The Delaware judiciary over the first three months of the year clarified the application of the business judgment rule, further shaped appraisal actions, weighed in on the termination of a transaction and stood by an order to sell a financially healthy company.
Here, Law360 outlines some of the biggest mergers and acquisitions-related developments of the first quarter of 2017 and their potential ramifications.
'Irrebuttable' Business Judgment Rule Extended to Tender Offers
The Delaware Supreme Court upheld the Chancery Court's ruling that extended "irrebuttable" business judgment protection to unconflicted tender offer mergers, confirming that the Corwin doctrine does not extend only to uncoerced shareholder votes.
Chief Justice Leo E. Strine Jr. wrote the two-sentence decision of the three-judge panel that heard the arguments on behalf of Volcano Corp. stockholders in February, affirming Vice Chancellor Tamika Montgomery-Reeves' decision "for the reasons stated" by the lower court in June.
The decision effectively cleared Volcano Corp. of class arguments that the medical device maker's board failed to fully inform company stockholders about details of a $1.2 billion merger with Philips Holding USA Inc., breaching its duty to the company in the process. The deal offered $18 per share and a 57 percent to 64 percent premium on the company's stock price from the day before the offer but was 33 percent lower than Philips' first offer of $24 per share.
The vice chancellor ruled that a solid majority of "fully informed, uncoerced, disinterested" stockholders agreed to sell, or tender, their shares at the price offered by Philips in a deal endorsed by Volcano's board. That result and the lack of any proof that the deal lacked a fair business purpose was enough to declare that the company's business judgment should trump objections.
The decision confirmed that the Delaware Supreme Court's seminal Corwin v. KKR Financial Holdings ruling, which held that a deal is evaluated under the First State's board-deferential business judgment rule if it is approved by a fully informed shareholder majority, also applies to tender offers.
"The prevailing reading of Volcano is that acts which may have otherwise provided a basis to rebut the business judgment rule can be subject to ratification if sufficiently disclosed. That is not really that controversial, but there is likely to be more to the story here as parties attempt to apply Corwin and Volcano in future cases," said John Reed, a DLA Piper partner.
The Volcano decision, taken together with the 2016 Trulia case, makes it more difficult for shareholders to bring litigation against a transaction, a trend that is expected to yield more appraisal actions.
"There are kind of meaningful changes in the deal litigation landscape, and this is really closing the door on a large number of post-closing challenges that plaintiff stockholders can bring," said Nicholas Ferrer, a Perkins Coie LLP partner.
But the Corwin doctrine isn't a foolproof protection for companies. A stockholder suit that accused Sabra Software Inc.'s directors of setting up a "tragic" and coercive no-choice vote to either approve a depressed-price merger or hold deregistered, illiquid securities moved ahead in March after Vice Chancellor Joseph R. Slights III declined to dismiss a fiduciary breach claim.
The case is In re: Volcano Corp. Stockholder Litigation, case number 372, 2016, in the Delaware Supreme Court. The underlying case in In re: Volcano Corp. Stockholder Litigation, case number CA-10485, in the Delaware Chancery Court.
Fair Value Calculations Take Center Stage in Appraisal Action
With the number of appraisal actions on the rise, M&A practitioners are closely watching the appeal of an appraisal case that found the fair value to be nearly 30 percent above the deal price agreed to in a management-led, private equity-backed buyout of a tech giant.
Dell Inc. is awaiting the decision of the Delaware Supreme Court, after contending that the Chancery Court abused its discretion when it appraised the company's $24.9 billion buyout as undervalued by 28 percent by refusing to even consider the actual market price of the deal.
In an opening brief before the state Supreme Court, Dell argued that Vice Chancellor J. Travis Laster ran afoul of Delaware appraisal law that requires the bench to "take into account all relevant factors" when valuing a stock by ignoring the market price of the deal, which was a management buyout led by company founder and CEO Michael Dell, even though he commended the actual sale process in his opinion.
Vice Chancellor Laster erred by making a "broad presumption" that management-led buyouts weren't reliable and constructed a discounted cash flow analysis of his own that Dell claims contained several errors, resulting in a fair value determination coming in at roughly $7 billion above the consideration shareholders actually received in the deal.
