From John Grossbauer of Potter Anderson: Recently, Delaware Vice Chancellor Laster delivered this opinion in In re BankAtlantic Bancorp, Inc. Litigation. In his opinion, the Vice Chancellor grants a permanent injunction against the sale of BankAtlantic Bancorp’s sale of its federal saving bank subsidiary to BB&T because it would violate covenants in several indentures for Trust Preferred Securities that prohibit the sale of “all or substantially all” of the Bancorp assets unless the purchaser assumed the obligations under the indentures.
BankAtlantic argued that the sale did not meet the “all or substantially all” test under New York law because it was retaining “criticized assets” as the consideration for the sale, and that the value of the retained assets rendering the sold banking subsidiary worth zero at closing. The Court rejected this argument, saying that the retained assets should be considered as part of the value of the subsidiary bank being sold, and that, qualitatively, the sale of the bank subsidiary represented the sale of Bancorp’s only operating asset and would fundamentally change the nature of Bancorp’s business. The Vice Chancellor relied extensively on the American Bar Foundation Commentaries on the Model Debenture Indenture.
Francis Pileggi also blogged about this case.
Here’s some analysis by Kevin Miller of Alston & Bird: In a recent decision – In re Micromet – Delaware Vice Chancellor Parsons denied plaintiffs’ motion to preliminarily enjoin Amgen’s acquisition of Micromet by means of a two-step transaction – an all cash tender offer to be followed by a back end merger at a $11 per share in cash.
Among other things, plaintiffs alleged that the Board breached its fiduciary duties by failing to disclose the fees paid by Micromet to Goldman Sachs over the past two years, as well as Goldman’s interest in Amgen stock and by failing to disclose certain information relating to the financial analyses performed by Goldman Sachs:
“Plaintiffs have made numerous disclosure claims in their Complaint and in the briefing. Having read and considered each of those claims, I find that Plaintiffs have not shown a likelihood of success on any of their disclosure claims.
[. . . ]
Goldman holds approximately $336 million in Amgen stock, most of which it holds on behalf of its clients. Even considering its total position, Goldman’s Amgen holdings equal approximately 0.16% of its overall investment holdings and 3.8% of its healthcare sector investments. Moreover, Goldman owns a substantially larger stake in Company B and a similar stake in another company that was contacted by Goldman as a potential acquirer during the market check.
Furthermore, the Recommendation Statement discloses that Goldman and its affiliates “may at any time make or hold long or short positions and investments, as well as actively trade or effect transactions, in the equity, debt and other securities of both Micromet and Amgen. Given this notice, any investor who desired to know the size of Goldman’s position in Micromet or Amgen as of the last reporting period could find this information in Goldman’s publicly-filed Form 13F. More importantly, Plaintiffs did not present any more detailed evidence from which the Court could reasonably infer that the size and nature of Goldman’s Amgen holdings in this case would be likely to impede its ability effectively and loyally to perform its assignment for Micromet.
As for Plaintiffs’ argument for disclosure of the fees paid to Goldman by the target, Micromet, over the past two years, I note that the Recommendation Statement does disclose Goldman’s contingent interest in the transaction, as well as the fees paid by Amgen to Goldman over the past two years. The Recommendation Statement also discloses that Goldman has performed certain services to Micromet in the past and received compensation for those services. Nevertheless, Plaintiffs claim that this partial disclosure requires supplementation to provide the actual amounts received by Goldman. They fail to provide any persuasive explanation, however, as to why the actual amount of fees paid by Micromet to Goldman would be material to shareholders or to cite any Delaware case law mandating such disclosures. This is not a situation in which Micromet, apart from Amgen, would be a potential source of future business.
[. . .]
Plaintiffs also complain that the Company should have disclosed Goldman’s “Sum of the Parts” discounted cash flow (“DCF”) analysis. The Sum of the Parts analysis was not relied on by Goldman in providing its fairness opinion. There is no dispute that Goldman did prepare such analyses at the request of the Board, buy not all analyses produced by financial advisors and given to the board are required to be disclosed under Delaware law. Instead, “[i]n Delaware only that information that is material must be disclosed.”
