There were important developments in 2015 in Delaware law concerning issues of corporate governance and/or arising in the context of M&A transactions. These developments arose from a number of sources, including statutory amendments to the Delaware General Corporation Law (DGCL), decisions issued by the Delaware Supreme and Chancery Courts, and SEC interpretive guidance.
The Delaware courts had a typically active year, issuing important decisions in a number of areas. Significantly, in the context of appraisal proceedings under DGCL Section 262, the Delaware Court of Chancery further clarified the circumstances under which it might conclude that the most reliable indicator of a stock's fair value for purposes of an appraisal is the negotiated merger consideration. In particular, where the merger price is arrived at following an arm's length, thorough and informed sales process, it now appears (absent other countervailing factors) that Delaware courts are likely to find that price to constitute fair value. The Delaware courts also issued a number of decisions addressing whether directors were independent of controlling and/or interested stockholders, and in the process may have muddied the waters on when relationships among directors rise to the level of a conflict and thereby destroy director independence. And, as they have for the past few years, the Chancery and Supreme Courts issued decisions that discuss the appropriate role and conduct of M&A sell-side financial advisors. These decisions do not do anything to reverse the courts' relentless scrutiny of financial advisors, although the Delaware Supreme Court last month did articulate limits on the scope of a financial advisor's responsibilities.
On the non-judicial front, the Delaware Legislature enacted several amendments to the DGCL, including laws permitting the adoption of Delaware forum selection bylaws and precluding the adoption of "loser pay" bylaw provisions. The SEC also weighed in, issuing two compliance and disclosure interpretations (CDI) of the "unbundling" rule, which requires that proxy statements "identify clearly and impartially each separate matter to be acted on" at a shareholder meeting. The CDIs articulate the SEC's position requiring a separate target shareholder vote on corporate governance changes contemplated in connection with a merger.
A. Courts Continue to Rely on Merger Consideration to Determine Fair Value in Appropriate Situations
The Chancery Court issued several notable decisions in the context of appraisal actions under DGCL Section 262. In Merion Capital LP v. BMC Software, Inc., No. 8900-VCG (Del. Ch. Oct. 21, 2015), Vice Chancellor Glasscock issued a post-trial opinion in an appraisal action in which he found that the merger price was the most reliable indicator of fair value. The action arose in connection with the sale of BMC Software to a consortium of investment firms led by Bain Capital for $46.25 per share. The sale was the culmination of a lengthy and vigorous auction process, which entailed: (i) an initial sales process in mid-2012 that the company terminated after not receiving any expressions of interest from strategic buyers and only two non-binding expressions from financial buyers; (ii) BMC conducting a second sales process in 2013 that was also covered in the media, and receiving three non-binding expressions of interest, only one of which turned out to be viable; (iii) BMC actively negotiating for more favorable terms with the lone bidder, including a higher price and a go-shop period that was active but unsuccessful.
As is typical in these proceedings, each side offered widely divergent expert testimony on value. The stockholder expert opined that BMC shares should be valued at $67.08 per share (or 145% of the merger price), while the expert for BMC opined that fair value was $37.88 per share. The court performed its own discounted cash flow analysis (DCF), resulting in a valuation of $48.00 per share. Confronted with these differing DCF analyses and taking into account "all relevant factors" as mandated by Section 262, including the quality of BMC's sales process, the court rejected both parties' experts and settled on the merger price as the most reliable evidence of fair value:
Taking these uncertainties in the DCF analysis—in light of the wildly-divergent DCF valuation of the experts—together with my review of the record as it pertains to the sales process that generated the Merger, I find the Merger price of $46.25 per share to be the best indicator of fair value of BMC as of the Merger date.
