Delaware Chancery Issues Limited Disclosure and Notice-Based Injunction
Here's news from Tom Bayliss of Abrams Bayliss:
On November 9th, the Delaware Court of Chancery issued the transcript ruling in In re Complete Genomics Shareholder Litigation, C.A. No. 7888-VCL. In the ruling, Vice Chancellor J. Travis Laster:
- Rejects a challenge to deal protection provisions prohibiting the termination of a merger agreement until nearly six months after signing, regardless of whether a superior proposal emerges;
- Acknowledges and discusses the "significant issues of Delaware law lurking" in provisions that (a) restrict a board's ability to change its recommendation or (b) prohibit a target from waiving standstill provisions in confidentiality agreements executed by potential topping bidders;
- Conditions the denial of substantive injunctive relief regarding the change of recommendation and "no-waiver" provisions on the defendants' commitment to give the stockholder plaintiffs notice and an opportunity to object if factual developments potentially trigger the operation of the challenged provisions; and
- Issues a preliminary injunction that will lift ten days after the dissemination of supplemental disclosures including text detailing the acquirer's communications with the target's CEO about post-transaction employment.
Complete Genomics, Inc. ("Complete Genomics" or the "Company") is a publicly-traded Delaware corporation whose primary product is a unique DNA sequencing technology. The Company's board of directors (the "Board") is comprised of the CEO and four outside directors.
The Company has yet to achieve profitability and received a going concern qualification on its most recent year-end financial statements. After unsuccessfully exploring financing options, the Company resolved to explore strategic alternatives and engaged Jefferies & Co. as its financial advisor. On June 5, 2012, the Company publicly announced that it was exploring strategic alternatives and reached out to 42 parties that it believed might be interested in an equity investment, strategic partnership or acquisition. Nine parties expressed interest and, after signing confidentiality agreements, received management presentations. Four of the confidentiality agreements contained standstill provisions that prohibited the signatories from approaching the Company with an unsolicited offer to acquire the Company but permitted the signatory to request to be released from the standstill. Six of the parties that received management presentations submitted nonbinding indications of interest to the Company.
During the solicitation process, Clifford Reid, the Company's CEO, interacted with the CEO of BGI-Shenzhen ("BGI"), one of the bidders. The CEO of BGI indicated that BGI wanted Reid to stay on after any potential acquisition and that BGI intended to run the Company as an independent entity under the BGI umbrella.
The Board ultimately determined to focus on two expressions of interest that contemplated the acquisition of the Company. After a period of parallel negotiations, one of the bidders demanded exclusivity. After the Complete Genomics declined that request, the bidder withdrew, leaving BGI as the sole remaining bidder (with corresponding bargaining leverage). On September 15, 2012, the Company entered into a merger agreement (the "Merger Agreement") pursuant to which Beta Acquisition Corporation ("Beta"), a wholly-owned subsidiary of BGI, would launch a first-step tender offer at $3.15 per share in cash followed by a second-step merger with Complete Genomics at the same price. The transaction consideration represented a 54% premium over the closing price of the Company's stock on the day before the Company announced that it was exploring strategic alternatives.
The Merger Agreement
The Merger Agreement included several provisions worth consideration. First, Beta's obligation to close the tender offer was conditioned upon a so-called "minimum tender condition" requiring the holders of at least a majority of the Company's outstanding stock to tender their shares. The Merger Agreement gave Beta until December 14, 2012 to satisfy the minimum tender condition. If Beta did not make that deadline, an automatic extension gave Beta until March 14, 2013. During this period, the Merger Agreement's "no-shop" clause prohibited the Company from soliciting competing offers.
Second, the Merger Agreement did not allow the Company to terminate in the event the Board changed its recommendation in favor of a superior proposal, so the Company was irrevocably committed to the transaction until March 14, 2013. In addition, a tender and support agreement committed the holders of 17.7% of the Company's outstanding stock to tender into Beta's offer. Interestingly, the Company's precarious financial position raised concern that the Company could run out of cash before March 14, 2013, even with the benefit of a $30 million bridge loan provided by BGI.
Third, if Beta failed to satisfy the minimum tender condition after the Board changed its favorable recommendation or the Company received a topping bid, termination required Genomics to pay BGI $5.2 million in cash (4.8% of the transaction's equity value), unless BGI elected to convert its bridge loan into shares of the Company and receive the topping bid. In that case, BGI would own a maximum of approximately 22% of the Company (assuming the bridge loan was fully drawn).
