We have seen a significant number of cases out of Delaware in the past year dealing with disabling conflicts of interest from bankers, management and directors, and criticizing faulty board process in considering M&A transactions. It is refreshing to review a Chancery Court decision that recognizes the value of a board-driven process and which concludes that the business judgment rule will apply where the controlling stockholder has received pro rata treatment with the public stockholders.
In In Re Synthes, Inc. Shareholder Litigation,1 the controlling stockholder “refused to consider an all-cash offer that might have delivered a better deal for the minority stockholders,” because he “was not willing to roll a substantial part of his equity stake into the post-merger entity.” The plaintiffs’ main argument was that the controlling stockholder had breached his fiduciary duties by favoring a merger with a strategic buyer, J&J, for 65% stock and 35% cash, where he “shared the control premium evenly with the minority stockholders.” Chancellor Strine held that “minority stockholders are not entitled to get a deal on better terms than what is offered to the controller, and the fact that the controller would not accede to that deal does not create a disabling conflict of interest.” Chancellor Strine explains that “if one wishes to protect minority stockholders, there is a good deal of utility to making sure that when controlling stockholders afford the minority pro rata treatment, they know they have docked within the safe harbor created by the business judgment rule.”
Plaintiffs argued that the controlling stockholder “received liquidity benefits that were not shared equally with the rest of the stockholders.” Chancellor Strine found that there were no well-pled facts that the controlling stockholder had some urgent need for cash or was in any rush to sell his shares. Plaintiffs conceded that they also wanted liquidity for their shares, and so the controlling stockholder’s “interests were precisely aligned with plaintiffs’ in terms of seeking the best deal.”
Plaintiffs argued that the Synthes board should have invited a further bid from a group of private equity buyers who had made a prior club bid, despite their clear communication that their last bid, lower than the current bid on the table from the strategic buyer, was best and final and required the controlling stockholder to retain a substantial equity position. Chancellor Strine rejected plaintiffs’ objection as a “tactical quibble,” first noting that Revlon duties do not apply in a deal involving 65% stock and 35% cash, applying settled Delaware Supreme Court precedent. Chancellor Strine also reviewed the “lengthy sales process involving solicitation of all logical buyers, patient negotiations to raise the ultimate winner’s bid, and the use of [standard] deal protections” and found that plaintiffs’ arguments under Revlon would fail even if that standard were applicable. The court held that “even when Revlon applies, ... [i]t does not require a board to engage in deceptive or even edgy negotiating tactics.” Thus, Chancellor Strine rejected an argument that the board was required to try to deceive J&J into believing there was a rival bidder willing to pay more when they had no basis to believe that was true.
Synthes was a global medical device company incorporated in Delaware with headquarters in Switzerland, stock traded on the SIX Swiss Exchange, and a market cap in excess of $15 billion. Hansjoerg Wyss was Synthes’ 76-year-old chairman of the board, controlling stockholder, and former CEO for 30 years until his retirement in 2007. Synthes had a ten-director board. Plaintiffs alleged that Wyss controlled a majority of the board by dominating five other members through a mix of alleged close familial and business ties, but effectively conceded the independence of the remaining four directors.
In April 2010, the Synthes board approached Wyss regarding a potential sale of the company. Following Wyss’ approval of the board’s strategy, the board appointed an independent director to lead the sales process and hired Credit Suisse as financial advisor.
Approximately five months later, in September 2010, the Synthes board began actively marketing itself for sale. Nine logical strategic buyers with the capacity to acquire a company of its size were contacted. Three of those potential buyers (including J&J) executed confidentiality agreements and received due diligence information. After reviewing preliminary due diligence materials, J&J was the only strategic bidder to emerge.
Less than two months after commencing the sale process, in November 2010, the Synthes board authorized a second negotiating front with nine private equity firms that were considered to have the means necessary to acquire a company of Synthes’ size. Four of these firms signed confidentiality agreements and received due diligence information from Synthes in a non-discriminatory fashion as compared with J&J and the other strategic bidders. Three of the potential financial buyers submitted separate non-binding proposals to acquire Synthes at prices ranging up to CHF (Swiss franc) 150 per share in cash, but indicated that they would need to form a consortium to secure sufficient financial resources.
