Public company merger agreements frequently contain provisions under which a buyer agrees to cause the surviving corporation to indemnify the seller’s directors to the same extent that they are currently indemnified “or to the fullest extent permitted by law.” While this is pretty standard practice, language like this can provide a seller’s directors with much broader indemnity rights than they would be able to obtain from the seller itself. That is usually good news for a seller’s board, but not always.
That point was brought home last month when a Tennessee appellate court, applying Delaware law, refused to dismiss duty of loyalty claims against a seller’s directors premised on the inclusion of customary director indemnity arrangements in a merger agreement.
In Indiana State District Council of Laborers v. Brukardt, No. M2007-02271-COA-R3-CV (Tenn. App. Feb. 17, 2009) the Tennessee Court of Appeals overruled a trial court’s dismissal of a shareholder class action lawsuit against the board of directors of Renal Care, Inc., a health care company that was acquired by Fresenius Medical Care AG in 2005. Among their other allegations, the plaintiffs contended that the defendants breached their fiduciary duty of loyalty by entering into the merger in order to “cover alleged Medicare fraud and back dating of stock options, [and] also to insure that they would be free of any possible liability for such acts.”
In dismissing the plaintiffs’ loyalty claim, the trial court held that a majority of the Board had no conflicts of interests. The appellate court disagreed, noting that the plaintiffs had alleged that “by engineering the merger which included indemnification, all defendants were able to significantly minimize their exposure to liability in connection with the alleged brewing problems at Renal Care.”
The defendants contended that no conflict of interest existed between the interests of directors and shareholders when the indemnity rights given them under the merger agreement were “essentially duplicative” of rights that they already had, but the court disagreed:
“First as a matter of Delaware law, Renal Care could only indemnify defendants for “acts in good faith and in the best interests of the corporation.”But Fresenius, as a third party indemnifying Renal Care directors, is not bound by “the restrictions of statutory corporate law” and can extend indemnifications to defendants for breaches of the duty of loyalty and good faith.”
In reaching this conclusion, the court cited the Delaware chancery court’s decision in Louisiana Mun. Police Employee’s Ret. Sys. v. Crawford, 918 A.2d 1172, 1180 n. 8 (Del. Ch. 2007). In that case, the chancery court characterized the distinction between the indemnification that a buyer could provide and that which the seller could provide its own directors as being “quietly critical.” In the present situation, the court believed that under Delaware law, “the indemnification offered by Fresenius covers defendants’ liability for option backdating, a breach of the duty of good faith, whereas the indemnification offered to defendants by Renal Care could not.”
Crawford involved the CVS/Caremark transaction and attracted a lot of attention when it was decided. At the time, most of the discussion surrounded the court’s decision that Caremark’s shareholders had appraisal rights in a purported stock-for-stock merger because a special dividend declared in connection with transaction should be considered part of the merger consideration.
The Chancery Court’s discussion of the distinction between the rights to indemnity that a director could obtain from his or her corporation and those that a buyer could provide was confined to a footnote. Nevertheless, as the Tennessee Court of Appeals decision in Laborers v. Brukardt suggests, that footnote may have some pretty important implications for those involved in mergers and acquisitions.
Oddly, I’ve been watching a few of CNBC’s stock market shows lately. I guess I’ve been curious how they’ve been touting stocks in this downturn and it’s been comic relief. And the recent feud between Jon Stewart and Jim Cramer has been absolutely hilarous – and coming to a head tomorrow when Jim appears on “The Daily Show.”
One of the delightful surprises was catching one of my DealLawyers.com advisors, Frank Aquila of Sullivan & Cromwell, on “Fast Money” Monday night (here is a video archive of it). Apparently Frank is a regular guest and he was great riffing on the state of M&A.
His shining moment was dealing with one of the host’s awkward statements that more deals tended to happen during the proxy season as she seemed to be confused about cause and effect. Frank didn’t show her up for her inartful statement (she probably meant that if companies were going to run slates they would have to be going forward right now).
Anyways, I think I’ve gotten CNBC out of my system. Fun while it lasted…
Following up on my earlier blog portraying some “deal cube” chronicles, I’m holding a contest for the coolest cube. Please email me pictures of the cube(s) that you cherish the most. If you wish to remain anonymous, I’ll honor that request as always.
