholder, the court held that Revlon applied because half of each of the target’s investment was liquidated. As such, the court held that the transaction represented an “end-game for all or a substantial part of a stockholder’s investment,” requiring the application of Revlon.
Even After Application of Revlon, the Board's Actions Were Likely Reasonable
The court then considered whether the Smurfit-Stone board’s conduct was appropriate even under Revlon. The Chancery Court emphasized that “reasonableness, and not perfection, is what Revlon requires.” In addition, the court noted that there is “no single path that a board must follow in order to maximize stockholder value.” Applying these principles, the Chancery Court held that the plaintiffs had not shown a reasonable probability of success on their claim that the Smurfit-Stone board breached its fiduciary duties by dealing exclusively with RockTenn and not otherwise conducting an auction process or other market check. According to the court, while the directors have a duty to maximize stockholder value, they have “no duty to employ a specific device such as the auction or market check mechanism.” In Smurfit-Stone, the directors reviewed and considered a “sufficient amount of reliable evidence” by the time they received RockTenn’s best and final offer so that they could reasonably determine that a topping bid was unlikely. Moreover, the directors had sufficient information to determine that the RockTenn bid was superior to remaining a stand-alone company, and, therefore, “the Board reasonably could have sought to sign an exclusive deal with RockTenn to prevent the latter from considering other acquisitions, subject to its fiduciary duties.”
Similarly, the Chancery Court rejected the plaintiffs’ claim that the deal protection provisions in the merger agreement were impermissible under Delaware law. The Chancery Court found that the mutual no-shop and matching-rights provisions, along with the termination fee, were “relatively standard” and “have not been shown to be preclusive or coercive, whether they are considered separately or collectively.” Even under Revlon, the court concluded that agreeing to these provisions was not likely to constitute a breach of fiduciary duty.
Conclusions and Practical Applications
The Chancery Court's determination that Revlon duties applied in Smurfit-Stone provides an additional data point to practitioners in determining the appropriate legal analysis for transactions involving cash and stock consideration. While the case clearly resolves the question of whether Revlon applies to a transaction involving merger consideration consisting of 50% cash and 50% stock, there is still significant uncertainty regarding the application of Revlon to transactions with mixed stock and cash consideration. It is not clear that Revlon would apply under circumstances in which the cash component of the consideration represents more than 33% of the merger consideration, but less than the 50% at issue in Smurfit-Stone. It is also not clear whether the Delaware Supreme Court would endorse the analysis employed by the Chancery Court. Thus, while Smurfit-Stone is instructive on Revlon’s reach, it does not end the debate.
Beyond the application of Revlon, the Chancery Court's decision also reaffirms that Revlon does not require a specific course of action. Rather, as the Chancery Court stated in its decision, a board can satisfy Revlon only by “follow[ing] a path of reasonableness which leads toward” the end of maximizing shareholder value. Thus, Delaware law does not specifically require boards to employ an auction or other market check in a Revlon transaction. So long as the Board makes a reasonable, informed determination that its obligations have otherwise been satisfied in the sale process, the board’s actions will withstand scrutiny. Under circumstances in which a target company board has less information regarding market interest or pricing than that of the Smurfit-Stone board, an auction or market check device may be appropriate.