November 13, 2008

The Wachovia Shareholder Suit

– by John Jenkins, Calfee, Halter & Griswold LLP

There is some interesting shareholder litigation in North Carolina’s Superior Court over Wells Fargo’s pending acquisition of Wachovia Corporation. In Ehrenhaus v. Baker, 2008 WL 4787584 (N.C. Super. 2008), the plaintiff alleges that the Wachovia directors breached their fiduciary duties by entering into a merger agreement that did not contain an adequate fiduciary out clause, and by entering a lock-up agreement involving the issuance to Wells Fargo of shares representing almost 40% of the corporation’s voting power.

The plaintiff contends, among other things, that the merger agreement’s “fiduciary out” clause was inadequate because it merely permitted the board to change its recommendation, and did not give the board the right to terminate the merger agreement and accept a superior proposal. In addition, the plaintiff alleges that the share exchange agreement under which Wells Fargo obtained preferred stock representing approximately 39.9% of Wachovia’s voting power was a “draconian and unlawful” deal protection that rendered the shareholder vote on the merger essentially meaningless.

This is a fact pattern that the Delaware courts have dealt with quite extensively over the past decade. A series of cases beginning in 1999 culminated in the Delaware Supreme Court’s controversial decision in Omnicare v. NCS Healthcare, 818 A.2d 914 (Del. 2003). In that case, the court held that voting agreements covering shares representing a majority of the total voting power of the corporation were impermissible when combined with a merger agreement provisions that did not permit the target’s board to terminate the deal and accept a superior proposal. Unlike Omnicare, Wells Fargo’s stake in Wachovia is not sufficient to guarantee approval of the merger absent an effective fiduciary out, it is certainly large enough to raise concerns about its potentially preclusive effect. See, for example, ACE Limited v. Capital Re, C.A. No. 17488 (Del. Ch. Oct. 25, 1999).

However, Delaware’s deal protection cases may ultimately prove to be of little relevance to the resolution of this case. That’s because, as Professor Steven Davidoff noted in a recent blog entry, the standard of review for deal protections in North Carolina appears to be very different – and much more director friendly – than the Unocal standard that applies in Delaware.

While Unocal places the burden on the board to establish that a defensive measure is reasonable and proportionate, North Carolina precedent suggests that the burden remains on the plaintiff to rebut the business judgment rule, and that “the court should not intervene unless the shareholder can rebut that presumption by clear and convincing evidence that the deal protection provisions were actionably coercive, or that the deal protection provisions prevented the directors from performing their statutory duties.” First Union Corp. v. SunTrust Bank (N.C. Super. 2001).

In ruling on the plaintiff’s motions for expedited discovery and expedited resolution of his motion for a preliminary injunction against the transaction, the court acknowledged that the plaintiff has alleged colorable claims concerning possible breaches of fiduciary duties. However, at the same time, the court noted that the plaintiff “may well be unable to overcome the high hurdle imposed upon him here by the business judgment rule.” In support of that statement, the court noted the board’s assertion that it needed to act quickly in order to avoid a liquidation of the company by its regulators, as well as the absence of a competing bid.

The court granted plaintiff’s request to rule on its motion on an expedited basis, and established a hearing date of November 24, 2008. It will be interesting to see how the court grapples with these issues in an analytical framework that employs a business judgment rule approach instead of Unocal.