© 2013 Cleary Gottlieb Steen & Hamilton LLP. All rights reserved. Throughout this presentation,...

© 2013 Cleary Gottlieb Steen & Hamilton LLP. All rights reserved.

Throughout this presentation, “Cleary Gottlieb” and the “firm” refer to Cleary Gottlieb Steen & Hamilton LLP and its affiliated entities in certain jurisdictions, and the term “offices” includes offices of those affiliated entities.

July 10, 2013

Recent Developments in Delaware M&A Caselaw: What Corporate Counsel Should Know

Presentation Overview

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Case Issue

Siga v. PharmAthene Enforceability of obligation to “negotiate in good faith”

Meso Scale v. Roche Interpretation of anti-assignment clauses

Koehler v. Netspend Implications of retained “Don’t Ask/Don’t Waive” provisions on a subsequent sales process

In re MFW Structuring controlling shareholder buyouts; Rights of minority shareholders in “going private” transactions

Enforceability of Obligation to Negotiate in Good Faith

SIGA Technologies, Inc. v. PharmAthene (Del. May 24, 2013)

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Overview

Recent Delaware Supreme Court ruling affirmed that an express contractual obligation to negotiate in good faith is enforceable

Court recognized “expectation damages,” which would effectively enforce a term sheet as a binding agreement, when the record shows that the parties would have reached agreement but for one party’s bad faith

Unique circumstances of the underlying transaction likely contributed to Court’s extraordinary remedy but case highlights the risks and unintended consequences of early stage negotiation of transactions

Careful attention to pre-deal negotiations and commitments and undertakings to “negotiate in good faith” are critical for all transactional lawyers

SIGA Technologies, Inc. v. PharmAthene (Del. May 24, 2013)

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Case Background

• Cash-strapped bio-defense company, SIGA, with valuable antiviral drug under development for treating smallpox begins discussions with PharmAthene about some form of collaboration

• On March 10, 2006, SIGA and PharmAthene signed a merger letter of intent that included a license agreement term sheet ("LATS") for smallpox drug

• The LATS contain the key material provisions for the license (worldwide exclusive license, upfront cash payments, funding guarantees, cash milestone payments, composition of R&D committee and sublicensing rights) -- footer on LATS stated “Non Binding Terms”

• On March 20, PharmAthene provided SIGA a bridge loan while parties negotiated definitive merger agreement, which required that parties negotiate in good faith a license agreement “in accordance with the terms of the LATS” if definitive merger agreement is not entered into or, if entered into, if the merger agreement is terminated

• On June 8, SIGA and PharmAthene entered into a merger agreement containing the same clause requiring the parties to negotiate a license agreement in good faith “in accordance with the terms” of the LATS if the merger agreement were terminated

Enforceability of Obligation to Negotiate in Good FaithSIGA Technologies, Inc. v. PharmAthene (Del. May 24, 2013)

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Case Background (cont'd)

• SIGA's liquidity position improved after the merger agreement was signed with the receipt of NIH grants and SIGA terminated the merger agreement once the drop-dead date passed

• PharmAthene then sent SIGA's counsel a draft license agreement patterned on the LATS

• SIGA responded by asking for a partnership (instead of license) and for revisions to the LATS economic terms due to the drug’s clinical progress during the intervening period

– e.g., upfront payments of $100mm (vs. $6mm), milestone payments of $235mm (vs. $10mm)

• SIGA informed PharmAthene that it intended to renegotiate the LATS "without preconditions" or "there was nothing more to talk about"

• PharmAthene sued and after trial VC Parsons held:

– SIGA was liable for breach of obligation to negotiate in good faith a definitive license agreement in accordance with the LATS

– Appropriate remedy was an equitable payment stream that approximated terms of the license agreement the parties would have reached if they had negotiated in good faith


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Delaware Supreme Court Affirms Chancery Court

• Court ruled that an express contractual obligation to negotiate in good faith is enforceable under Delaware law

• SIGA acted in bad faith when negotiating the license agreement in breach of its obligation under the Bridge Loan and the Merger Agreement

– terms it proposed were “drastically different” than those in the LATS

• Expectation damages are an appropriate remedy when the parties had agreed to major terms of an agreement and have agreed to negotiate in good faith and the record shows that parties would have reached agreement but for bad faith