Fourth, the Merger Agreement included a five day "match right" that prohibited the Board from withdrawing or otherwise changing its recommendation in favor of a superior proposal unless it first provided BGI with five business days advance notice of its "intention" to change its recommendation, during which time the Company was required to attempt in good faith to renegotiate the terms of the proposed transaction with BGI.
The Stockholder Litigation
Shortly after the announcement of the transaction, stockholders of Complete Genomics filed four lawsuits in the Delaware Court of Chancery alleging, among other things, that the Board had breached its fiduciary duties by agreeing to the proposed transaction. The Court of Chancery consolidated these lawsuits into a single action on October 4, 2012. In support of their motion for a preliminary injunction, the plaintiffs argued that the Merger Agreement contained impermissible deal protection measures and that the defendants had disseminated materially misleading disclosures.
The Ruling on the Termination Provisions
The Court rejected the plaintiffs' contention that the Merger Agreement provisions prohibiting termination until March 14, 2013 were coercive under Unocal, despite acknowledging the possibility that the Company might run out of cash before reaching the deadline. The Court emphasized that "wrongful coercion" exists only where a party takes actions which cause the stockholders to vote in favor of a transaction for some reason other than its merits. According to the Court, "if stockholders can reject the transaction and maintain the status quo, then the transaction is not coercive. There may be negative consequences to continuing with the status quo, but neither the existence of those negative consequences nor accurate disclosures about them constitutes wrongful coercion." The Court emphasized that the Merger Agreement only required payment of the termination fee if Beta failed to satisfy the minimum tender condition and either (a) the Company had received a topping bid or breached the Merger Agreement or (b) the Board failed to maintain its recommendation. In other words, because the stockholders could "choose the status quo without penalty," the Merger Agreement was not coercive.
The Court rejected the argument that the Merger Agreement was "preclusive" under Unocal after determining that there was a "realistic path for stockholders to receive an alternative bid." The Court emphasized the possibility that a competing bidder could make a public commitment to purchase any and all of the Company's stock in a tender offer and follow with a back-end merger at the same price. The Court acknowledged the "heavy tolls" that the termination fee and the bridge loan conversion feature imposed upon any competing bid but ultimately concluded that those provisions were not preclusive because the cost of termination remained below five percent (after accounting for the impact of conversion).
For these reasons, the Court concluded that the plaintiffs had failed to establish a reasonable likelihood of success on the merits of their challenge to the Merger Agreement's termination provisions. The Court also reasoned that the Company's "highly fragile state" tipped the balance of the equities against the issuance of an injunction addressing this issue, despite the fact that a preliminary injunction would apparently not give BGI a termination right under the Merger Agreement.
The Ruling on the Change of Recommendation and Waiver of Standstill Provisions
The Court gave more credit to the plaintiffs' challenge to the Merger Agreement provisions restricting the Board's ability to change its recommendation. The Court observed that these provisions mimicked the "types of conditions and procedures frequently and historically used to regulate a target's contractual ability to terminate a merger agreement or accept a superior proposal." The Court emphasized that "transplants of this variety are fraught with peril" because a "carve-out from a target board's obligation to recommend a merger agreement raises issues that are fundamentally different because it implicates duties to target stockholders to communicate truthfully." Thus, "[u]nlike in ... no shop and termination outs, fiduciary duty law in this context can't be overridden by contract." The Court also voiced concern about the provision in the Merger Agreement prohibiting the waiver of standstill provisions embedded in the confidentiality agreements executed by the other potential bidders.
Despite these reservations, the Court determined that the plaintiffs' challenges to these provisions were hypothetical. There was no evidence that the Board was even considering a change of recommendation, and no evidence that a potential bidder had requested and was denied a waiver of the standstill provisions of a confidentiality agreement. Thus, the potentially offensive provisions were not implicated by the specific facts of the case.
Instead of ruling on the merits of these issues, the Court determined to deny the requested injunction conditioned on the defendants' commitment to give the plaintiffs notice if either (a) the Board "considers whether it should change its recommendation" or (b) "if any party to a standstill agreement makes a non-public request to be released from the agreement." According to the Court, if either event came to pass, "we can have a litigation on an actual set of facts rather than a law school exam hypothetical."
The Disclosure Ruling
The Court granted the plaintiffs' request for an injunction pending the dissemination of supplemental disclosures describing the discussions between Clifton Reid, the Company's CEO, and BGI's CEO regarding post-transaction employment. Citing to the Atheros case, the Court determined that the omitted facts were material.
The Court also required supplemental disclosures regarding a typographical error in the Merger Agreement, an inaccurate definition, and the mechanics of the 90 day automatic extension of the time to satisfy the minimum tender condition.
