– by Steven Haas, Hunton & Williams

As one of his last acts before moving on, Delaware Vice Chancellor Lamb issued a noteworthy decision in Louisiana Mun. Police Employees’ Ret. Sys. v. Fertitta, 2009 WL 2263406 (Del. Ch.; 7/28/09), upholding challenges to a special committee’s decision to terminate a merger agreement and not block a CEO’s open-market purchases to acquire control of the company.

Background

Fertitta arose from Landry’s Restaurants’ failed go-private transaction led by its CEO, who owned 39% of the company prior to the deal. After the merger was announced, some of the company’s Texas locations were damaged by a hurricane. The CEO immediately claimed that his lenders would declare an MAE if the transaction was not renegotiated. The company’s special committee agreed and reduced the merger consideration and the reverse termination fee. In exchange, the CEO negotiated with his lenders and obtained their commitment to refinance the company’s existing debt if the merger wasn’t consummated.

After the renegotiation, two key events took place. First, the CEO made open-market purchases of Landry’s stock, increasing his stake from 39% to 56.7%. Second, the SEC requested additional disclosures about the CEO’s acquisition financing. The lenders refused to consent to the disclosures, so the company terminated the merger agreement. The special committee claimed that by terminating the merger agreement, it preserved the lenders’ obligation to refinance the company’s existing debt – though it also relieved the CEO from paying a $15M reverse termination fee under the merger agreement.

Opinion

The Court of Chancery upheld all claims against the CEO and special committee based on the following three factors: “(1) [the CEO’s] negotiation (and the board’s acquiescence to his taking that role) of the refinancing commitment on behalf of the company as part of the amended debt commitment letter; (2) the board’s apparent and inexplicable impotence in the face of [the CEO’s] obvious intention to engage in a creeping takeover; [and] (3) the board’s agreement to terminate the merger agreement, thus allowing [the CEO] to avoid paying the $15 million reverse-termination fee.”

The decision could rest almost exclusively on the CEO’s status as controlling stockholder, which gives rise to a per se rule of entire fairness review because of the potential for undue influence. For purposes of a motion to dismiss, the court viewed the CEO’s management position plus 39% stock ownership sufficient to demonstrate actual control over the corporation. The CEO then obtained true majority control through his stock accumulation by the time Landry’s terminated the merger agreement.

Nevertheless, the court seems to have been particularly struck by the substantive decisions allegedly made by an independent and disinterested special committee. Even if the CEO did not have “controlling stockholder” status, the allegations of disloyal conduct were likely sufficient to rebut the business judgment rule. The “Deal Professor” Blog chronicled problems with this transaction last October in this blog – and again this January in this one.

Upholding the waste claim is particularly unusual and could have been decided differently, by finding that the board exercised its discretion to secure a $400 million refinancing by forgoing a $15M reverse termination fee. This is the second notable waste claim to go forward in Delaware in the past few months (see Citigroup, refusing to dismiss a waste claim challenging an outgoing CEO’s severance package).

The court’s criticism of the CEO’s open-market purchases is more straightforward. The court confirmed there is no per se rule that directors must adopt a particular defensive measure in response to an accumulation of shares. However, this case presented a CEO who obtained majority control without paying a premium. That, along with other allegations of “suspect conduct,” supported a “reasonable inference at the motion to dismiss stage that the board breached its duty of loyalty in permitting the creeping takeover.” It’s unclear whether the special committee spotted this issue before agreeing to the merger agreement, which may have had covenants barring adoption of a rights plan. The ability of stockholders to obtain a control premium later will be a significant damages issue at trial. Earlier this year, in Loral, the court nullified the voting rights of preferred stock that was issued in breach of the board’s fiduciary duties.

Lastly, the decision highlights some ongoing disclosure issues relating to buyer-financing. When the M&A markets return, this may be an area of increased SEC oversight. If so, the ability to invoke legal “outs” to provide information will be important as long as commitment letters are not publicly disclosed. Here, the court was skeptical that the banks could have walked rather than consent to the additional disclosures, noting that “such commitment letters generally contain an exception to any confidentiality clause to the extent disclosure is required by applicable law.”

– by John Jenkins, Calfee Halter & Griswold

Kevin Miller’s recent blog on Berger v. Pubco touched on a recurring topic of discussion in the Delaware courts – the extent to which projections need to be disclosed to shareholders in connection with a merger. Delaware courts have spent a lot of time on this issue, but it’s a topic on which their decisions have shed plenty more heat than light.

