Delaware Court Allows Expedited Proceedings to Seek Injunctive Relief Based on Revlon Claims

Kevin Miller of Alston & Bird notes: In this order on Friday, Delaware Chancellor Chandler granted plaintiff's motion for expedited proceedings to seek injunctive relief to address a board's alleged failure to fulfill its Revlon duties.

Highlighting the significance that the procedural posture of a case can have, the Court noted that the Delaware Supreme Court's recent decision in Lyondell Chemical v. Ryan may preclude an award of monetary damages for a breach of the duty of care where the target company's charter contains a 102(b)(7) exculpatory provision. But exculpation for monetary damages does not preclude injunctive relief -"[t]hus, in cases such as this one, the shareholders' only realistic remedy for certain breaches of fiduciary duty in connection with a sale of control transaction may be injunctive relief."

Background/Allegations (for purposes of motion, the court treats plaintiff's well plead allegations as true):

- In March 2009, Data Domain began discussions with NetApp regarding a potential business combination

- On May 11, the Data Domain board was informed that EMC was interested in meeting with Data Domain and a meeting was subsequently scheduled for May 27.

- On May 20, Data Domain and NetApp entered into a merger agreement pursuant to which Data Domain would become a wholly owned subsidiary of NetApp and Data Domain's shareholders would receive $25 in a combination of cash and Net App stock. The merger agreement allegedly contains a number of deal protection provisions including a no-shop clause, a matching right and a termination fee and certain officers and directors of Data Domain entered into an agreement to vote approximately 20% of Data Domains shares in favor of the merger with NetApp.

- On June 1, EMC launched an all cash tender offer for Data Domain at $30 per share.

- On June 3, NetApp increase the cash component of its offer by $5, raising the overall value of its offer to $30 per share. Data Domain agreed to NetApps revised offer and left all the deal protection measures in place.

Plaintiffs alleged that Data Domain's directors violated their fiduciary duties in the context of a sale of control of the company under Revlon v. MacAndrews & Forbes - i.e., that Data Domain's directors breached their fiduciary duties by failing to take steps to obtain the best price reasonably available, by granting/permitting preclusive deal protection provisions and by failing to inform themselves.

[Note: where the consideration is cash and stock, Delaware case law is unclear as to whether and when Revlon duties apply. Here it appears a majority of the consideration is cash.]

“It’s Groundhog Day!” Deciding Whether to Disclose Merger Negotiations

- by John Jenkins, Calfee Halter & Griswold

Sometimes you can’t blame deal lawyers for feeling like Bill Murray’s character in Groundhog Day - there are just some things that seem to happen over and over again in almost the same way on practically every deal. When it comes to public company deals, having to decide whether or not to disclose pending negotiations is defin itely one of those recurring events.

Assuming you’re not dealing with an auction or some other process where the seller has decided to hang a “for sale” sign on itself, nobody involved in the transaction wants the world to know that talks are going on until the parties are ready to announce a signed deal. Among other issues, premature disclosure may create problems for the buyer and the seller with key constituencies - like their employees, customers and in some cases, shareholders - that they would like to postpone until a later date when they have had time to map out a communications strategy.

The SEC cuts public companies some slack when it comes to disclosure of merger negotiations. In general, the Staff’s position is that even though MD&A’s “known trends” disclosure requirement might be read to require companies to address pending talks, if the company doesn’t otherwise have an obligation to disclose preliminary talks, then disclosure won’t be required in response to this line item in an Exchange Act report. (See, e.g., Securities Act Rel. No. 6835 (May 18, 1989)).

The SEC’s position is helpful, but this issue isn’t confined to Exchange Act reporting. Public companies have a duty to disclose material information under other circumstances as well, including situations involving leaks for which the corporation or insiders are responsible - and it’s these situations in which the disclosure issue usually arises.

Legally, there are two major issues to keep in mind in deciding whether you need to say something. The first is whether you’ve got a duty to disclose that you’re engaged in discussions. While there’s no general obligation to dispel rumors in the marketplace that you aren’t responsible for, the problem is that you’ll seldom be able to determine whether you’ve got responsibility for the leak or not - and there’s a pretty good chance that you might.

The second legal issue is whether information about the potential deal is “material.” That question, as everybody knows, is a function of its probability and its magnitude under the test announced by the Supreme Court in Basic v. Levinson. There are a lot of ways to look at Basic’s requirements, but it goes without saying that the further down the path you are, the more likely it is that information about your deal is going to be considered material.

While lawyers naturally tend to focus on the legal issues, business concerns frequently drive a decision to go public with negotiations. Companies may feel that their hands are forced by the media’s decision to run with a story on the rumored deal, or by inquiries from the Nasdaq or the NYSE about the reasons behind unusual market activity. Once information leaks, the need to manage the potential damage to key relationships may also make a compelling business case for disclosure. What’s more, there’s sometimes concern that speculation may cause the market to get carried away. That can lead to the unpleasant situation where the market price rises above the price levels that the parties are negotiating.

Once a decision to disclose pending talks is made, the next issue becomes, how much do you say? Often, people want to say as little as possible. The parties may decide not to identify the buyer, and sometimes, will avoid making any disclosure about the price as well. Sometimes, discussions about what you’re going to say can get pretty contentious, as the two sides may have conflicting views when it comes to the extent of disclosure that’s appropriate.

If you’ve got a relatively efficient market for your stock, and you don’t feel a need to reach out to other constituencies, a minimalist approach may work. Just bear in mind that the less you say, the less freely you can communicate with your key constituencies and the more you remain at risk for the consequences of market speculation. If you don’t say enough, you may find yourself needing to make a second announcement, which only further complicates everyone’s life.

When leaks happen, companies often find themselves in a completely reactive position, with very little time to think through all of the implications of their decisions about disclosure. That’s why I think the best advice is to address the possibility of leaks early on in the process, and chart out a course for managing the disclosure process if they do occur.