Court’s Reasoning

• The parties had a duty to negotiate toward a license with "economic terms substantially similar" to the LATS rather than using it as a "jumping-off point"

– Incorporation of the terms into the Merger Agreement and Bridge Loan demonstrated parties intent

– Bridge loan would not have been made by PharmAthene if there was not a reasonable expectation that it would control the smallpox drug either through merger or license on these terms


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Court’s Reasoning (cont’d)

• SIGA argued that it would be inconsistent to hold that the LATS is not a binding license agreement and at the same time conclude that SIGA’s obligation to negotiate in good faith requires that SIGA only propose terms substantially similar to the LATS

• Considering both NY and Delaware precedents, the Delaware Supreme Court:

– reaffirmed that an obligation to negotiate in good faith is enforceable, which the Court had previously recognized in Titan Investment Fund II, LP v. freedom Mortgage Corp (Del. Dec. 5, 2012)

– distinguished SIGA from Delaware precedent (applying NY law) holding that “obligations to negotiate are said to be invalid where material aspects of the contract remain open”

– concluded that where a party agrees to negotiate in good faith a term sheet or “an incomplete agreement” (like the LATS), good faith differences may prevent the parties from concluding a definitive agreement BUT a counterparty cannot insist on conditions that do not conform to the preliminary agreement


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Expectation Damages Are Appropriate Remedy

• In Titan Investment Fund, the Court found that given the plaintiff’s inability to establish that the contract would have closed but for the defendant’s breach, the plaintiff was not entitled to benefit-of-the-bargain damages but instead was limited to “reliance” damages (e.g., actually-incurred costs and expenses)

• Deciding a question of first impression in Delaware, the Court held that expectation damages are an appropriate remedy for a “Type II preliminary agreement”

• Court borrowed from NY law precedent, which recognizes two types of binding preliminary agreements:

• Type I: a fully-binding preliminary agreement, created when parties agree on all points that require negotiation but agree to memorialize in a more formal document

• Type II: parties agree on certain major terms, but leave others open for negotiation

• Court concludes that in a Type II preliminary agreement, if the plaintiff can prove that but for the defendant’s bad faith, the parties would have made a final contract, then the plaintiff is entitled to recover expectation damages


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Final Outcome is Pending

• Though recognizing availability of expectation damages, Delaware Supreme Court reversed VC Parsons on applicability of promissory estoppel (which had been part of the Chancery award analysis) and remanded the case for reconsideration of the appropriate expectation damages award

Takeaways

• Should be mindful of highly fact-based analysis in drawing lessons

• Delaware reaffirmed the enforceability of a promise to negotiate in good faith so parties should not take words lightly

• Before sending a term sheet to another party in the context of having a duty to negotiate in good faith, need to consider whether liability will attach as a result of refusing to finalize a definitive agreement in a manner that may be construed, based on this opinion, to be based on less than good faith

– Court described “bad faith” as: ”not simply bad judgment or negligence, but rather it implies the conscious doing of a wrong because of dishonest purpose or moral obliquity; it is different from the negative idea of negligence in that it contemplates a state of mind affirmatively operating with furtive design or ill will.”

• Was there a simple drafting fix?

• Would the Court have reached a different answer if there was no bridge loan?


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Interpretation of Anti-Assignment Clauses

Meso Scale Diagnostics, LLC v. Roche Diagnostics GMBH (Del. Ch. Feb. 22, 2013)

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Overview

After initially questioning the widely-held view that RTMs do not constitute “assignment by operation of law” in Delaware, the Chancery Court at a later stage of the same proceeding reversed course and affirmed that assets of the surviving corporation in a merger are not deemed to be “assigned”

Court affirmed that RTMs and share sales would not be deemed to be assignments, notwithstanding acquirer’s actions to wind-down the target business following acquisition

For in-house counsel, the question of whether deal structure triggers anti-assignment restrictions under target contracts is often part of early-stage due diligence

While Meso Scale clarifies the treatment of assignment clauses in the case of mergers for Delaware governed agreements, the law in other jurisdictions may be less clear and counsel should be mindful of limitations on assignment and whether their post-closing plans would be consistent with the terms of any contract acquired through an RTM

Meso Scale Diagnostics, LLC v. Roche Diagnostics GMBH (Del. Ch. Feb. 22, 2013)