Questions about projections frequently are raised in connection with claims concerning the overall adequacy of fairness opinion disclosure. It is probably fair to say that Vice Chancellor Strine’s view in Pure Resources that shareholders are entitled to a “fair summary” of the investment banker’s work has been accepted by other members of the Chancery Court, but what a “fair summary” requires in terms of disclosure about projections is an issue that the judges have really struggled to resolve. Their struggles are reflected in a series of opinions that involve a lot of hair-splitting and not much in the way of useful guidance.

Unfortunately, the Delaware courts do not appear to have an easy way out of this messy, ad hoc approach to projection disclosure, and M&A lawyers are likely to struggle with very murky guidance on this topic for quite some time. That raises a question: just exactly how did Delaware get into this situation in the first place?

The roots of Delaware’s projections problem go back to the mid-1980s, and specifically to a case called Weinberger v. Rio Grande Indus., Inc., 519 A.2d 116 (Del. Ch. 1986). In that case, the Chancery Court adopted the Third Circuit’s test for determining whether projections need to be disclosed. In Flynn v. Bass Brothers, 744 F.2d 978, 988 (3d Cir 1984), the Third Circuit held that for purposes of the federal securities laws, the existence of a duty to disclose projections should be determined on a case-by-case basis “by weighing the potential aid such information will give a shareholder against the potential harm, such as undue reliance, if the information is released with a proper cautionary note.”

The Flynn court’s take on disclosure of projections represents a minority position among federal circuit courts. Most appellate courts that have addressed the issue take the position that the federal securities laws do not impose an obligation upon an issuer to disclose projections. See, e.g., Glassman v. Computervision, 90 F.3d 617, 631 (1st Cir. 1996). The Sixth Circuit, which probably continues to reflect the view of most circuit courts that have addressed the issue, has criticized the Third Circuit’s standard, noting that it is “uncertain and unpredictable judicial cost-benefit analysis.” In the Sixth Circuit, soft information is only required to be disclosed if it is “virtually as certain as hard facts.” Starkman v. Marathon, 772 F.2d 231 (6th Cir. 1985).

Obviously, the disclosure gurus among our readers know that I’m painting with a very broad brush here, and there are a number of nuances that can result in exceptions to the “majority view” that disclosure of projections is not required. What’s more, as a practical matter, the SEC Staff will frequently push for disclosure of information about projections if it is not contained in a summary of the fairness opinion including in a merger proxy statement.

My point is only that by adopting the Third Circuit’s position as the starting point, the nation’s most influential state corporate law court has adopted the least influential federal approach to the issue of disclosure of soft information, and the consequences of that decision for M&A litigation have been far reaching. In fact, it seems fair to say that adoption of the facts and circumstances-based Flynn standard made the subsequent unpredictability of Delaware’s case law on projections almost inevitable. What’s more, adoption of that standard also guaranteed that there would be plenty of cases in which disclosure of projections would be at issue.

In order to understand why both of these outcomes were likely, you need to appreciate that disclosure litigation in Delaware offers some real advantages to a plaintiff to begin with. The business judgment rule does not protect against disclosure claims, because a decision about disclosure is not “a decision concerning the management of the business and affairs of the enterprise.” In re Anderson, Clayton Shareholders Litig., 519 A.2d 669 (Del. Ch. 1986). Disclosure claims have proven to be an effective way for plaintiffs to obtain an injunction against a pending merger transaction, which maximizes their potential leverage in negotiating a settlement.

When you add Flynn‘s plaintiff-friendly disclosure standard into the mix with the existing advantages of disclosure litigation, you can see why disclosure of projections is raised as an issue in so many M&A cases. There seems to be no reason to expect that the Delaware courts will see less of these cases in the years to come and, unfortunately, there also seems to be no reason to expect that these new cases will provide clearer guidance on when projections will need to be disclosed or how much will need to be said about them.

In this podcast, Bob Filek of PricewaterhouseCoopers discusses the state of the M&A market, including:

– What major deal trends have characterized 2009?
– What have been the biggest surprises?
– Why are cross-border deals at greatest risk due to the down market?
– What will restore CEO confidence?
– How big is the distressed M&A opportunity?
– What sectors are still consolidation hot spots?