Advance planning won’t stop leaks from happening, but it will put everyone in a better position to respond to them if they do. Getting a jump on this issue may make it less painful when you hear the familiar sound of Sonny & Cher’s “I Got You Babe” coming through your clock radio, followed by a couple of morning DJ’s cheerily reminding you that “It’s Groundhog Day!”

Again.

Broc's note: A great version of "I Got You Babe" is the one by UB40 and the Pretender's Chrissie Hynde.

More on "Strategic Sandbagging": Let the Buyer Beware

Reacting to this blog recently from John Jenkins, a member posed the question: why, given the virtually universal use of indemnification, does reliance matter? This member would characterize most claims as actions to enforce a covenant to indemnify for damages resulting from inaccuracies in representations and warranties, rather than claims for breaches of representations and warranties themselves - and he noted John's somewhat oblique reference to specific indemnities and wondered if he had given any thought to the issue.

The member stated there are three main fact patterns:

1. Traditional breach of representation or warranty claim that can be analyzed under the existing case law relating to the reliance element - Ziff Davis or Galli v. Metz, which are fact specific and can lead to different results

2. Specific/special indemnity - indemnification for any loss relating to a specific issue - e.g., environmental problem, cost overruns on budgeted severance

3. Traditional indemnity for breach or inaccuracy of representation

John Jenkins responsed to this question as follows:

I'm not sure I've got a good answer to your question, although I think there are two reasons that reliance still matters:

1. I think that because of the indemnity right's status as a remedy that is tied in some fashion to a "breach" (whether defined broadly to include inaccuracies or in more narrow terms) of a rep or warranty, courts that think reliance matters won't view the covenant to indemnify as being an independent obligation. The existence of a right to indemnity is predicated on the rep, and therefore reliance on the rep remains an issue when a claim for indemnity is made.

2. The more fundamental problem is that you get it right, and the courts that adopt a reliance requirement don't. You're applying contract law principles to contract law issues, while the courts that are requiring a showing of reliance in these cases aren't. They are importing the tort concept of reliance into contract claims, which doesn't make sense to begin with:

"Transplanting tort principles into contract law seems analytically unsound. If a party to a contract purchases a promise, he should not be denied damages for breach on the grounds that it was unwise or unreasonable for him to do so. Indeed, Judge Hand admonishes: 'To argue that the promisee is responsible for failing independently to confirm [the warranty], is utterly to misconceive its office.' Metropolitan Coal Co. v. Howard, 155 F.2d 780, 784 (2nd Cir.1946). Thus, a claim for relief in breach of warranty is complete upon proof of the warranty as part of a contract and proof of its breach." Ainger v. Michigan General Corp., 476 F.Supp. 1209, 1224-1225 (S.D.N.Y. 1979).

Once courts have crossed this particular Rubicon, it's probably not too surprising that they would go on to ignore other principles of contract law, like the one that prompted your concerns.

If you read Robert Quaintance's article (which is where the quote about specific indemnity rights came from), I think this is where some of his concerns are coming from. For example, he says that buyers that rely solely on express reservations of rights run the risk of running into a court that looks principally to Ziff-Davis, "where timing [of the buyer's knowledge] seemed to matter a lot - and reservation of rights seemed not to matter very much - and holds that that if the buyer knew before signing that the seller's representation was untrue, the buyer could not have been relying on that representation when it entered into the agreement." In other words, the risk is that a court might approach the contract issues from a tort law perspective that elevates the "reliance" concept above the ability of the parties to bargain their own appropriate allocation of risk.

Delaware Supreme Court Affirms Alliance Data Systems

Last week, the Delaware Supreme Court affirmed - in Alliance Data Systems v. Blackstone Capital Partners V - the Chancery Court's decision dismissing Alliance Data Systems suit against Blackstone acquisition entities for breach of their merger agreement.

As we have blogged, the Chancery Court had dismissed ADS's claims that the Blackstone shell entities that had signed the merger agreement to acquire ADS had breached their obligations under the merger agreement and were obligated to pay ADS a $170 million “business interruption fee.” The Chancery Court found that those Blackstone entities had fulfilled their obligations under the merger agreement and had not promised to cause the Blackstone entities that control them to agree to terms demanded by the Office of the Comptroller of the Currency in order to obtain a required regulatory approval.

The Chancery Court's decision was widely considered an affirmation of the typical private equity transaction structure in which PE managers/advisors seek to shield themselves and their investment funds from liability for breaches of the transaction agreement by forming shell acquisition vehicles to enter into the transaction agreement.

In the succinct ruling, the Delaware Supreme Court stated: “Upon consideration of the briefs of the parties and their contentions in the briefs and oral argument, it appears to the Court that the judgment of the Court of Chancery should be affirmed on the basis of and for the reasons set forth in its well-reasoned January 15, 2009 opinion.”

Study: Private Equity-Backed IPOs Not Shareholder Friendly

Recently, The Corporate Library and the IRRC Institute teamed up to study whether private equity buyout firms institute more shareholder-friendly corporate governance structures in their IPO companies than non PE-backed IPO companies. The study – “What Is the Impact of Private Equity Buyout Fund Ownership on IPO Companies’ Corporate Governance?” - examined the ownership, board characteristics, takeover defenses and compensation policies of 90 companies that went public during 2004-06 (48 were PE-backed; 42 were not). [By the way, we recently blogged on TheCorporateCounsel.net about governance trends for all types of IPOs.]

The study found that PE-backed IPOs do not have superior corporate governance procedures as compared to non PE-backed IPOs. On the contrary, the study found that the PE-backed IPOs exhibit - in a higher proportion than average - a number of features that have the potential to benefit executives at the expense of shareholders, including takeover defenses and boards whose independence may be compromised.

