In its recent decision in Martin Marietta Materials, Inc. v. Vulcan Materials Co., Civ. No. 7102 (CS), 2012 WL 1605146 (Del. Ch. May 4, 2012), aff’d mem., 2012 WL 1965340 (Del. May 31, 2012), aff’d, 2012 WL 2783101 (Del. Jul. 10, 2012), the Delaware Court of Chancery enjoined Martin Marietta from pursuing a hostile takeover bid for Vulcan based on the court’s reading of two non-disclosure agreements (“NDAs”). The two NDAs in question were executed by Martin Marietta and Vulcan in connection with their earlier consideration of a negotiated transaction and neither NDA contained any provision expressly prohibiting Martin Marietta’s unsolicited bid. The court’s careful analysis in this case demonstrates that, even in the absence of express restrictions or strained interpretation, relatively standard provisions of an NDA may combine to prevent a party who has received confidential information from pursuing alternative transactions related to the provider of the confidential information.
Confidentiality Agreement Basics
It is standard practice for parties considering a merger or other potential business transaction to enter into an NDA at the outset of discussions in order to protect the confidentiality of any proprietary or non-public information they might exchange in the course of their discussions. To appreciate the court’s decision in Martin Marietta, it helps to review some of the most basic terms of confidentiality agreements.
The central feature of any confidentiality agreement is, of course, the non-disclosure restriction, prohibiting the information recipient from sharing the disclosing party’s confidential information with anyone outside of a limited group of the recipient’s representatives and advisors. Non-disclosure obligations are generally qualified by various standard exceptions, including the right to make disclosures where compelled by law or regulation in order to ensure that a recipient’s contractual non-disclosure obligations under the NDA do not conflict with its legal disclosure obligations.
Equally important is the non-use obligation: a promise by the information recipient not to use the confidential information for any purpose other than evaluating and negotiating the transaction under consideration. Whereas non-disclosure provisions are intended to preserve the competitive advantage a party may enjoy generally from the continued secrecy of its non-public information, non-use provisions (typically called “use clauses”) are specifically intended to ensure that non-public information disclosed to facilitate the receiving party’s evaluation of a transaction favored by the disclosing party is not exploited by the receiving party for an alternate transaction or any other purpose.
In the case of confidentiality agreements executed in connection with merger discussions and other significant strategic transactions involving public companies, it is not unusual for one or both parties to demand a “standstill” provision, expressly prohibiting the other party from pursuing any alternative acquisition of its securities or from attempting to exert any control over its management or board of directors for a set time period. Standstills are particularly common in agreements with public companies that are concerned about becoming takeover targets. With a standstill in place, the disclosing party can freely negotiate with the recipient, without having to worry that the recipient will use the information it learns to mount a hostile takeover during the standstill period. Because of the clear restrictions they impose on a receiving party, standstills, when included, are typically the most heavily negotiated and hard-fought terms in a confidentiality agreement.
Non-disclosure obligations, use clauses and standstills are generally regarded as independent provisions, each with a specific purpose. The Martin Marietta decision demonstrates, however, that a use clause, or even the non-disclosure provision, can prevent a party’s pursuit of an alternate transaction just as effectively as a standstill, thereby imposing upon the receiving party potentially serious restrictions it had not anticipated and, in Martin Marietta’s case, thwarting a hostile takeover attempt.
Background of Martin Marietta Case
The Martin Marietta case dealt with a dispute between Martin Marietta Materials, Inc. and Vulcan Materials Company, the leading US producers of crushed stone, sand and gravel for construction. The two companies had entered into a pair of confidentiality agreements as they explored the possibility of a negotiated merger. Neither confidentiality agreement contained a standstill provision or any other provisions specifically prohibiting either party from pursuing a hostile transaction. When it became clear that Vulcan was not interested in a merger, Martin Marietta commenced an unsolicited exchange offer, including a proxy contest to elect new directors to Vulcan’s board. Vulcan objected and sought to enjoin Martin Marietta’s bid, claiming Martin Marietta had breached the non-disclosure and non-use provisions of the confidentiality agreements. Vulcan alleged that the prohibited disclosure was made in Martin Marietta’s filings with the SEC relating to its proxy bid and in investor calls and presentations and the prohibited use occurred in Martin Marietta’s reliance on the information to support its decision to pursue and formulate the terms of its hostile bid.
Martin Marietta did not dispute Vulcan’s claim that it had publicly disclosed confidential information (including the fact that negotiations had taken place) in its SEC filings and other documents related to the bid. Rather, Martin Marietta contended that disclosure of Vulcan’s confidential information in that context was permitted under the legally required disclosure exception since the proxy rules mandated such disclosure.
Martin Marietta further noted that Vulcan was a sophisticated party that understood the purpose of a standstill, yet Vulcan did not insert such a provision in the confidentiality agreements. Martin Marietta argued that in the absence of a standstill, it was free to make a takeover bid for Vulcan.
The Court’s Analysis
Based on a thorough review of the plain language of the NDAs as well as extrinsic evidence of the intent of the parties, the court disagreed with Martin Marietta on both points.