Here, the total value range reported under the Sum of the Parts analysis was $7.74 to $10.42 and the ex-corporate valuation range, which excluded the costs of running Micromet, was $8.92 to $11.60. Although the high-end of the ex-corporate range under this Sum of the Parts DCF analysis is slightly higher than the high-end of Goldman’s DCF analysis, the latter analysis yielded a substantially similar valuation range of $7.09 to $11.44. Therefore, I find it unlikely that disclosure of the Sum of the Parts DCF analysis materially would have altered the total mix of information available to shareholders. Accordingly, it did not need to be disclosed.
[. . . ]
Finally, Plaintiffs’ claim regarding Goldman’s use of an historical Ibbotson equity risk premium, rather than a supply-side equity risk premium, is not a disclosure claim. Instead, it is a challenge to the methodology employed by Goldman in conducting its illustrative DCF analysis. Under Delaware law, “a complaint about the accuracy or methodology of a financial advisor’s report is not a disclosure claim.” Plaintiffs claim amounts to nothing more than a “quibble with a financial advisor’s work” arguing that Goldman applied an inappropriate equity risk premium in its analysis This does not state a valid disclosure claim.”
The opinion is worth a close reading as it contains lots of additional guidance on a number of current issues relating to process and other disclosure claims.
Last week, Kevin Miller blogged about the hearing transcript in the In re El Paso S’holder Litig. case that wound up being decided the next day. This WSJ commentary by Ronald Barush analyzes Chancellor Strine’s opinion:
Wednesday, Chancellor Leo Strine, who heads the Delaware Court of Chancery, all but threw up on parts of the negotiation process of Kinder Morgan’s acquisition of El Paso. But in the end he decided that if shareholders, who are being told of the troubling facts, can live with it and vote for it, he can hold his nose and let the deal move forward. It doesn’t mean that down the road the defendants, if they don’t settle, won’t be looking at big damages. We will come back to that.
But you have to hand it to El Paso. It gave Chancellor Strine a lot of grist for the mill of his criticism. For example, the CEO got caught considering a management buyout of El Paso’s E&P assets (which Kinder Morgan was always planning to sell) without telling his board, the opinion says. Frankly, it is not clear that he went very far with that interest, but this is a bit like getting caught with too big a lead off of first base. He was just asking to be picked off. Any CEO should know there is going to be litigation and that conflicting interests will be searched for. And it costs nothing to move closer to base and tell your board everything.
And then there is Goldman Sachs. Goldman, one of El Paso’s financial advisers, had different issues. Goldman thought it had fully disclosed its conflict (its PE arm owns a big stake in Kinder Morgan). But in another unforced error, according the Chancellor Strine, even though an attempt was made to wall off the part of Goldman with that interest, no one bothered to tell El Paso that the Goldman lead banker on the El Paso account personally owned $340,000 of Kinder Morgan stock. And in addition, Strine characterized the efforts to address Goldman’s disclosed conflicts as “inadequate.”
But what is more significant than the salacious details–since, after all, if the shareholders vote for the deal Strine will let it close–is the unstated messages of Strine’s opinion. It is filled with implicit warnings to both investment bankers and directors.
First, this decision caps a series of recent decisions where courts have been critical of investment bankers’ conduct and conflicts. The world of investment banking is filled with conflicts. Bankers trade securities, they have proprietary interests (like Goldman’s 19.9% interest in Kinder Morgan) and they seek M&A advisory roles–all at once. There is no code of conduct for investment bankers–they can have conflicts. They should disclose them to their clients, but if clients can live with them, up until recently it would appear to be up to the board of directors’ business judgment as to what to do about them.
