DealLawyers.com Blog

Tune in tomorrow for the webcast – “Developments in Debt Restructurings & Debt Tender/Exchange Offers” – to hear Casey Fleck of Skadden Arps, Ward Winslow of Jones Day, Jay Goffman of Skadden Arps and Richard Truesdell of Davis Polk discuss how to conduct debt tender and exchange offers and restructure debt – including how these deals have changed in the current economic climate.

Cliff Neimeth of Greenberg Traurig notes (here are memos regarding this case):

As expected, on Tuesday, Delaware Chancellor William Chandler upheld the Airgas rights plan using a traditional Unocal/Unitrin analyses (and a DGCL 141 director-stockholder balance of power policy analyses) to assess the validity of maintaining the Airgas pill in place to block consummation of Air Product’s fully financed, non-coercive tender offer which all three of Airgas’ financial advisors deemed inadequate.

The decision in Air Products and Chemicals, Inc. v. Airgas, Inc., C.A. No. 5249-CC has various unique (and outcome determinitive) facts – chief among them that each of the three members of the Airgas Board who recently won election in last year’s Air Product’s short-slate proxy fight determined that Air Products $70 “final and best” offer price was clearly inadequate (by at least $8 per share).

The decision is careful not to suggest that “just say no” or “say never” is indefinitely sustainable by a target Board. But, as always is the case with Delaware’s highly context-specific decisions, the (modern pill) fact pattern has not yet presented itself where the Court of Chancery actually orders redemption in a circumstance where the target Board and management offer no meaningful strategic or financial value maximizing alternative to an unsolicited offer, and a substantial majority of stockholders have tendered into such fully financed, “financially fair” and non-coercive offer which has remained open for a protracted time period.

The last time a redemption order was “threatened” by the Delaware Court of Chancery was a few years ago when VC Strine encouraged Oracle and People Soft to settle the pill and related litigation after a protracted takeover battle and numerous increases to the tender offer price where a majority of stockholders had tendered their shares. We’ll have to wait a bit longer to see the “say yes”- pill redemption order case.

Here is news repeated from this Richards Layton memo:

In In re Del Monte Foods Company Shareholders Litigation, Consol. C.A. No. 6027-VCL (Del. Ch. Feb. 14, 2011), the Court of Chancery found on a preliminary record that a proposed $5.3 billion cash merger (including assumption of debt) with a group of private equity buyers was potentially tainted by alleged misconduct by the target banker, with the alleged knowing participation of the buyers. The Court preliminarily enjoined the defendants from proceeding with a stockholder vote on the proposed transaction for a period of twenty days and further enjoined the defendants from enforcing certain deal protection measures in the merger agreement (including no solicitation, termination fee and matching right provisions), pending the stockholder vote.

Under the terms of the merger agreement, a private equity group consisting of Kohlberg Kravis Roberts & Co., Vestar Capital Partners, and Centerview Partners would acquire all outstanding shares of Del Monte common stock for $19 per share. The Court expressed that, on the preliminary record, the Del Monte board appeared to have “sought in good faith to fulfill its fiduciary duties” and predominantly made decisions that ordinarily would be regarded as falling within the range of reasonableness for purposes of Revlon enhanced scrutiny. The Court found, however, that the Board “was misled by Barclays” Capital, its financial advisor, and that Barclays “secretly and selfishly manipulated the sale process.”

In particular, the Court noted that (1) Barclays “crossed the line” in seeking permission from Del Monte to provide buy-side financing before a price was agreed to between KKR and Del Monte while failing to disclose to the Board the fact that Barclays had intended to seek to provide buy-side financing since the beginning of the process; and (2) Barclays had paired Vestar with KKR in violation of existing confidentiality agreements and then concealed the fact of the pairing from the Board for several months. According to the Court, the pairing of KKR and Vestar materially reduced the prospect of price competition for Del Monte. Further, the Court found (on the preliminary record) that plaintiff had shown a reasonable probability of success on its claim that the Board, despite not knowing the extent of Barclays’ behavior, failed to act reasonably in ultimately acceding to Barclays’ request to provide buy-side financing and Barclays’ recommendation to permit Vestar to participate in KKR’s bid, and by then permitting Barclays to run the go-shop process. The Court also found (on the preliminary record) that plaintiff had shown a reasonable probability of success on its claim that KKR “knowingly participated” with Barclays in these self-interested activities.

