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.

From Travis Laster: On Monday night, Delaware Vice Chancellor Lamb issued his much anticipated post-trial decision on the Hexion/Huntsman deal. In the opinion and implementing order, Vice Chancellor Lamb holds that (i) Huntsman had not suffered an MAE, (ii) Hexion “knowingly and intentionally” breached its obligations under the merger agreement such that potential damages are not limited to the $325 million termination fee, (iii) whether or not the combined entity would be insolvent is an issue that is not yet ripe, and (iv) Hexion must specifically perform its obligations under the merger agreement (which does not include an obligation to close). This decision is a blockbuster that will occupy center stage for a while. Here are some highlights from this major ruling.

Practitioners should start with the implementing order. It is a partial final order that Vice Chancellor Lamb certified as final pursuant to Court of Chancery Rule 54(b), thereby setting up an appeal as of right for Hexion.

Several paragraphs leap out of the order. In paragraphs 3-7, Vice Chancellor Lamb orders Hexion to move forward with the actions necessary to complete the merger. This is the type of open-ended, affirmative relief that Delaware courts often resist giving. Even more strikingly, in paragraph 8, Vice Chancellor Lamb prohibits Hexion from terminating the merger, and in paragraph 11, Vice Chancellor Lamb orders that “If the Closing has not occurred by October 1, 2008, the Termination Date under the Merger shall be and is hereby extended until five (5) business days following such date that this Court determines that Hexion has fully complied with the terms of this Order.” This language would appear to eliminate the drop dead date and make the Merger Agreement effectively open-ended, requiring Huntsman consent or court approval to terminate the deal. To my knowledge, this is unprecedented relief.

Turning to the opinion, VC Lamb first holds that there was no MAE. This is largely a fact-driven application of IBP and Frontier Oil; however, three points are particularly noteworthy. First, the Huntsman MAE contained a carveout for industry-wide effects, with an exception for effects with a disproportionate effect on HUN. Hexion argued that this required comparing Huntsman’s performance against the chemical industry’s performance to determine whether an MAE had occurred. VC Lamb rejects this reading and holds squarely that the initial inquiry is whether the target suffered an MAE at all. “If a catastrophe were to befall the chemical industry and cause a material adverse effect in Huntsman’s business, the carve-outs would prevent this from qualifying as an MAE under the Agreement. But the converse is not true–Huntsman’s performance being disproportionately worse than the chemical industry in general does not, in itself, constitute an MAE.” (37-38). This interpretive approach should apply to MAE carveouts generally and will affect how they are read and the leverage respective parties have.

Second, addressing the expected future performance of Huntsman, VC Lamb holds that whether Huntsman suffered an MAE is NOT measured by how it performed versus its projections. This is principally because in the merger agreement, Hexion disclaimed reliance on any Huntsman projections. “Hexion agreed that the contract contained no representation or warranty with respect to Huntsman’s forecasts. To now allow the MAE analysis to hinge on Huntsman’s failure to hit its forecast targets during the period leading up to closing would eviscerate, if not render altogether void, the meaning of [that section].” (46).

Third, in assessing the past performance aspect of the claimed MAE, VC Lamb concurred with Huntsman’s expert that the terms “‘financial condition, business or results of operations’ are terms of art, to be understood within reference to their meaning in Reg S-X and Item 7, the ‘Management’s Discussion and Analysis of Financial Conditions and Results of Operation’ section” of SEC filings. That section requires companies to disclose their results for the reporting period as well as their results for the same time period in each of the previous two years. Therefore, VC Lamb, holds that the proper benchmark for assessing whether changes in a company’s performance amount to an MAE is an examination of “each year and quarter and compare it to the prior year’s equivalent period.” (47-48) Though it addresses only one aspect of the MAE analysis-i.e. past performance not expected future performance-this is the clearest guidance the Court of Chancery has yet provided on the appropriate metrics for evaluating an MAE.

As in IBP and Frontier, burden of proof appears to have played a significant role in the ruling, and VC Lamb suggests in a footnote that parties to a merger agreement contractually allocate the burden of proof for establishing an MAE. (41 n.60).

In the next major ruling in the opinion, VC Lamb holds that Hexion committed a “knowing and intentional breach” of its obligations under the merger agreement. Hexion argued that the phrase “knowing and intentional” requires that a party (i) know of its actions, (ii) know that they breached the contract, and (iii) intend for them to breach of contract. (57). VC Lamb rejects this view as “simply wrong.” (57). He rather holds that a “knowing and intentional” breach is “a deliberate one — a breach that is a direct consequence of a deliberate act undertaken by the breaching party, rather than one which results indirectly, or as a result of the breaching party’s negligence or unforeseeable misadventure.” (59). It thus simply requires “a deliberate act, which act constitutes in and of itself a breach of the merger agreement, even if breaching was not the conscious object of the act.” (60).