But Thursday’s decision, as well as other recent decisions, was highly critical of the conduct of investment banks. Under the business-judgment rule, in which courts defer to disinterested directors, one would expect these matters to be the realm of the business judgment of the directors and not subject to second guessing by a court. However, Chancellor Strine concluded that the plaintiffs have “a reasonable likelihood of success in proving that the Merger was tainted by disloyalty.”
Chancellor Strine does not say it, but the courts are coming very close to the conclusion that investment-banker conflicts are deserving of some form of enhanced scrutiny by a court to determine if a process has been “tainted” by those conflicts–even if they are fully disclosed. That is a big warning to both investment banks and directors that more vigilance is required. As a result, bankers may be forced to pass on more assignments where they have conflicts, even if their client does not object.
There is another subtle warning to directors as well. The court did not criticize the directors for not ferreting out the El Paso chief executive’s desire to buy the E&P products which, according to the Court, gave him a conflicting interest. Indeed the court said it thought it unlikely the directors (other than the CEO) would be held liable for any damages in this case.
Rather, the court was critical of the negotiating strategy of the CEO–largely with the concurrence of the board- which the court characterized as “velvet gloved.” In future cases, directors cannot count on judges being so sympathetic to sale processes that go awry if independent directors are not actively exercising real time oversight. To entrust a CEO with full authority to negotiate a sale of a company without close independent director supervision could lead to something more disastrous. And after the El Paso experience, not to question the CEO carefully about conflicts could damage how a judge looks at a board’s conduct.
This case isn’t over. The court found that the plaintiffs have a reasonable likelihood of prevailing on the merits of the case and the lawsuit has now turned into a damages action. Chancellor Strine hints that he sees exposure in the half billion dollar range (and there will be no jury and he is the judge).
It is likely that in the end Kinder Morgan will end up paying most of any damages since, once the deal is completed, Kinder Morgan will own El Paso and have indemnity obligations to pretty much all of the defendants: the directors, the CEO and Goldman. With a record like this, look for Kinder Morgan to find a way to settle the case and write some checks without the agony of a full-blown trial.
Kevin Miller of Alston & Bird provides this analysis: Although the primary focus of the press coverage regarding the recent In re El Paso S’holder Litig. case in the Delaware Court of Chancery has been on alleged management and financial advisor conflicts, there is a lot of discussion in the hearing transcript regarding valuation issues:
1. Chancellor Strine specifically references the debate as to whether terminal value multiples should be based on a comparable companies analysis (which may implicitly include a minority discount) or a comparable transactions analysis.
2. Plaintiffs allege that the terminal multiples used by El Paso’s financial advisors implied a perpetuity growth rate of 0.7% for a a company that allegedly has significant growth prospects – arguing that its absurd for the financial advisors to have used financial analyses implying that El Paso will grow at less than half the rate of inflation.
3. Chancellor Strine appears critical of using a terminal value multiple based on a comparable companies analysis that is below the mean/median multiple for the comparable companies – effectively taking a haircut off of a multiple that already reflects a minority discount.
See the following quotes from the attached transcript:
On Selection of Terminal Value Multiples
THE COURT: I understand. I assume you’ll think it’s too low. There are ways to do exit multiples because there is, for example, a philosophical debate you could have about if you use a current trading multiple of comparable companies, does that arguably embed a minority discount if you use this as an exit multiple.
On the other hand, if you think the growth rate of companies over time tends to normalize to the market perhaps using the current trading multiples, adjust for that. And, whereas, if you use comparable transactions, which are sales of whole companies, then you’d be overstating the future exit multiple.
You know, so there is that philosophical debate that men and women of valuation science and the academy never solved these problems.
And they don’t really think about them much, but judges like us who have to do appraisals do.
What did they, in fact, use? Did they use a current sample of so-called comparable companies? Did they use comparable transactions? […]
MR. DiPRIMA: I think it’s trading data. And they did look at a median for the current period and used a slightly lower multiple for the terminal period. And that’s calculated in the book, Morgan Stanley’s —
THE COURT: So they used a lower period for the — they used a minority, a current minority trading multiple, and then they reduced it to use it as an exit multiple for an entire company?
