Judicial decisions in Ontario and, more recently, Delaware have transformed restrictions on use of shared information commonly found in confidentiality agreements into de facto standstill provisions. Each of the Ontario Superior Court of Justice in Certicom Corp. v. Research in Motion Limited1 and the Delaware Court of Chancery in Martin Marietta Materials, Inc. v. Vulcan Materials Company2 enjoined a hostile bidder’s offer because it was formulated in part by the prohibited use of confidential information that had been shared pursuant to a confidentiality agreement negotiated in the context of a possible friendly business combination. These decisions raise strategic considerations that buyers and targets should address before negotiating confidentiality arrangements, especially where it is important to preserve or preclude an effective hostile option for the potential acquiror. Failure to proactively consider these issues may mean that the boilerplate or typical structure of a confidentiality agreement will determine whether a hostile option can be utilized if friendly negotiations fail.
Negotiating technical and drafting points in a confidentiality agreement to avoid application of Certicom and Martin Marietta will likely highlight the acquiror’s willingness to go hostile, or at least its desire to preserve flexibility to do so. As discussed below, to avoid complicating the suitors’ initial relationship with this issue, certain key considerations should be explored at the outset of discussions. These include: (i) whether to negotiate a shorter term on use restrictions or the agreement as a whole, (ii) if feasible, whether to establish a separate “clean team” of internal personnel, directors and advisors that could determine whether to make a hostile bid based solely on public information, (iii) the overall value of access to nonpublic information and whether to limit the scope of nonpublic information reviewed to material that would likely be disclosed in the near term by the target, e.g., recent financial results or recently incurred liabilities, and (iv) how to preserve flexibility to reengage with the target if discussions stall.
The Certicom Decision
In Certicom, Ontario’s Justice Hoy permanently enjoined a hostile takeover bid by Research in Motion Limited (RIM) for Certicom Corp. (Certicom). In requesting the injunction, Certicom argued that RIM had improperly formulated its bid using confidential information provided by Certicom under two separate non-disclosure agreements. While a standstill provision included in one of the non-disclosure agreements had in fact expired when RIM initiated its bid, each of the agreements continued to explicitly limit use of shared confidential information to certain specified purposes.
After carefully parsing the language of the confidentiality and use provisions of each of the two agreements, particularly the standard covenant to use information subject to the terms of the agreements solely for the purpose of evaluating a “Transaction,” Justice Hoy concluded that use of shared information was limited only to evaluation of a friendly, negotiated transaction between RIM and Certicom, and that neither party had intended to permit use of such information to consider or initiate an unsolicited offer. In reaching this conclusion, Justice Hoy placed considerable emphasis on the parties’ decision to define a “Transaction” as “some form of business combination between the parties” (emphasis added). In her view, use of the word “between” imported the concept of a contractual relationship to be entered into between the parties, and prohibited RIM from using Certicom’s confidential information in connection with a hostile takeover bid.
The Martin Marietta Decision
On facts in many ways similar to Certicom, Delaware Chancellor Leo Strine, Jr. concluded in Martin Marietta that the confidentiality and use provisions of two confidentiality agreements between Martin Marietta Materials, Inc. (Martin Marietta) and Vulcan Materials Company (Vulcan) prevented Martin Marietta from using Vulcan’s confidential information for any purpose other than a friendly, negotiated transaction with Vulcan. Chancellor Strine’s decision was later affirmed in all respects by an en banc decision of the Delaware Supreme Court.
Martin Marietta and Vulcan entered into two separate confidentiality agreements in the spring of 2010 to facilitate their discussions regarding a potential merger of equals transaction. Following over a year of friendly discussions, Vulcan’s enthusiasm for the transaction waned and talks between the parties stalled. When Martin Marietta commenced a hostile exchange offer for Vulcan in December 2011 (a time at which both of the parties’ confidentiality agreements remained in effect), litigation ensued.
As in Certicom, the more contentious of the two agreements permitted use of confidential information only for purposes of evaluating a possible business combination “between” Martin Marietta and Vulcan. Reminiscent of Justice Hoy’s decision in Certicom, Chancellor Strine devoted considerable attention to the language of the confidentiality and use restrictions in each of the agreements, and particularly on the meaning of the word “between.” After examining the circumstances in which the parties had negotiated their confidentiality arrangements, Chancellor Strine ultimately concluded that the parties’ use of the word “between” evidenced their intention that shared information not be used in an unsolicited bid and temporarily enjoined Martin Marietta’s offer.
Strategic Considerations in Light of Certicom and Martin Marietta
The demonstrated willingness of the courts in both Certicom and Martin Marietta to enjoin unsolicited offers made in violation of common confidentiality and use restrictions in confidentiality agreements is of significant strategic consequence to M&A practitioners. When negotiating confidentiality agreements, target companies will in most cases be reluctant to explicitly authorize a counterparty’s use of confidential information for purposes of formulating a hostile bid. Consequently, potential acquirors wishing to preserve an effective hostile option should consider each of the following points well in advance of signing up to a confidentiality agreement.