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Legal Background: Reverse Triangular Mergers (“RTMs”)

• Merger Sub merges with and into Target, with Target continuing as the “Surviving Corporation”

• Surviving Corporation retains its own assets and liabilities and succeeds to those of Merger Sub

• Generally constitutes a change of control of Target, but generally does not constitute an “assignment” of Target’s contracts, but depends on the assignment provision

Legal Background: Reverse Triangular Mergers

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Parent

Merger Sub

Target Shareholders

Target

Parent

Surviving CorporationMerger

Surviving Corporation Stock

Merger Consideration

Legal Background: Interpreting anti-assignment clauses

• Typical, boilerplate anti-assignment provision prohibits assignment of the agreement, and any rights or obligations thereunder, “by operation of law or otherwise” without consent of the other party

• Boilerplate language would pick up assignment via a “forward” merger, after which the party to the relevant contract ceases to exist

– Although limited caselaw directly on point, traditional understanding in Delaware was that an RTM does not implicate an anti-assignment provision, because the target of the merger is the surviving corporation, and so continues as the counterparty in the relevant contracts

But, in a 1991 unpublished opinion, the Northern California District Court held that an anti-assignment clause providing that the rights granted under a license agreement were not to be “assigned or transferred” without prior consent of the licensor was violated when the licensee was acquired in an RTM (SQL Solutions, Inc. v. Oracle Corp. (N.D. Cal. Dec. 18, 1991))

Denying a motion to dismiss in Meso Scale Diagnostics, LLC v. Roche Diagnostics GMBH (Del. Ch. Apr. 8, 2011), Vice Chancellor Parsons created significant uncertainty as to the status of a target’s contracts following an RTM, when he suggested that an RTM might, depending on the circumstances, constitute an assignment “by operation of law”

Legal Background: Interpretation of Anti-Assignment Clauses

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Case Background

• In 1992, IGEN grants an exclusive license to use “ECL” technology in certain limited contexts to an entity later acquired by Roche

• In 1995, IGEN and Meso Scale Technologies (“MST”) enter into a joint venture and form Meso Scale Diagnostics (“MSD”) to develop ECL-related IP

– Exclusive license granted to MSD to use ECL in certain broadly-defined fields, based on the rights retained by IGEN and outside of the limited contexts covered by the 1992 Roche license

MSD license includes “springing right” to expand license in the event any third-party ECL exclusive licenses were terminated or became non-exclusive

• In 1997, IGEN sues Roche for certain breach of contract claims, including use of ECL technology outside of the license’s scope

– Jury delivers special verdict in favor of IGEN, and awards compensatory and punitive damages

– Court of Appeals affirms jury’s finding, reduces jury’s award, and permits IGEN to terminate Roche’s license

Interpretation of Anti-Assignment Clauses Meso Scale Diagnostics, LLC v. Roche Diagnostics GMBH (Del. Ch. Feb. 22, 2013)

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Case Background (cont’d)

• Beginning in 2004, additional disputes between Bioveris and Roche regarding scope of Roche’s use of ECL technology

• In 2006, Roche approaches Bioveris with offer to purchase the company

• In 2007, Roche and Bioveris sign merger agreement, through which Roche obtains 100% of Bioveris in all cash deal

– Merger effected as reverse triangular merger (through which newly-created, wholly-owned subsidiary of Roche is merged with and into Bioveris, with Bioveris as the surviving corporation)

– Roche essentially halts Bioveris’s operating activities (Plaintiffs assert essentially converted into holding company for intellectual property and license rights)

• In 2010, MSD and MST sue, including claim that Roche acquisition of Bioveris constituted an assignment of Bioveris’s intellectual property, and, effected without MSD and MST consent, was breach of anti-assignment clause

– Roche files motion to dismiss


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Delaware Chancery Court

• 2011 – Denies Roche’s motion to dismiss, noting that there may be circumstances where a reverse triangular merger can trigger prohibitions on assignments by operation of law or otherwise

• 2013 – A reverse triangular merger does not constitute an assignment by operation of law under Delaware law

Court’s Reasoning

• Parties’ collective intent – “by operation of law or otherwise” under the language of the Delaware statute

– Section 259(a) of the DGCL: [At the effective time of] any merger . . . the separate existence of all the constituent corporations, or of all such constituent corporations except the one into which the other or others . . . have been merged . . . shall cease and . . . the rights, privileges, powers and franchises of each of said corporations, and all property, real, personal and mixed . . . shall be vested in the corporation surviving or resulting from such merger or consolidation; and all property, rights, privileges, powers and franchises, and all and every other interest shall be thereafter as effectually the property of the surviving or resulting corporation as they were of the several and respective constituent corporations.