Take Aways & Further Thoughts
1) Complete Genomics confirms that an exhaustive, public, pre-signing market check gives a target board significantly more room to accede to an acquirer's demand for stringent deal protection measures, particularly when the target is financially distressed. In the words of the Court, "[w]hen a board has informed itself thoroughly, it can enter into an exclusive merger agreement."
2) The Court quotes language from WaveDivision Holdings v. Millenium Digital Media Systems explaining that "Delaware entities are free to enter into binding contracts without a fiduciary out so long as there is no breach of fiduciary duty involved when entering into the contract in the first place." This guidance remains somewhat puzzling given that the absence of a fiduciary out could (and often does) lead to the contention that the target board breached its fiduciary duty "when entering into the contract in the first place."
3) The guidance on deal protections in Complete Genomics has to be read in conjunction with the Delaware Supreme Court's controversial decision to invalidate the deal protection provisions in Omnicare, Inc. v. NCS Healthcare, Inc., (Del. 2003). Both cases involved financially distressed companies that were exhaustively shopped. In Omnicare, however, voting agreements locked up more than 65% of the target's outstanding stock, and the existence of a topping bidder swept away any argument that the challenge to the deal protections was somehow hypothetical.
4) The Court's reluctance to write a termination provision into the Complete Genomics Merger Agreement is unsurprising. The provisions prohibiting termination until the expiration of the deadline to achieve the minimum tender condition mimic the operation of so-called "force the vote" provisions that obligate a target board to submit a merger agreement to a stockholder vote even if the target board has changed its recommendation and believes that stockholder approval of the merger agreement is no longer advisable. These "force the vote" provisions are expressly authorized by 8 Del. C. § 146.
5) Complete Genomics highlights the distinction between (a) provisions governing a board's ability to shop or terminate a merger agreement and (b) provisions governing a board's ability to change its recommendation. Where merger agreement provisions appear to compromise the board's ability to communicate with stockholders truthfully and in a timely fashion, they are likely to be viewed with great skepticism. Echoing the discussion of this topic in the Compellent decision, the Complete Genomics ruling underscores the dangers of importing procedural constructs typically used to govern shopping and termination decisions into provisions governing changes of recommendation.
6) The Court's decision to withhold an injunction against certain merger agreement provisions based on the defendants' commitment to give the plaintiffs notice of the board's consideration of a change of recommendation or the request of a bidder to be released from a standstill obligation is perhaps the most interesting component of the decision. This result appears to be a logical extension of the Court of Chancery's traditional reluctance to enjoin transactions absent a competing bid (particularly where Company faces bankruptcy if the transaction fails to close). The holding could apply to any facial challenge to allegedly problematic merger agreement provisions at the preliminary injunction stage.
7) The Court's decision to impose the "notice and opportunity to object" mechanism rather than an injunction sets up an interesting contrast with situations where the Court has used its judicial "blue pencil" to strike down deal protection measures despite the absence of a topping bid.
8) The Court's reluctance to articulate its views on the permissibility of the challenged change of recommendation and no-waiver provisions may in part be the product of the recent decision in Gatz Properties, LLC. V. Auriga Capital Corporation, in which the Delaware Supreme Court cautioned Delaware trial courts against opinions "ruminat[ing] on what the proper direction of Delaware law should be." In a transcript ruling prior to Gatz, Vice Chancellor Laster commented that he found the persistence of provisions prohibiting requests for standstill waivers "weird" given the Court's view that enforceability is uncertain: "When is that ever going to hold up if it's actually litigated, particularly after Topps?"
9) After Complete Genomics, stockholder plaintiffs raising facial challenges to merger agreement provisions could shoot for "notice and opportunity to object" orders instead of traditional preliminary injunctions. Those types of orders might even constitute settlement consideration in the right circumstances.
10) When addressing the combined preclusive effect of the termination fee and the conversion feature of the BGI bridge loan, the Complete Genomics Court takes pains to distinguish the termination fee and lock-up options invalidated in Paramount Communications Inc. v. QVC Network Inc., 637 A.2d 34 (Del. 1994). According to the Court, "the stock option lock-up in QVC didn't provide any benefit to the target and only came into play in the event of a topping bid. The bridge loan here provided substantial benefit to [Complete] Genomics in the form of much needed cash to get them through at least most of, and ideally all of, ... the transaction process and possibly a little bit beyond."
11) The Court indicated that its limited injunction would lift ten days following the identified supplemental disclosures. This holding provides another data point for transactional planners estimating the time required for stockholders to absorb supplemental disclosures.