Delaware Vice Chancellor Lamb's Last Opinion
- by Steven Haas, Hunton & Williams
As one of his last acts before moving on, Delaware Vice Chancellor Lamb issued a noteworthy decision in Louisiana Mun. Police Employees' Ret. Sys. v. Fertitta, 2009 WL 2263406 (Del. Ch.; 7/28/09), upholding challenges to a special committee's decision to terminate a merger agreement and not block a CEO's open-market purchases to acquire control of the company.
Fertitta arose from Landry's Restaurants' failed go-private transaction led by its CEO, who owned 39% of the company prior to the deal. After the merger was announced, some of the company's Texas locations were damaged by a hurricane. The CEO immediately claimed that his lenders would declare an MAE if the transaction was not renegotiated. The company's special committee agreed and reduced the merger consideration and the reverse termination fee. In exchange, the CEO negotiated with his lenders and obtained their commitment to refinance the company's existing debt if the merger wasn't consummated.
After the renegotiation, two key events took place. First, the CEO made open-market purchases of Landry's stock, increasing his stake from 39% to 56.7%. Second, the SEC requested additional disclosures about the CEO's acquisition financing. The lenders refused to consent to the disclosures, so the company terminated the merger agreement. The special committee claimed that by terminating the merger agreement, it preserved the lenders' obligation to refinance the company's existing debt - though it also relieved the CEO from paying a $15M reverse termination fee under the merger agreement.
The Court of Chancery upheld all claims against the CEO and special committee based on the following three factors: "(1) [the CEO's] negotiation (and the board's acquiescence to his taking that role) of the refinancing commitment on behalf of the company as part of the amended debt commitment letter; (2) the board's apparent and inexplicable impotence in the face of [the CEO's] obvious intention to engage in a creeping takeover; [and] (3) the board's agreement to terminate the merger agreement, thus allowing [the CEO] to avoid paying the $15 million reverse-termination fee."
The decision could rest almost exclusively on the CEO's status as controlling stockholder, which gives rise to a per se rule of entire fairness review because of the potential for undue influence. For purposes of a motion to dismiss, the court viewed the CEO's management position plus 39% stock ownership sufficient to demonstrate actual control over the corporation. The CEO then obtained true majority control through his stock accumulation by the time Landry's terminated the merger agreement.
Nevertheless, the court seems to have been particularly struck by the substantive decisions allegedly made by an independent and disinterested special committee. Even if the CEO did not have "controlling stockholder" status, the allegations of disloyal conduct were likely sufficient to rebut the business judgment rule. The "Deal Professor" Blog chronicled problems with this transaction last October in this blog - and again this January in this one.
Upholding the waste claim is particularly unusual and could have been decided differently, by finding that the board exercised its discretion to secure a $400 million refinancing by forgoing a $15M reverse termination fee. This is the second notable waste claim to go forward in Delaware in the past few months (see Citigroup, refusing to dismiss a waste claim challenging an outgoing CEO's severance package).
The court's criticism of the CEO's open-market purchases is more straightforward. The court confirmed there is no per se rule that directors must adopt a particular defensive measure in response to an accumulation of shares. However, this case presented a CEO who obtained majority control without paying a premium. That, along with other allegations of "suspect conduct," supported a "reasonable inference at the motion to dismiss stage that the board breached its duty of loyalty in permitting the creeping takeover." It's unclear whether the special committee spotted this issue before agreeing to the merger agreement, which may have had covenants barring adoption of a rights plan. The ability of stockholders to obtain a control premium later will be a significant damages issue at trial. Earlier this year, in Loral, the court nullified the voting rights of preferred stock that was issued in breach of the board's fiduciary duties.
Lastly, the decision highlights some ongoing disclosure issues relating to buyer-financing. When the M&A markets return, this may be an area of increased SEC oversight. If so, the ability to invoke legal "outs" to provide information will be important as long as commitment letters are not publicly disclosed. Here, the court was skeptical that the banks could have walked rather than consent to the additional disclosures, noting that "such commitment letters generally contain an exception to any confidentiality clause to the extent disclosure is required by applicable law."