On October 5, 2010, in In re Cogent the Delaware Court of Chancery denied plaintiff stockholders’ motion for a preliminary injunction seeking to halt the proposed friendly two-step acquisition of Cogent, Inc. by 3M Company. The court found that the Cogent board had not violated its Revlon duties, provided clarity on the appropriate calculation of termination fees, and provided comfort that top-ups may be used to accelerate the time required for closing.
According to the facts set out in the opinion by Vice Chancellor Parsons, in 2008, Cogent’s board began reaching out to potential counterparties through financial advisors in its consideration of strategic options for Cogent. By the summer of 2010, only four companies remained interested in Cogent, and two dropped out of the process soon thereafter, leaving only 3M and Company D 3M began to negotiate in earnest over the Summer of 2010, while Company D continued to indicate interest but moved more slowly. In early August, 3M provided Cogent with a comprehensive proposal to acquire Cogent for $10.50 per share and a marked up merger agreement. Approximately a week later, Company D submitted a nonbinding preliminary indication of interest in acquiring Cogent for between $11 and $12 per share and an initial list of issues with the merger agreement, subject to various contingencies, including satisfactory due diligence. Cogent's board then approved a merger agreement with 3M whereby 3M would make a tender offer for all shares of Cogent stock at $10.50, followed by a short-form merger. The merger agreement contained several deal protection mechanisms, including a termination fee of 3% of transaction value and a top-up option allowing 3M to elect to purchase approximately 139 million shares of Cogent stock at the tender offer price of $10.50 per share, which could be financed with a promissory note due in one year.
Plaintiff stockholders filed suit on September 1, 2010 seeking to stop the merger. They argued that the Cogent directors violated their fiduciary duties by agreeing to the lower priced proposal and the attendant deal protection clauses, which they argued made a superior proposal unlikely.
Revlon Duties. With respect to the auction process, the court held that the Cogent directors followed a reasonable course of action and were justified in discounting the Company D offer in preference of a firm offer from 3M. The court noted that the Cogent board hired two investment banking firms to find potential bidders; the board aggressively pursued potential transactions and acted reasonably in locking up a firm offer with 3M; there was no evidence of bias for 3M; and competing bidders had more than adequate time to complete due diligence and submit competitive bids. The court stated “Given all of the attempts by Cogent’s Board to reach out to Company D and Company D’s lukewarm response, it was reasonable for the Board to conclude that the lack of a firm offer from Company D in conjunction with the risk associated with its completion of due diligence represented a risk of a magnitude serious enough to justify taking the somewhat lower, but firm offer from 3M.” Plaintiffs argued that the Cogent directors violated their Revlon duties by accepting a lower price when a higher price was offered. Vice Chancellor Parsons disagreed, writing: “I similarly find that the Cogent Board acted reasonably when it effectively discounted Company D’s offer based on, among other things, the risk that Company D would not make a firm offer.”
Termination Fee. Plaintiffs argued that the termination fee, payable if the Cogent board terminated the 3M deal in favor of a competing bid, was excessive. The agreed upon fee was only 3% of the transaction value, but that equaled 6.6% of the enterprise value because of Cogent’s large net cash position. The court rejected plaintiffs’ contention that the cash should be excluded because it could be used by 3M to help finance the deal or could simply be paid out to 3M as a dividend following the closing. The court indicated that enterprise value may be the appropriate metric for determining a reasonable termination fee when the buyer is assuming a significant amount of target company debt, such as in a leveraged buyout transaction. However, the court stated that “there is no dispute in this case that 3M is purchasing $943 million worth of assets. The fact that a sizeable part of those assets are especially liquid, like cash, does not change the fact that a buyer still must come up with the cash to purchase it, even if the buyer may be able to obtain very favorable financing (by using the cash of the target as security).” Vice Chancellor Parsons noted that plaintiffs’ argument “misses the mark. As the court stated in Dollar Thrifty, the relevant transaction value is ‘logically quantified as the amount of consideration flowing into [stockholders’] pockets—not the amount of money coming exclusively from [bidder and bidder] alone.’ ” .
Top-Up Option. Finally, plaintiffs advanced several arguments against the top-up option, all of which the court rejected. First, plaintiffs argued that the top-up option was exceedingly broad because it allowed 3M to exercise the top-up without having acquired a majority of the shares in the tender offer, if the Cogent board waived the minimum tender condition. The court wrote that the possibility of such a waiver by the board was “far too speculative” to support an injunction. Second, plaintiffs argued that allowing 3M to pay for the shares with a promissory note was in effect a sham transaction, because it meant 3M would be paying itself a year later when the note came due. The court rejected this premise, saying that the note would be a legally binding obligation of 3M, and noting that the Cogent board had the right to determine the sufficiency of consideration received for stock, absent fraud, which was not alleged here. Finally, plaintiffs argued that, if the top-up were exercised, the additional 139 million issued shares would dilute the value of each already outstanding share in the event that a stockholder sought to exercise appraisal rights. The court concluded, however, that the merger agreement provided adequate protection against such an event because it stated that fair value in any appraisal action should be determined without regard for the top-up shares or the related promissory note. Vice Chancellor Parsons wrote: “While the issue of whether [Delaware General Corporation Law] § 262 allows merger parties to define the conditions under which appraisal will take place has not been decided conclusively, there are indications from the Court of Chancery that it is permissible.”
The tender offer period for Cogent shares closed on October 26, 2010. and the stockholders’ meeting to approve the merger is scheduled for December 1, 2010.