Merion was decided a few months after two other Chancery Court decisions that adopted similar approaches to determining fair value in appraisal proceedings. In Merlin Partners LP v. AutoInfo, Inc., No. 8509-VCN (Del. Ch. Apr. 30, 2015), Vice Chancellor Noble issued a post-trial opinion in which he rejected an attempt by dissenting shareholders to extract extra consideration for their shares above the merger price through appraisal rights. In finding that the $1.05/share merger consideration constituted fair value, the court rejected the parties' competing expert valuations of $2.60/share (for the stockholders) and $.97/share (for the company). According to the court, the $1.05 merger price was a reliable indicator of fair value because, among other things, it was the product of an adequate process, and in fact the board had been considering a sale even before the company's larger institutional shareholders began pressuring the board for improved performance; the company was "'shopped quite a bit;'" and negotiations with the buyer were conducted at arm's length by an independent special committee. The court also took into account the reality that AutoInfo's stock had not reached as high as $1.00 in the prior two years, and the $1.05 merger price, which was the highest offer made by any bidder in the sales process, exceeded the highest price that AutoInfo's stock reached in the past five years.
LongPath Capital, LLC v. Ramtron Int'l Corp., No. 8094-VCP (Del. Ch. June 30, 2015), was decided along similar lines. There, Vice Chancellor Parsons expressed significant deference to the price reached by means of a process reasonably expected to identify the highest price available in the market, stating:
This lengthy, publicized process was thorough and gives me confidence that, if Ramtron could have commanded a higher value, it would have. For me (as a law-trained judge) to second-guess the price that resulted from that process involves an exercise in hubris and, at best, reasoned guess work. As such, I conclude that the Merger price is a reliable indication of Ramtron's fair value.
Conversely, Delaware courts likely will accord little weight to the merger price in determining fair value where the transaction is the product of a flawed sales process. In In re Appraisal of Dole Food Company, Inc., Nos. 8703-VCL & 9079-VCL (Del. Ch. Aug. 27, 2015), for instance, Vice Chancellor Laster held in a post-trial opinion that Dole's CEO and controlling stockholder, David Murdock, and his "right hand man," C. Michael Carter, undermined the sales process by depriving the special committee of the ability to negotiate, and stockholders of the right to vote, on a fully informed basis. The court found that Carter intentionally attempted to depress the price of the company's stock in advance of a going-private proposal and interfered with the special committee by, among other things, providing it with false financial information and misrepresenting that other financial information was not available. The court concluded that:
The evidence at trial established that the Merger was not a product of fair dealing. . . . Carter engaged in fraud. . . . Here it rendered useless and ineffective the highly commendable efforts of the Committee and its advisors to negotiate a fair transaction that they subjectively believed was in the best interests of Dole's stockholders.
In short, in the right circumstances merger price can be the most reliable evidence of fair value. Courts have given merger price 100% weight in the fair value analysis. As Vice Chancellor Jacobs once stated, "[t]he fact that a transaction price was forged in the crucible of objective market reality (as distinguished from the unavoidably subjective thought process of a valuation expert) is viewed as strong evidence that the price is fair." Van de Walle v. Unimation, Inc., No. 7046, 1991 WL 29303, at *17 (Del. Ch. Mar. 7, 1991). Nor is a multi-bidder auction a prerequisite to finding that the merger price is a reliable indicator of value. Where the price is the result of an arm's length process, particularly one in which a premium has been extracted by the seller, courts are likely to find that market forces have generated the most reliable indicator of the selling company's fair value.
B. Director Independence and Conflicts of Interest
The Delaware courts also issued significant decisions in 2015 in the area of director independence. Caspian Select Credit Master Fund Ltd. v. Gohl, No. 10244-VCN (Del. Ch. Sept. 28, 2015), involved a challenge by minority shareholders of Key Plastics Corporation to a loan transaction between Key Plastics and a lender managed by affiliates of two investment funds (the Wayzata Funds) that together owned 91.5% of Key Plastics' stock. The minority stockholders alleged that the board was beholden to the controlling stockholders and as a result agreed to loan amendments that benefitted the Wayzata Funds' affiliated lender to the detriment of minority stockholders. Specifically, the minority stockholders alleged that Key Plastics' CEO, who was also a member of the board, had been appointed to his position by the Wayzata Funds. The Wayzata Funds had also appointed three other members of Key Plastics' five-member board, including one director who was a principal of the Wayzata Funds' agent and one who was the CEO of a consulting firm that obtained substantial revenues from the agent. Both had also been appointed by Wayzata to the boards of numerous other companies in which the Wayzata Funds held a significant stake. Based on these relationships, Vice Chancellor Noble excused the demand requirement ordinarily imposed upon plaintiffs asserting derivative claims under Chancery Court Rule 23.1 because there was reason to doubt the independence of a majority of Key Plastics' board, and no special committee of independent directors was formed to address that conflict. (It also is unclear whether the Key Plastics board could have formed an independent committee, since only one board member was not beholden to the controlling entities and Delaware courts disfavor one-person committees.)
