September 9, 2008

VC Strine Validates Naked No-Vote Termination Fee

Here is a guest blog from Steven Haas of Hunton & Williams:

Last Tuesday, Delaware Vice Chancellor Leo Strine upheld a “naked no-vote termination fee” in the Lear litigation (2008 WL 4053221). Lear involved a renegotiated merger agreement whereby Carl Icahn agreed to increase his bid to acquire Lear Corporation by $1.25 per share (or 3.5%) in exchange for a $25 million termination fee (or 0.9% of total deal value) payable if the stockholders rejected the agreement–which happened in July 2007. The plaintiff claimed that the directors breached their duty of loyalty because they knew the merger wasn’t going to be approved when they amended the merger agreement to include the naked no-vote termination fee.

VC Strine’s opinion was driven largely by the fact that independent and disinterested directors were advised by competent outside advisors: “Where, as here, the complaint itself indicates that an independent board majority used an adequate process, employed reputable financial, legal, and proxy solicitation experts, and had a substantial basis to conclude a merger was financially fair, the directors cannot be faulted for being disloyal simply because the stockholders ultimately did not agree with their recommendation.”

He gave zero weight to the plaintiff’s argument that the demands for higher consideration made by certain stockholders and proxy advisory firms proved to the board that the merger was doomed:

These pled facts reflect uncertainty in an ongoing game of financial chicken. Institutional investors do not have to be sworn as witnesses and give their reservation prices to merger targets soliciting proxies. They can and do play it cagey and attempt to extract value.

Firms like MacKenzie are paid to peer into this murk and make sense of it, so as to estimate what it will ultimately take to get the votes. And the incentives of a firm like ISS also give it reason to play coy. In order to demonstrate its value and clout to its customers, ISS has an incentive to act as a quasi-negotiator, using the proxy solicitation process as a way to encourage a higher bid, and using its recommendation tool to extract value.

VC Strine also picked up where he left off in Mercier v. Inter-Tel (2007), making clear that directors have broad latitude in pursuing corporate objectives, including change-of-control transactions, even when stockholders and other observers seemingly disagree:

Directors are not thermometers, existing to register the ever-changing sentiments of stockholders. Directors are expected to use their own business judgment to advance the interests of the corporation and its stockholders. During their term of office, directors may take good faith actions that they believe will benefit stockholders, even if they realize that the stockholders do not agree with them. In the merger context, directors are free to adopt a merger agreement and seek stockholder approval if they believe that the stockholders will benefit upon adoption, even if they recognize that securing approval will be a formidable challenge.

It would be inconsistent with the business judgment rule for this court to sustain a complaint grounded in the concept that directors act disloyally if they adopt a merger agreement in good faith simply because stockholders might (?), were likely (?), or were almost certain (?) to reject it. This sort of speculative second-guessing may be good fun for sports talk shows or political pundits, but it is not the stuff of which duty of loyalty case law is made.

The court concluded by calling plaintiff’s waste claim “frivolous” and finding that the directors were not guilty of even “simple negligence,” let alone gross negligence or bad faith.