DealLawyers.com Blog

Regarding the latest Caremark decision, there seems to be a fair amount of confusion regarding the structure of the fees payable to Caremark’s investment bankers leading the Delaware Chancery Court to believe that additional, corrective disclosure is required and, in part, justified injunctive relief. In an attempt to resolve such confusion, a more detailed discussion and analysis/explanation of the fee arrangements seems appropriate (albeit by someone not involved in the transaction and without access to the actual engagement letters):

According to the decision: “By their terms, both the UBS and JP Morgan agreements require an opinion as to the advisability of the Caremark/CVS merger in the first instance. Such an opinion, regardless of the conclusion reached therein, triggers the payment of $1.5 million to each advisor. Upon the consummation of the transaction (the Caremark/CVS merger) or alternative transaction (i.e., a merger with a third party) within a specified time period, an additional $17.5 million becomes payable to each company. As a technical matter, the financial advisors must approve the CVS/Caremark merger to trigger their respective $17.5 million fees. Both the UBS and JP Morgan agreements state that “in the event that, following the public announcement of a Transaction with the Counterparty [CVS], the Company pursues a transaction structured in a manner contemplated by the definition of “Transaction” herein, with a third party other than the Counterparty (an “Alternative Transaction”)…with nine months,” the $17.5 million fee becomes payable.”

While it may not be exactly the way negotiations transpired, I believe the following story/mock negotiation explains the motives of the parties and why the UBS and JP Morgan fee structures reflect a rational fee structure intended to protect both sides and should not be assumed to be unique or unusual, much less suspect, in the MOE context.

First, from Caremark’s perspective, Caremark is engaging UBS and JP Morgan as its financial advisors with respect to a specific transaction – the proposed merger of equals with CVS. Caremark is not asking for advice on and, most importantly, does not want to pay UBS or JP Morgan a fee if it pursues a different transaction following the termination of negotiations with CVS. [Note: Caremark is not in Revlon mode and is not trying to sell itself to whomever is willing to pay the highest price. It has a specific long term value maximizing strategy in mind.] This fee structure is the most common structure in buyside engagement letters (where a buyer hires an advisor to help pursue a specific target) and consequently it should not be surprising that its structure has spilled over into MOE engagement letters which have elements of buyside and sellside.

Next, Caremark presumably proposes that it pay the agreed fee of $19 million to each advisor upon the consummation of the contemplated transaction. This ensures that Caremark will not be required to pay UBS and JP Morgan substantial fees if its discussions with CVS terminate or a deal with CVS doesn’t otherwise pan out. The contingent nature of the fee means that Caremark will only be required to pay its advisors if it consummates a transaction providing substantial benefits to its shareholders. [Note: In TCI, the same Chancellor questioned contingent fees for financial advisors to special committees but did not seem to question contingent fees payable to a company’s financial advisors. It is also worth noting that, if they could, bankers would love to be paid on a noncontingent basis.]

UBS and JP Morgan presumably raised two issues regarding Caremark’s fee proposal:

1. The financial advisors would point out that Caremark will likely request a fairness opinion in connection with the contemplated transaction with CVS and the financial advisors should receive a portion of their fees upon the rendering of any such opinion – after all such opinions aren’t without risk and shouldn’t be free. UBS and JP Morgan can’t request to be paid for rendering an opinion on any other transaction as they had not been engaged to advise on any other transaction.

They can only request an opinion fee for rendering a fairness opinion with respect to a transaction with CVS because that is the transaction on which they have been engaged to advise. Presumably, Caremark accepts this argument and agrees to pay a small portion of their financial advisors’ fees upon receipt of their fairness opinion, regardless of the conclusion reached therein. [Note: Caremark continues to insist that a substantial portion of the bankers’ fees be contingent on consummation of a transaction in order to avoid paying large sums to its advisors in the absence of a transaction providing substantial benefits to its shareholders.]

2. UBS and JP Morgan point out that, as a practical matter, the public announcement of a Transaction with CVS will likely put Caremark “in play”, susceptible to rival bids, etc. and it would not be fair for UBS and JP Morgan not to get paid if their hard work in assisting Caremark on the proposed CVS deal ultimately resulted in Caremark engaging in transaction providing even greater benefits to Caremark’s shareholders. [Note: this type of backstop/fee protection is common in sellside engagement letters where a target engages financial advisors with respect to a potential stock-for-stock strategic transaction with a specific buyer but recognizes that once a transaction is announced, anything can happen and they may end up being sold to a rival bidder.]

UBS and JP Morgan are not asking to be compensated if Caremark engages in an alternative transaction absent the public announcement of a transaction with CVS as they weren’t engaged to advise on such transaction and couldn’t argue that their work on the CVS transaction led to such alternative transaction since the CVS transaction was never publicly announced. UBS and JP Morgan only ask to get paid if its clear that their hard work on the proposed CVS transaction leads to a superior transaction with another party because the superior transaction was proposed after the public announcement of the CVS transaction effectively put Caremark into play. [Note: this is not dissimilar to many merger agreement breakup fees that are payable if target shareholders voted the originally proposed transaction down after public announcement of an alternative transaction and an alternative transaction is subsequently consummated but are not payable if target shareholders vote the originally proposed transaction down in the absence of an alternative transaction proposal.]

Caremark likely recognizes the logic of the bankers’ position but to ensure that the “alternative transaction” truly resulted from the hard work of UBS and JP Morgan insists that it only be obligated to pay them a transaction fee if the alternative transaction is pursued within nine months of the public announcement of the CVS deal.

Finally, as the court correctly noted, there is case law that “the contingent nature of an investment banker’s fee can be material.” [emphasis added]. It is not always the case and here, once Express Scripts came forward with its alternative transaction proposal, the bankers’ fairness opinions on the original CVS transaction became irrelevant. Caremark shareholders no longer care whether the original CVS transaction was fair or the bankers had improper incentives to render a fairness opinion on that proposal. They only care about the merits of the revised CVS transaction as compared to the proposed Express Scripts transaction. To the extent the bankers’ fee structure is material, it is because the bankers have no reason to favor one bidder over the other, they get paid whichever wins, and will consequently provide unbiased advice to the Caremark board.