Vice Chancellor Noble then denied the motion to dismiss as to all directors, except as to the director who had not been appointed by the controlling stockholders. Applying "entire fairness" review, Vice Chancellor Noble concluded that the plaintiffs had adequately alleged that the amendments to the Wayzata loan were not entirely fair. As a matter of price, plaintiffs alleged that comparable companies had obtained unsecured financing at 50-80% lower interest rates and secured financing at 75-90% lower rates, and that seven companies expressed interest in refinancing the company's debt. As far as process, the court found it significant that the board never obtained an independent fairness opinion or considered alternative sources of financing. Caspian underscores that directors will find it difficult to prove the "entire fairness" of a controlling stockholder transaction not approved by independent directors, particularly where the board does not retain independent legal and financial advisors or obtain an independent fairness opinion.
Delaware County Employees Retirement Fund v. Sanchez, No. 702, 2014 (Del. Oct. 2, 2015), involved a challenge by minority shareholders of a public company, Sanchez Energy, to a transaction between Sanchez Energy and a private company, Sanchez Resources. The Sanchez Family owned the private company and was a significant stockholder (16%) of the public company, with A.R. Sanchez serving as Chairman of the Board and his son serving as a director and CEO of Sanchez Energy. Sanchez Energy's stockholders brought derivative claims against the five-member board of directors, alleging that the directors approved the transaction with Sanchez Resources on unfair terms designed to benefit the private company at the expense of the public company.
The Chancery Court dismissed their claims on the ground that they had not satisfied Rule 23.1's demand requirement or adequately pled that demand was excused. There was no dispute that two of Sanchez Energy's five directors—A.R. Sanchez and his son—were interested in the transaction because they both held ownership interests in Sanchez Resources. Thus, the question on appeal was whether the plaintiffs had adequately alleged that any of the three other directors were not disinterested, in which case demand would be excused. On appeal, the Delaware Supreme Court reversed and held that the plaintiffs had adequately alleged that one of the three purportedly independent directors was not disinterested, and therefore demand was excused. The Supreme Court based this determination on its finding that one director maintained a lengthy personal and professional relationship with A.R. Sanchez sufficient to raise an inference of a lack of independence. With respect to this director, the complaint alleged that: (i) he earned 30-40% of his income from his service on the Sanchez Energy board; (ii) he had maintained a close personal friendship with A.R. Sanchez for over 50 years; (iii) he contributed thousands of dollars to A.R. Sanchez's political campaign; and (iv) he owed his and his brother's full-time positions at an insurance company to A.R. Sanchez, who was a director and the largest stockholder of the insurance company's parent. The complaint also alleged that the insurance company did substantial work for Sanchez Energy and Sanchez Resources.
Sanchez demonstrates that even if a director does not have a direct financial interest in a transaction, the director's independence can be called into question based on long-standing close personal friendships and economically advantageous relationships with an interested party. The ruling, however, also has to be squared with prior Delaware Supreme Court decisions declining to draw an inference of a lack of director independence based upon allegations that directors "moved in the same social circles, attended the same weddings, developed business relationships before joining the board, and described each other as 'friends.'" Beam v. Stewart, 845 A.2d 1040, 1051 (Del. 2004). The tension is best resolved by considering the particular facts and circumstances of the case, where there was a "rare" 50-year friendship and other allegations supporting a pleading stage inference that the relationship was personally and economically important to the director.