But before you decide to stop investing in PE-backed IPOs, consider that this study did not review any performance metrics of these companies and, as pointed out in this DealBook blog, PE firms are themselves large shareholders after the IPO and are therefore incentivized to ensure the long-term success of the company. For more on the study, see Larry Ribstein’s Ideoblog and The Corporate Library’s Blog.

New Trend? Diminished Power for CEOs

We note that one of our DealLawyers.com board advisors, Frank Aquila of Sullivan & Cromwell, weighed in recently on the state of corporate governance in this BusinessWeek article.

Frank argues that the recent market environment and reform efforts may serve to diminish the power of CEOs. He notes: “If we are to move beyond the current financial crisis, we will need business leaders who are permitted to take actions that will have a positive impact beyond the next quarter or next fiscal year. But at a time when businesses need long-term, strategic decision-making the most, the new corporate order actually impedes decisive action.”

"Cool Deal Cube Contest": We Have a Winner!

Recently, I announced a "cool deal cube contest" as part of our ongoing "Deal Cube Chronicles." John Newell of Goodwin Procter takes the prize with this cube. John notes:

Here is an old JPMorgan advertisement from the late '80s that explains this cube. In a nutshell, it is that the cube/tombstone from the "tombstone of the unknown deal." I made a joke to a senior guy at Bowne of Boston after a public deal cratered and he made a couple of these babies.

Recently, I also received this story from a member:

During a drafting session for a follow-on offering in which we were underwriters' counsel, we commented that the CFO was referred to in his bio as a certified pubic accountant. Company counsel expressed surprise because they had copied the language verbatim from the original IPO prospectus. There followed 1-1/2 seconds of uncomfortable silence, after which we flipped through a copy of the IPO prospectus and confirmed the worst.

There is some consolation in the fact that a search of the term "certified pubic" on EDGAR yields 142 hits (and counting).

Japan: Proxy Season Preview

As the proxy season gets underway in Japan – where the majority of companies hold their meetings during the last two weeks of June - defensive measures are the hot topic once again this year. This report is from the RiskMetrics Group:

The most controversial issue of the 2009 Japanese proxy season will continue to be the introduction and renewal of “poison pills” and other types of takeover defenses. In the wake of attempts to take over companies including Hokuetsu Paper, Bull-Dog Sauce, and Sapporo Holdings - as well as the successful proxy challenge at Aderans Holdings - many companies have introduced defensive measures because of fears of being acquired.

However, these fears may be overblown because the difficulties of successfully managing a company after a hostile acquisition will help to ensure that the number of such cases will be limited. Nevertheless, several hundred companies will introduce or renew a poison pill this year. More than one in seven Japanese issuers already have a pill in place as of May 1, according to RiskMetrics data.

Notwithstanding investors’ skepticism toward takeover defenses, companies that have put their pills to a vote usually have had no difficulties in winning approval, thanks to the support of cross-shareholders and other management-friendly parties. One exception is Works Applications, which was forced to withdraw a pill proposal after the company could not garner enough shareholder support.

According to RiskMetrics data, about 30 companies have removed poison pills to date. However, this includes companies where pills became unnecessary due to organizational changes such as becoming listed subsidiaries of larger companies; RiskMetrics data shows that only about 10 companies, including Shiseido, Nissen Holdings, and Rohm, removed pills because they came to believe that the defenses were not in the best interests of shareholders.

Most poison pills introduced in 2005 were so-called “trust-type” plans, where warrants are issued to a trust bank, to be transferred to all shareholders (other than a would-be acquirer) in the event the pill is triggered. These plans require a shareholder vote under Japanese law. Since 2006, the vast majority of poison pills have been so called “advance warning-type” or “advance notice-type” plans. In these cases, the board announces a set of disclosure requirements it expects any bidder to comply with, as well as a waiting period between the submission of this information and the launch of the bid. As long as the bidder complies with these rules, the company “in principle” will take no action to block the bid and allow shareholders to decide. The exceptions are where the bid is judged to be clearly detrimental to shareholders, such as in cases of greenmail, asset stripping, and coercive two-tier offers. Usually, such judgments are made by a “special committee” or “independent committee,” but the committee’s decision is usually subject to being overruled by the board. At some companies, the decisions are made by the board with no committee input at all.

Advance warning-type defenses do not require shareholder approval, although in most cases, companies are choosing to put them to a shareholder vote, as it is believed that doing so will put the company in a stronger position in the event of a lawsuit. However, the primary problem is not the terms of the poison pills themselves - these are often superior to those of U.S. companies due to relatively high trigger thresholds, clear sunset provisions, and an absence of “dead hand” provisions. Rather, the main problem is with Japanese companies’ insider-dominated boards and insufficient disclosure. The presence of a critical mass of independent directors is essential to ensure that a takeover defense is used not merely to entrench management, but contributes to the enhancement of shareholder value.

Notwithstanding management fears, some of the companies implementing pills are in fact not especially vulnerable, because founding families, business partners, or other insiders own more than a third of outstanding shares. This is enough to veto any special resolution, such as an article amendment or a merger, meaning that even if a hostile bidder is able to accumulate a sizable stake in such a company, that bidder will be unable to force any major restructuring moves opposed by the insiders. It is difficult to see what shareholders of such a company stand to gain from a poison pill.

Many of the poison pills introduced in the past few years will be up for renewal in 2009. In evaluating these renewals, investors should examine the company's share price performance, relative to its peers, since the pill was first put in place. Where the company has underperformed the market, it will be difficult to argue that shareholders have benefited from the pill.

Some companies, while not putting a poison pill on the ballot, will seek to pave the way for the eventual introduction of a pill through measures such as increasing authorized capital. Investors should expect to see other article amendments designed to ward off hostile takeovers, such as the elimination of vacant board seats that could be filled by shareholder nominees, and the tightening of procedures for removing a director.

