Especially in light of the tightening credit conditions for leveraged buyouts, stapled financing remains an attractive technique to mitigate financing uncertainties in today’s market. In a typical stapled financing transaction, a seller arranges the availability of credit for a range of potential buyers through the seller’s financial advisors. In addition to increasing the pool of potential bidders for the asset to be sold, stapled financing can create a financing floor, speed the pace of the transaction and provide greater financing certainty at the inception of a deal. Following the Toys-R-Us decision, investment banks have implemented policies to address potential conflicts that can arise when a banker wears the hat of both financial advisor and lender. It has become a best practice to provide for a fairness opinion from an independent third-party advisor. Despite the adoption of these procedures, the recent Ortsman decision offers a cautionary tale.
In Ortsman v. Green (2007 Del. Ch. LEXIS 29 (Del. Ch. 2007)), the Delaware Court of Chancery (the Court) granted the plaintiffs, a class of stockholders, limited expedited discovery into the allegedly conflicted role played by an investment bank that both advised the seller, ADESA, Inc. (Adesa), and offered stapled financing to potential purchasers of Adesa.
Adesa, a publicly traded Delaware corporation, engaged the investment bank as its financial advisor in a proposed merger. Later, Adesa began to consider a complete sale of its operations rather than a merger and permitted the same bank to offer stapled financing to potential buyers. In hopes of staving off any appearance of potential conflicts of interest and preserving the integrity of the process, Adesa’s board engaged a second investment bank to provide an opinion regarding fairness in connection with the proposed sale.
Although Adesa obtained a fairness opinion from an independent third party, it was still sued by plaintiffs alleging that the bank’s dual role as both advisor and lender caused it to advise Adesa’s board not to pursue an indication of interest from an alternative buyer that was believed to be less inclined to seek financing from the bank. In addition, the plaintiffs alleged a number of deficiencies in Adesa’s proxy statement, particularly the lack of disclosure of amounts the second bank had earned in other transactions that involved the potential buyer, and, more broadly, the fees to be paid to both banks.
Although an appraisal remedy remained available to the plaintiffs, and evidence of any impropriety was scant, the Court concluded that the plaintiffs were entitled to limited expedited discovery and an opportunity to move for a preliminary injunction in advance of a stockholder vote. This case demonstrates that Delaware courts will scrutinize any potential conflicts of interest involving financial advisors and will require that sellers specifically disclose material information, including fee arrangements, to stockholders.
It also serves as a reminder that the mere appearance of impropriety can derail any transaction. Although Adesa had followed what were understood to be best practices in obtaining a fairness opinion from an independent advisor, potentially insufficient disclosures in the proxy statement concerning past dealings of the parties with both investment banks gave rise to litigation. Ortsman is not a reason to avoid stapled financing, but certainly a reason to approach stapled financing and related disclosures with great care and planning.