The Chancery Court in In re El Paso Pipeline Partners, L.P. Derivative Litigation, No. 7141-VCL (Del. Ch. Apr. 20, 2015), imposed liability against a general partner (the General Partner) of a publicly traded Master Limited Partnership (El Paso MLP) for causing El Paso MLP to overpay for assets sold to it by its corporate parent, despite the fact that the relevant limited partnership agreement eliminated general partner fiduciary duties owed to the limited partners. As Vice Chancellor Laster observed, the limited partnership agreement permitted the General Partner to cause El Paso MLP to engage in a transaction involving a conflict of interest if the transaction received "Special Approval" from the Conflicts Committee of the General Partner's board. The court found that the "only contractual requirement for Special Approval was that the Conflict Committee members believe in good faith that the transaction was in the best interests of El Paso MLP."
Despite these minimal requirements, the court found that the General Partner failed to satisfy the contractual standard, ruling that "the Committee members failed to form a subjective belief that the transaction was in the best interests of El Paso MLP. The General Partner therefore breached the LP Agreement by causing El Paso MLP to engage in the transaction."
The court observed that while the Committee members were outside directors who met the NYSE's audit committee independence standards, two of the three members had significant ties to the parent. Each had been a high ranking executive at the parent or an affiliate and still had a significant portion of his net worth tied up in the company. These relationships called the Committee's independence into question. The court also recognized that the Committee's financial advisor lacked complete independence: it was retained "as a matter of course" for similar transactions; had engaged in "back-channel" discussions with the corporate parent concerning these transactions—thereby circumventing the Committee; structured its fee so it was contingent on a transaction being consummated; and "manipulated its presentations in unprincipled ways to justify the deal," by, for example, comparing the deal (which involved an acquisition of a minority 49% interest) to precedent transactions for the acquisition of majority interests, which typically commanded higher premiums.
The absence of a truly independent Committee or financial advisor was one important factor that led the court to conclude that the Conflicts Committee and its advisor "went through the motions, but the substance was lacking:
"[I]n most instances, the Committee members and their financial advisor had no explanation for what they did. The few explanations they had were conclusory or contradicted by contemporaneous documents. Rather than evaluating what was in the best interest of El Paso MLP, the Committee members regarded as dispositive whether the [transaction] was accretive, in the sense of enabling El Paso MLP to increase distributions to holders of its common units. . . . The evidence at trial ultimately convinced me that when approving the [transaction], the Committee members went against their better judgment and did what Parent wanted, assisted by a financial advisor that presented each dropdown in the best possible light, regardless of whether the depictions conflicted with the advisor's work on similar transactions or made sense as a matter of valuation theory.
The court ultimately determined that El Paso MLP paid $171 million more for the assets than it would have if the General Partner had not breached the limited partnershp agreement, and awarded this amount as damages against the General Partner.
While the facts in El Paso in some respects are atypical, the decision again highlights the intense scrutiny Delaware courts will apply in reviewing parent-subsidiary and other interested party transactions, carefully reviewing the details of financial advisor presentations and director communications to discern the quality of the process leading to the approval of transactions. It is also a reminder that the applicable standard of review is not necessarily outcome determinative, as the Conflicts Committee in this case was subject to a very low standard, which it nevertheless was found to have violated, resulting in substantial monetary liability being imposed on the General Partner. Finally, the fact that a majority of the Committee was beholden to the corporate parent was a theme that permeated the opinion, and would have made it difficult to demonstrate the fairness of or the Committee's good faith belief in the transaction even had the Committee discharged its duties more diligently.
C. Challenges to Disclosure-Only Settlements
The potential viability of disclosure-only settlements, where a class receives no monetary recovery in exchange for giving defendants broad liability releases, was seriously called into question by the Delaware courts in 2015. Given that over 90% of all public M&A transactions are subject to litigation, the Delaware courts' evolving position on this method of resolving such cases is significant. In In Re Riverbed Technology, Inc. Stockholders Litigation, No. 10484-VCG (Del. Ch. Sept. 17, 2015), the Chancery Court fired a warning shot regarding "disclosure-only" settlements and indicated that it will become increasingly difficult for defendants to obtain broad releases of claims and for plaintiff's counsel to secure substantial legal fee awards in such settlements.
Riverbed involved the leveraged buy-out of Riverbed for $21 per share ($3.6 billion) by private equity firm Thoma Bravo and Teachers' Private Capital, an affiliate of Ontario Teachers' Pension Plan. Plaintiffs initially challenged the deal but subsequently entered into a settlement agreement.