The Court concluded that loss of “the opportunity to receive a pre-vote topping bid in a process free of taint from Barclays’ improper activities” constituted irreparable injury to the Del Monte stockholders. The Court held that the imprecision of a potential post-closing monetary remedy weighed in favor of injunctive relief, as did the powerful defenses available to the director defendants (including exculpation under Section 102(b)(7) and reliance on the advice of experts selected with reasonable care under Section 141(e) of the General Corporation Law of the State of Delaware).

Finally, regarding the balance of the hardships, the Court considered that an injunction could jeopardize the stockholders’ ability to receive a premium for their shares and pose difficult questions regarding the parties’ contract rights under the merger agreement. The Court also recognized that the deal had been subject to a 45-day go-shop period and to a continuing “passive market check” for several more weeks. Ultimately, however, the Court concluded that enjoining the deal protection devices was appropriate because “they are the product of a fiduciary breach that cannot be remedied post-closing after a full trial,” and a twenty-day injunction would “provide ample time for a serious and motivated bidder to emerge.” The Court conditioned the injunction on plaintiff posting a bond in the amount of $1.2 million.

Ken Adams has been sharing his contract interpretation wisdom with us for some time. So I was excited to see that he has packaged his knowledge into a new PDF-only book entitled, “The Structure of M&A Contracts.” Here is an excerpt that deals with the phrase “double materiality”:

Another issue related to materiality is “double materiality.” It ostensibly arises when a materiality qualification is included in the bringdown condition to one party’s obligation to close as well as in one or more representations of the other party. The concern is apparently as follows: If the bringdown condition to the buyer’s obligation to close incorporates a materiality qualification, then to determine whether that condition has been satisfied you apply a discount to the accuracy required for any given seller representation to be accurate. If a seller representation itself includes a materiality qualification, the same discount is also applied to the representation, with the result that the level of accuracy required to satisfy the bringdown condition is further reduced. Consequently, the buyer could be required to close even if a seller representation was on the date of the agreement, or is at closing, materially inaccurate.

It’s common practice for drafters to seek to neutralize double materiality. To do so, either they incorporate in the bringdown condition a materiality qualification only with respect to those representations that do not themselves contain a materiality qualification, as in [12f], or for purposes of the bringdown condition they strip out materiality qualifications from those representations that have them and apply instead a materiality qualification across the board, as in [12g].

But such contortions are unnecessary. If material conveys the “affects a decision” meaning (see 2.77)–and using the proposed definition of Material and Materially would make it clear that that’s the case (see 2.86)–then materiality qualifications are not in fact equivalent to an across-the board discount on accuracy, and materiality on materiality isn’t equivalent to a discount on a discount. Instead, for purposes of determining both accuracy of a representation subject to a materiality qualification and satisfaction of a bringdown condition subject to a materiality qualification, one would consider the same external standard–whether the representation inaccuracy in question would have affected the buyer’s decision to enter into the contract or would affect the buyer’s decision to consummate the transaction. Because the same standard applies in both contexts, for purposes of determining satisfaction of the bringdown condition it’s irrelevant whether the representation too contains a materiality qualification.

So the notion of double materiality is based on a misunderstanding of how materiality operates in M&A contracts. It should come as no surprise that caselaw makes no mention of double materiality–it’s a figment of practitioner imagination.

West is new to ebooks, so for the moment the book is available only by calling West at (800) 308-1700. It only costs $25! The first chapter is available for free to give you more of a taste. Learn more about the book.

– by Tom Bayliss, Abrams & Bayliss LLP

On January 28th, the Delaware Supreme Court issued a decision in King v. VeriFone Holdings, Inc., No. 330, 2010. The twenty-four page opinion reverses a Court of Chancery decision dismissing a books and records suit under 8 Del. C. § 220 because the stockholder plaintiff had previously initiated a derivative action in California. The Supreme Court’s opinion is important because it rejects a bright-line rule that would require stockholders seeking books and records to demand them first, before filing corresponding derivative litigation.