Establishes that, in a merger, the rights and obligations of a non-surviving corporation are transferred and vested in the surviving corporation; with respect to rights and obligations that originated in the surviving corporation (e.g., when the target corporation is the surviving corporation) no “assignment by operation of law or otherwise” has been effected


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Court’s Reasoning (cont’d)

• Parties' collective intent – reasonable expectation of the parties

– “the vast majority of commentary” and case law indicate that an RTM does not constitute an assignment by operation of law with respect to the surviving company’s contracts

• Doctrine of independent legal significance

– The mere fact that the result of actions taken under one section [of the DGCL] may be the same as the result of actions taken under another section does not require that the legality of the result must be tested by the requirements of the second section (e.g., the fact that a different legal structure would have triggered MSD consent rights has no bearing on the analysis of the legal structure (the RTM) employed here)


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Takeaways

• While the Chancery Court’s decision created greater certainty regarding how Delaware will treat a target’s contracts following an RTM, context and the parties’ intent are still important

– While the Court confirmed that, under Delaware law, an RTM does not result in an assignment by operation of law, the Court acknowledged that the entire agreement provides the context in which to read the anti-assignment language, and that ambiguities in a contract might indicate that operation of law language should pick up RTMs in certain situations

– Acquirors should remain cautious about their treatment of a target’s contracts (and any necessary consents related to an entity other than the acquired company utilizing the acquired company’s licensed IP) following an RTM

• Practitioners should be careful to draft anti-assignment clauses (and any other boilerplate language) so that they accurately capture the parties’ intent

– The Court noted that Meso could have negotiated for a “change of control provision”, but instead negotiated for a term that prohibits “assignments by operation of law or otherwise”. If a company’s intention is to limit its obligations under a contract in the event of a chance of control of the other party, this should be explicitly stated

• Relevance of choosing appropriate governing law

– While the Court declined to adopt the California approach described in SQL Solutions Inc., the applicability of anti-assignment clauses in RTMs has not been squarely addressed in all jurisdictions. Practitioners should be aware of how the “governing law” of a contract views anti-assignment provisions


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Don’t Ask/Don’t Waive Standstill Provisions

Koehler v. NetSpend Holdings Inc. (Del. Ch. May 21, 2013)

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Overview

Drawing on two recent bench rulings regarding the use of "Don't Ask/Don't Waive" standstill provisions, the Chancery Court highlighted the Board's failure to fully consider (or, ostensibly, understand) the impact of DADW provisions in certain of its confidentiality agreements as part of a sales process that was likely unreasonable, and, as such, in breach of the Board's duty to seek the best value reasonably obtainable for its stockholders

But, the Court declined to issue an injunction, finding that the potential harm of an injunction outweighed the harm from allowing the transaction to proceed

In-house counsel often sign up confidentiality (non-disclosure) agreements before outside counsel is hired; re-assessment of any DADW provisions in those agreements must be made a part of the Board process at the earliest stages of discussion of a deal

To ensure continuing compliance with a Board’s fiduciary duties, in-house counsel should keep track of confidentiality/standstill agreements that remain effective after a deal dies

Koehler v. NetSpend Holdings Inc. (Del. Ch. May 21, 2013)

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Legal Background: Revlon Duties

• When a company decides to sell itself, certain Revlon duties kick in.


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Pursuing a Sales Process: Revlon

Duties

Not Pursuing a Sales Process: Directors’

Fiduciary Duties (Generally)

Duty of Care (duty to be fully informed)

Duty of Loyalty (duty of good faith)

Duty of Complete Disclosure (Delaware)

Generally, Business Judgment Rule Review

General Fiduciary Duties (Care, Loyalty, Disclosure)

Duty to seek “the highest value reasonably obtainable for stockholders”

Enhanced Scrutiny

Duty to “act in a fully informed manner, and in good faith, to obtain the best deal available”

Legal Background: Revlon Duties (cont’d)

• “Enhanced Scrutiny” involves:

