Caremark Rx, Inc. (“Caremark”), a Delaware corporation best known for its role in the 1996 Delaware Court of Chancery decision which formulated the standard for directors’ oversight duties [In re Caremark Int’l Inc. Deriv. Litig., 698 A.2d 959 (Del. Ch. 1996)], was involved in another recent decision of note: Louisiana Municipal Police Employees’ Retirement System v. Crawford, 918 A.2d 1172 (Del. Ch. 2007) (“LAMPERS”). LAMPERS involved a vertical merger between Caremark, a pharmaceutical benefits management company, and CVS Corp. (“CVS”), the largest U.S. retail pharmacy. Caremark and CVS entered into a merger agreement on November 1, 2006. The parties characterized the transaction as a “merger of equals,” whereby Caremark stockholders would exchange each share of Caremark stock they held for 1.67 shares of CVS stock. The merger resulted in the former Caremark stockholders owning approximately 45% of CVS. The merger agreement included several deal protection devices implemented to mitigate risk of the deal not closing. These devices included: (i) a $675 million reciprocal termination fee, equal to approximately 3% of the transaction value, which would be triggered if, for almost any reason, either board withdrew or changed its recommendation of the merger; (ii) a “force the vote” provision that contractually bound the board of each company to submit the merger to a stockholder vote; (iii) a “no shop” provision under which neither board could speak with a competing bidder unless the competing offer is deemed a “Superior Proposal” as defined in the merger agreement; and (iv) a “last look” provision that obligated either board to disclose a Superior Proposal and allow the counterparty a five-day window in which to match the unsolicited bid.
These deal protection measures were implicated shortly after execution of the merger agreement when Express Scripts, Inc. (“Express Scripts”), announced an unsolicited bid for Caremark. Express Scripts offered cash and stock representing more than $3 billion (or 22%) over CVS’s offer, which was valued at $26 billion. While CVS’s offer provided a premium for Caremark stockholders, the Delaware Court of Chancery noted that the deal also provided substantial benefits to certain Caremark insiders by, among other things, accelerating the vesting of their options. After review, Caremark’s board publicly announced its conclusion that Express Scripts’ bid did not constitute a Superior Proposal and, thus, did not trigger a release from the “no shop” provision.
The board cited several reasons. First, as a matter of corporate policy, Caremark had determined to effect a vertical as opposed to horizontal merger, and Express Scripts was, like Caremark, a pharmaceutical benefits management company. Second, certain Caremark clients were purportedly reluctant to work with Express Scripts. Third, the merged entity would be highly leveraged. Fourth, Caremark’s board suspected that Express Scripts’ offer was a defensive ploy to disrupt the Caremark/CVS merger.
Following Express Scripts’ unsolicited bid, CVS enhanced its offer to Caremark. CVS agreed to waive certain provisions in the merger agreement in order to allow Caremark to declare a special $2.00 dividend to its stockholders that was contingent on stockholder approval of the merger. The dividend would be declared prior to the date of the special meeting at which Caremark’s stockholders would vote at the meeting, but the dividend would be payable only on or after the effective date of the Caremark/CVS merger. CVS also proposed to initiate an accelerated share repurchase program pursuant to which the merged Caremark/CVS entity would retire approximately 150 million shares of common stock after the merger. The Caremark board approved these revisions to the merger agreement.
Within one day of the Caremark board’s approval of CVS’s increased offer, Express Scripts commenced an exchange offer for all outstanding shares of Caremark common stock on the same terms as its unsolicited bid. The Caremark board recommended its stockholders reject Express Scripts’ exchange offer. A proxy contest ensued. On February 12, 2007, Caremark issued an 8-K in which it provided stockholders with additional information. The next day, CVS agreed to allow an increase in the conditional special dividend from $2.00 to $6.00 per share (the special dividend was later increased to $7.50 per share). In order to provide stockholders with additional time to digest the February 12 disclosures, the Delaware Court of Chancery enjoined Caremark’s special meeting, scheduled for February 20, 2007, until at least March 9, 2007. Prior to the March 9, 2007, meeting date, minority stockholders of Caremark and Express Scripts brought actions to preliminarily enjoin the meeting yet again, alleging that the individual defendants (members of Caremark’s board) breached their fiduciary duties by: (i) agreeing to deal protection devices that were inconsistent with their fiduciary duties; (ii) failing to investigate and consider other merger opportunities, including Express Scripts’ offer; and (iii) failing to disclose to stockholders information material to their determination of which, if either, offer to accept. Plaintiffs also contended that CVS aided and abetted the individual defendants in the foregoing breaches of fiduciary duty.
The Court of Chancery did not consider substantively the likelihood of success of plaintiffs’ challenges to the deal protection devices employed by Caremark and CVS, but instead enjoined the special meeting on other grounds and concluded that stockholders would suffer no irreparable harm if given the opportunity to exercise a fully informed vote. However, some of the Court’s comments regarding deal protection, though dicta, merit mention. Defendants argued that the deal protection devices in the merger agreement were customary and not worthy of the scrutiny urged by plaintiffs. The Court was unconvinced by defendants’ “argument by custom,” particularly in regard to the termination fee. After acknowledging that termination fees in the range of 3% of overall transaction value have been upheld by Delaware courts on prior occasions, the Court refused to “presume that all business circumstances are identical or that there is any naturally occurring rate of deal protection, the deficit or excess of which will be less than economically optimal.” Rather, opined the Court, the evaluation of a termination fee requires consideration of multiple factors, including, without limitation: (i) size of the fee and its percentage value; (ii) the benefit to stockholders (including a premium) that the directors seek to protect; (iii) the absolute size of the transaction; (iv) the relative size of the merger parties; (v) the degree to which a counterparty determined the deal protection devices to be crucial, keeping in mind discrepancies in bargaining power; and (vi) the preclusive or coercive effect of all deal protection devices taken as a whole.
