Exploratory negotiations toward a going private transaction may well have violated a shareholders' agreement provision barring such discussions unless the Special Committee invited them - ruling suggests that such an invitation may need to be formally issued before negotiations begin, not merely at the point where the price settled on is to be voted on In re TD Banknorth Shareholders Litigation

Court of Chancery (Delaware)

July 19, 2007 . C.A. No. 2557-VCL

Lamb V.C.

Delaware's Court of Chancery has refused to approve a proposed settlement of a class action brought by minority shareholders of TD Banknorth, Inc. with respect to majority shareholder Toronto-Dominion Bank's $3.19 billion acquisition of the shares of the U.S. financial institution that it did not already own. Several TD Banknorth shareholders had balked at the deal, arguing that the representative plaintiffs in the class action had negotiated away "viable contractual and entire fairness claims in return for insubstantial consideration". The court agreed.


In March 2005, TD Bank acquired a 51% interest in Banknorth in a $3.8 billion cash and stock deal. A stockholders' agreement was then put in place that restricted any attempt by TD to increase its ownership above 66.7%, as follows:

2.2(b) Until March 1, 2007, TD "shall not.propose or initiate any Going Private Tran¬saction unless invited to do so by a majority of the [Special Committee]. Any Going Private Transaction effected during this period shall also be subject to the requirements of Section 2.2(c)."

2.2(c) March 1, 2007 - March 1, 2010: (i) TD "may initiate and hold discussions regarding a Going Private Transaction with the Board on a confidential basis that would not reasonably be expected to require either [Banknorth or TD] to make any public disclosure thereof [as required by applicable securities laws].. If a majority of the [Special Committee] approves such a transaction, [TD] may publicly announce, commence and effect such Going Private Transaction.."

2.2(d) After March 1, 2010: TD "may propose, initiate or effect a Going Private Transaction, provided that such Going Private Transaction is either approved by a majority of the [Special Committee] or by Unaffiliated Stockholder Approval and further provided that [TD] shall not propose, publicly announce or initiate a Going Private Transaction.without providing prior notice to the [Special Committee] and offering to first discuss and negotiate confidentially the terms [of] such proposed Going Private Transaction with the Special Committee."

The process 

The version of events accepted by Lamb V.C. for the purpose of the order was as follows. In December 2005, the TD board of directors discussed a buyout of Banknorth's minority shareholders. In January 2006, a meeting of Banknorth's Strategic Planning Committee was attended by several senior representatives of TD (including two TD directors who were also on Banknorth's board). One attendee, the COO of Banknorth, met the next day with Banknorth's Special Committee to discuss a possible going private transaction. The Special Committee appointed its chair, Condron, to study the issue. In April, Condron wrote a letter suggesting that the committee meet in May or June to discuss possible financial and legal advisors.

Before any meeting took place, however, Condron met with Ryan, then the president and CEO of Banknorth and a member of both boards. Ryan raised the possibility of a TD buyout at that meeting and again at a meeting of the Special Committee on May 8. On May 9, Ryan and TD's president and CEO, Clark, attended a meeting of the Banknorth board's Executive Committee. Clark was said to have indicated that TD "might be interested in pursuing exploratory discussions if invited to do so" by the Special Committee. Negotiations continued and on November 15, Condron and Clark arrived at a figure of $32.33 per share (all cash).

It was only on November 18 that, following a presentation regarding the offer, the Special Committee formally issued an invitation to TD to submit a proposal according to the negotiated terms. Two days later, both boards had approved the transaction and the deal was publicly announced.

Class actions

Within days, six class action lawsuits had been commenced in Delaware. These were consolidated by court order on November 29. The class plaintiffs agreed to settle for 3 cents per share, some new disclosure and the exclusion of a few officer-owned shares (about 0.1% of those eligible) from the majority of-minority vote.

In a vote held April 18, 2007, almost 95% of the minority investors favoured the deal. But the settlement still had to be approved, and the objecting shareholders continued to press their case before Vice Chancellor Lamb.

Did the process violate s. 2.2(b)?

The plaintiffs and defendants (who were allied in this hearing against the objectors) argued that the process had been completely normal and proper, with a disinterested committee of directors bargaining in an entirely fair way. The 3 cents per share and improved disclosure were evidence of this. Extracting more would have been difficult, because (in their view) s. 2.2(b) had been complied with - in the world of M&A, they claimed, the "initiation" or "proposal" of a transaction occurs only when it is "formally proffered for consideration by the board of directors". They maintained that s. 2.2(b) was understood by all sides as merely preventing TD from bypassing the Special Committee altogether and making a public tender offer or from attempting the sort of tender/short-form merger offer that was at issue in Pure Resources.1

The court agreed with the objectors that the s. 2.2(b) argument was much stronger than the plaintiffs had concluded. While this hearing was not the place to determine the underlying claim, the plain language of s. 2.2(b) clearly gave substantial support to the objectors' position:

...a plain reading of section 2.2(b) supports a robust argument that, because there was no preceding invitation from the Special Committee, Toronto-Dominion's prompting of exploratory negotiations or discussions as to a going private transaction, regardless of how skeletal, amounted to a breach of section 2.2(b)'s prohibition.

The court also observed that the plaintiffs' interpretation left little to distinguish subsection (b) from subsection (c).

The court concluded that the "near-constant series of discussions and negotiations" between Clark and Condron from June to November 2006 - prior the Special Committee's "invitation" - constituted "substantial evidence to support a claim that the merger agreement is the product of the defendants' violation of the stockholders' agreement".

Entire fairness

Having concluded that there was "substantial evidence" that the going private transaction was "the product of the defendants' violation of the stockholders' agreement", the court turned to the plaintiffs' argument that the minority had suffered no harm.

The court disagreed with the plaintiffs' claim that any financial harm was suffered by Banknorth rather than individual shareholders. Moreover, under the "entire fairness" doctrine in Weinberger v. UOP, Inc., 457 A.2d 701 (Del. 1983), a court faced with a minority freeze-out must conclude that there was not only a fair price but fair dealing. That meant that objectors' claim could not be defeated by showing that the TD offer was within "the range of fairness at the time the merger agreement was executed or completed". As the italics suggest, an entire fairness analysis would also have had to consider the timing of the offer, since s. 2.2(b) could also be seen as an attempt to prevent the controlling shareholder from making oppor¬tunistic buyout offers during economic downswings etc. A finding that s. 2.2(b) had been breached would therefore lend even more credibility to the argument that the transaction failed the entire fairness test.


The court concluded that:

...the plaintiffs unreasonably chose not to pursue viable claims based upon a violation of section 2.2(b) of the stockholders' agreement and any resultant inequitable timing of the transaction. While expressing no opinion as to the ultimate merits of these causes of action, the court must conclude that, according to established principles of contract interpretation and Delaware case law, these claims have some substantial strength. A reasonable class representative in the plaintiffs' position certainly would have tried to extract substantial consideration for the settlement of these claims. That plainly did not happen here.

Even though the court did not decide the underlying issues here, the lesson of the case is to consider the risk that a court would hold that exploratory discussions about the possibility of a going private transaction constitute the "initiation" or "proposal" of such a transaction, and that if there are restrictions on the initiation of such transactions they may need to be dealt with at a very early stage rather than when the deal is essentially done. While this was an application for the approval of a settlement, Lamb V.C. quite clearly considered the process to have been flawed, even though both TD and Banknorth had evidently made conscientious efforts to live up to the terms of s. 2.2(b).