The main NDA between Martin Marietta and Vulcan provided that each party could use the other party's confidential information solely for the purpose of evaluating a “Transaction,” which was defined as a “a possible business combination transaction between” Vulcan and Martin Marietta. Following a highly detailed analysis of the words “business combination transaction between,” the court determined that it did not encompass Martin Marietta’s takeover attempt. Citing extrinsic evidence, the court noted that the initial draft of the first NDA had referred to a transaction “involving” the two parties. In the court’s view, changing the word “involving” to “between” during negotiation of the NDA evidenced that the parties had contemplated a negotiated transaction and not a hostile takeover.1 The court also pointed out that the second NDA between the parties contemplated use of the confidential information in connection with “the Transaction” (defined as “a potential transaction being discussed” by the parties), rather than “a transaction,” evidencing the parties’ intent that the confidential information be used only in connection with the specific transaction they were considering and not just any transaction that could potentially take place between them. The court therefore concluded that Martin Marietta was prohibited from using the confidential information in furtherance of its bid.
As an alternative argument against Vulcan’s misuse claim, Martin Marietta asserted that it had not actually used the confidential information in coming to its decision to pursue a hostile takeover. As Martin Marietta learned, however, it can be very difficult for a party in possession of confidential information to convince a court that it did not use that information in arriving at a decision to which the information was highly relevant. The court noted that Martin Marietta did not establish a “clean team” of employees who had not participated in the earlier negotiations with Vulcan to prepare its takeover bid. Rather, the same team at Martin Marietta worked on both the negotiations and the hostile takeover attempt, increasing the likelihood of improper use of Vulcan’s information. The court was further able to identify particular information provided to Martin Marietta that was used in the exchange offer.
Turning to Martin Marietta’s admitted disclosure of confidential information to satisfy SEC proxy rules, the court rejected Martin Marietta’s argument that because this disclosure was required by the proxy rules it fell within the exception for legally compelled disclosures. The court thoroughly analyzed the legally compelled disclosure provisions of the NDAs which permitted disclosure where “requested or required (by oral questions, interrogatories, requests for information or documents in legal proceedings, subpoena, civil investigative demand or similar process).” The court ruled that this exception permits compliance with external legal and regulatory demands, but does not permit a party to manufacture conditions under which it is legally compelled to disclose confidential information and then claim the exception. Because the proxy rules applied only as a result of Martin Marietta’s voluntary commencement of a takeover bid, the court held that they did not constitute an external legal requirement to disclose for purposes of the NDA. The court expressly acknowledged the impact of this holding, saying:
...even where a confidentiality agreement does not contain an express standstill provision, transactional lawyers are advised that restricting the scope of legally required disclosures to those that arise in the context of some sort of discovery obligation or affirmative legal process may have the effect of creating a backdoor standstill restriction if what is subject to that restricted definition is [information] that would need to be disclosed under Regulation M-A in the event that one of the parties to the agreement sought to pursue an unsolicited offer for the other.
Based on its findings, the court granted an injunction prohibiting Martin Marietta from undertaking a proxy contest, making an exchange offer, or taking any other steps to acquire control of Vulcan shares or assets for four months, thereby preventing Martin Marietta from having its slate of directors elected to the Vulcan board at the Vulcan annual meeting and forestalling Martin Marietta’s hostile takeover bid just as effectively as a standstill provision would have.
Martin Marietta reminds us that express standstills are not the only shackles on a receiving party’s pursuit of business opportunities. Indeed, while the court refers to the possibility that certain contractual language can have the effect of creating a “backdoor standstill,” the reality may be more complicated than that characterization. Even though standstill provisions are typically more heavily negotiated than other NDA provisions, the risks they present are generally simpler to anticipate since they establish a prior restraint on a defined set of actions irrespective of the use or disclosure of information. A party seeking to understand the potential impact of non-disclosure and non-use provisions and their limited exceptions must undertake a more complicated fact-specific analysis: What information will be considered confidential? What uses of the information are expressly permitted? What other uses might a party wish to make of the information? Who in the organization will learn the confidential information? Is there any reliable way to partition the people who receive the information from those who don’t and, if so, will there be a way to provide competent evidence of who did not receive the confidential information?
While some commentary has suggested that the Martin Marietta decision provides a set of hard-and-fast rules for drafters of confidentiality agreements, such a reading may miss the larger point. Martin Marietta certainly gives valuable guidance to companies engaged in merger discussions and their prospective acquirers with respect to use clauses, legally required disclosure exceptions and other specific clauses. More crucially, however, the decision highlights the importance of undertaking a thoughtful review of the language used in NDAs, informed each time by a complete understanding of a party’s ultimate goals and intentions, including any alternate goals and intentions the party may have if the transaction currently contemplated does not move forward. Companies should not simply sign up ostensibly “market standard” agreements or rely on a set of standard comments, mechanically applied. Parties who do so in a rush to gain access to a data room may later find themselves at an unexpected and costly standstill.