Take Aways:

1. In the opinion, Vice Chancellor Strine articulated several policy reasons for imposing a rule requiring the submission of a books and records demand before the initiation of derivative litigation. Writing for the Court en banc, Justice Jacobs acknowledged the legitimacy of these policy concerns but determined that a bright-line rule was inconsistent with the results reached in Disney, McKesson HBOC and CNET — three cases which allowed § 220 inspections despite the plaintiff’s prior initiation of derivative litigation. Ironically, practitioners have generally viewed Disney, McKesson, HBOC and CNET and their tortured histories (including failed attempts to plead demand futility) as examples of what not to do as a plaintiff when pursuing derivative claims against a Delaware corporation.

2. Read broadly, the result in VeriFone suggests that stockholders of Delaware corporations may simultaneously pursue corporate books and records under § 220 and derivative claims against the corporation’s directors and officers. This timing issue is critical, because under prior law (at least as it was understood by the Court of Chancery), derivative plaintiffs had to elect whether to (a) seek books and records and then follow with a detailed, fact laden derivative complaint or (b) file suit quickly without seeking books and records to maximize the chance of winning the race to the courthouse (and capturing lead plaintiff status).

3. Anecdotal evidence suggests that under the prior rule, most derivative plaintiffs chose to forego § 220 inspections, win the race to the courthouse and then fight dismissal on typically weak pleadings drafted without the benefit of access to the corporation’s books and records. VeriFone appears to allow stockholders who win the race to the courthouse to avail themselves of the benefit of § 220 after having captured lead plaintiff status (once they know whether the investment in time and resources is likely to pay off). This may lead to more § 220 inspections and better derivative pleadings in the long run, but it undercuts the incentive to conduct pre-suit § 220 inspections, something the Delaware Supreme Court and the Court of Chancery have long encouraged.

4. The result in VeriFone seems to cut against the result contemplated by Court of Chancery Rule 23.1 and analogous rules in other jurisdictions (including Federal Rule 23.1) which have been interpreted to bar discovery until a derivative plaintiff satisfies its substantial pleading burdens. VeriFone appears to envision a regime in which a stockholder can seek indirectly — through a books and records inspection — precisely the type of information that the stockholder cannot seek directly in the pending derivative action before surviving a motion to dismiss. If VeriFone allows this end run around federal pleading requirements, it could reinvigorate pre-emption arguments that, at least until now, have made little headway in § 220 cases.

5. Future litigants will dispute whether VeriFone should be limited to its facts. The stockholder in VeriFone had brought derivative litigation in the United States District Court for the Northern District of California. The federal court had dismissed the stockholder’s suit without prejudice and suggested that the stockholder “engage in further investigation to assert additional particularized facts” by filing a Section 220 action in Delaware. It is unclear whether the federal court’s instruction played a critical role in the Supreme Court’s decision-making process.

6. Future litigants may also dispute whether some form of dismissal is required before the holding in VeriFone becomes applicable. However, it is not entirely clear why the opinion should be limited in that way. The plaintiff in VeriFone filed an amended derivative complaint in federal court during the pendency of the § 220 proceeding. Thus, the Supreme Court’s decision appears to validate the use of a § 220 proceeding to support a pending derivative action regardless of a prior dismissal order.

7. In the opinion, the Supreme Court emphasizes that filing a derivative suit first and then seeking books and records is “ill-advised” and “may well prove imprudent and cost-ineffective.” However, the powerful incentives that drive the race to the courthouse will likely overwhelm these warnings, particularly if a books and records inspection is available after the commencement of a derivative suit. Because of this dynamic, VeriFone may reduce the number of pre-suit § 220 demands (and increase the number of post-suit § 220 demands) served on Delaware corporations.