- Term of the agreement and its confidentiality and use restrictions; Current market practice generally accepts a one- to three-year term on the confidentiality and use restrictions in a confidentiality agreement. As discussed above, one implication of each of Certicom and Martin Marietta is that the common formulations of these covenants may be viewed as effective standstill provisions. Accordingly, potential acquirors should think carefully about how long they are willing to be subjected to these de facto standstills and, where possible, explicitly limit them to a shorter period of effectiveness. For example, acquirors may insist that the confidentiality and use provisions expire, or that the confidentiality agreement itself terminate, after a period similar to that for which they would be willing to be subject to an explicit standstill (generally in the range of six to 18 months). Conversely, targets and their counsel should be aware that, in light of these decisions, acquirors may seek to shorten the term of use restrictions (or the term of the confidentiality agreement generally). Sell-side counsel should discuss with their clients the risks associated with potentially accepting a shorter effective period.
Consideration should also be given as to whether certain information (e.g., certain non-public financial information that may underpin evaluation of a transaction) should be made subject to a shorter period of confidentiality and restricted use than other forms of proprietary or technical information (which would not typically form a material part of an acquiror’s consideration of an unsolicited offer but is often competitively significant).
- Early sequestration of a “clean team;” Both Chancellor Strine’s decision in Martin Marietta and Justice Hoy’s decision in Certicom discuss the possibility that a company that creates a “firewall,” and effectively sequesters a so-called “clean team” of internal personnel, directors and advisors from exposure to confidential information, could use this alternative team to assess publicly available information and commence a hostile bid despite the acquiror having obtained confidential information that is subject to use restrictions contained in a confidentiality agreement.
While in many instances a “firewall” may not be a feasible option because senior executives will need to be involved in the negotiation of any significant acquisition, where preservation of a hostile option is important, acquirors should consider whether a team of key business people, directors and advisors can be reserved for possible later use on an unsolicited transaction. Consideration should also be given to the appropriate stage in the process at which confidential information will be shared with key executives, directors and advisors, recognizing that providing such persons with confidential information may effectively “taint” them and render them unable to participate in the evaluation of a subsequent hostile offer.
It may also be possible to invert the “clean team” decision-making process and formulate a credible “Plan B” hostile option prior to commencing negotiations of a confidentiality agreement with a target (and receiving access to confidential information). The present threat of a credible unsolicited offer or other unwelcome public announcement, while undoubtedly complicating to friendly discussions, may persuade target companies to negotiate reasonable confidentiality and use restrictions, which could include specified time periods after which hostile action by the acquiror would be explicitly permitted. Alternatively, the acquiror might simply use the “clean team” determination as the basis for making a future hostile offer -- though the offeror would likely not be able to revise its price (upward or downward) using any information subject to an existing confidentiality agreement covering friendly discussions.
- The value of access to confidential information; For potential acquirors intent on preserving a hostile option, the Certicom and Martin Marietta decisions require a careful assessment of whether access to a target company’s confidential information is sufficiently valuable to warrant being subjected to a de facto standstill. Where such access is desirable, acquirors should consider whether to limit the scope of review to nonpublic information that would likely be disclosed in the near term by the target, e.g., recent financial results or recently incurred liabilities. Once publicly disclosed, such information would typically no longer be considered confidential information under the agreement and its use in connection with an unsolicited proposal would therefore not be prohibited.
- Post-signing flexibility; While both Certicom and Martin Marietta make clear that courts are willing to prohibit a hostile offer that involves the improper use of confidential information, acquirors otherwise subject to restrictive confidentiality provisions may nevertheless focus on drafting the definition of “confidential information” to retain some flexibility to publicly announce both a desire to reengage in negotiations with the target and to request a waiver of the relevant confidentiality agreement provisions. For this avenue to remain open, the scope of “confidential information” subject to use restrictions should be tailored to include actual shared information but exclude information regarding the transaction process itself, including that the target may be for sale.
Conclusion: A Reminder of the Significance of Confidentiality Agreements
Each of Justice Hoy’s and Chancellor Strine’s detailed and technical analyses of the confidentiality agreements at issue in Certicom and Martin Marietta, respectively, serves as a fresh reminder to target companies, potential acquirors and practitioners alike: confidentiality agreements should not be viewed as “standard,” preliminary agreements that can be negotiated or entered into without consequence. On the contrary, both Certicom and Martin Marietta remind M&A lawyers and deal professionals of the need to proceed with care when drafting and negotiating confidentiality agreements and understand the constraints they may place on a subsequent hostile transaction, especially in circumstances where interests may no longer be aligned.