– Judicial determination regarding adequacy of decisionmaking process (including information on which directors based decision)

– Judicial examination of the reasonableness of the directors’ action in light of circumstances then existing

• No single “blueprint” by which a Board must fulfill its Revlon duties. Board can successfully fulfill Revlon through:

– Public “Auction” (publicly announced deal process)

– Private Limited “Auction” (approaching a smaller number of bidders confidentially)

– One-on-one negotiations + market check

• If challenged, directors must be able to prove they were adequately informed and acted reasonably


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Legal Background: Don’t Ask/Don’t Waive Standstill Provisions

• “Standstill”: contractual prohibition of acquisition of a public company’s stock and other unsolicited actions that may influence management of the company

– Typical in a sales process involving public companies and other contexts in which parties share significant inside information

– Generally negotiated as part of Confidentiality Agreement

Typical quid pro quo that a public company will require in exchange for providing a third party with material, non-public information

– Term of standstill is a key part of negotiation – typical term one year or less though can be longer

– Objectives:

Prevent actions that put the public company in play

Maintain orderly and competitive sales process

Give Seller the ability to cease discussions entirely, if so desired


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Legal Background: Don’t Ask/Don’t Waive Standstill Provisions (cont’d)

• Don’t Ask/Don’t Waive Provision (“DADW”)

– Prohibits bidder from (publicly or privately) asking Seller to waive the standstill for as long as the standstill remains in effect

– Common provision, particularly in the auction context

– Purpose:

In an auction context, restrictions on waivers of standstills force participating bidders to put their best offer on the table during the auction

o Bidders often argue for “fall-away” of standstill permitting a re-bid if another party wins; with re-bid right can “test the auction” and potentially pay less

o Sellers resist “fall-aways” to prevent bidders in auction from holding back; induce best offer by promising certainty to winning bidder

– Example:

“…The Bidder also agrees during such period not to request, directly or indirectly, that the Seller (or its directors, officers, employees or agents) amend or waive any provision of this paragraph (including this sentence)


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Case Background

• From 2007 through 2009, NetSpend discussed possible sale or merger transaction with several companies, some of which were very advanced before the deals fell through

• In October 2010, NetSpend conducted its IPO at $11/share; within a year its stock price bottomed out at $3.90/share

– Believing its stock was undervalued, the Board conducted two rounds of stock repurchases, but stock price remained in $7-9 range

• During 2011-2012:

– NetSpend contacted by multiple entities interested in M&A transaction, but entities either failed to follow through or, in the case of a potential strategic partner seeking merger of equals, NetSpend determined its stock would be undervalued in the transaction and that transaction was risky

– NetSpend’s two largest stockholders (JLL and Oak Fund - cumulative ownership approx 47%) indicate interest in selling their NetSpend stock

NetSpend engages with two private equity firms (“Private Equity A” and “Private Equity B”), regarding purchase of JLL shares; sign confidentiality agreements with standstill and DADW provisions

Don’t Ask/Don’t Waive Standstill ProvisionsKoehler v. NetSpend Holdings Inc. (Del. Ch. May 21, 2013)

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• In late 2012, TSYS expresses interest in acquiring NetSpend in a negotiated transaction

– In November, NetSpend and TSYS execute confidentiality agreement; Private Equity A indicates an interest in buying JLL’s 20% stake in NetSpend for $12/share

– In December, TSYS submits indication of interest in conducting all-cash tender offer for 100% of NetSpend shares at $14.50/share (NetSpend’s stock trading around $11.65/share)

NetSpend terminates discussions with Private Equity A and Private Equity B

NetSpend sends notice to one credible alternative purchaser, who does not indicate an interest in a transaction with the company

Towards the end of the month, TSYS submits draft merger agreement

• Throughout January, TSYS and NetSpend negotiate merger agreement

– Negotiations focus on price, go-shop (v. no shop) clause, termination fee

– Netspend declines to contact other potential purchasers, citing (1) possible adverse effects of leaks, (2) perception of general market indifference, (3) possible loss of negotiating leverage if no bidders emerge, (4) recommendation from financial advisor that financial bidder unlikely to compete with TSYS, (5) Board could always accept an unsolicited, higher offer, (6) perception that other strategic buyers would not be deterred from making a competing offer


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• In February 2012, parties execute merger agreement, announce anticipated closing in May. Terms include:

