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This Davis Polk memo says that the plaintiffs’ bar has discovered Section 203 of the DGCL – the Delaware Takeover Statute – and has recently been asserting claims based on alleged non-compliance with its requirements in M&A litigation. That statute restricts second stage merger transactions & other business combinations between a target corporation and an “interested stockholder” – which it defines generally as someone who acquired a 15% or greater stake in the target without the prior approval of the target’s  board of directors.

As this excerpt from the memo explains, plaintiffs are alleging that a “meeting of the minds” on voting agreements and similar support arrangements between a potential buyer and major stockholders occur prior to the board’s authorization of the deal and result in the buyer becoming an interested stockholder:

Plaintiff stockholders are claiming that discussions and negotiations for a support agreement (i.e., a commitment to tender into a tender offer or vote in favor of a merger) or a rollover agreement (i.e., an agreement to take equity in the surviving corporation or its parent in a merger, in lieu of the merger consideration paid to other target stockholders) between an acquirer, on the one hand, and stockholders of the target who either individually or collectively own 15% or more of the target’s voting stock, on the other, resulted in the formation of an agreement, arrangement or understanding between the acquirer and those stockholders (and therefore the acquirer has ownership of that stock for purposes of Section 203) without receiving prior approval by the target’s board.

The plaintiff stockholders are essentially arguing that these discussions evidence a “meeting of the minds” among the acquirer and those stockholders for the purpose of tendering, voting or rolling over equity. And the claim is that Section 203 was triggered because this meeting of the minds occurred at a time prior to approval by the target board of the merger agreement.

The memo points out that if a friendly deal inadvertently runs afoul of Section 203, that opens up a great big bag of snakes – including heightened stockholder approval requirements and potential breaches of the target’s reps & warranties in merger agreement.

Fortunately, the memo says that Delaware courts have been hesitant to accede to plaintiffs’ efforts to expand the reach of Section 203 beyond hostile deals, and have generally rejected arguments that negotiations around support agreements resulted in the buyer becoming an interested stockholder in advance of board approval.  It also offers up recommendations on how boards and their advisors can structure the negotiation process to reduce the risk of these allegations.

– John Jenkins