The proposed settlement provided supplemental disclosures to the effect that the target's financial advisor "had present engagements with the purchasers and their affiliates," and also "informed the stockholders, for the first time, of the substantial nature of [the target financial advisor's] relationship with these entities. . . . [including] approximately $25 million in fees from one of the purchasers (or its affiliates) within the two years leading up to the Merger . . . ."
Nevertheless, Vice Chancellor Glasscock observed that, despite the disclosures, holders of 99.48% of shares voted in favor of the merger. The court therefore concluded that:
This demonstrates to me, even without resort to the academic literature that questions the value of disclosures to the [stockholders], that the disclosure here was not of great importance. To use the expression first made in this context by Chancellor Allen, the Plaintiffs have achieved for the Class a peppercorn, a positive result of small therapeutic value to the Class which can support, in my view, a settlement, but only where what is given up is of minimal value.
The court went on to approve the settlement despite its misgivings, but with two caveats: (i) the legal fees were reduced from $500,000 to approximately $329,000 (inclusive of costs); and (ii) the court indicated that it was approving the broad release included in the settlement in part because the parties negotiated the settlement "with the reasonable expectation that the very broad, but hardly unprecedented, release negotiated in return would be approved by this Court." The court stated, however, that such an expectation would no longer be justified in future settlements "in light of this Memorandum Opinion and other decisions of this Court."
The court added that:
If it were not for the reasonable reliance of the parties on formerly settled practice in this Court . . . the interests of the [stockholder] might merit rejection of a settlement encompassing a release that goes far beyond the claims asserted and the results achieved."
The "other decisions" referenced by Vice Chancellor Glascock include, among others, Acevedo v. Aeroflex Holding Corp., No. 9730-VCL (Del. Ch. Jul. 8, 2015). There, Vice Chancellor Laster rejected a disclosure-only settlement in a case challenging the sale of Aeroflex to Cobham Plc. The court concluded that the settlement, which included supplemental disclosures, a reduction of a termination fee and a reduction of matching rights in the context of a sale agreement supported by a controlling stockholder of the seller, meant that:
The class in this situation gets nothing. Zero. Zip. The only consideration they theoretically get is therapeutic relief. Usually that means only disclosures. Here it means disclosures plus two tweaks to the merger agreement.
Transcript of Settlement Hearing and Request for Attorneys' Fees and the Court's Ruling, Acevedo v. Aeroflex Holding Corp., No. 9730-VCL (Del. Ch. Jul. 8, 2015).
The court then concluded that the benefits to the stockholder class were too meager to support either the broad release contained in the settlement or an award of legal fees to the plaintiffs' counsel, and rejected the settlement. The court also observed that because the deal had been approved by a fully informed vote of disinterested stockholders, it could likely be simply dismissed upon motion by defendants under the business judgment rule.
Each of these decisions evidences the Delaware courts' growing impatience with disclosure-only settlements. In the future, it is possible that only highly significant additional disclosures will support a broad release and substantial attorneys' fees award. For companies subject to such litigation, this will be a mixed blessing. On the one hand, such a trend could reduce the number of or frequency with which such suits are filed. On the other hand, when litigation is commenced, merging companies may no longer have the option of a relatively inexpensive method for easy disposition of frivolous merger litigation.
D. Financial Advisor Liability
As in the past few years, there were a number of important decisions concerning the responsibilities of financial advisors to companies or boards in the context of challenged transactions, particularly when a sale of the company is at issue. Last month, the Delaware Supreme Court affirmed the Chancery Court's post-trial decisions in In re Rural/Metro Corp. Stockholders Litigation, No. 625, 2014 (Del. Ch. Dec. 2, 2014). See RBC Capital Mkts., LLC v. Jervis, No. 140, 2015, slip op. (Del. Nov. 30, 2015). The Chancery Court had found a seller's financial advisor liable in the amount of $76 million for aiding and abetting the Rural/Metro Corporation board's breaches of fiduciary duty in connection with Rural's 2011 sale to the private equity firm Warburg Pincus LLC.