Monitoring Activist Activity

During this podcast, Mary Beth Kissane of Walek Associates analyzes how companies should be monitoring shareholder activist activity, including:

- How do hedge funds have such a solid activism record?
- What should companies do to prepare for an activist attack?
- Who within the company owns the "monitoring activists" task?
- Who within the company should be dealing with the financial press?
- Who is the "financial press" these days? Bloggers included? Social media?

More on "First Drafts: On the Two Yard Line or Closer to Midfield?"

- by Scott Walker, Walker Corporate Law Group

I want to expand on John Jenkins' recent blog on first drafts to capture a broader - and perhaps more important - point: The initial draft of the acquisition agreement should reflect the ongoing substantive discussions among members of the acquiror’s transaction team regarding risk allocation, purchase price considerations and the overall negotiating strategy.

Perhaps the purchase price is so “good” and any significant risks deemed to be so remote (or containable) that a “seller-friendly” (or “middle-of-the road”) draft is appropriate; on the other hand, perhaps the target has certain significant, uncontainable risks and/or the acquiror perceives it is paying a full purchase price, that the agreement should be aggressively drafted, with broad representations and warranties and indemnification obligations (assuming it is a private deal).

In short, every deal is different, and the role the acquiror’s counsel plays is critical: he must ensure that his client is making an informed judgment with respect to price and terms.

Strategic Sandbagging: Let the Buyer Beware

- by John Jenkins, Calfee Halter & Griswold

Webster’s Dictionary defines the term “sandbagging” to mean “to conceal or misrepresent one's true position, potential, or intent especially in order to take advantage of...to hide the truth about oneself so as to gain an advantage over another.” In the world of M&A, the term sandbagging generally refers to the ability of the beneficiary of a representation and warranty to rely on that rep - and sue for its breach - notwithstanding the fact that the beneficiary knew that it was untrue when it was made.

Many buyers will assert that they ought to be able to rely on a representation despite knowing that it was incorrect when made. The justification for pro-sandbagging position is that representations and warranties serve a risk allocation function in M&A, and the parties have a right to bargain to allocate that risk as they see fit.

If that’s your argument, and your agreement is governed by Delaware law, then it looks like the law is on your side. In Cobalt Operating LLC v. James Crystal Enterprises LLC, No. Civ.A. 714-VCS (Del. Ch.; 7/20/07), Vice Chancellor Strine held that a breach of contract claim arising out of an acquisition agreement does not depend on the buyer establishing justifiable reliance:

Due diligence is expensive and parties to contracts in the mergers and acquisitions arena often negotiate for contractual representations that minimize a buyer's need to verify every minute aspect of a seller's business. In other words, representations like the ones made in the Asset Purchase Agreement serve an important risk allocation function. By obtaining the representations it did, Cobalt placed the risk that WRMF's financial statements were false and that WRMF was operating in an illegal manner on Crystal.

So sandbag away, right?

Not so fast. It isn’t entirely clear that Vice Chancellor Strine’s position in Cobalt Operating is the last word on this issue under Delaware law. The Delaware Supreme Court affirmed the Vice Chancellor’s decision last year, but it did so in summary fashion, and it didn’t address a long line of cases from Delaware and other jurisdictions holding that “according to sound Delaware law, a plaintiff must establish reliance as a prerequisite to a breach of warranty claim.” Kelly v. McKesson HBOC, Inc., C.A. No. 99C-09-265 WCC (Del Super.; 1/17/02).

Perhaps it’s fitting that the Delaware courts leave us scratching our heads a bit on this issue, because frankly, the case law in this area is a bit of a mess across the country. The trend seems to be toward the kind of position enunciated by Vice Chancellor Strine, and the leading case is probably the New York Court of Appeal’s decision in CBS, Inc. v. Ziff-Davis Publishing Co., 553 N.E.2d 997 (NY 1990). (Here is a survey of the state of the law on this issue in various jurisdictions, as of 2002.)

Still, courts are still pretty far from giving buyers a license to intentionally sandbag. First of all, not everybody is with the program - some states still have an express reliance requirement. For example, if your agreement is governed by Minnesota law, the Eighth Circuit has held that you’ll need to demonstrate justifiable reliance in order to proceed with a claim for a breach, and you won’t be able to do that if you knew of the inaccuracy when the representation was made. Hendricks v. Callahan, 972 F2d 190 (8th Cir. 1992).

What’s more, cases following the Ziff-Davis line make it clear that the facts count. For instance, it may matter whether the buyer knew of the misrepresentation before signing (see Galli v. Metz, 973 F.2d 145 (2d Cir. 1992)), or whether the information about the inaccuracy of the information came from the seller or from a third party (see Rogath v. Siebenman, 129 F.3d 261 (1997)).

Since the case law remains somewhat opaque, lawyers often recommend that buyers negotiate for language stating that the seller’s representations and indemnity obligations won’t be affected by the buyer’s due diligence or its knowledge or suspicion that a rep is false. That kind of language puts buyers in a much better position to argue that they bargained for the risk allocation that’s embodied in the agreement.

That’s good advice, and it’s advice that many buyers appear to be taking. The 2006 Deal Points Survey of private company transactions indicates that approximately 50% of private deals contained “pro-sandbag” language, while only 8% contained an “anti-sandbag” clause that would preclude a buyer from making a claim with respect to a rep it knew was false. Still, 41% of the deals surveyed were silent on this issue, and the case law suggests that there may be more risks to this approach than most buyers realize.

That brings up another point. Maybe the most important advice for a buyer is that intentionally sandbagging the other side is a very risky tactic. As one commentator who analyzed the Ziff-Davis line of cases put it: “sandbag at your peril - if you have knowledge of a breach before signing and do not seek a specific indemnity, you risk losing your rights, even if you have attempted to preserve them.” Robert Quaintance, Jr. “Can You Sandbag? When a Buyer Knows Seller’s Reps and Warranties Are Untrue,” 5 The M&A Lawyer 9 (March 2002).