Having interpreted “knowing and intentional breach” in this fashion, VC Lamb turns to Hexion’s actions over the past few months, during which Hexion identified a concern about the combined entity’s solvency, retained Duff & Phelps to analyze the issue, obtained an “insolvency” opinion, and then went public with its insolvency contentions and filed a lawsuit in Delaware. VC Lamb holds that this course of conduct breached (i) Hexion’s covenant to use its reasonable best efforts to consummate the financing and (ii) Hexion’s obligation to keep Huntsman informed about the status of the financing and to notify Huntsman if Hexion believed the financing was no longer available.

VC Lamb notes that “[s]ometime in May, Hexion apparently became concerned that the combined entity … would be insolvent.” (62). He remarks that a “reasonable response” at that time would have been to contact Huntsman and discuss the issue. But rather than doing that, Hexion hired counsel and began analyzing alternatives. At this stage, however, he observes that was not Hexion “definitively” in breach of its obligations. (63). But Hexion and its counsel then hired Duff & Phelps, which developed an insolvency analysis. At that point, “Hexion was … clearly obligated to approach Huntsman management to discuss the appropriate course to take to mitigate these concerns.” (63). Hexion’s failure to do so “alone would be sufficient to find that Hexion had knowingly and intentionally breached.” (64). Rather than doing so, Hexion obtained an insolvency opinion from Duff & Phelps and delivered it to the banks, which VC Lamb regarded as a clear, knowing and intentional breach. (67-68).

Vice Chancellor Lamb then wraps up by writing that “In the face of this overwhelming evidence, it is the court’s firm conclusion that by June 19, 2008 Hexion had knowingly and intentionally breached its covenants and obligations under the merger agreement.” (77). He holds that if it is later necessary to determine damages, “any damages which were proximately caused by that knowing and intentional breach will be uncapped and determined on the basis of standard contract damages or any special provision in the merger agreement.” (77). The merger agreement in fact contains a provision contemplating damages based on the lost value of the merger for stockholders. VC Lamb also rules that Hexion will have the burden to prove that any damages were not caused by its knowing and intentional breach.

After addressing two major issues, VC Lamb declines to make any ruling on the solvency of the combined entity, which was the issue that consumed the bulk of the parties’ litigation efforts at trial. VC Lamb holds that the question of the solvency of the combined company is not ripe “because that issue will not arise unless and until a solvency opinion is delivered to the lending banks and those banks either fund or refuse to fund the transaction.” (78). He notes that solvency of the combined entity “is not a condition precedent to Hexion’s obligations under the merger agreement,” and the lack of a solvency opinion “does not negate [Hexion’s] obligation to close.” (79). The issue is only relevant to the obligation of the lending banks. (79). He therefore leaves it for another day.

Finally, VC Lamb holds that Hexion must specifically perform its obligations under the merger agreement, while noting that the merger agreement specifically exempts Hexion from having the obligated to close. He finds the specific performance provision of the merger agreement to be “virtually impenetrable” and ambiguous, and he therefore resorts to extrinsic evidence, including the testimony of Hexion’s counsel, to interpret its meaning. He concludes that the Court can require Hexion to comply with all of its obligations short of consummation, but cannot order Hexion to consummate. “[I]f all other conditions precedent to closing are met, Hexion will remain free to choose to refuse to close. Of course, if Hexion’s refusal to close results in a breach of contract, it will remain liable to Huntsman in damages.” (87).

The Hexion decision joins IBP and Frontier as the major guideposts for MAE analysis. Hexion applies and elaborates on IBP and Frontier; it does not appear to open up any inconsistencies in Delaware’s approach. The opinion rather tends towards greater clarity in MAE application by establishing a rubric for interpreting carveouts, putting projections off limits when reliance on them has been disclaimed, and establishing a securities law-based standard for evaluating past performance. It is not readily apparent to me what the long-term impact of this greater clarity will be. Some MAE threats will likely not be made and others may be more readily rejected. But since part of the leverage to recut deals and resolve MAE issues flows from uncertainty over how the MAE issues will play out, the existence of more defined judicial standards could result in parties being more aggressive in their MAE positions and less willing to compromise. This ironically could lead to more MAE litigation.

The Hexion opinion is also a reminder of the importance Delaware places on contracts and contractual obligations. Both the URI decision from December 2007 and the Hexion ruling provide examples of Delaware courts enforcing bargained-for contractual provisions. In URI, those provisions favored the acquiror. In Hexion, they favored the target.

The Rise of Sovereign Fund Investing

Tune in tomorrow for this webcast – “The Rise of Sovereign Fund Investing” – and hear about the role of sovereign wealth funds in this crisis marketplace and more:

– G. Christopher Griner, Partner, Kaye Scholer
– Michael Hagan, Partner, Morrison & Foerster
– Jerry Walter, Partner, Fried Frank Harris, Shriver & Jacobson
– Steven Wilner, Partner, Cleary Gottlieb Steen & Hamilton