Here are a few more deal toy stories:
– We did a public offering of subordinated debt a number of years back. There was an extensive negotiation with the senior lender regarding the subordination agreement and specifically on the “fish or cut bait” provisions which force the senior lender to exercise remedies or free the subordinated debt holders to exercise their remedies. The cube for the deal was the bones of a fish.
The underwriter only provided one such cube to one of the lawyers in my firm who worked on the deal. Over the next ten years, the cube was stolen from the office of the receiving lawyer multiple times by the other lawyers in the firm who worked on the deal and hidden away, but subsequently retrieved. Eventually, he brought the cube home only to have it stolen again at a firm party that he threw at his house.
– I have a cube from a deal I did about five or six years ago that looks like a miniature suitcase nuke. Some poor junior banker had to carry these things through airports on his way to the closing dinner. It’s a miracle he didn’t end up in Guantanamo in the cell next to “Harold and Kumar.”
More to come. Keep those deal cube stories coming…
In our “Private Equity” Practice Area, we have posted a number of memos and articles discussing the future of the private equity and hedge fund industries. One of the articles states:
“In fact, new research from The Boston Consulting Group and the IESE Business School indicates that at least 20 percent of the 100 largest leveraged-buyout private equity firms – and possibly as many as 40 percent – could go out of business within two to three years. More disturbingly, most private equity firms’ portfolio companies are expected to default on their debts, which are estimated at about $1 trillion.”
In a somewhat unusual move, the AICPA has put out draft guidance regarding FAS No. 157, “Valuation Considerations for Interests in Alternative Investments” in which they have promised to keep all comments confidential.
My guess is that this will be the year that law firms start catching up in the digital world. For example, Torys has started doing podcasts, including this podcast entitled “Carbon Risks and Opportunities: Implications for Investment Activity and M&A.”
Developments in Debt Restructurings & Debt Tender/Exchange Offers
We have posted the transcript for the webcast: “Developments in Debt Restructurings & Debt Tender/Exchange Offers.”
As a follow-up to the excellent piece by John Jenkins, I thought the following point worth noting:
Under Pure Resources, any shareholder of Genentech should be able to get Roche’s tender offer enjoined until Genentech publicly discloses a summary of the financial analyses of Goldman Sachs underlying Goldman Sach’s inadequacy opinion on which the Genentech special committee relied in recommending that shareholders not tender their shares into the Roche offer.
That result was intended by the Pure Resources court to force the Pure Resources special committee to disclose the valuation ranges indicated by its financial advisors’ analyses so that shareholders could make an independent decision based on that analysis whether to tender or not. The Pure Resources court argued that because the special committee failed to obtain the right to implement a poison pill (just imagine the likelihood that Roche’s representatives on the Genentech board would authorize an independent special committee of Genentech directors to implement a pill), the special committee had no negotiating leverage and forcing the special committee to disclose its reserve price would not have adverse consequences, as shareholders were being left to their own devices and it was their reserve price that mattered.
The Pure Resources court’s ruling was problematic for a number of reasons including, among other things, that the court, rather than mandating that the special committee disclose a summary of its financial advisors’ valuation analyses, enjoined the offer, essentially playing into the hands of a spec. comm. recommending against the offer by giving them the ultimate defensive device, a judicial injunction.
So long as the Genentech special committee is not satisfied with the price offered by Roche, it should refuse to disclose a summary of GS’s financial analyses and welcome shareholder suits seeking to enjoin the offer on the basis of inadequate disclosure. For additional – and more detailed – criticisms of the Pure Resources decision, see my article.
Recently, I blogged about the potential demise of the deal cubes and asked people for their stories (as well as conducted a deal toy poll, which is still ongoing if you want to vote). My own tale to tell is a woman I know who took a bunch of cubes to tile her bathroom walls. It actually looked pretty cool.
Here is a story from Bob Dow of Arnall Golden Gregory: As an associate in 1995 worked on an IPO for Moovies, a video chain, sort of mini-Blockbuster. Interesting deal cube, actually it was shaped like an old fashioned movie reel. Only the problem was, of course, even in 1995 no one was still handling the old reel-to-reel movies anymore, they were all video tapes. Fortunately when we did the secondary the next year, the underwriters (Needham) updated and gave us a deal toy in the shape of a VCR tape.
Here are some thoughts from a member who wished to remain anonymous: When I was a new associate, it was nice to receive one at the conclusion of a deal. Whatever it looked like (whether it had moving parts or just a tombstone in lucite), it felt good (to believe) that I was being acknowledged (by the powers that be) as a contributor to the team that closed the deal.