Although the Court concluded that most of plaintiffs’ disclosure claims were insufficient to warrant an injunction, it was persuaded by one of them: defendants’ failure to disclose properly the structure of the investment bankers’ compensation. Each banker received a $1.5 million fee for the rendering of an opinion as to the advisability of the merger, regardless of the conclusion reached. The second prong of the bankers’ compensation was a $17.5 million fee payable upon the consummation of the Caremark/CVS merger, or, alternatively, a merger with a third party within a specified period of time. In Caremark’s February 12, 2007, supplemental disclosures, the company informed stockholders that the consummation of the merger would yield a combined $35 million payment to the two bankers. Caremark also disclosed that if Caremark entered into an agreement with a third party other than CVS within a specified period of time, then the bankers would be entitled to the same $35 million fee payable in connection with a Caremark/CVS merger. By the time of this disclosure, however, the initial requirements for payment to the bankers had already been met (i.e., public announcement and approval of the merger). Thus, the bankers were already entitled to $35 million in fees upon the occurrence of any Transaction (as defined in the bankers’ engagement letters) with any party within a specified period of time, which, by the time of the court’s opinion, was nine months.
The Court held that defendants’ disclosure of the bankers’ fee arrangement was technically true, but nevertheless misleading because it omitted to disclose the initial requirements the bankers had to meet to be entitled to their respective $17.5 million fees. Recognizing that the contingent nature of bankers’ fees is material because it can impact the weight a stockholder ascribes to a banker’s opinion, the Court held:
Where a public announcement of a contemplated transaction is a prerequisite for receipt of fees, those fees are naturally contingent upon initial approval of the transaction. It follows then that where a significant portion of bankers’ fees rests upon initial approval of a particular transaction, that condition must be specifically disclosed to the shareholder. Knowledge of such financial incentives is material to shareholder deliberations.
Regarding the $6.00 per share “special dividend,” the parties took competing views as to its proper characterization. Plaintiffs contended that the dividend was merger consideration subject to appraisal rights. Under Delaware’s appraisal statute [Section 262 of the Delaware General Corporation Law (“DGCL”)], a stockholder who dissents from a merger is entitled to petition the Delaware Court of Chancery for an independent determination of the “fair value” of that stockholder’s pro rata portion of the to-be-merged entity on a going concern basis. Defendants countered that the dividend was declared and payable by Caremark and, therefore, had independent legal significance such that it should not be included in the merger consideration. The doctrine of independent legal significance provides that action taken pursuant to the authority of one section of the DGCL constitutes an act of independent legal significance, the validity of which is not dependent on other sections of the DGCL. Ostensibly, then, defendants’ argument is that the declaration of a dividend under Section 170 of the DGCL is an act of independent legal significance and thus not contingent on, or subject to, a stockholder’s appraisal rights under Section 262 of the DGCL. The Court resolved the dispute in favor of plaintiffs, holding that the “‘special dividend,’ although issued by the Caremark board, is fundamentally cash consideration paid to Caremark shareholders on behalf of CVS.” The Court premised this holding on the facts that the dividend was contingent on stockholder approval of the merger, was payable after the effective date of the merger, and that CVS controlled the value of the dividend (i.e., by its power to waive provisions of the merger agreement that would otherwise prohibit the dividend). That the “special dividend” was contingent on stockholder approval of the merger and only payable after the effective date weighs against a finding of independent legal significance. In sum, the Court stated:
So long as payment of the special dividend remained conditioned upon shareholder approval of the merger, Caremark shareholders should not be denied their appraisal rights simply because their directors are willing to collude with a favored bidder to “launder” a cash payment. As Caremark failed to inform shareholders of their appraisal rights, the meeting must be enjoined for at least the statutorily required notice period of twenty days.
Based on the improper disclosure of the bankers’ fee structure, as well as defendants’ failure to recognize the “special dividend” as merger consideration and provide the requisite notice, the Court enjoined the meeting of Caremark’s stockholders for at least twenty days following the notice required under the appraisal statute. Section 262 of the DGCL provides that if a merger is to be submitted for approval at a stockholder meeting, then notice of appraisal rights must be given stockholders at least 20 days in advance of such meeting. The Court also ordered Caremark to disclose the structure of the bankers’ fees prior to any stockholder vote. Although the Court expressed concerns about the process surrounding the negotiations culminating in the Caremark/CVS merger agreement, it declined to enter a broader injunction because the combination of a fully informed stockholder vote and appraisal rights adequately protected Caremark’s stockholders. This ruling underscores the importance of full disclosure of all material facts when a corporation requests stockholder action and the corresponding deference that Delaware courts will then afford stockholders when they exercise their franchise and vote on a merger or other significant transaction. Finally, it is important to note that all preliminary injunction applications are decided on incomplete factual records. Preliminary injunctions operate only to preclude imminent irreparable harm to the applicant. As such, the Court’s decision in LAMPERS to issue only a limited injunction does not preclude litigation on the merits of plaintiffs’ fiduciary duty claims. Subsequent to the issuance of the Court’s opinion on plaintiffs’ preliminary injunction application, the CVS and Caremark stockholders voted to approve the merger on March 15 and 16, 2007, respectively. It remains to be seen what, if any, litigation will proceed regarding this transaction.