A little over one week after receipt of the three private equity bidders’ proposals, J&J submitted a nonbinding proposal of CHF 145-150 per share, with more than 60% of the consideration to be paid in J&J stock. Thereafter, the board authorized the three private equity bidders that had previously indicated interest in a consortium to club together to enable them to put together an attractive, all-cash offer. These three private equity bidders did in fact club together and offered a firm “all-cash” offer of CHF 151 per share. This offer was contingent on Wyss’ rolling over “a substantial portion” of his equity investment into the post-merger company. The consortium also told Synthes that it “could not increase [its] proposal above CHF 151 per share.”
Soon thereafter, the Synthes board met with its financial advisors to compare the competing proposals in view of its strategic alternatives, such as foregoing a transaction in favor of growing by acquisition, or maintaining the status quo. The board recognized the greater value certainty of the consortium’s all-cash offer (aside from the rollover requirement), compared to the J&J bid, but also considered the reduced certainty of closing of the private equity bidders’ offer due to the dependence of the consortium on the health of the financial markets. The Synthes board also discussed the rollover requirement in the consortium’s bid. Wyss would have had a substantial bloc of stock tied up in a company where he no longer had the same voting power. The Synthes board then authorized its lead independent director to negotiate with J&J exclusively for a higher price. The Synthes lead director then proceeded to bid up the purchase price with J&J, resulting in J&J’s initially coming back with a CHF 155 per share offer in cash and stock and, after further negotiations, increasing its offer to CHF 159 per share with a consideration mix of 65% stock (subject to a collar) and 35% cash. Almost three months had passed since the private equity club had submitted the firm CHF 151 bid.
In April 2011, the board obtained a fairness opinion from Credit Suisse concerning merger with J&J and proceeded to approve the merger. The next day, the parties entered into a merger agreement and voting agreement with an implied equity value of $21.3 billion representing a 26% premium to Synthes’ trailing 30-day trading price. Critical to the court’s decision was the fact that Wyss shared the control premium ratably with the minority stockholders.
The deal included deal protections, including a noshop clause with a fiduciary out, a force-the-vote provision, matching rights, a termination fee representing 3.05% of the equity value of the merger (or 2.9% of enterprise value) at the time of signing, and a lock-up of 37% of Wyss’ shares, which would be reduced to 33% if the board exercised its fiduciary out.
Approximately eight months later, in December 2011, Synthes’ stockholders voted to approve the merger. After concluding the lengthy process of obtaining necessary antitrust approvals in June 2012, the merger finally closed—more than one year after the merger agreement was signed and more than two years after the board first began exploring a potential sale transaction.
Lessons Learned from Synthes
As usual, Chancellor Strine provides here a witty and insightful review of the key issues presented by the facts, emphasizing the open, board-driven process and the equal treatment of the minority stockholders. Here are a few key takeaways:
- Transactions Where Controlling Stockholder Affords Minority Stockholders Pro Rata Treatment Will Be Reviewed Under Business Judgment Rule
In Synthes, the court held that the business judgment rule will apply to a merger resulting from an open and deliberative sales process where a controlling stockholder shares the control premium ratably with the minority. Chancellor Strine noted that “controlling stockholders are typically well-suited to help the board extract a good deal on behalf of the other stockholders because they usually have the largest financial stake in the transaction and thus have a natural incentive to obtain the best price for their shares.” Controllers always have “the right to vote their shares in their own interest” and have “no duty to engage in self-sacrifice for the benefit of minority stockholders.”
