DealLawyers.com Blog

From Travis Laster: Last week, Vice Chancellor Strine of the Delaware Court of Chancery issued an opinion – In re: Netsmart Technologies – enjoining the cash sale of a small public corporation to a private equity firm until the directors (i) supplemented the disclosures regarding the sale process and (ii) disclosed their investment bankers’ projections. Vice Chancellor Strine was quite critical of the sale process used in the case, which he described as “a microcosm of a current dynamic in the mergers and acquisitions market.” Here are some high points from the 75-page opinion (ed. note: we have posted memos analyzing the opinion in the “Auctions” Practice Area):

1. VC Strine found that the Board and Special Committee did not act reasonably in failing to contact strategic buyers. The defendants attempted to justify this refusal based on sporadic contacts with strategic buyers over the half-decade preceding the deal. VC Strine held that “[t]he record, as it currently stands, manifests no reasonable, factual basis for the board’s conclusion that strategic buyers in 2006 would not have been interested in Netsmart as it existed at that time.” In later discussion, he carefully distinguished such informal contacts from a targeted, private sales effort in which authorized representatives seek out a buyer. He viewed the record evidence regarding prior contacts as “more indicative of an after-the-fact justification for a decision already made, than of a genuine and reasonably-informed evaluation of whether a targeted search might bear fruit.”

2. VC Strine rejected a post-agreement market check involving a standard window-shop and 3% termination fee as a viable method for maximizing value for a micro-cap company. He noted that such an approach has “little basis in an actual consideration of the M&A market dynamics relevant to the situation Netsmart faced” and would not have attracted topping bids “in the same manner it has worked … in large-cap strategic deals.”

3. VC Strine was quite critical of the lack of minutes for key board and Special Committee meetings, as well as the fact that most of the minutes were prepared in omnibus fashion after the litigation was filed.

4. VC Strine criticized the Special Committee for permitting management to conduct the due diligence process without supervision. “In easily imagined circumstances, this approach to due diligence could be highly problematic. If management had an incentive to favor a particular bidder (or type of bidder), it could use the due diligence process to its advantage, by using different body language and different verbal emphasis with different bidders. ‘She’s fine’ can mean different things depending on how it is said.” The Vice Chancellor ultimately found no harm, no foul on this issue because management did not have a favored PE backer and there was no evidence that they tilted the process in favor of any participant.

5. VC Strine found that the proxy’s disclosures regarding the company’s process and its reasons for not pursuing strategic buyers had no basis in fact. Adhering to his opinion in Pure Resources, he also found that the latest management projections relied on by the Special Committee and their financial advisor in its fairness opinion needed to be disclosed.

Each of these issues underscores the benefits of bringing Delaware counsel into the transactional process early, both for purposes of structuring the exploration of alternatives and reviewing the proxy statement. The issues that VC Strine addresses in his opinion are frequent subjects of counseling by Delaware practitioners. Although this is the first opinion to bring many of them to judicial light, all have been on the radar screen for some time. There are many other nuggets to be gleaned from this important decision, particularly for those of us currently involved in processes with PE players (and in this market, who isn’t?).