While the Rural board authorized a Committee of non-management directors to explore potential strategic alternatives, it did not authorize the Committee to pursue a sale. The Committee nonetheless did just that, retaining primary and secondary financial advisors and ultimately recommending a sale to Warburg. Rural's shareholders sued the company's directors for breaching their fiduciary duties and also asserted aiding and abetting claims against the financial advisors. The Rural directors and the secondary advisor settled near trial. In post-trial opinions, Vice Chancellor Laster found the primary financial advisor liable in the amount of nearly $76 million.
The Delaware Supreme Court's decision reaffirmed the importance of financial advisor independence and the courts' exacting scrutiny of M&A advisors' conflicts of interest. In particular, the court upheld the Chancery Court's ruling that the transaction failed to pass muster under Revlon because Rural's committee and the full board were unaware of, and did not meaningfully attempt to inquire into, the financial advisor's conflict of interest in seeking to leverage its role as Rural's advisor to obtain buy-side financing roles in other industry transactions. According to the court, "[b]ecause a conflicted advisor may, alone, possess information relating to a conflict, the board should" have, but failed to, "require disclosure of, on an ongoing basis, material information that might impact the board's process." Here, the financial advisor was motivated to recommend that the board commence a sale process by its interest in leveraging its role as Rural's sell-side advisor to secure a role in buy-side financing in other transactions in the industry. The court found that the maximum financing fee for the Financial Advisor was $55 million, "more than ten times the advisory fee."
In addition to the financial advisor's conflicts of interest, the Supreme Court also agreed with Vice Chancellor Laster that the advisor manipulated its financial analyses for a desired outcome. As a result, the board was not adequately informed concerning the company's value. The financial advisor failed to include any valuation metrics or analysis in board presentations until only three hours before the board voted to approve the deal. Moreover, the lower court determined that, unbeknownst to the board, the financial advisor altered its financial analyses in its fairness presentation to make the Warburg bid look more attractive, namely by: (1) disregarding its prior reliance on comparable company analyses; (2) reducing the low end multiple in both the management case and "consensus" case projections by "weigh[ing] heavily the 2004 acquisition of AMR by Onex Partners at 6.3x EBITDA, a course of action it had discredited earlier"; and (3) lowering the "consensus" adjusted EBITDA by deducting certain one-time expenses, even though its earlier analyses had added these one-time charges back to EBITDA.
Importantly, however, the Supreme Court disagreed with Vice Chancellor Laster's characterization of financial advisors as "gatekeepers" whose role is virtually on par with the board's to appropriately determine the company's value and chart an effective sales process. Instead, the court found that the relationship between an advisor and the company or board is primarily contractual in nature and the contract, not a theoretical gatekeeping function, defines the scope of the advisor's duties in the absence of undisclosed conflicts on the part of the advisor. In that regard, the court stated, "[o]ur holding is a narrow one that should not be read expansively to suggest that any failure on the part of a financial advisor to prevent directors from breaching their duty of care gives rise to" an aiding and abetting claim. In that (albeit limited) sense, the decision offers something of a silver lining to financial advisors in M&A transactions.
Fox v. CDX Holdings Inc., No. 8031-VCL (Del. Ch. July 28, 2015), sounded a similar cautionary note. There, Vice Chancellor Laster issued a post-trial opinion criticizing in particularly strong terms the analysis performed by a financial firm that was retained to value companies being sold to a third party or spun off to stockholders (the Valuation Firm). Calling the Valuation Firm's work "a new low," Vice Chancellor Laster's opinion lays bare how financial firms can be exposed not only to potential monetary liability but, as importantly, significant reputational harm from flawed sell side work on M&A transactions.
The action involved the sale or spin-off of the businesses of Caris Life Sciences, Inc., a privately-held Delaware corporation that operated through three subsidiaries: Caris Diagnostics, TargetNow and Carisome. To secure financing for TargetNow and Carisome, Caris sold Caris Diagnostics to Miraca Holdings in the fall of 2011. To minimize taxes, the transaction was structured as a "spin merge," whereby Caris transferred ownership of TargetNow and Carisome to a new subsidiary, which it then spun off to stockholders. At that point, Caris (owning only Caris Diagnostics) merged into a subsidiary of Miraca.
