February 26, 2007

Delaware Chancery Court Enjoins Caremark-CVS Meeting (Again)

On Friday, Chancellor Chandler of the Delaware Court of Chancery again enjoined Caremark from proceeding with its meeting of stockholders to vote on its proposed merger with CVS. The Chancellor granted the injunction based on two disclosure issues, one regarding investment banker compensation, the other regarding the triggering of appraisal rights under Delaware law. We have posted a copy of the opinion in our “M&A Litigation” Portal.

Here is some analysis of the case from Travis Laster of Abrams & Laster: There are several key points in the opinion for M&A practitioners. First, the Chancellor criticized the combination of deal protection measures in the Caremark-CVS merger-of-equals. The combination is one that many M&A practitioners would regard as relatively standard: an approximately 3% breakup fee, a no shop with a superior proposal out, and a 5-day last-look matching right for CVS. The Chancellor rejected the view that these provisions are beyond question because they are a “customary set of devices.” (p. 11 n.10).

He instead cautioned that any analysis of deal protection devices must depend on the facts: “[A] court focuses upon ‘the real world risks and prospects confronting [directors] when they agreed to the deal protections.’ That analysis will, by necessity, require the Court to consider a number of factors, including without limitation: the overall size of the termination fee, as well as its percentage value; the benefit to shareholders, including a premium (if any) that directors seek to protect; the absolute size of the transaction, as well as the relative size of the partners to the merger; the degree to which a counterparty found such protections to be crucial to the deal, bearing in mind differences in bargaining power; and the preclusiveness or coercive power of all deal protections included in a transaction, taken as a whole. The inquiry, by its very nature fact intensive, cannot be reduced to a mathematical equation. Though a ‘3% rule’ for termination fees might be convenient for transaction planners, it is simply too blunt an instrument, too subject to abuse, for this Court to bless as a blanket rule.” Id. (citation omitted).

The Chancellor did not in fact rule on the deal-protection measures because, in his words, “I conclude that plaintiffs are not subject to any irreparable harm so long as shareholders are given the opportunity to exercise a fully-informed vote.” This, of course, necessarily means that the Chancellor did not find the combination of measures to be coercive or preclusive: If he had, the measures would interfere with the stockholder vote.

In light of this holding and the lack of any definitive guidance in the opinion, the Chancellor’s comments may well be a rhetorical effort to restrain the customary level of termination fees, which started years back at 1-2%, climbed to 2-3%, and now rests in the 3-4% range. It also remains to be seen whether the Court’s language will have any impact on the ability of defendants to obtain dismissals of complaints challenging what previously would have been seen as garden-variety combinations of defensive measures. I predict it will not.

Second, the Chancellor held that the disclosures regarding the Caremark investment bankers’ $35 million fee were materially misleading because they did not make clear that the bulk of the investment bankers’ fees, as a practical matter, were contingent upon their opining in favor of a Caremark-CVS deal. Caremark’s two bankers stood to receive $1.5 million each if they issued opinions as to the advisability of the Caremark/CVS merger, regardless of the conclusion. Upon the consummation of the transaction, each would receive an additional $17.5 million.

The bankers also would receive their additional $17.5 million if, after the announcement of the merger, Caremark completed a similar transaction within nine months. The Chancellor noted that as a technical matter, the $35 million was contingent upon opining in favor of the merger, because the bankers had no ability to receive their full fee if they did not. The Chancellor found the proxy to be materially misleading because it failed to explain adequately the contingent nature of the $35 million, which gave the bankers an incentive to approve the deal.

Third, the Chancellor found that Caremark and CVS’s agreement to issue a special dividend in connection with the merger triggered appraisal rights in what otherwise was a stock-for-stock merger to which appraisal rights would not have applied. Concluding that the Caremark $6 special dividend “is fundamentally cash consideration paid to Caremark shareholders on behalf of CVS,” the Chancellor held that this constituted consideration other than publicly traded stock of the acquirer and hence gave rise to appraisal rights.

The Chancellor rejected an argument that the dividend had independent legal significance and was therefore not merger consideration triggering appraisal rights. This holding has significant implications for transactional planners in stock-for-stock deals: bumps in an exchange ratio will not trigger appraisal rights, but bumps in the form of cash, whether by dividend or directly in the merger, will trigger appraisal rights.

Fourth, the Chancellor noted in the footnote the distinction between (i) a merger agreement provision that maintains the existing indemnification rights of officers and directors under a corporation’s charter and bylaws and (ii) a provision that provides additional, direct contractual indemnification rights from the acquirer. See p. 30 n.33.

The former are clearly limited by the scope of Section 145 of the General Corporation Law; the latter arguably are not. (In what would seem to be a typographical error, the Chancellor refers to Section 102(b)(7), rather than to Section 145). In my experience, practitioners who do not deal regularly with indemnification rights often are unaware of or do not focus on this important distinction.

The Chancellor concludes by enjoining Caremark from proceeding with the meeting for a period of 20 days after the issuance of supplemental disclosures, which he notes corresponds to the notice period required by the appraisal statute.

In addition to these highlights, the opinion contains a number of other comments that give flavor to the decision. A full read is necessary to infer how the Court viewed the transaction and the related process.