May 25, 2011

Delaware Refines Rules for Mixed-Consideration Mergers

Here’s news culled from this Wachtell Lipton memo:

The Delaware Court of Chancery last week provided fresh guidance on the standards of director conduct applicable to part-cash, part-stock mergers and reaffirmed the rules of the road for board process and deal protection provisions in strategic mergers. In re Smurfit-Stone Container Corp. S’holder Litig., C.A. 6164-VCP (May 20, 2011).

In a merger agreement announced on January 23, Smurfit-Stone, a leading containerboard manufacturer, agreed to merge with Rock-Tenn Corporation. The agreement provides that Smurfit-Stone stockholders will receive consideration valued at $35.00 per share as of the date of the merger agreement, representing a 27 percent premium over the stock’s pre-announcement trading price, with 50 percent of the consideration payable in cash and the other 50 percent payable in Rock-Tenn common stock. Shareholder plaintiffs sought to enjoin the deal, alleging that the Smurfit-Stone board had improperly failed to conduct an auction and that the deal protection provisions in the merger agreement were impermissible as a matter of Delaware law.

Vice Chancellor Parsons denied the injunction motion. In a matter of first impression, the Court ruled that the so-called Revlon standard would likely apply to half-cash, half-stock mergers, reasoning that enhanced judicial scrutiny was in order because a significant portion “of the stockholders’ investment [] will be converted to cash and thereby deprived of its long-run potential.” The Court twice noted, however, that the issue remains unresolved by the Delaware Supreme Court, and that the “conclusion that Revlon applies [to a mixed-consideration merger] is not free from doubt.”

The Court went on to rule that the shareholder plaintiffs had not shown a likelihood of prevailing on their claims under any standard. Rejecting plaintiffs’ contention that the Smurfit-Stone board had insufficiently managed the merger process, the Court noted with approval that the Smurfit-Stone board “took firm control over the sales process,” “asserted its control over the negotiations” with both a private equity bidder and Rock-Tenn, and “engaged in real, arm’s-length dealings with potential acquirors.”

Vice Chancellor Parsons also rejected plaintiffs’ contention that Smurfit-Stone should have conducted a broad market check before signing the Rock-Tenn merger agreement. Crediting the board’s knowledge of the merger market and its concerns that a broad market check could lead to a damaging leak, the Court reaffirmed that a Delaware company can agree to a merger, even in Revlon mode, without a broad market check, provided that the merger agreement permits the emergence of a higher bid after signing.

Finally, the Court ruled that the deal protection provisions in the merger agreement – including a 3.4% termination fee, customary no-shop provisions with a fiduciary out, and market-standard matching rights – were “relatively standard in form and have not been shown to be preclusive or coercive, whether they are considered separately or collectively.”

The Smurfit-Stone decision suggests that deal planners should expect that any merger including a significant amount of cash consideration is likely to be subject to “intermediate” judicial review under Revlon. At the same time, the decision confirms that Delaware continues to afford informed and well-advised independent directors wide latitude to customize a merger or sales process in the best interests of a target company and its stockholders.