Let’s face it, the optics of strategic sandbagging look pretty bad, and as the case law suggests, there are all sorts of ways for courts to distinguish situations involving what it thinks is unfair behavior from those more benign situations in which general right to allocate risk through representations and warranties has been upheld. So when it comes to strategic sandbagging, caveat emptor - let the buyer beware.

Proxy Access: Chinese Menu Ballots Address Concerns

- by Professor J.W. Verret

The ghosts of securities law past, present, and future seem to haunt the headlines lately. But proxy access is heralded as the issue most likely to bring a tectonic shift in the balance of power between shareholders and boards - and the boundary between federal and state authority in corporate governance. Many are concerned that the SEC's access proposal will empower special interests to hijack corporate policy toward objectives threatening long-term wealth maximization. In this article, Marty Lipton outlines his concerns. I have an answer that significantly alters the dynamic.

I call it the Chinese Menu Ballot. I explore the idea briefly in an article entitled "Pandora's Ballot Box, or a Proxy with Moxie?" The SEC's proxy access proposal concerns shareholder nominations. It says nothing about procedures to determine the winner of those elections. My method minimizes the ability of a small minority of highly interested, special interest shareholders to influence corporate elections. This danger is caused by the current plurality standard (most votes wins, even if not a majority) for contested elections.

The problem with plurality voting is that as more nominees appear on the ballot, the likelihood increases that a director not supported by a majority of voting shareholders will be able to win. And the number of nominees could be quite high. The SEC proposal limits individual shareholders from nominating more than a quarter of the total board size, but the presence of multiple shareholders nominating candidates could widen the field.

The reason why we don't currently use majority voting for contested elections is that it may require a runoff, which would necessitate a second round of solicitations and double the expense. But my method alleviates the need for a runoff. A Chinese Menu Ballot would require a shareholder to rank the candidates in order of their preferences. The ballots would clearly state that any ballots that do not rank all candidates will be excluded. Then, any runoffs will be determined using the shareholders preferences to successively eliminate candidates in new vote tallies.

The result is very similar to what would happen if the company had a pure majority vote election with an actual runoff, and the result is significantly different from an election in which there are a large number of candidates and plurality voting is used. In each new round of a vote tally, the vote of a shareholder that voted for an eliminated candidate will be transferred to the next highest ranked candidate. And this transitive property of the Chinese Menu Ballot is the key to its ability to screen out special interest directors. The result is that candidates ranked high by a small number of shareholders, but not ranked within the top echelon by a majority of shareholders, are eliminated from the pool very quickly. Candidates ranked in the top echelon by a majority of shareholders will tend to emerge as winners.

There are a multitude of algorithms to use the shareholders' rankings to generate an outcome. The appropriate method will depend upon circumstances particular to a company, including whether the board is staggered. The appropriate method will also depend on the demographics of a company's shareholders, including the balance of institutional vs. retail investors and the type of institutional investors it has.

Consider a simple example: In the first round of vote tallying, each ballot's vote will count toward the first ranked choice. After the first round of the tally, any seats not filled by a candidate receiving a majority of the votes will be determined by subsequent rounds of tallying. Before starting the second round of the tally, the candidate with the fewest number of votes (the candidate ranked first by the fewest number of shareholders) will be eliminated.

Any ballots that ranked the eliminated candidate first will now be registered as votes for their second ranked choice. This process would continue until the number of candidates remaining equals the number of available seats. There are a wide variety of available implementation methods and further recommendation would require a company-specific analysis.

For a brief analysis of the legality of this method under Delaware Corporate Law, I first note that DGCL 216 provides the plurality method as a default from which companies are free to opt-out via bylaw or charter amendment. And presuming that a company has the authority to amend the bylaws in its charter, it would be able to install this method unilaterally. In the unlikely event, however, that a company had a shareholder-adopted bylaw specifying the method for contested elections it would need to seek shareholder approval to implement this method.

I also do not think Chinese Menu Ballots would be subject to scrutiny under Blasius. Indeed, this method does not limit votes, it actually permits shareholders who voted for an eliminated candidate in one round to continue to have their vote counted in each successive round of the election. An analysis of this method under the federal proxy rules also indicates its legality. The Chinese Menu Ballot will need to include a space that permits withhold votes in accordance with Rule 14a-4(b)(2), but otherwise the proxy rules do not prohibit this method. I also note that this method would be difficult to implement, though not impossible, for companies that permit cumulative voting.

For assistance with implementing a Chinese Menu Ballot or other proxy access related issues, I am available for consultation.

Canadian Regulator Weighs In: Contingent Fee Fairness Opinions

Recently, the Ontario Securities Commission announced its reasons for its January ruling that led to the withdrawal of HudBay Minerals’ proposed acquisition of Lundlin Mining. In doing so, the OSC expressed concerns about potential conflicts of financial advisers who are compensated on the basis of the success of a transaction:

“[Contingent] fees create a financial incentive for an advisor to facilitate the successful completion of a transaction when the principal focus should be on the financial evaluation of the transaction from the perspective of shareholders. While the Commission does not regulate the preparation or use of fairness opinions, in our view, a fairness opinion prepared by a financial advisor who is being paid a signing fee or a success fee does not assist directors comprising a special committee of independent directors in demonstrating the due care they have taken in complying with their fiduciary duties in approving a transaction.”

The statement may signal an increased sensitivity by OSC to this issue - and call into question the ability of a board to rely on a fairness opinion where the financial advisor has a contingent fee arrangement. For more on this, see the related memos posted in our "Canadian M&A" Practice Area.

Delaware Chancery Court: "Continuing Director" CIC Provision

A few weeks ago, Delaware Vice Chancellor Lamb issued his opinion in San Antonio Fire & Police Pension Fund v. Amylin Pharmaceuticals that had challenged "poison puts" in debt agreements. The Court interpreted the fairly common "continuing director" provision in the indenture in a way that could have been expected, stating the board may approve as continuing directors persons nominated by dissident stockholders.

