DealLawyers.com Blog

– by Brad Aronstam of Connolly Bove Lodge & Hutz:

Last week, Delaware Vice Chancellor Noble – in In re NYMEX S’holder Litig. (C.A. No. 3621-VCN) and Greene v. New York Mercantile Exchange, Inc. et al. (C.A. No. 3835-VCN) – reflects the Court of Chancery’s latest post-Lyondell decision reinforcing the significant deference afforded under Delaware law to independent boards in the change of control context.

This consolidated action arose out of NYMEX’s August 2008 merger with CME. The plaintiffs alleged numerous breaches of fiduciary duty by NYMEX’s directors that purportedly resulted in NYMEX’s shareholders not receiving fair value for their shares. Specifically, the plaintiffs alleged that NYMEX’s fourteen member Board was dominated and controlled by its then Chairman, Richard Schaeffer, “and that the Board agreed to sell NYMEX through an unfair process at an inadequate price in order for Shaffer and NYMEX Chief Executive Officer and President James Newsome to obtain nearly $60 million in severance payments.”

In rejecting these – and numerous other – shopworn allegations, the Court touched upon a number of noteworthy and evolving principles of Delaware corporate law. Below are some of the highlights:

– Conclusory Allegations of Control Fall Far Short of the Requisite Inference of Domination or Bad Faith – Having determined summarily that twelve of the Board’s fourteen directors were “unquestionably independent,” the Court rejected plaintiffs’ conclusory allegations that mere facially questionable actions by the Board — e.g., actions in which the Board, among other things, (i) approved the above referenced change of control severance plan, (ii) accepted CME’s first offer, (iii) failed to utilize a strategic initiatives committee (the “SIC”) previously formed to consider, negotiate and recommend any significant company transactions, and (iv) failed to obtain a “collar” on the stock portion of the merger consideration — alone failed to support the requisite “dominance such that the independence or good faith of the board may be fairly questioned.” As explained by the Court, the fact “[t]hat directors acquiesce in, or endorse actions by, a chairman of the board — actions that from an outsider’s perspective might seem questionable — does not, without more, support an inference of domination by the chairman or the absence of directorial will.”

– No Single Blueprint for the Fulfillment of Fiduciary Duties – Having rejected plaintiffs’ above allegations as “too conclusory” to support an inference of domination, the Court turned to plaintiffs’ averments concerning the allegedly flawed merger negotiation process. Noting the well established principle in Delaware that “there is no single blueprint that a board must follow to fulfill its duties,” the Court held that “claims of flawed process are properly brought as duty of care, not loyalty, claims and [that such] claims [we]re [accordingly] barred by the exculpatory clause of NYMEX’s Certificate of Incorporation.”

– Heavy Deference to Independent Directors in Assessing Lack of “Good Faith” – In regards to any claims that the Board acted in “bad faith” and thus fell outside the protections of NYMEX’s aforementioned exculpatory clause, the Court found that it could not “be said that the Board intentionally failed to act in the face of a known duty to act, demonstrating a conscious disregard for its duties.” The Court quoted Lyondell and Chancellor Chandler’s recent decision in Wayne County Employees’ Ret. Sys. v. Corti (C.A. No. 3534-CC) in support of the proposition that the Complaint must be dismissed given plaintiffs’ failure to allege “that the Board ‘utterly failed to obtain the best sale price.'” This high standard set forth by the Delaware Supreme Court in Lyondell, as evidenced by recent decisions of the Delaware Court of Chancery, thus poses a substantial obstacle to plaintiffs that are unable to allege violations of the duty of loyalty (e.g., self-dealing transactions involving controlling shareholders or insiders standing on both sides of a challenged deal).

– No Breach of Fiduciary Duties for Chairman and CEO Serving as Sole Negotiators of the Deal – The Court also rejected plaintiffs’ claim that “Schaeffer and Newsome breached their fiduciary duties by being the sole negotiators with CME and not involving the SIC in the consideration or negotiation of the acquisition.” The Court explained that “[i]t was well within the business judgment of the Board to determine how merger negotiations will be conducted, and to delegate the task of negotiating to the Chairman and the Chief Executive Officer.” Important to the Court in reaching this conclusion was its finding “that the Board was clearly independent” and, thus, “there was no requirement to involve an independent committee in negotiations.” Also interesting was the Court’s statement that the “the presence of such a committee [i.e., the SIC] [did not] mandate its use.”

– Continuing Uncertainty Regarding the Applicability of Revlon in Mixed Cash/Stock Deals – While the Court’s holding that NYMEX’s exculpatory provision – and plaintiffs’ failure to allege sufficient facts circumventing the protections of that provision – obviated the need for the Court to specifically decide the issue, the Court noted the continuing uncertainty regarding the applicability of Revlon vis-a-vis transactions involving mixed merger consideration of cash and stock.

Specifically, the Court noted that although “[a] fundamental change of control does not occur for purposes of Revlon where control of the corporation remains, post-merger, in a large, fluid market,” the Delaware Supreme Court “‘has not set out a black line rule explaining what percentage of the consideration can be cash without triggering Revlon.'” Indeed, the consideration paid to NYMEX’s shareholders was 56% CME stock and 44% cash and thus fell between the Supreme Court’s Santa Fe decision (holding that merger transaction involving consideration of 33% cash and 67% stock did not trigger Revlon) and the Court of Chancery’s Lukens decision (holding that a merger transaction involving consideration of 60% cash and 40% stock likely triggered Revlon).

–The Continued Narrow Interpretation of the Parnes Direct/Derivative Exception – Also noteworthy was the Court’s detailed discussion of the direct/derivative inquiry in the merger context and, specifically, the Court’s reaffirmation that the so-called “Parnes exception” for direct challenges to the validity of a merger itself has properly been interpreted “very narrowly.” In short “there must be a causal link between the breach complained of and the ultimate unfairness of the merger” for purposes of pleading a direct claim and overcoming the loss of derivative standing typically accomplished by virtue of the transaction.

The NYMEX decision, when read in concert with the Chancellor’s recent Wayne County decision upon which NYMEX expressly relied, further evidences the weighty deference shown by Delaware courts to independent boards in the change of control context. The decision thus warrants careful review and consideration by M&A practitioners and those who advise them.