For me, after receiving a number of deal toys, the desire to receive more quickly vanished. Although a number of the toys were quite a novelty, they took up precious space in my office that was better served more practically. I’d much rather occupy the space with good precedent documents, and even better, receive leather bound volumes (another practice that has ebbed) for the transaction documents, which I could refer to for precedents. [Of course today, we can keep thousands of precedents on a thumb drive.]
Today, junior associates are still fascinated by deal toys – like opening presents on Christmas Day. It’s a subject of conversation with their fellow associates, and even a perceived badge of achievement. What I believe they really want is some recognition – from the partner or client – as being part of the team and for a job well done. Cubes seem a less than satisfactory method of serving this function (but maybe no different that a retirement watch). Closing dinners are a bit better but practically more difficult to organize (and certainly more costly).
Partners have even more deal toys in their offices – some collected since their first year as an associate (carried with them as a lateral from another firm). It serves a purpose for the partners: reminding them of their past conquests (when they were younger); reminding other people (including clients and potential clients) that “you’ve stepped into the office of a ‘dealmaker’; giving associates something to look at or play with while waiting for the partner to get off the phone; and giving employment to the evening cleaning crew to keep the dust off the deal toys (but pity them if they break a piece and raise the ire of the partner).
There will be more “deal cube chronicles” soon. Keep the stories coming. I’ll keep your identity anonymous if you wish…
In Madden v. Cowen & Co. (C.A.9 (Cal.)) (2/11/09), the Ninth Circuit held the “Delaware carve out” contained in the Securities Litigation Uniform Standards Act of 1998 applied to disclosure claims brought against an investment banking firm that rendered a fairness opinion to the board of a seller’s subsidiary in connection with a merger transaction. The case appears to be the first in which a court has extended the Delaware carve-out to shareholder claims made against persons other than officers or directors of the company in which they owned stock.
SLUSA preempts certain state-law based securities fraud class actions involving “covered securities” under the Private Securities Litigation Reform Act of 1995. Before SLUSA’s enactment, plaintiffs had used state-law based class actions to avoid the heightened pleading requirements and other procedural impediments imposed on federal securities class actions by the PSLRA. Under SLUSA, federal claims are generally the only ones permitted to be made for class actions involving securities traded on a national securities exchange, and federal court is the only forum in which those claims may be brought.
SLUSA contains several important exceptions to its preemption of state law shareholder class actions. These include derivative actions and actions based on the law of the issuer’s state of incorporation. These two exceptions have come to be known as the Delaware carve-out. In order for a non-derivative claim to fall within the scope of the Delaware carve-out, it must involve either:
– the purchase or sale of securities by the issuer or an affiliate of the issuer exclusively from or to holders of equity securities of the issuer; or
– a recommendation, position, or other communication with respect to the sale of the issuer’s securities that is made by or on behalf of the issuer or its affiliate to equity holders, and concerns the equity holders’ decisions with respect to voting their securities, responding to a tender or exchange offer, or exercising dissenters’ or appraisal rights.
The second bulleted exception has been used to preserve state law fiduciary duty of disclosure-based claims against directors. See, e.g, Alessi v. Beracha, 244 F. Supp. 2d 354 (D. Del. 2003). However, courts have traditionally declined to extend the carve-out for disclosures made “by or on behalf of an issuer” to disclosure based claims involving communications from persons other than the corporation or its officers and directors. See e.g. Greaves v. McAuley, 264 F. Supp. 2d 1078, 1083-84 (N.D. Ga. 2003) (holding that fiduciary duty claims by former shareholders against the company and its board members were covered by the Delaware carve-out but that claims against the buyer were not).
In Madden, the Ninth circuit rejected contentions by the investment bank that its communications were not made “on behalf of” the issuer. In making this argument, the bank pointed out that it did not serve as the financial adviser to the company in which the plaintiffs were shareholders. Instead, the bank was retained to render a fairness opinion to the board of directors of that company’s majority-owned subsidiary.
Nevertheless, the court noted that the complaint alleged that investment bank’s fairness opinion “was provided to the shareholders of St. Joseph with Cowen’s consent and that the shareholders relied on the opinion when voting in favor of the merger.” Accordingly, the court held that the complaint sufficiently alleged that the bank’s communication was “on behalf of” St. Joseph for purposes of the Delaware carve-out, regardless of whether Cowen addressed its letter only to the subsidiary’s board.