– $16/share price

– Supported by Bank of America fairness opinion, though discounted cash flow analysis indicated implied value of $19.22-$25.52/share

– $52.6 million termination fee (3.9% of deal value)

– No-shop clause (with fiduciary out for superior offer)

– Prohibition on Netspend’s waiving any standstill agreements without TSYS consent

• Shortly after, two stockholder derivative actions filed, claiming disclosure violations, breach of directors’ fiduciary duties; request preliminary injunction

• NetSpend did not receive any indications of interest from any other bidders after sale announced


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Plaintiffs’ Fiduciary Claims

• Claim breach of Revlon duty to secure the highest value reasonably obtainable for stockholders

– Courts apply “enhanced scrutiny” to assess Revlon claims – consider adequacy of decisionmaking process; reasonableness of directors’ action in light of circumstances then existing

Plaintiff challenges “reasonableness” of Board’s decisions, including single-bidder sale process without a market check, the Board’s reliance on a weak fairness opinion, the Board’s failure to waive DADW provisions binding Private Equity A and Private Equity B

Delaware Chancery Court

• The sales process – the combination of the lack of market check at any stage of the process, the Board’s reliance on a weak fairness opinion, the deal protections including the DADW clauses (and their incorporation into the merger agreement), and the lack of an anticipated leisurely post-agreement process which would give other bidders an opportunity to appear – reviewed as a whole, was unreasonable

– The DADW provisions are enjoined

• The balance of the equities does not favor enjoining the deal, even for a temporary go-shop period


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Minority Shareholder Protections in a “Going Private” Transactions

In Re MFW Shareholders Litigation (Del. Ch. May 29, 2013)

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Overview

Historically, Delaware courts have scrutinized negotiated mergers involving a controlling stockholder under the heightened “entire fairness” standard, which in practice minimizes the chances of pre-trial dismissal of shareholder suits and increases settlement costs

Under a recent ruling by Chancellor Strine, controlling stockholder buyouts may be structured in a manner that would qualify for the more deferential “business judgment rule”

Assuming the decision is not reversed by the Delaware Supreme Court on appeal, the MFW structure has the potential to significantly reduce litigation costs from shareholder challenges in these types of transactions

However, significant drawbacks for acquirors, including increased execution risk arising from the required majority of the minority approval condition, may discourage universal adoption

For in-house counsel, MFW highlights the importance given to minority protections in the controlling stockholder buyout context and highlights how upfront deal structuring can have material consequences for deals facing stockholder challenges

In Re MFW Shareholders Litigation (Del. Ch. May 29, 2013)

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Legal Background: Alternative standards of judicial review for claims of breach of fiduciary duties in sales transactions

• Business Judgment Rule

– Courts typically do not probe substantive basis of Board’s decision

– Motions to dismiss or for summary judgment are routinely granted

– Plaintiff has burden of proving that directors breached their fiduciary duties

• Entire Fairness

– Much higher bar than deferential business judgment rule

– Motions to dismiss or for summary judgment are rarely granted

– Defendant has burden of proving fair dealing and fair price (but not best price) at trial

– Burden can be shifted to plaintiff under certain circumstances

• Standard of review has implications for the cost and uncertainty of fiduciary duty lawsuits – regardless of the merits, the standard of review impacts the stage at which non-meritorious suits can be dismissed and, therefore, the settlement value

– Business judgment rule significantly increases likelihood of potential dismissal of claims without merit; likelihood of winning at trial when motion to dismiss is denied

Legal Background: Standards of Review

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Legal Background: “Controlling stockholder going private transactions”

• Transactions in which controlling stockholder owns a controlling stake in the target, and wishes to own the target in its entirety

– Two ways to purchase shares from “minority” stockholders

Negotiated merger (pursuant to a merger agreement)

Unilateral tender offer or exchange offer followed by a short-form merger

• Perceived risks of self-dealing and coercion in going private transactions – risk that controlling stockholder and target board prioritize own interests over those of unaffiliated stockholders

– Until recently, “bifurcated” treatment of negotiated merger vs. unilateral tender offer. Appropriate standard of review (business judgment vs. entire fairness):

Negotiated mergers would always be subject to “entire fairness” regardless of procedural protections (e.g., use of a special committee, conditioning deal on approval by majority of the minority)