However, the Court did not rule - as not yet ripe - on the duty of good faith and fair dealing claim alleging the directors agreed to approve the dissidents here for purely self-interested reasons, but the Court suggested that the board must be fully informed about the inclusion of such provisions in debt instruments and might face a fairly high hurdle in justifying their agreeing to them. We have posted memos analyzing the opinion in our "Change-in-Control" Practice Area.

At Amylin's annual meeting last week, dissident shareholders Carl Icahn and Eastbourne Capital each elected one director from their slate - thus avoiding triggering of the CIC provision at issue, as noted in this DealBook blog. We previously blogged about Icahn and Eastbourne's unique no-action letters from the SEC to "round out" a short slate with other dissident's nominees.

Target's Annual Meeting Campaign: "Bringing It" Online

Some interesting news comes courtesy of Target, whose annual meeting is being held today. This will be no "regular" annual meeting as William Ackman, whose Pershing Square Capital Management owns a 7.8% stake, is seeking a seat for himself and four other nominees on Target's board (as noted in this article) as well is seeking the company to use a "universal ballot" (as noted in The Corporate Library blog).

Although it's become fairly common for dissidents in the throes of a proxy fight to leverage the Web (see this list of examples I have collected), it's still fairly rare for companies to do the same. That's why it's worth noting Target's annual meeting page to point out how they "get it" when it comes to campaigning online in their defense.

A number of the items posted on the company's annual meeting home page were recommended in my article from the Spring '08 issue InvestorRelationships.com entitled "The Coming Online IR Campaigns: The Future of Director Elections" (which is still available for free). To begin with, Target bothered to create an annual meeting home page. That's a critical first step. They highlight endorsements from proxy advisors. They even post a white paper making their argument why they think one proxy advisor's report is flawed (as noted in this article).

Have a good look. I predict these types of shareholder meeting sites will become more of the norm for IR departments/corporate secretaries when we live in a proxy access world without broker non-votes (ie. next year)...

You want further proof that the Web is changing the job of a corporate secretary? How about when a shareholder proponent posts a transcript of his remarks from the annual meeting? Governance guru Bob Monks did just that yesterday on his blog, right after he presented five proposals at Exxon-Mobil's annual meeting.

Deal Protection: The Latest Developments in an Economic Tsunami

We have posted the transcript from our recent webcast: “Deal Protection: The Latest Developments in an Economic Tsunami.”

Corp Fin Grants General Motors Relief for Debt Exchange Offers

Last week, Corp Fin granted General Motors exemptive relief so that GM can move fast and exchange its debt. The relief is highly unusual, but certainly seems merited under the circumstances. GM has something like 26 series of debt outstanding, the federal government has lent the company billions under the TARP/TALF program - and pursuant to the terms of those loans, the company must restructure its debt (and operations) within a limited time period.

Therefore, GM had to commence its exchange offers immediately and begin soliciting consents to postpone the maturity dates. The two primary forms of relief granted by the Staff to GM include:

- Ability to solicit consents before a definitive proxy statement has been filed; and
- Ability to cut off withdrawal rights after 20 business days, but before the exchange offers necessarily expire.

I believe similar relief was granted to Chrysler back in the early '80s under similar circumstances...

Due Diligence: Aim Before You Fire

- by John Jenkins, Calfee Halter & Griswold

Spearheading the legal due diligence investigation of a potential acquisition target is a big part of a deal lawyer’s job. With the possible exception of preparing disclosure schedules, due diligence usually is the most tedious part of the transaction, but it is also among the most important. That’s why the “ready...FIRE!!!...aim” mindset that a deal’s time pressure sometimes causes lawyers to adopt when it comes to due diligence is almost always counterproductive.

Time is invariably of the essence in a transaction, so there is great pressure on everyone to get moving - particularly if you’re talking about a big deal with a mountain of paper to review and little time to do it. There’s an overwhelming temptation to wade into the pile and start reviewing things before you’ve figured out what the deal is about. This leads to a disorganized process that produces incomplete or incoherent results. That can make it very difficult for your client to make decisions about valuation in a timely fashion, and in a competitive situation, can be fatal to its efforts to acquire the target.

UCLA’s legendary basketball coach John Wooden had what I think is the best advice for anyone dealing with time pressure situations - “be quick, but don’t hurry.” What he meant by this is that when the pressure is on, you’ve got to move fast, but you’ve also got to remain in control of your situation. I think the best way to apply Coach Wooden’s advice to a deal with a short fuse is not to start your due diligence before you’ve done some due diligence.

No, I’m not trying to follow up John Wooden with advice that sounds like its coming from the mouth of Lakers’ coach Phil Jackson. What I’m talking about is spending some time at the front end to convert a scatter-shot approach to due diligence into a more disciplined preliminary assessment of the issues you’re likely to encounter. Investing time in laying the groundwork for your due diligence can make the investigation more efficient, less burdensome to both sides, and more effective overall.

How do you go about doing this? If you’re dealing with a public company target, then the first step should be to spend some time with the target’s SEC filings. Many of the documents that you’re going to want to review are going to be in those filings, but more importantly, a company’s SEC filings contain a wealth of other legal, financial and business information about the target that will be very useful to you in mapping out a strategy for approaching due diligence.

If you’re not dealing with a public company, chances are still pretty good that it competes with companies that are public, and their filings may provide you with a lot of help in focusing your initial due diligence efforts. SEC filings are also a good place to start if you’re not buying the company itself, but only a subsidiary or a division. If the business is large enough or represents a reportable segment, those filings will contain a remarkable amount of financial and other information about the business your client is looking to buy.

