June 22, 2007

Disclosure Injunctions on Merger Deals: An Emerging Trend

Some analysis from Davis Polk (copies of both opinions are in our “M&A Litigation” Portal): In back-to-back decisions late last week, the Delaware Chancery Court enjoined both The Topps Company and Lear Corporation from proceeding with shareholder votes on separate going-private transactions pending additional disclosure of material information to shareholders. While the more significant legal ruling, In re The Topps Company S’holders Litig., also grants substantive relief on a Revlon claim (which we discuss in detail below), the decisions punctuate a recent trend in the Delaware courts towards issuing disclosure injunctions. This trend underscores what appears to be heightened sensitivity in the Delaware courts to alleged conflicts of interest and the corresponding concern that stockholders be presented with full and detailed disclosure of all material facts surrounding any possible conflicts before being asked to approve an LBO or otherwise controversial transaction.

The plaintiffs in Topps (comprising both shareholder plaintiffs and a slighted bidder, Upper Deck) alleged that the Topps board of directors had breached their Revlon duties to maximize value in a sale of control transaction. The substance of the allegation was that the Topps board had unfairly favored a deal with a private equity consortium led by Michael Eisner over a competing offer from rival Upper Deck because they perceived Eisner as a friendly suitor who had pledged to retain management.

As an initial matter, the Court found no fault in the board’s decision to negotiate an exclusive deal with Eisner rather than run an auction, observing that Topps had previously conducted a failed auction for its confectionary business and that it was reasonable for its directors to conclude that another failed auction risked damage to the company. In this respect, the decision should provide great comfort to M&A participants by reaffirming that, notwithstanding the recent Netsmart decision and despite having received another indication of interest, a company may conduct exclusive merger negotiations with one party in a going-private transaction, provided it has left itself “reasonable room for an effective post-signing market check.” In this case, the most significant deal protection terms reviewed and blessed by the Court were:

– a 40-day post-signing go-shop period (“For 40 days, the Topps board could shop like Paris Hilton.”);

– a matching right (While “a useful deal protection” for buyers, they have “frequently been overcome in other real-world situations.”); and

– a 4.3% termination fee (While “a bit high in percentage terms,” the break-up fee was reasonable since it included Eisner’s expenses and “can be explained by the relatively small size of the deal.”)

However, the Court criticized Topps for failing to exercise its right to continue negotiations with Upper Deck after the go-shop period, which it could have done by declaring Upper Deck to be an “Excluded Party” that was likely to submit a “Superior Proposal.” The Court found that Upper Deck was likely to succeed on its claims that the Topps board had breached its fiduciary duties by failing to try to negotiate a better deal with Upper Deck and by failing to release Upper Deck from a standstill agreement to allow it to proceed with a tender offer for all shares and communicate directly with Topps stockholders about its version of events. The Court therefore ordered substantive relief requiring Topps to grant Upper Deck a waiver of the standstill for these purposes.

On the disclosure side, the Court further enjoined the Topps shareholder vote until Topps discloses material facts regarding a valuation presentation by Topps’s financial adviser that casts doubt on the fairness of the merger consideration, discloses certain facts about Upper Deck’s bid (i.e., its willingness to bear all antitrust risk in the transaction), and most importantly, discloses Eisner’s assurances to Topps management.

In a similar vein, the Lear Court enjoined the Lear Corporation from proceeding with a stockholder vote on a proposed $5.3 billion acquisition by Carl Icahn’s American Real Estate Partners pending supplemental disclosure of facts indicating that the CEO had “material economic motivations that differed from [the stockholders] that could have influenced his negotiating posture with Icahn.”

The Chancery Court’s readiness in these cases to delay transactions over deemed disclosure deficiencies should serve as a cautionary reminder that clearing the SEC is not the limit of the disclosure considerations on a public company transaction. Topps and Lear are the latest in a series of injunctions issued by the Court over the last three months in going-private or otherwise controversial transactions, which seem to reflect greater effort to shine a spotlight on a perceived conflict of interest or to equalize the playing field between competing bidders. Such injunctions can result in critical time delays and radically alter the landscape for a transaction (which can be particularly important in a competitive bidding situations), as well as raise the price tag of settlement negotiations with the plaintiffs bar.

The Art of the Cross-Border Deal

We have posted the transcript from our recent webcast: “The Art of the Cross-Border Deal.”