October 2, 2008

After Omnicare: Delaware Chancery Court Denies Injunction Against Target Merger Agreement

From Cliff Neimeth of Greenberg Traurig: In its first published consideration of the issue since the Delaware Supreme Court’s 2003 decision in Omnicare v. NCS Healthcare, the Delaware Chancery Court recently declined to issue a preliminary injunction enjoining the merger of closely-held WCI Steel (“WCI”) with a wholly owned subsidiary of OAO Severstal (“Severstal”). The May 2008 merger agreement provided for the adoption thereof by the written consent of the holders of a majority of WCI’s outstanding voting power pursuant to DGCL Section 228 (in lieu of a special meeting of WCI’s stockholders). Here is a transcript from the motion hearing.

In Optima International of Miami v. WCI Steel, (Del. Ch. Ct.; 6/27/08), Vice Chancellor Lamb, who decided the Delaware Chancery (lower) Court decision in Omnicare, questioned the precedential validity of Omnicare (as has, to date, literally every current Delaware Chancery Court judge and the overwhelming majority of the NY and Delaware public M&A bar) and then distinguished the facts of Omnicare to reject plaintiff’s argument that the written consent used to obtain stockholder adoption of the WCI-Severstal merger agreement within 24 hours of the WCI Board’s approval thereof, constituted the equivalent type of “lock up,” preclusive deal structure and “fait accompli” invalidated by the Omnicare court.

[As you recall, Omnicare, according to the rare split decision of the Delaware Supreme Court as constituted at that time, involved a defective trilogy of deal protection features: (x) the target’s “force-the-vote” covenant in the merger agreement under then-DGCL Section 251(c) (today DGCL Section 146), (y) the absence of a fiduciary termination right in the event of a subsequent superior offer and (z) a voting support agreement executed by the holders of a majority of the target’s outstanding voting power.]

In particular, Vice Chancellor Lamb observed that nothing in DGCL Section 251 (or elsewhere in the DGCL) mandates any minimum time frame between Board approval and stockholder adoption of a merger agreement, and he found nothing under the totality of circumstances leading to the Board’s approval of the merger agreement that infected the Special Committee’s recommendation or that impugned the reasonableness of the Board’s overall decisional process. The Special Committee, composed wholly of independent directors, was formed as a matter of administrative expedience, rather than to facilitate burden shifting in a conflicts or “entire fairness” transaction.

Moreover, VC Lamb found nothing in the parties’ briefings to indicate that the WCI Board exceeded or abdicated (within the meaning of DGCL section 141 (a)) its directoral authority or that the Board “contracted away” its fiduciary duties in violation of Delaware corporate law policy (as found in common law decisions in other contexts; e.g., QVC, Phelps Dodge, ACE and Quickturn, etc.). Lamb noted that the Board conducted a reasonable pre-sign process and negotiation, and that there was nothing to suggest that WCI impermissibly favored one bidder over the other to prematurely shut down the sale process before it ran its course.

In that connection, the case’s transcript and briefings describe:

1. WCI’s pre-sign contact with 22 potential buyer candidates;
2. that few candidates expressed interest or entered into a CSA to conduct diligence;
3. that WCI continued the bidding process as best and as long as it could between finalists Severstal and competing bidder, Optima;
4. that Severstal was the only party to submit a “conforming bid” at the initial deadline for final and best offers;
5. that Optima violated its standstill agreement by communicating a higher offer directly with WCI’s stockholders after the final bid deadline, yet WCI still sought to reinject Optima into the process before signing up with Severstal;
6. that WCI bargained for a price increase from Severstal as a quid pro quo for Severstal’s insistence on 24-hour stockholder approval of the merger agreement; and
7. that WCI entertained alternative deal structures that might enable a deal with Optima – which had offered a substantial $150 million of total equity value (“TEV”) conditioned on reaching an accord with the United Steel Workers Union (the “Union”) under the collective bargaining agreement (“CBA”) successorship clause vis a vis Severstal’s $ 140 million TEV, unconditional and Union-endorsed offer.

[NB: The Union previously indicated to WCI that it would not consent under the CBA to a deal with Optima and there is an interesting colloquy in the transcript with respect to WCI’s prior bankruptcy and the origin of the successor clause and 45-day right to match clause in the CBA.]

