From Kevin Miller of Alston & Bird: In Shandler v. DLJ Merchant Banking, a recent decision of the Delaware Court of Chancery, the Chancery Court refused to apply the choice of law provision in an investment bank’s engagement letter to a claim alleging that the investment bank had aided and abetted a breach of fiduciary duty.
Noting that the choice of Ohio law would have been outcome determinative (Ohio law does not appear to recognize claims for aiding and abetting a breach of fiduciary duty, and the application of Ohio law would have required the dismissal of that claim against KeyBanc), the Delaware Chancery Court held that:
“the mere fact that any contractual or malpractice obligations KeyBanc owed to Insilco were governed by Ohio law does not give Ohio a stronger interest in[sic] Delaware as to an aiding and abetting claim. When the claim against a third-party is that it was knowingly complicitous in a breach of fiduciary duty against a Delaware entity, Delaware’s interest is paramount. Because Delaware has the strongest interest, because our law recognizes aiding and abetting claims, and because the complaint clearly states such a claim against KeyBanc. . . , its motion to dismiss is denied.”
While not cited by the Shandler Court, § 187(2) of the Restatement (Second) of Conflict of Laws would appear to provide the appropriate basis for resolving this issue. In pertinent part, § 187(2) of the Restatement provides that:
“The law of the state chosen by the parties to govern their contractual rights and duties will be applied, even if the particular issue is one which the parties could not have resolved by an explicit provision in their agreement directed to that issue, unless . . . (b) application of the law of the chosen state would be contrary to a fundamental policy of a state which has a materially greater interest than the chosen state in the determination of the particular issue and which, under the rule of § 188, would be the state of the applicable law in the absence of an effective choice of law by the parties.”
However, where Courts, applying § 187(2) of the Restatement, have determined that the application of the law of the chosen state would be contrary to fundamental policy of a state with materially greater interest, they have typically relied on an express statutory provision of the state whose laws would otherwise be applicable that application of the law of the chosen state would violate a fundamental policy (e.g., finding that an indemnification provision in a construction contract providing indemnification for a party’s own negligence was contrary to a fundamental policy of the state with a materially greater interest where a statute of the state with a materially greater interest specifically prohibited such indemnification in construction contracts). Absent a statute declaring a contractual provision against public policy and/or null and unenforceable, it is not clear that a Court, applying § 187(2) of the Restatement, would find such provision sufficiently repugnant to a fundamental state policy.
In Shandler, it is not clear that, applying § 187(2) of the Restatement, the application of Ohio law would be contrary to a fundamental policy of the State of Delaware:
– while Section 102(b)(7) of the DGCL does not permit a Delaware corporation’s charter to exculpate its directors for breaches of their duty of loyalty or for acts or omissions not in good faith or which involve intentional misconduct, no Delaware statute prohibits a Delaware corporation from exculpating its financial advisors or other independent contractors for aiding and abetting such breaches;
– Section 145 of the DGCL only limits the power of a Delaware corporation to indemnify directors, officers, employees and agents of the corporation, not its financial advisors or other third party consultants;
– Many merger agreements contain provisions pursuant to which the buyer agrees to indemnify a Delaware target’s board of directors for a variety of claims, including claims with respect to which the Delaware Target could not provide exculpation (e.g., “The proxy specifically states that Caremark’s directors will be indemnified not only “to the same extent such individuals are indemnified pursuant to Caremark’s certificate of incorporation and bylaws” but also “to the fullest extent permitted by law . . . .” This conjunctive language suggests an intent to grant indemnity in excess of that already offered by Caremark.”;
– Delaware law permits sophisticated parties such as parties to an LLC Agreement to agree to extremely broad exculpatory provisions which can cover breaches of the duty of loyalty by fiduciaries; and
– in Shandler, the plaintiff Trustee stood in the shoes of one of the sophisticated parties that entered into the contract containing the Ohio choice of law provision.
Refusing to enforce such a choice of law provision, permits a sophisticated party to effectively sandbag its counterparty by depriving the counterparty of the benefits of a contract otherwise governed by the laws of its home state for which it bargained even where the contractual provisions at issue are not void or voidable under the laws of a state the sophisticated party later argues has a materially greater interest.
Citing “decades of settled law,” the Delaware Court of Chancery last week upheld the validity of a standard shareholder rights plan and affirmed the continuing relevance of rights plans to address not only threatened takeovers but also acquisitions of substantial, but not controlling, positions. Yucaipa Am. Alliance Fund II, L.P. v. Riggio, C.A. No. 5465-VCS (Del. Ch. Aug. 11, 2010).
The case involved a dispute between funds controlled by activist investor Ronald Burkle and the bookseller Barnes & Noble, Inc. In late 2008, Burkle acquired an 8% stake in Barnes & Noble and met with its founder and largest shareholder in March 2009 to promote his ideas for strategic changes in the company’s policies. When Barnes & Noble declined to accept the suggestions and later completed an acquisition over Burkle’s objections, Burkle dramatically increased his stake in the company, amassing a 17% position in a matter of days in November 2009 and noting in the corresponding 13D filing the possibility of acquiring more shares or even effecting a change of control.