8. The result in VeriFone may increase the likelihood that corporate defendants will face two suits filed by the same plaintiff in different jurisdictions – one seeking books and records and another seeking damages and other relief against the corporation’s officers and directors. A representative plaintiff may be better off filing its books and records suit and its derivative suit in different jurisdictions to avoid arguments that the books and records demand constitutes impermissible backdoor discovery prohibited by Court of Chancery Rule 23.1 or the analogous rule in the applicable forum. However, VeriFone could be interpreted to allow this backdoor discovery as matter of right.

9. The result in VeriFone may widen a chink in the armor of corporate defendants that are otherwise protected by the automatic discovery stay in the Private Securities Litigation Reform Act. Derivative actions have always represented a potential vulnerability to these defendants, but the high pleading burdens associated with those derivative actions have typically served as a formidable barrier. VeriFone may presage a new breed of derivative litigation that involves complaints armed with details from post-suit books and records inspections.

10. The Supreme Court emphasizes that “[i]f relief under Section 220 is to be restricted in the manner adjudicated by the Court of Chancery, any such restriction should be imposed by the General Assembly, not decreed by judicial common law decision-making.” It is unclear whether the General Assembly will respond to this invitation.

11. The VeriFone decision may not have any effect on the parties to that action. In a footnote, the Supreme Court acknowledges that the federal district court had dismissed the stockholder plaintiff’s derivative suit with prejudice during the pendency of the appeal. The Supreme Court refused to find that this development mooted the dispute because the Court of Chancery’s decision announced a principle of Delaware law “that could have significant impact in future cases… and should be subject to appellate review before it becomes operational prospectively.”

Tune in tomorrow for the DealLawyers.com webcast – “Recent Developments Regarding Fairness Opinions, Valuation Analyses and Related Topics” – to hear Kevin Miller of Alston & Bird, Steve Kotran of Sullivan & Cromwell, Stuart Rogers of Credit Suisse Securities and Jennifer Muller of Houlihan Lokey discuss the latest developments and trends of fairness opinions and valuation analyses. Please print off these course materials before the program.

This January-February issue of the Deal Lawyers print newsletter was just sent to the printer and includes articles on:

– How to Respond to Shareholder Proposals Seeking Board Declassification
– The ABCs of Board De-Staggering
– Acquiring US Companies with Foreign Subsidiaries: Relevant Issues
– The Window Closing Pill: One Response to Stealth Stock Acquistions

If you’re not yet a subscriber, try a no-risk trial to get a non-blurred version of this issue on a complimentary basis.

Here is news from Richards Layton & Finger culled from this memo (posted in our “Minority Holders” Practice Area):

Following trial in In re John Q. Hammons Hotels Inc. Shareholder Litigation, the Delaware Court of Chancery ruled in favor of defendants, finding that the merger price was fair value, that controlling stockholder John Q. Hammons did not breach his fiduciary duties, and that the third-party acquirers did not aid and abet a (nonexistent) fiduciary duty breach.

In the Court’s summary judgment opinion in this case, the Court applied the entire fairness standard of review to the merger, which involved the third-party purchase of a corporation with a controlling stockholder who received consideration that was different from the minority. Because the transaction was approved by an independent and disinterested special committee, plaintiffs bore the burden at trial of proving the transaction was unfair. In its post-trial opinion, the Court noted that defendants “may actually have been entitled to business judgment rule protection,” but it analyzed the transaction under the entire fairness standard and found the process and the price to be fair.

The Court found that Mr. Hammons did not breach any fiduciary duties, particularly as he took less per-share consideration than the minority stockholders received. Finally, because no fiduciary duties had been breached, the Court rejected the claim against the acquirers for aiding and abetting.

Here is news culled from this Wachtell Lipton memo:

Last week, Industrial and Commercial Bank of China announced that it had entered into an agreement to purchase 80 percent of the outstanding common stock of the U.S. subsidiary bank of The Bank of East Asia, Limited, a privately held Hong Kong-based bank. Bank of East Asia also has an option to sell to ICBC its remaining 20% interest in the U.S. bank for a period of 10 years following the acquisition. Although relatively small in size, this transaction is a most significant precedent. The ICBC deal would mark the first control acquisition by a mainland Chinese bank of a U.S. bank since Congress passed a law in 1991 substantially tightening the regulation of foreign banks operating in the U.S. following the collapse of BCCI. The transaction could be the start of a very significant new dynamic in U.S. bank M&A.

