When the board of directors of a company chooses to put it up for sale, the board usually proceeds either by way of an auction or by negotiating with a single bidder, followed by a so-called ‘post-agreement market check,’ to confirm that the agreed-upon price is appropriate.
In the U.S., the ‘Revlon duty’ (named after the leading case in the area) imposes a positive duty on the board to determine the existence and viability of possible alternatives in order to maximize shareholder value. The recent decision of the Delaware Chancery Court in Netsmart Technologies Shareholders Litigation casts doubt on the effectiveness of a post-agreement market check in satisfying that duty.
Post-Agreement Market Checks in Canada
In Maple Leaf v. Schneider, Ontario’s Court of Appeal stated that, although "Revlon is not the law in Ontario" and "an auction need not be held every time there is a change of control of a company," nonetheless a "canvass of the market to determine if higher bids may be elicited is appropriate, and may be necessary" when the board has received an offer and no reliable grounds exist upon which to judge its adequacy.
Until now Canadian M&A practitioners have generally believed that such a market check or canvass could effectively be conducted ‘post-agreement’ (in other words, after the signing and public announcement of a merger agreement), provided that:
- the merger agreement contained an adequate ‘fiduciary out’ permitting the target board to accept a more favourable, subsequent offer; and
- the deal protection measures in the merger agreement (break fee, ‘window shop’ clause, etc.) were not so onerous as to prevent a potential competing bid from surfacing.
Legal delays imposed by Canadian securities laws in change of control transactions will generally ensure that there is adequate time after the merger announcement for a competing bid to appear. For example, take-over bids must be open for a minimum of 35 days and information circulars in the case of business combinations must be mailed to beneficial holders at least 21 days before the meeting to approve the transaction. In both cases, it will take at least two to three weeks (particularly if securities are being issued and prospectus-level disclosure is required) for the legal documentation to be prepared and mailed to target shareholders. Regulatory approvals and other necessary consents may also prolong the delay before closing.
The Delaware Chancery Court in In Re Mony Group recently stated that post-agreement market checks take typically between one and two months. The court cited with approval a previous Delaware court decision that had held a six-week market check to be adequate.
The Netsmart Decision
In the Netsmart decision, the court found, among other things, that, in the context of a proposed merger transaction with two private equity firms, the Netsmart board had conducted a flawed auction process and consequently had not satisfied its Revlon duty.
The court held that the post-signing market check was not adequate in the circumstances, despite the fact that:
- at the time of the hearing, a full three months had elapsed since the announcement of the merger and no other more lucrative bid had yet appeared; and
- the merger agreement contained relatively lax deal protections (such as a break fee of 3 per cent, a ‘window shop’ provision that allowed the board to entertain unsolicited bids and a ‘fiduciary out’ clause that allowed the board to accept a superior offer).
In the court’s view, "Because of the various problems Netsmart’s management identified as making it difficult for it to attract market attention as a micro-cap public company, an inert, implicit post-signing market check does not, on this record, suffice as a reliable way to survey interest by strategic buyers" (our emphasis). Central to this conclusion, therefore, was that, as a ‘micro-cap’ public company, Netsmart’s announcement of its proposed merger likely attracted scant, if any, notice among potential buyers.
The court’s conclusion was no doubt also influenced by other factors:
- the auction for the company had been intentionally limited to private equity buyers to the complete exclusion of strategic buyers;
- the CEO and other senior management were conflicted in that they were being given (in the court’s words) a "second bite at the apple" in being retained by the buyer post-merger (an unlikely scenario with a strategic buyer); and
- although a special independent committee had been formed, "it largely deliberated with management at the table."