The continuing saga of Swiss pharmaceutical giant Roche’s efforts to acquire the 44% of Genentech that it does not already own added a chapter on Monday, when Genentech’s special committee unanimously voted to recommend against Roche’s most recent $86.50 per share bid. Last month, Roche broke off negotiations with Genentech’s special committee and withdrew its proposal for a negotiated transaction, opting instead to launch a hostile bid after Genentech balked at its $89 per share offer (the company is asking $112 per share).
At first blush, it is tempting to conclude that this whole process is a bit contrived. After all, didn’t Roche’s decision to launch a unilateral tender offer make things easier on everyone under Delaware law? The Unocal Exploration and Siliconix decisions established that a unilateral tender offer followed by short form merger offered controlling shareholders (and subsidiary boards) a path to freeze out minority shareholders without subjecting the transaction to entire fairness review, so why bother with negotiations? Pure Resources made things a little more complicated and Cox Communications suggested that we’d be better off if Delaware just started over, but Delaware law still provides a roadmap for avoiding the entire fairness review that usually applies to parent/subsidiary mergers, doesn’t it?
Delaware may provide a roadmap for many such controlling shareholder-subsidiary mergers, but the contractual relationship between Roche and Genentech makes this situation unusual, and far from simple. The two companies have a wide-ranging business relationship, and there are several agreements in place governing various aspects of their relationship. For purposes of Roche’s bid, the most notable of these agreements is an “Affiliation Agreement” that imposes a number of obligations on Roche in connection with any merger involving Genentech.
According to Roche’s offer to purchase, the Affiliation Agreement requires any merger between Genentech and Roche to either:
– receive the favorable vote of a majority of the shares not beneficially owned by Roche and its affiliates (with no person or group entitled to cast more than 5% of the votes cast at the meeting); or
– provide public shareholders with consideration “equal to or greater than the average of the means of the ranges of fair values for the shares as determined by two investment banks of nationally recognized standing appointed by a committee of [Genentech’s] independent directors.”
The Affiliation Agreement also provides that if Roche owns more than 90% of the outstanding shares for more than two months, it must complete a merger in compliance with either of the requirements described above as soon as reasonably practicable. So if Roche completes its tender offer, it will have to obtain shareholder approval of a long-form merger proposal (which would subject the deal to entire fairness review), or complete a short form merger in which it pays a price determined by Genentech’s chosen investment bankers (which is probably not a pleasant prospect given how far apart the two sides are on valuation). That complicates things considerably.
But the complications do not end there. A purported class action lawsuit filed by a group of institutional investors challenges, among other things, the enforceability of these provisions of the Affiliation Agreement. The plaintiffs allege that agreement’s attempt to limit the percentage of shares that can be voted by any person or group to 5% of the votes cast violate Section 212(a) of the Delaware General Corporation Law (which provides that Unless otherwise provided in the certificate of incorporation, each stockholder is entitled to one vote for each share of stock held by such stockholder) and Genentech’s bylaws. They also challenge the alternative “fair price” procedure as being inconsistent with Roche’s (and the Genentech board’s) fiduciary duties. (See Section III of this complaint).
Roche has kept its cards pretty close to its vest in terms of how it intends to navigate the requirements of the Affiliate Agreement subsequent to the completion of a successful tender offer. Its tender offer materials include a Q&A on how the Affiliate Agreement affects the offer and any subsequent merger. In its response to that question, Roche merely points out that the agreement has no affect on its offer, and notes that compliance with its provisions would be required in connection with any subsequent merger.
Exactly how Roche plans to comply with the agreement is unspecified in the tender offer materials, but it seems like the Affiliation Agreement provides Genentech shareholders who decide to hang on to their shares and wait for a back-end merger with an opportunity to exert significant leverage.
And guess what? It looks like the market knows it.
Most analysts reportedly expect that Roche will up its price in response to the Genentech special committee’s rejection of its current offer. That may prove to be a path to a negotiated deal, and the special committee’s endorsement of a deal will clearly put Roche in a much better position to obtain the shareholder approval that it needs under the Affiliation Agreement. Genentech is probably wagering that this endorsement is something that Roche is willing to up the ante in order to receive. That may turn out to be a pretty good bet.