Chinese banks have tried for years to try to persuade U.S. regulators to permit them to acquire a U.S. bank. The primary regulatory obstacle has been that, by law, the Federal Reserve may not approve an acquisition by a foreign bank of a U.S. bank unless the Federal Reserve determines that the foreign bank is subject to comprehensive supervision or regulation on a consolidated basis by its home country supervisor. To do so, the Federal Reserve must find that the foreign bank is supervised or regulated so that its home country supervisor receives sufficient information on the worldwide operations of the bank, including its relationship to any affiliates, to assess the bank’s overall financial condition and its compliance with law and regulation.

An initial determination by the Federal Reserve that a foreign bank regulator exercises comprehensive consolidated supervision is highly fact dependent and can take years of analysis and deliberation. Here, the analysis is made more challenging by significant factors specific to China, including the unique structure of the Chinese political system, and the extremely rapid pace of change in China’s economy and financial markets. That being said, once the Federal Reserve has determined that a foreign bank regulator meets this standard, the determination becomes much less of an issue in subsequent acquisitions by the same bank or by other banks from that country.

The transaction is subject to regulatory approval, and both the U.S. Committee on Foreign Investment in the U.S. (an interagency committee headed by the Secretary of the Treasury) and the Federal Reserve will certainly give it a close review. However, given the larger political context and the events surrounding the announcement of the deal, it seems likely that the parties have carefully vetted this transaction from all relevant angles.

In a hearing on Monday, upon motion to preliminarily enjoin the acquisition of Occam Networks by Calix, Delaware Vice Chancellor Travis Laster made a number of significant rulings in Steinhardt v. Occam Networks (Del. Ch. Ct.; 1/24/11) , including a ruling that could significantly alter the parameters of when the enhanced scrutiny (application of the Revlon rules generally requiring a board to seek the best price reasonably available) rather than the presumption of the business judgment rule will apply to a stock and cash merger.

According to the September 16th press release of the parties announcing the transaction:

Calix [will] acquire Occam Networks in a stock and cash transaction valued at approximately $171 million, which is approximately $7.75 per outstanding share of Occam Networks stock. . . . each outstanding share of Occam Networks common stock (other than those shares with respect to which appraisal rights are available, properly exercised and not withdrawn) will be converted into the right to receive (a) $3.8337 per share in cash, without interest plus (b) 0.2925 of a validly issued, fully paid and non-assessable share of Calix common stock. After the completion of the acquisition, former Occam Networks stockholders will own between 16.5 percent and 18.9 percent of the outstanding shares of Calix’s common stock based on the number of Calix shares outstanding as of September 15, 2010″ Other published reports noted that the $7.75 per share in consideration represented a 27% premium to the share price of Occam stock prior to the announcement of the transaction.

In this transcript of the hearing, VC Laster suggests that a transaction in which the target stockholders will only own approximately 15% of the acquiror after giving effect to the transaction is a “final stage transaction” requiring the application of enhanced scrutiny (i.e., the Revlon rules) rather than the presumption of the business judgment rule:

“This is a deal where the consideration was approximately 50 percent cash floating based on the market price. It was priced as up to 19.9 percent of the acquirer’s share plus enough cash to make the total value number. But the problem is it actually doesn’t receive the 19.9 because of their employee options and awards that are rolling, and so the public will end up holding approximately 15 percent of the post-transaction entity after the fact.

We tend to focus, in our juris prudence, on change of control and the change of control test. So there was a lot of debate over whether this, in fact, was sufficient cash to merit a change of control. I think what people need to remember is that the change of control test is ultimately a derivative test. The point is that when enhanced scrutiny applies is when you have a final stage transaction. The reason enhanced scrutiny applies to a change of control is because it’s a constructive final stage transaction. You’re giving up control to a person who could then cash you out because he’s the new controller. This is a situation where the target stockholders are in the end stage in terms of their interest in Occam. This is the only chance they have to have their fiduciaries bargain for a premium for their shares as the holders of equity interests in that entity.