However, attorneys for the winning side in the lower court suit have argued that justices should either uphold the price over Dell's objections or take it higher.
In a brief opposing Dell's appeal of the lower court decision, lead attorneys at Grant & Eisenhofer PA disputed Dell's argument that the vice chancellor failed to give appropriate, substantial weight to the company's official deal.
Dell's position "would create an inflexible bright-line rule, effectively overturning the long line of precedent in which this court consistently has eschewed both bright-line rules in general and mandatory deference to the deal price in particular in determining fair value" under Delaware's provisions for appraisal actions, the brief said.
The back-and-forth has practitioners watching closely to see how the state Supreme Court decides the deal price should factor in during an appraisal case, particularly as the number of appraisal actions is expected to continue to rise given decisions like Volcano and Trulia.
"There are an increasing number of appraisal actions over the last couple of years too," said Edward Micheletti, a Skadden Arps Slate Meagher & Flom LLP partner. "The Delaware Supreme Court weighing in on this type of issue is going to be helpful and important."
The appellate case is Dell Inc. v. Magnetar Global Event Driven Master Fund Ltd. et al., case number 565, 2016, in the Delaware Supreme Court. The lower court case is In re: Appraisal of Dell Inc., case number 9322, in the Delaware Court of Chancery.
Missing Tax Docs Prove Fatal to Merger Agreement
An oil and gas company was allowed to terminate an 11-figure merger over its inability to deliver an opinion concerning the expected tax treatment of the deal, despite evidence favoring claims that the terminating party had breached a duty to make all commercially reasonable efforts to close.
In a rare split decision in March, the Delaware Supreme Court rejected a bid by The Williams Cos. to salvage what was once a $38 billion merger with Energy Transfer Equity. The court split 4-1, with the majority choosing to uphold Vice Chancellor Sam Glasscock III's ruling in June that ETE was free to walk away from the merger because tax adviser Latham & Watkins LLP could not in good faith conclude the pipeline company tie-up would be tax-free at the level of confidence required.
The high court said the vice chancellor had adopted an "unduly narrow" view of ETE's conduct and obligation to work for the merger and the tax opinion. But even accounting for that, the majority opinion, written by Justice James T. Vaughn Jr., concluded that Latham's inability to render the needed tax finding was uncontested by Williams, mooting the effect of ETE's potential failure to make all reasonable efforts for the merger.
The decision highlights how difficult it is to keep a deal on track when the party wishing to move forward has to prove that the failed condition of the merger agreement should not have failed, explained David Hennes, a Ropes & Gray LLP partner.
"When there is a failure of a condition to closing, the decision in ETE-Williams shows that it is going to be very hard to prove to the court that the failure was caused by some form of bad faith conduct," he said.
In the dissent, Chief Justice Leo E. Strine Jr. recommended a new trial for the Chancery Court case under appeal. The dissent cited possible multiple breaches of an "affirmative covenant" to pursue a pivotal opinion that the deal should be tax-free, questions of undue pressure on a tax adviser and failures to make other salvage efforts.
ETE's conduct, the chief justice said, required a more critical examination of the deal terms and tax opinion issue, as well as a close look at an "epiphany" that the lower court said ETE head of tax Brad Whitehurst had experienced: an after-signing recognition that changing energy markets had changed the deal math.
While ETE's stock price had fallen, the cash-and-share merger agreement transaction called for a $6.05 billion ETE payment for a fixed number of shares in a merger entity. The depressed values of ETE and Williams meant ETE was paying the same price for lower-value shares, with a potential $4 billion difference becoming taxable.
"I think [Chief Justice Strine's] kind of giving a little bit of a warning shot," Ferrer said. "Parties can't expect that they can rely on these sort of conditions to get out when deal economics sour."
Since the deal failed, companies are taking more care to use provisions that do not tie the deliverance of a necessary tax opinion on one specific law firm, allowing either the buyer's or seller’s counsel, or even an independent firm, to deliver it, explained Paul Scrivano, a Ropes & Gray partner.