Some of the equity in Caris consisted of stock options that were cancelled in connection with the Miraca transaction, with each holder having the right to receive for each covered share the amount by which the "Fair Market Value" of the share exceeded the option exercise price. Option holders brought suit challenging, among other things, the value attributed to TargetNow ($47 million) and Carisome ($18 million) for purposes of determining Fair Market Value. Caris' tax advisor initially arrived at these valuations, and the Valuation Firm (which was retained at the buyer's insistence) then supposedly independently arrived at the same results. The court found that Caris breached its contract with option holders, determined that the value of TargetNow and Carisome combined was approximately $300 million, and awarded damages of approximately $16 million to the option holders for their interest.
The Chancery Court repeatedly criticized as results-driven the analyses performed by Caris' valuation firm regarding TargetNow and Carisome, and found that Caris' valuation advisor manipulated downward its valuation of TargetNow and Carisome to achieve a desired zero-tax outcome. Among other things, the court found that the valuation firm: (i) did not perform a comparable companies analysis even though only months before, during its "ordinary course" work, it deemed another transaction in fact to be comparable (and that transaction implied a significantly higher valuation for TargetNow but such a valuation would have frustrated the goal of a tax-free spin-off); (ii) reached the same valuation for Carisome as the tax advisor despite using materially different inputs in its analysis, such that the "only possible explanation" was that the valuation firm "did not prepare its table independently"; (iii) simply copied the tax advisor's report, doing so blatantly such that "the output matched . . . even when the inputs differed"; (iv) used for its analysis "the cost method" and rejected other valuation methods, all of which "conflicted with all of its prior valuations"; (v) for the spin-off opined that it is not possible to accurately forecast cash flows notwithstanding that its ordinary course analyses "relied on management projections and used" discounted cash flow analyses based on those projections; (vi) "made significant errors," including mistakenly using a company's trailing nine-month revenue for 2010 instead of projected twelve-month revenue for 2011; (vii) based its valuation on the tax advisor's work, which did not determine the common stock's fair market value, but instead was intended to determine intercompany transfer tax liability—as a result, certain assets were excluded, including goodwill. Taken together (and perhaps in some instances individually), these issues led the court to conclude that the valuation firm's analyses were "so flawed as to support both an inference of bad faith and a finding the process was arbitrary and capricious."
In In re Zale Corporation Stockholders Litigation, No. 9388-VCP (Del. Ch. Oct. 1. 2015), the Chancery Court again addressed financial advisor liability in a case stemming from the merger of Zale Corporation and Signet Jewelers. Zale had previously been advised by its largest stockholder, Golden Gate Capital (23%), that a particular financial advisor (the Financial Advisor) was working as lead underwriter on a secondary offering of stock owned by Golden Gate, and the Zale's appointed Negotiation Committee retained the Financial Advisor in part due to its familiarity with Zale. The Financial Advisor did not disclose that it earned approximately $2 million from Signet from 2012-2013 and, more importantly, made a presentation only a month earlier to Signet's management regarding a possible acquisition of Zale in the range of $17 to $21 per share. The merger at $21 per share was approved by a majority of Zale's disinterested stockholders, but thereafter Zale stockholders filed suit, asserting claims against Zale's directors for breach of fiduciary duty and against Signet and the Financial Advisor for aiding and abetting breach of fiduciary duty.
Vice Chancellor Parsons dismissed all claims except for the plaintiffs' claim against the Financial Advisor, ruling that, in an all-cash merger, "Revlon enhanced scrutiny applies, even after the merger has been approved by a fully informed, disinterested majority of stockholders." Only one day later the Delaware Supreme Court ruled differently in a separate case and held that the business judgment rule is the appropriate standard of review when a merger that is not subject to "entire fairness" review has been approved by a fully informed, uncoerced majority of disinterested stockholders. See Corwin v. KKR Financial Holdings LLC, No. 629, 2014 (Del. Oct. 2, 2015). Notwithstanding that decision, Zale's discussion of the financial advisor's conflicts, and the board's failure to uncover them, remain relevant and important. Specifically, courts will likely find it to be a breach of the board's duty of care where it relies unquestioningly on its financial advisor's representations as to a lack of conflict without further investigation. Vice Chancellor Parsons held that the Zale board's duty of care included a duty to detect preexisting conflicts when engaging a financial advisor, including by negotiating for representations and warranties in an engagement letter and asking probing questions about the advisor's past work for the counterparty to the transaction and other potential buyers. The court criticized the Zale board's conflict detection measures, as alleged in the complaint, which "consisted simply of discussing the possibility that [the Financial Advisor] would be conflicted and apparently relying without question on [the Financial Advisor's] representations" as to a lack of material conflict.