It’s easy to see here in two ways. First, it’s easy to see in terms of the amount of cash. If you want more cash for your shares, this is the only time you have to get it. But it’s also easy to see in terms of the amount of interest you’re going to have in the post-transaction entity. We often talk about, oh, well, but the stockholders can get a future control premium. That’s all well and good for the future entity, but what you’re bargaining over now is how much of that future premium you’re going to get.

So let’s say that Calix is some day sold, and let’s all hope that it does very well and becomes an attractive acquisition target, and that one of the big boys picks it up at some point for a healthy premium. The target stockholders today are bargaining for what their share of that premium will be. They’re going to only get 15 percent, and obviously there could be more acquisitions that dilute everybody, et cetera. I get that. But as between the Calix stockholders and the Occam stockholders, now is the time; when the target fiduciaries are bargaining for how much of that future control premium their folks will get. This is it. This is the end. This is the only opportunity where you can depend upon your fiduciaries to maximize your share of that value.

I think back in 1989, it made sense for people to be worried over the line between Revlon and non-Revlon. It was three years after that landmark case. That case was a Cunian[sic] paradigm shift if there ever was one. We had language in there like “auction duty, radically altered state,” really seemingly heavy duty stuff. We now know it’s a reasonableness standard. There’s no single blueprint. A target board doesn’t have to take the facially higher cash price. It can consider the strength of the currency. It can take a stock deal if it believes that the stock offers better long-term appreciation and more potential synergies.

That’s why I said at the outset in this case it’s just not worth having the dance on the head of a pin as to whether it’s 49 percent cash or percent cash or where the line is. This is the only chance that Occam stockholders have to extract a premium, both in the sense of maximizing cash now, and in the sense of maximizing their relative share of the future entity’s control premium. This is it. So I think it makes complete sense that you would apply a reasonableness review, enhanced scrutiny to this type of transaction.”

The Occam ruling appears to imply that because Occam stockholders will only own 15% of Calix after giving effect to the transaction, they are less likely to get a significant premium if Calix is subsequently acquired, even though Calix does not appear to have a controlling stockholder or group of stockholders.

Historically, the courts and most practitioners have focused on the percentage of the consideration being paid in cash v. the percentage being paid in stock – i.e., the greater the percentage of the consideration paid in stock, the greater the likelihood that target stockholders will be able to obtain a significant premium in a subsequent transaction in addition to the premium, if any, received in the initial transaction. See footnote 27 in Lawrence Hamermesh’s UPenn Law Review article “Premiums in Stock-for-Stock Mergers and Some Consequences in the Law of Director Fiduciary Duties” that says:

See In re Santa Fe Pac. Corp. S’holder Litig., 669 A.2d 59, 70-71 (Del. 1995) holding that a transaction in which thirty-three percent of the company’s shares were acquired for cash was not subject to Revlon duties—the duties of a board of directors, once they have decided to sell control of the company, to gain the best available price for the shareholders of that company); cf. In re Lukens Inc. S’holders Litig., 757 A.2d 720, 732 n.25 (Del. Ch. 1999) (suggesting that a merger in which consideration consisted of sixty-two percent cash and thirty-eight percent stock of the acquirer would likely be subject to Revlon duties).

It is not clear why the Occam Court‘s reasoning would not be equally applicable to a stock for stock merger where the target’s stockholders will only own a small percentage of the pro forma combined entity. See Arnold v. Soc’y for Sav. Bancorp., Inc., 650 A.2d 1270 (Del. 1994) for an example of a pure stock for stock transaction in which the court rejected the notion that Revlon duties were triggered even though the acquiror was many times bigger than the target, focusing instead on the lack of a change in control where control of both corporations remains in a large, fluid, changeable and changing market.

Based on the information in the press release announcing the transaction, it appears that Calix/Occam transaction is a 50% cash/$50% stock deal in which the stockholders of Occam are effectively rolling over half of their investment into shares of Calix and will preserve the opportunity to get the same premium as other Calix stockholders if and when Calix is ultimately sold in addition to the 27% premium received in Occam’s acquisition by Calix.