"In the wake of the ETE-Williams decision by the Delaware Supreme Court, no party to a deal will want to agree to conditions that the counterparty may be able to engineer a failure of, such as by the counter-party's adviser not delivering an opinion," he said.
The appellate case is The Williams Cos. Inc. v. Energy Transfer Equity LP, case number 330, 2016, in the Supreme Court of the State of Delaware. The lower court case is The Williams Cos. Inc. v. Energy Transfer Equity LP et al., case numbers 12337 and 12168, in the Court of Chancery of the State of Delaware.
Court-Ordered Sale of Warring CEOs' Company Upheld
A financially healthy company has been ordered to be sold through a custodian due to a deadlock between its warring co-CEOs, an unprecedented move that has drawn the attention of M&A practitioners and serves as a harsh reminder of the need for shareholder protections when launching a company.
The Delaware Supreme Court in February upheld the Chancery Court's right to appoint a custodian to oversee the sale of translation services firm TransPerfect to bring an end to the standstill between co-founders and co-CEOs Philip Shawe and Elizabeth Elting, unconvinced of the statutory and constitutional arguments made on appeal.
The dispute over TransPerfect centers on what is essentially a business divorce between Shawe and Elting, once romantically linked partners who formed the company 25 years ago out of a New York University dorm room and grew it into a global powerhouse with recent revenues exceeding $400 million annually.
While their romantic ties appear to have soured, their business relationship continued through the ensuing decades but descended into a morass of tangled litigation between the two. One of the myriad lawsuits had Elting petitioning the Chancery Court for equitable dissolution of the company over the seemingly endless corporate battles.
After years of litigation, which detailed a turbulent and volatile business relationship between the two, Chancellor Andre G. Bouchard ordered the company to be sold in a process overseen by a custodian in order to break the deadlock that he believed threatened the enterprise's future.
Some of what has caught the attention of the M&A world are the personal details that have arisen throughout the case, but the fact that a financially healthy company could be ordered to be sold is eye-opening, Ferrer explained.
"It just kind of makes for a salacious story more than anything. What I think is capturing people's attention is one, all of these crazy facts, but two, the fact that the court would order the sale through a custodian a company that is profitable," he said. "There really is no precedent for this."
Ultimately, it serves as a reminder that founders should have a stockholders agreement in place from the outset to help break up any future deadlocks.
"These people did not have any stockholders agreement. They did not plan for any potential dispute. Any company with good counsel from the beginning could have avoided these circumstances," Ferrer said.
The litigation has not stopped with the state Supreme Court ruling, however. Shawe, who owns 49 percent of the company, and his mother Shirley Shawe, who owns 1 percent of TransPerfect, lost a bid in March to hold back the court-ordered sale after Chancellor Bouchard dismissed as "frivolous" and "legally defective" a motion to overhaul the sale order in ways that would benefit Shawe and his mother.
And Shawe also recently filed a suit in federal court alleging that Section 226 of the Delaware General Corporation Law has for the first time been construed by the Delaware Chancery Court and the state's high court to allow the taking of property not to be applied for public use. The move, he argues, is unconstitutional.
"The TransPerfect situation is a very contentious litigation and now has gone up to the Delaware Supreme Court and then back to the Delaware Chancery Court, and I think the Delaware Chancery Court is pursuing a very thoughtful remedy to resolve the dispute, but nevertheless the litigation continues," said Matthew Solum, a Kirkland & Ellis LLP partner.
The contentious back-and-forth also inspired Delaware lawmakers to float legislation in March that would require a minimum three-year test of alternatives before a court-ordered sale or dissolution of a solvent company.
The appellate case is Shawe et al. v. Elting, case number 423, 2016, in the Supreme Court of the State of Delaware. The lower court cases are In re: TransPerfect Global Inc., case numbers 9661, 9686 and 9700, in the Court of Chancery of the State of Delaware. The federal case is Shawe et al. v. Pincus et al., case number 1:17-cv-00277, in the U.S. District Court for the District of Delaware.
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