With respect to the successorship clause, the plaintiffs’ failed to convince VC Lamb that WCI was not vigilant enough in trying to get Optima and the Union back to the table in view of Optima’s higher TEV offer and was unable to show a reasonable likelihood to succeed on the merits with respect to its argument that the WCI Board abdicated its negotiating and decisional authority to the Union by not challenging the Union’s interpretation of the CBA successor clause.

Influencing his decision (at least in part), VC Lamb acknowledged that WCI was experiencing a serious liquidity crisis at the time the Board made its decision to pursue a sale process and that WCI had just emerged from Chapter 11 reorganization in 2006 and might be faced with the prospect of next seeking Chapter 7 liquidation.

[NB: There is no express discussion, however, of whether WCI was in a “zone of insolvency”). Lamb further observed that there was nothing offered by plaintiffs’ to contradict WCI’s belief (and fear) that if, as threatened, Severstal walked from its offer (especially after little to no interest was generated in the market check beyond the Severstal and Optima expressions), WCI could have been left with no deal on the table and a bleak outlook.]

Lastly, Lamb rejected plaintiffs’ arguments, based on In re Topps Shareholders Litigation, that WCI was required to release Optima from its standstill covenant in the CSA (which was entered into to facilitate the pre-sign diligence process) to allow Optima to proceed with a tender offer or otherwise communicate directly with WCI’s stockholders.

The Upshot: Optima v. WCI is the latest decision (Orman v. Cullman being the most notable prior decision) to distinguish and take a slice out of Omnicare and, more significantly, it is the first decision to address a challenge to the use of a DGCL Section 228 written consent (executed by the holders of a majority of a target’s voting power) to obtain stockholder adoption of a merger agreement.

The decision also reinforces prior Delaware decisions which counsel that at some point down the line a market check process or an auction must come to an end and that, depending on the overall circumstances, it is certainly reasonable for a Board not to risk losing a lower priced, but more certain, “bird in the hand” that, pursuant to a deliberate, independent, disinterested and well-informed Special Committee and Board process, is determined to be fair and in the best interests of the target’s stockholders and which constitutes the best price reasonably attainable. Here again, a higher priced, but highly uncertain deal, did not carry the day (nor should it have).

Judicial Review Standard Observation: Because Omnicare was a “controlled company”, Revlon was not implicated and the Delaware Supreme Court went on to analyze the structural trilogy of deal protections (referred to in note 1 above) under a Unocal/Unitrin standard of proportionality and preclusion/coercion.

By contrast, in the Optima v. WCI litigation, VC Lamb applied Revlon and noted that the record demonstrated a reasonable likelihood that the defendants would succeed on the merits because their substantive decisional process fell within a Revlon “range of reasonableness”. Accordingly, just because UBS and Harbinger Capital furnished written consents representing a majority of WCI’s outstanding voting power to adopt the merger agreement, this did not transform WCI into a “controlled” company ab initio which would have rendered Revlon/QVC inapposite.

I make this observation because the application of Delaware’s multi-dimensional judicial review standards often influence the outcome of litigations and settlements by shifting the litigants burdens of persuasion, framing the legal analyses and the body of case law used as precedent, establishing the evidentiary presumptions applied, and determining which facts are introduced (or emphasized) for judicial consideration.

Of course, in the real world, this often gets conflated -thus, Delaware’s occasional overcomplexity in these matters. For all of us as public M&A deal lawyers, however, these contexts also have very real impact on drafting the provisions of the merger agreement and support agreement, and establishing the negotiating positions of the parties.

Cautionary Note: As is often the case, the transcript of the decision must be read in light of and accordingly, it is limited by its procedural context and the specific facts presented to the Chancery Court on plaintiffs’ motion for a preliminary injunction. The decision does not stand for the proposition that action by the written consent of the holders of a majority of the target’s outstanding voting power in a sale of the company to a third party would be fair, equitable and permissible under every future set of facts and circumstances.

Although directoral fiduciary duties obviously pertain irrespective of whether a company is public or private (or closely held, disaggregated or controlled), we don’t know whether VC Lamb would have employed a different analysis if WCI were a widely-held, listed public company. Suffice it to say, the decision animates a broad range of commercial and legal issues well beyond the space limitations of this blog and the matters addressed at the injunction hearing and in the parties’ briefings.