MR. DiPRIMA: The multiple they used is I believe slightly below the median.
THE COURT: Of the current minority trading multiples?
MR. DiPRIMA: Correct. And I think part of the idea of that is that when you’re out to 2016, you’re in a slower growth period.
THE COURT: Well, if that’s the idea of it, and that may be part of why I talked about before decelerating the multiple by using a current minority trading multiple, but what you’re saying is they decelerated it even more. They took the minority —
On The Implied Perpetuity Growth Rate
THE COURT: I think what Mr. Clarke said, fundamentally, about KMI is if you look at the objective economic information in this record about KMI versus El Paso in the pipeline area, a big reason why KMI was buying El Paso was because of the attractiveness of its pipeline business; that if, really, what you’re assuming is that the future prospects of that pipeline business as recently as 2015 will translate into a perpetuity growth number of about a third of the historical inflation rate, then Kinder Morgan would not be doing this deal. The whole premise of the deal is stupid. That El Paso is dead. And yeah, I mean, this would be a great deal $10 per share less or something like this.
I mean, to get to a perpetuity growth rate of .7 takes some doing because what you have, obviously, is you’re going to have growth. You look at periods. And there might be a period between 2015 to 2025 where El Paso is still growing higher than the market.
Then you’re talking normalizing. Usually, you have to normalize through when they grow at the rate of the overall economy, then to where they kind of keep and they’re sort of the same share. This assumes that they’re relatively rapidly becoming less valuable as a proportion of the economy; in fact, not keeping up with inflation; in fact, not even keeping up with half of inflation; and it’s just a really odd thing.
On the Use of Medians
THE COURT: I’m talking about whether they used the median — look, I’m not saying the bankers did it here, but it is often the case that bankers will come up with eight comparable companies. That will generate a median. And use something that turns out to be the multiple of one of the companies, and they don’t use the median of their selected companies.
On Equity Risk Premium
THE COURT: Having had a case, frankly, where a very large bank changed the historical — the way it made a deal look more fair was to have its view of the historical equity risk premium change by nearly 2 percent within a period of two months. Which is a remarkable intellectual achievement, given that the historical risk premium is calculated — there is a debate about whether it goes back to the Ibbotson data or whether it goes back to the 19th century.
And then when I asked them whether they had done it at their committee, this is something they had decided for all representations, no. They were on the buy side. I said, Would you ever use this on the sell side? And the guy actually was real candid, and said something like, Heavens no. You know, and —
Here is another excerpt from Shareholder Representative Services’ new 3rd Edition of “Tales from the M&A Trenches“:
The dispute resolution terms in merger agreements are technical and cause many non-lawyers to glaze over when reading them. Details about who controls the defense of third party claims, jurisdiction, arbitration procedures and other similar terms are not fun to read but can be very important if problems do arise later. One particular issue worthy of special attention is which party controls the defense of third party claims. There are good arguments on each side for wanting this control. On the buyer’s side, the third-party claim is usually a claim against the combined company, and the buyer will want to control its exposure to such proceedings. On the seller’s side, if the claim relates to an indemnifiable matter, any payment of fees or settlement amounts is likely to come from the escrow, so the selling stockholders are most likely the ones ultimately paying the bill.
If the party that controls the defense is not the party responsible for any related payments, there can be a moral hazard problem. It is certainly possible that the party with control of such matter will behave differently if it is not their own money at stake. For instance, if the buyer controls the litigation but the payments are to come from the escrow, the buyer might be tempted to hire more expensive counsel than they otherwise would and might be motivated to agree to settlement terms early to avoid spending more time on the matter. Similarly, if the shareholders control the defense of a claim that will be subject to the indemnification basket or that might otherwise not be paid from the escrow, they might behave differently.
If the party that controls the defense is not the party responsible for any related payments, there can be a moral hazard problem.