E. Forum Selection Bylaws; Fee Shifting Bylaws
The Delaware State Legislature enacted several amendments to the DGCL in 2015, including the adoption of forum-selection bylaws and precluding the adoption of "loser-pay" attorney fee bylaw provisions.
The newly adopted DGCL Section 115 provides that "[t]he certificate of incorporation or the bylaws may require . . . that any or all internal corporate claims shall be brought solely and exclusively in any or all of the courts in [Delaware] . . . ." The statute defines "internal corporate claims" to include claims "(i) that are based upon a violation of a duty by a current or former director or officer or stockholder in such capacity, or (ii) as to which [the DGCL] confers jurisdiction upon the Court of Chancery." Notably, the statute prohibits designating a forum other than Delaware as the exclusive litigation jurisdiction, although private stockholder agreements could do so. We expect that bylaws restricting the litigation of "internal corporate claims" to Delaware will be widely adopted and should have the effect of reducing multi-forum litigation of intra-corporate claims.
The Legislature has also amended DGCL Section 109(b) to provide that "bylaws may not contain any provision that would impose liability on a stockholder for the attorneys' fees or expenses of the corporation or any other party in connection with an internal corporate claim . . . ." Similarly, DGCL Section 102(f) was added prohibiting fee shifting provisions in a corporation's certificate of incorporation. These amendments were adopted in reaction to the Delaware Supreme Court's decision in ATP Tour Inc. v. Deutscher Tennis Bund, 91 A.3d 554 (Del. 2014). In ATP Tour, the court held that a bylaw provision that shifted attorneys' fees and costs to unsuccessful plaintiffs in intra-corporate litigation was not per se invalid. In response to the decision, the legislature enacted the amendments to Sections 109(b) and 102. The impact of the amendments is far from clear, however, because the Chancery Court had tools to address frivolous claims even before the ATP Tour decision, such as the ability to impose costs on one of the parties.
F. SEC's Proposed Unbundling Rules
The Securities and Exchange Commission issued two compliance and disclosure interpretations (CDIs) on the so-called "unbundling rule" in 2015, likely as a reaction against, and desire to deter, inversion transactions.
Exchange Act Rule 14a-4(a)(3) requires that a company's proxy statements "identify clearly and impartially each separate matter intended to be acted on" at a meeting of the shareholders. The two SEC CDIs relate to proposed M&A transactions in which an acquirer issues equity securities to the target entity's stockholders and the agreement, Delaware law or the rules of a national securities exchange require the acquirer to make material changes to its organizational documents. In the CDIs, the SEC staff has established a new requirement for separate target stockholder votes on material changes to the acquirer's organizational documents, "unbundled" from the target vote on the transaction itself.
Each separate vote would require a separate disclosure in the proxy statement and a separate box on the proxy card. The CDIs create new procedural and disclosure-related requirements, but they do not impose any new substantive requirements. As a result, their actual impact on inversions or other transactions remains questionable.
The CDIs provide the following examples of amendments to the acquirer's organizational documents that would be material and thus require a separate vote: adoption of a classified or staggered board, limitations on the removal of directors, adoption of supermajority voting provisions, delaying the annual meeting for more than a year, eliminating the ability to act by written consent, and changing the minimum quorum requirements. The following would, in most cases, not be considered material: name change, restatement of a charter, and technical changes such as those resulting from anti-dilution provisions. The CDIs further confirm that the parties can condition closing of the transaction on acquirer and/or target stockholder approval of any or all of the separate proposals.