Chances are also pretty good that your client has managed to get a copy of an investment banker’s book on the target or some other form of offering document. That usually has lots of useful information about the business, although in order to get at it, you usually have to wade through a mountain of marketing spin and banker-speak (e.g., “management has proactively leveraged the company’s market leadership and value-added manufacturing expertise to position its new proprietary product to capitalize on the anticipated explosive growth in demand for...blah, blah, blah”). Research analyst reports on the target or its industry can also provide a wealth of information on the financial, business and even the legal issues confronting industry participants, and contain a lot less spin than the marketing materials typically do.

A lot of deal lawyers do everything I’ve just described as a matter of course, but sometimes what ends up happening due to the press of time is that the SEC filings, research reports and banker’s books end up getting thrown on the junior lawyers desks as “background” for that person to read as they wade through the data room. Most younger lawyers are smart people, but it isn’t reasonable to assume that they will necessarily pick up on the critical issues in the deal without some additional guidance. If you don’t give them that, you can almost count on them mindlessly regurgitating lease terms into a dictaphone without giving any thought to what they are doing. This is how useless 250 page due diligence memos are born.

I think a much better practice is to sit down with the legal due diligence team, the business people and the client’s financial advisor before turning the junior people loose on the data room. That way, you’ve got a shot at making sure that the people who will be reviewing the documents are aware of what the deal is all about, and what the critical legal issues that might affect valuation or the ability to complete the transaction are likely to be.

This effort to plan out due diligence may take a little more time than simply tossing a handful of associates into the deep end of the virtual data room, but it is guaranteed to produce a more efficient process in the long run and to generate results that are going to add a lot more value to the client.

New DOJ Antitrust Chief Announces Aggressive Enforcement Philosophy

In her first major public speech, new Assistant Attorney General for Antitrust Christine Varney announced last week that difficult economic times call for more aggressive - not less - antitrust enforcement and pledged the DOJ’s cooperation with other parts of the Executive Branch in pursuing reforms of numerous industries, including banking, healthcare, energy, telecommunications and transportation.

In addition, she announced that the DOJ's Antitrust Division has withdrawn a controversial report issued last September under the Bush administration. The Report addressed single-firm conduct under Section 2 of the Sherman Act and has been widely viewed as applying legal standards that would make it difficult for the DOJ to bring new cases involving monopolization or predatory practices. Plenty of antitrust blogs have addressed this important speech; we have a list of those blogs in our "Antitrust" Practice Area.

May-June Issue: Deal Lawyers Print Newsletter

This May-June issue of the Deal Lawyers print newsletter was just sent to the printer and includes articles on:

- Reversing Course: Delaware’s Supreme Court Provides Comfort to Directors Regarding Revlon Process and Bad Faith
- Going In-House: Stewart Landefeld On His Time at Washington Mutual
- The Shareholder Activist Corner: Mario Gabelli’s GAMCO
- Are We There Yet? Issuer Debt Tender Offers and Offering Period Requirements
- Private Equity in 2009: “Back to Basics” Practice Tips

If you're not yet a subscriber, try a no-risk trial to get a non-blurred version of this issue for free.

A Little “Deal Tact” Goes a Long Way

- by John Jenkins, Calfee Halter & Griswold

In my last blog, I talked about some advice given to our firm’s associates during a training session on becoming a seasoned business lawyer conducted by two senior investment bankers from one of our firm’s clients. The first thing they mentioned was the importance of avoiding boorish first drafts. That piece of advice, together with many of the other suggestions they made about things that young lawyers should do or avoid doing, falls under the general heading of the need to be sensitive to the messages that your actions are going to send to the other people involved in the transaction.

You might think that a lot of this stuff would be intuitive, but it doesn’t appear to be that way for lawyers. For instance, one of the specific “don’ts” that our investment banker friends mentioned in their presentation was the seemingly obvious point of not making critical remarks to the client concerning its other advisors. Apparently, that’s something that some lawyers are notorious for doing. Unless your client’s retained Patrick Bateman as its financial advisor, that’s a very bad idea, if for no other reason than what goes around, comes around. Besides, while “plays well with other children” may not be a line item that appears on most law firm or corporate law department evaluation forms, it’s on most clients’ short list of the qualities that they look for in a deal lawyer.

Deal making by its very nature is a group effort, and the ability to work effectively in a transactional setting requires a skill that might be called “deal tact.” The best deal lawyers use this skill not only in their dealings with their own client and fellow advisors, but also in their dealings with those on the other side of the table, and particularly the lawyers who are representing the other side in the deal.

From time to time, I have had a chance to work on transactions with lawyers who have national reputations as M&A advisors. Although their styles differ markedly, deal tact is one quality that they have all shared in common. Let me give you an example of this that I’ve seen many times. During the early stages of the deal, draft documents are often hacked-up pretty significantly by the lawyers receiving them because, well, they sometimes just don’t make any sense. Incompetence or inexperience may be part of the reason for this, but far more frequently, it’s attributable at least in part to an unreasonable time schedule that requires somebody to generate a document before they know what the deal is about.

When this happens, there’s usually a younger lawyer on the deal team who is chomping at the bit to highlight each and every flaw in the document during the course of a negotiation session. This is understandable, since that kid pulled at least one all-nighter finding and correcting every last one of them. The superstar generally doesn’t let this happen. Instead, that lawyer typically will focus his or her attention on the major deal issues while clients are present. When the meeting is about to break-up, the mark-up will be passed on to the other side’s lawyers, usually accompanied by a statement noting that the mark-up includes some “lawyer comments” that aren’t worth wasting the group’s time on. That may be followed up with some sidebar discussions, but the important thing is that nobody loses face in front of their clients.

Now if you know anything about your fellow M&A practitioners, you know that it isn’t a saintly sense of humility that motivates this kind of conduct. Instead, it’s an appreciation for the fact that if you put somebody on the defensive, they’re going to do a couple of things. First, they’re going to try to defend themselves by quibbling with every point you make. Second, they will look for opportunities to stick it to you-- and chances are pretty good that they’ll find at least one during the course of the transaction. Neither of these things moves the ball forward.