In response, Barnes & Noble adopted a rights plan that triggered when any stockholder acquired beneficial ownership of more than 20% of the company’s shares.
As is customary, a stockholder’s beneficial ownership was defined to include the shares of any person with whom the stockholder had agreements or understandings respecting acquiring, holding, voting, or disposing of Barnes & Noble shares. The plan grandfathered the company’s founder, who held a 29% stake, but would trigger if he acquired additional shares. Barnes & Noble stated that it intended to submit the rights plan for shareholder ratification within 12 months of adoption. The board later rejected Burkle’s request to increase the trigger threshold to 37% to equal the aggregate ownership of Barnes & Noble’s founder, management, and employees.
Vice Chancellor Strine rejected Burkle’s challenge to the board’s adoption of the rights plan, including the 20% triggering threshold, holding that the defensive action was a reasonable and proportionate response to the threat Burkle posed. Finding that “the board had a reasonable basis to conclude that Burkle was potentially planning to acquire a controlling stake in Barnes & Noble, or form a governing bloc with another large stockholder,” the Court held that “the board could reasonably conclude that [Burkle] should deal with the board in the first instance” to protect the interests of the company’s public shareholders. The Court further held that the rights plan did not “unreasonably inhibit[] the ability of [Burkle] to run an effective proxy contest.”
To the contrary, given the “influence over the vote” of proxy advisory firms such as RiskMetrics, the Court found that the plan left Burkle a realistic opportunity to wage a successful proxy contest by nominating a qualified slate and articulating the reasons why his vision for the company is meritorious. Vice Chancellor Strine rejected Burkle’s argument that a traditional rights plan was an unreasonable response in view of the protections already provided by Barnes & Noble’s classified board, given the influence that electing even one-third of the board would provide to the activist shareholder, as well as “the reality . . . that even the combination of a classified board and a rights plan are hardly show-stoppers in a vibrant American M&A market.” Nor, the Court held, could the plan be attacked for improperly interfering with corporate voting rights, as it neither “disenfranchise[d] any stockholder in the sense of preventing them from freely voting [nor] prevent[ed] a stockholder from soliciting revocable proxies.”
The Court also rejected Burkle’s argument that the plan’s definition of “beneficial ownership” was unworkably ambiguous because it might hypothetically be triggered by discussions among large investors. Ruling that “[a] corporate board is not required to conjure up every hypothetical situation imaginable and reduce it to writing in order to create a plainly drafted rights plan,” Vice Chancellor Strine reaffirmed that a rights plan could properly prevent dissident shareholders, who collectively own shares in excess of the triggering threshold, from working together to run a proxy contest. Another large investment firm, which the Court said frequently followed Burkle in his investments, had contemporaneously acquired a 17% stake in Barnes & Noble. In light of this, the Court concluded that the Barnes & Noble board was entitled to take:
reasonable, non-preclusive action to ensure that an activist investor like [Burkle] did not amass, either singularly or in concert with another large stockholder, an effective control bloc that would allow it to make proposals under conditions in which it wielded great leverage to seek advantage for itself at the expense of other investors. Precisely by cabining [Burkle] at a substantial, but not overwhelming, level of voting influence, the board preserved for itself greater authority to protect the company’s public stockholders.
Like the Court of Chancery’s recent decision in Selectica (which is now pending before the Delaware Supreme Court on appeal), the Yucaipa decision demonstrates once again that the Delaware courts are willing to uphold the use of a rights plan to deter open market accumulations of stock above the threshold set by the plan. While it is too early to know whether the Yucaipa decision will also be appealed to the Delaware Supreme Court, the press release that Burkle issued following the decision indicates that, at least for now, Burkle plans to focus on his proxy contest to replace the three Barnes & Noble directors up for election at this year’s annual meeting and to approve a shareholder proposal asking the board to increase the rights plan threshold from 20% to 30%.
Recently, PricewaterhouseCoopers released its U.S. mid-year M&A forecast which provides analysis on key drivers and challenges for M&A activity throughout the remainder of 2010. Among other things, the study found that U.S. M&A activity was down three percent compared with the same period in 2009. The number of closed deals in the first half of 2010 represents the lowest deal volume this decade, according to PwC. For the first five months of 2010, there were 2,969 closed deals representing $317 billion, compared with 3,065 deals valued at $323 billion in the same period of 2009.
This July-August issue of the Deal Lawyers print newsletter was just sent to the printer and includes articles on:
– Will Mandatory Shareholder Approval of Golden Parachutes Dull Their Luster?