- Liquidity Is Not Per Se Disabling Special Interest
Chancellor Strine rejected the general notion that Wyss breached his duty of loyalty simply because Wyss was a large stockholder, who allegedly had liquidity needs due to “retirement objectives” and wanted liquidity for his shares, which he could not achieve by selling blocs on the open market without adversely impacting the stock price. It is noteworthy that there were no allegations that Wyss had pushed for a quick sale; the facts suggest that the board, not Wyss, determined to explore the sale of Synthes, and the marketing of Synthes was pursued in a deliberate and thoughtful process. Compare these facts to the recent decision in In Re Answers Corp. Shareholders Litigation, Consolidated 2 (a controlling stockholder allegedly pushed for a transaction before public stockholders knew of improved financial results, allegedly because controlling stockholders wanted liquidity quickly and believed a higher price would jeopardize a sale).
Chancellor Strine notes that “a fiduciary’s financial interest in a transaction as a stockholder (such as receiving liquidity value for [its] shares) does not establish a disabling conflict when the transaction treats all stockholders equally.”
However, Chancellor Strine will not ignore a fiduciary’s potential differing interests. See Chancellor Strine’s discussion of concerns relating to the director serving on the special committee in the recent decision in In re Southern Peru Copper Shareholder Derivative Litigation,3 where that director’s employer stockholder negotiated registration rights from the controlling stockholder at the same time its employee, the director, was negotiating for the acquisition of a company controlled by the controlling stockholder.
- Revlon Standard Will Not Apply to a Transaction for 65% Stock and 35% Cash
Chancellor Strine, citing In Re Santa Fe Pacific Corp. Shareholder Litigation,4 noted that it is now settled law that where the merger consideration consists of 65% stock and 35% cash with “the stock portion being in a company whose shares are held in a large, fluid market,” the business judgment rule, rather than Revlon review, will apply. Chancellor Strine refused to consider an argument that the blended consideration “represents the last chance [the minority stockholders] have to get a premium for their Synthes shares.” Compare Steinhart v. Howard- Anderson5 (Vice Chancellor Laster held in a transcript ruling that a mixed cash and stock merger, where the target stockholders end up with a 15% interest in the survivor, would be viewed as an “end stage” transaction from the standpoint of the target’s stockholders and thus Revlon duties would apply) and Reis v. Hazelett Strip-Casting Corp6 (similar result).
Chancellor Strine did note, however, that plaintiffs did not make an argument which the Chancellor found to have more logical force in favor of applying Revlon, and that the board’s initial consideration of a range of strategic options, including an all-shares, all-cash bid, compels a different result. He questions in dicta whether, in such a case, “if ... it turned out that the final round of bidding was tainted by favoritism toward the winning bidder, would the fact that the winner paid in stock logically mean that the board was not, in real time, subject to Revlon duties?” Chancellor Strine further notes that if this question was raised, “one would have to answer whether extending Revlon’s myopic focus on immediate value would be optimal. So long as boards are held to their Unocal duties to avoid precluding better bids or coercing approval of their own preferred deal and to their duty of loyalty (which would require that any discrimination in bids be based on proper concerns), why shouldn’t the board choose the deal it believed was best on a long-term basis for stockholders and present that to them for their acceptance?” Thus, we will continue to have questions as to whether the Revlon standard will be applied in a case where the target board chooses a stock or a mixed consideration deal.
- Standard Deal Protections Will Be Upheld in the Context of a Reasonable Sales Process
Chancellor Strine noted that plaintiffs “made no attempt to show how the deal protections would have unreasonably precluded the emergence of a genuine topping bidder willing to make a materially higher bid.” He explained that “because the Board had deliberately searched the market and was seeking to close a favorable deal with the last remaining bidder, it had a firm market basis to make the decision about how likely a later emerging bid was and to judge what concessions in terms of deal protections were necessary in order to land the one huge fish it actually had on the hook.” Thus, the Chancellor emphasized that “this court should be particularly reluctant to deem unreasonable a board’s decision to use deal protections as part of the negotiating strategy to pull the best bid from the final bidder or bidders who emerge from an open process.” The Chancellor took into account the target board’s having negotiated for limited and standard deal protections in assessing whether the board satisfied its fiduciary duties. In passing, Chancellor Strine noted that enterprise value (as opposed to equity value) is typically the more relevant measure for assessing the preclusive effect of a termination fee on a materially better topping bid.