I’m not suggesting that deal lawyers should always act like Clark Kent -- possessing a little deal tact doesn’t mean you shouldn’t play hard ball when appropriate. I’m just saying that Conan the Barbarian shouldn’t be our role model either. I mean, if you really believe that what is best in life is “to crush your enemies, to see them driven before you, and to hear the lamentation of their women,” you’d probably be much happier as a litigator anyway.

Every deal presents opportunities for a knowledgeable and experienced deal lawyer to grandstand in front of the client or make somebody on the other side look foolish in front of their client. One of the big things that separates the pros from the pretenders is the ability to resist that temptation in order to move the transaction forward.

Deal Protection: The Latest Developments in an Economic Tsunami

Tune into our webcast tomorrow - "Deal Protection: The Latest Developments in an Economic Tsunami" - to hear these experts analyze the latest Delaware law developments in deal protection:

- Clifford Neimeth, Partner, Greenberg Traurig
- William Haubert, Director, Richards, Layton & Finger
- Ray DiCamillo, Director, Richards, Layton & Finger

First Drafts: On the Two Yard Line or Closer to Midfield?

- by John Jenkins, Calfee Halter & Griswold

A few months ago, our law firm had one of its periodic training sessions for our associate attorneys. The topic for this particular session was making the transition from junior associate to seasoned business lawyer, and the presenters were two investment bankers from one of our firm’s clients.

Lawyers have an obligation to zealously represent clients and protect their legal interests in a transaction, and that may cause lawyers to butt heads with bankers from time to time. But when bankers speak about the things lawyers do that drive them nuts or impress the heck out of them, it’s worth listening to them, because I think you can pretty much count on their position being consistent with that of the typical corporate client.

After all, when it comes to what an M&A client wants to accomplish - getting the deal done as quickly and efficiently as possible - there’s nobody in the transaction whose interests are more closely aligned with the client’s than its investment banker. That’s because bankers eat what they kill: they only get paid for their efforts if the deal closes.

The bankers who spoke to our associates shared a lot of insights about good and bad lawyering, and I’ll talk about more of them in later posts, but at the very top of their list of bad habits was something that anybody who has worked on a deal has experienced - namely, receiving a first draft of a purchase agreement that is so aggressively one-sided that it’s like starting a drive from your own two yard line.

They pointed out that this bit of grandstanding usually ingratiates you to absolutely nobody, including your own client. The first draft of a deal document sets the tone for the entire transaction. When you start out with one that’s burdensome and oppressive, the recipient’s legal and financial advisors immediately let their client know that the document is over the top. That means that not only does the draft usually get flyspecked, but each succeeding draft, along with just about every request made by the other side during the course of negotiations, gets looked at with a jaundiced eye.

Instead, the bankers suggested that a more balanced first draft is a much better way to approach a deal. If you start out with a document that puts the ball on the 35 yard line, you not only create an atmosphere that suggests your side wants to do business, but ironically, you’ll probably be more successful in your efforts to win on the handful of important deal points that you’ve drafted in your favor. When it comes to doing deals, it’s usually the reasonable people who can get away with murder.

From my perspective, I’ll concede that there are circumstances where it makes sense to be pretty aggressive in documentation. For example, if you’ve got a very hot commodity or a buyer that’s drooling all over the conference room table, then a little documentary boorishness is probably in order. But most deals don’t fall into that category, and most experienced business people don’t view an acquisition or a divestiture as a zero sum game. A first draft that suggests otherwise is usually a bad idea if your client’s primary objective is to get a deal done quickly and efficiently.

The "Deal Cube" Chronicles: Part 3

Following up on Part 2, Charles Vaughn of Nelson Mullins Riley & Scarborough provides us some fodder for the latest installment of the "Deal Cube Chronicles":

"In my office at home is a beautiful deal cube for a follow on offering led by a bulge bracket firm in 2001. The cube refers to an offering of "Commom" Stock. When I pointed this out to the analyst at the firm who approved the toy, his face lost all color, and soon we had panicked emails from the higher ups requesting all of the toys. I have kept mine as an example to my sons, now 15 and 20, of how important it is to proofread carefully."

Those jonesing for their deal toys might want to know they can pick up some Lehman swag – cheap - as noted in this article from The Deal. There’s a certain cachet about owning branded merchandise for a company that no longer exists. Too bad I didn’t score a Pets.com sock puppet when I had the chance.

And as a follow-up to John Jenkins recent musings on closings generally, Chris Parrott, VP and Senior Counsel, Unum Group gives us his nostalgic memories:

"I am an in-house counsel who worked on my first transaction of any size in 1987. I lived out of state more or less for two months, working late into every night with outside counsel, ordering dinner from the Pacific Dining Car like it was McDonald's, watching similarly hard-working litigators recreating automobile accidents with toy cars. The last night of work, before heading to closing in another city put me in the sellers' offices, putting documents to bed, until about 4 am when I hurried to catch a plane. At the closing itself, there was all of the tedium and boredom, with the occasional excitement of counting pages in copies, related in this space by others on this subject.

Eventually, funds were received and we made a mad dash to the airport in limos (which added to a sense of living, at least for a while, among the masters of the universe) only to find we had missed our flight, in spite of every flight having been rain delayed. When I finally arrived late that evening at a connecting airport, there were no more connections to be made. I ultimately arrived at the office by the middle of the next morning.

The point of this recitation is not to bemoan the loss of the glamour of preparation, closing and celebration of a deal as it was done in the last century, but to say that hindsight suggests that the perception of such glamour may have been self-delusion. Today's process of emails and telephone calls along with one or two all-hands meetings is certainly more efficient but it leaves little room for war stories that prove to younger generations how tough the practice of law was in the 'old days.'"