June 20, 2007
And Another Notable Vice Chancellor Strine Decision: Lear
From Travis Laster: Last Friday, Vice Chancellor Strine of the Delaware Chancery Court issued a limited, disclosure-only injunction in In re Lear Corporation Shareholders Litigation, C.A. No. 2728-VCS. The injunction directs Lear to issue a supplemental disclosure regarding the Lear’s CEO’s request to the Lear board in late 2006, prior to negotiating on an exclusive basis an all-cash going-private transaction with Carl Icahn in January and February 2007, that the board take steps to secure the CEO’s retirement benefits. Like the recent decision in Topps, Lear contains many practical lessons for private equity deals and go-shop processes. Here are some highlights from the 55-page opinion:
1. VC Strine criticized the decision by the Lear Special Committee to permit Lear’s CEO to conduct negotiations over the merger price without any direct involvement by the Special Committee or the Company’s investment banker. VC Strine nevertheless found no evidence that this decision adversely affected the overall sale process. The Court determined that the Special Committee’s general approach to obtaining the best price was reasonable because a formal pre-agreement auction presented the risk of losing Icahn’s bid, the absence of any serious interest by a third party in acquiring Lear prior to the Icahn proposal, and the go-shop process after the Icahn merger agreement secured the opportunity for Lear to solicit a higher bid.
2. Despite his concern about the CEO’s role, VC Strine found that the Special Committee proceeded reasonably in relying on a post-agreement market check. VC Strine concluded that the market was fully aware of Lear’s willingness to consider alternative transactions in light of (i) the Lear board’s redemption of its poison pill in 2004, (ii) Icahn’s purchase of a significant stake in Lear in early 2006, (iii) Icahn’s purchase of an additional $200 million of Lear stock in October 2006, which took his stake to 24%, and (iv) an aggressive post-agreement market check during which Lear’s financial advisors contacted 41 potential buyers, including both financial sponsors and strategic acquirers. VC Strine explicitly distinguished Netsmart as involving a micro-cap company without similar market dynamics.
3. The Icahn merger agreement incorporated a two-tier termination fee, with a lower fee payable during a 45-day go-shop period. After the 45 days, Lear became subject to a more traditional no-shop provision and a somewhat higher termination fee. The lower fee only would be payable, however, if the Lear board terminated the Icahn deal and entered into a topping merger before the end of the 45-day period. Icahn had a 10-day match right prior to termination. Given this timeline, VC Strine analyzed the reasonableness of the termination fee using only the higher, post go-shop figure because he concluded that the 45-day go-shop period was too short for a bidder to conduct adequate due diligence, present a topping bid, and have the Lear board make the required decision, wait out the 10-day match, and then accept the bid. He noted
that a go-shop period could be structured differently to give a lower fee to a bidder who entered the process in a meaningful way during the go-shop period, for example by signing a confidentiality agreement or making an initial proposal.
4. The post-go-shop period fee was 3.5% of equity value and 2.4% of enterprise value. VC Strine found these fees to be reasonable, noting that “[f]or purposes of considering the preclusive effect of a termination fee on a rival bidder, it is arguably more important to look at the enterprise value metric because, as is the case with Lear, most acquisitions require the buyer to pay for the company’s equity and refinance all of its debt.”
5. VC Strine commented favorably on the Lear board’s securing Icahn’s agreement to vote his shares in favor of any topping bid that the board recommended, “thus signaling Icahn’s own willingness to be a seller at the right price.”
6. VC Strine rejected all but one of the “Denny’s buffet of disclosure claims” raised by the plaintiffs. In one noteworthy ruling, he held that Lear did not have to disclose an interim version of its DCF model that generated marginally higher values: “The only evidence in the record about the iteration … suggests that it was just one of many cases being prepared in Sinatra time by a no-doubt extremely-bright, extremely-overworked young analyst….” He did, however, hold that the CEO’s interest in securing his retirement benefits in Fall 2006 required disclosure given that it created a potential incentive for the CEO to
pursue a going-private deal that was not shared with Lear’s public stockholders.
M&A practitioners will notice some familiar themes in Lear, such as the need for independent directors to be more involved in a sale process and the importance of chaperoning management. Practitioners who have followed the stapled-debt financing debate will be glad to see VC Strine’s reference to JPMorgan’s offer of stapled debt financing as part of the post-agreement market check. VC Strine cited the staple in rejecting of criticisms of the process by TACO, an Indian bidder who failed to come forward with a topping bid. Although the opinion is not explicit on this point, it seems clear from the context that VC Strine viewed the availability of the staple in this scenario as process-enhancing. It bears noting that in conjunction with giving JPMorgan the go ahead to provide the staple, the Lear board shifted control over the go-shop to Evercore to avoid creating any appearance of a potentially conflicted banker.
Lear is also the first Delaware decision to give some indication regarding when enterprise value as opposed to equity value is the more relevant metric for evaluating a termination fee. VC Strine first noted the potential use of the two metrics in the Pennaco case, but did not comment on when one would be preferable to another. Lear indicates that enterprise value should be preferred when the debt will need to be refinanced and the whole transaction is at issue, such as in an analysis of preclusiveness under Unocal or, one would expect, when a fee is structured as a liquidated damages provision. Although Lear does not say this explicitly, the converse inference is that equity value would be more relevant if the debt does not need to be refinanced or in a voting coercion analysis, where the principal issue is the impact of a no-vote on stockholders equity.