– Mini-Tender Offers: More Frequent – No Less Troubling
– Latest Developments in Use of Top-Up Options
– Blood in the Water? Use of Delaware’s Two-Record Date Statute May Provide Flexibility, But Can Also Expose a Weak Hand
– Delaware Protects Attorney-Client Privilege for Investment Banker Communications
– Leveraged Acquisitions: A New Post-Credit Crisis Structure
– Delaware Court of Chancery Announces New Rules for Controlling Shareholder Freeze-Out Transactions
As noted in this Morrison & Foerstermemo, two recent decisions by United States federal courts serve as useful reminders to companies and their advisors of the rules regarding disclosure of merger negotiations. While the cases do not enunciate new law, they do provide several useful illustrations of circumstances where disclosure is, and is not, required.
Recent media accounts have cited a bank in formation – Aris Bank – as taking advantage of a “loophole” in the Dodd-Frank Act signed into law last week. Contrary to these reports, the transaction is part of a familiar theme in which a private equity firm proposes to make a noncontrolling investment in a bank as part of a capital raise with other passive investors who invest side-by-side. What is new under Dodd-Frank is a modestly enhanced ability of both national and state-chartered banks alike to branch “de novo” into new states notwithstanding state laws to the contrary. Like many other banks, Aris Bank would reportedly take advantage of this enhanced ability to cross state lines via de novo branching.
Over the past year, there have been numerous capital raises, led by one or more noncontrolling investors, by both existing banks and start-up banks – particularly “shelf charter” banks set up to participate in FDIC auctions. The new financial reform legislation does not materially impair or expand the ability of investors to make these types of investments in banks. In fact, as regulatory capital demands increase as a result of Dodd-Frank and existing industry trends, many more are likely to follow.
Under the Dodd-Frank Act, a bank may now establish a branch in a new state to the same extent as banks chartered by that state. Despite the fact that a number of states, such as New York, permitted de novo branching by out-of-state banks prior to the new Act and federal savings banks have long had the ability to branch de novo into all 50 states, for many banks de novo branching has not been a preferred method for entry into new states. These banks have instead preferred to enter new markets via acquisition in order to reach critical mass more quickly. Banks wishing to expand into new geography in other states will still need to make the fundamental business calculation about whether it is more cost effective to do so by acquisition or de novo branching.
Recently, in a thorough and well-reasoned opinion, the Maryland Circuit Court confirmed that directors of Maryland corporations who act in good faith and on an informed basis in connection with a sale-of-control transaction do not have personal liability exposure. The court threw out a stockholder suit alleging that Terra’s directors had breached their fiduciary duties in connection with Terra’s agreement to merge with CF Industries Holdings, Inc. In re Terra Industries, Inc. Shareholder Litigation, No. 24-C-10-001302 (July 14, 2010).
Beginning in early 2009, Terra rejected a series of hostile bids made by CF. In early 2010, CF purported to abandon its pursuit of the company. Shortly thereafter, Terra entered into a merger agreement with another company, Yara, at a price above CF’s highest bid. The Yara agreement included a $123 million termination fee. When CF returned with a substantial topping bid, Terra accepted CF’s offer and terminated the Yara deal, and CF paid the $123 million to Yara. Stockholder plaintiffs brought purported class action lawsuits alleging that Terra’s directors should not have agreed to the Yara deal without first attempting to negotiate with CF. The plaintiffs sought damages at or above the value of the termination fee.
Maryland, like Delaware, recognizes a direct cause of action for failure to use good faith efforts to maximize stockholder value in the sale-of-control context. In rejecting plaintiffs’ claims, the Terra court held that the directors had acted diligently in responding to CF’s offer, that they had not breached any fiduciary duties, and that the result achieved by Terra’s board precluded plaintiffs’ claims. The court found, moreover, that plaintiffs’ contention that Terra’s board could have gotten CF to bid more without entering into a deal with Yara was based on “magical thinking.”
In reaching this result, the Terra court followed principles developed in the Delaware courts on a number of important issues, including:
– that judicial scrutiny in the sale-of-control context is not a license for courts to second guess reasonable tactical choices that directors have made in good faith;
– that directors can fulfill their duties in this context by entering into a merger agreement with a single bidder, establishing a “floor” for the transaction, and then testing the transaction with a post-agreement market check; and
– that termination fees are a regular term in sale-of-control transactions, and that plaintiffs’ attack on the 3% termination fee in this case was “totally baseless.”
Terra should stand as an important precedent protecting directors of Maryland corporations who act in good faith and on an informed basis from litigation brought by the plaintiffs bar in the sale-of-control context.
This article about the need to preserve institutional knowledge – particularly for integration and post-acquisition disputes – fits in well with today’s webcast…
Tune in tomorrow for the DealLawyers.com webcast – “Overcoming the Challenges: Integration Issues & Merger of Equal Issues” – to hear Wally Bardenwerper of Towers Watson, Chris Cain of Foley & Lardner, Stephen Glover of Gibson Dunn and Jessica Kosmowski of Deloitte Consulting discuss how to overcome the challenges of deal integration as well as factors you should consider when negotiating a merger of equals to ease the transition afterwards. Please print off these course materials in advance.