Unilateral tender offers, followed by short-form mergers would not be subject to “entire fairness” absent coercion or disclosure violations

– Beginning about ten years ago, in a series of cases, the Chancery Court began to move towards a “unified standard” for review of controlling stockholder buyouts

Legal Background: Shareholder Protections in Going Private Transactions

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Kahn v. Lynch (1994) In re Siliconix (2001) In re Pure Resources (2002)

Negotiated Merger

Entire fairness, with burden shifted to plaintiff if transaction approved by either:

•Independent special committee

•Informed majority of the minority stockholders

Unilateral tender or exchange offer

Business judgment rule, absent coercion or disclosure violations, defendant does not have duty to demonstrate entire fairness

“Non-coercive” means:•Non-waivable majority-of-the-minority•Commitment to short-form merger•No retributive threats

“Full Disclosure” means:•Balanced and truthful re all material facts•No materially false or misleading disclosures

Independent directors must have free rein and adequate time to react to offer; hire advisors; make a recommendation and disclose adequate information to minority stockholders; Special committee need not have the power to block the deal

Historical Progression: Court Review of Going Private Transactions

No incentive to

use both protections

No incentive to use either protection

Changing perception of potential for coercion


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In re Cox Comm’ns (2005)

In re CNX Gas (2010) In re MFW (2013)

Negotiated Merger

Court suggests, in dicta, that “unified standard” could be developed to apply to both negotiated mergers and unilateral offers, with a path for both to business judgment treatment

Business judgment rule if, from the time of controller’s first overture, deal subject to:• negotiation and approval by a special

committee of independent directors fully empowered to select and hire its own advisors and to reject the transaction

• approval by an uncoerced, fully informed vote of a majority of the minority investors

Summary judgment in favor of defendants

Unilateral tender or exchange offer

Court adopts unified standard (but applies to unilateral tender offer). Business judgment rule if:•Negotiated and recommended by special committee with full authority of the Board (including blocking power)•Approved by majority of the minority stockholders

Historical Progression: Court Review of Going Private Transactions (cont’d)

Heightened perception that deal

structure not determinative of

coercion; desire to incentivize use of

shareholder protections

Changing perception of potential for coercion

In re MFW summary judgment in favor of defendants

• After concluding that the procedural protections used to protect the minority qualify as “cleansing devices” under Delaware’s approach to the business judgment rule and that the Delaware Supreme Court has not already decided the issue, Strine concludes that the “rule of equitable common law” that best protects minority investors is one that encourages controlling stockholders to accord the minority the “potent combination” of procedural protections

• MFW lays out a six-part test for determining whether a going private transaction can be reviewed under the business judgment rule:

the controlling stockholder conditions the transaction on approval by both a special committee and a majority of the unaffiliated stockholders

the special committee is independent

the special committee is empowered to negotiate the merger and say no definitively to the transaction

the special committee fulfilled its duty of care (made an informed decision regarding the terms on which it would be advantageous for the minority stockholders to sell their shares)

the stockholder vote is fully informed (no disclosure violations)

there is no coercion of the unaffiliated stockholders

• MacAndrews & Forbes’ commitment not to “go around” the special committee was an especially important factor underpinning the decision

Shareholder Protections in Going Private TransactionsIn Re MFW Shareholders Litigation (Del. Ch. May 29, 2013)

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Intended Benefits of In re MFW

• Encourage use of both shareholder protections

– “By giving controlling stockholders the opportunity to have a going private transaction reviewed under the business judgment rule, a strong incentive is created to give minority stockholders broader access to the transactional structure that is most likely to effectively protect their interests"

• Permit early-stage dismissal of spurious shareholder litigation and minimize legal costs and delay

Potential Limitations of In re MFW

• Continued likelihood of costly discovery (significant opportunity for complaints to survive motion to dismiss)

• Risk of adopting unwaivable majority-of-the-minority condition

• Unclear whether settlement costs will be substantially reduced (vs. entire fairness cases)

• For those defendants that choose to go to trial, potential to win even under entire fairness by demonstrating effective special committee without majority of the minority condition

• Uncertainty regarding consequences of controlling stockholder deviating from “promise” to only move forward with shareholder protections

Shareholder Protections in Going Private TransactionsIn Re MFW Shareholders Litigation (Del. Ch. May 29, 2013)

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© 2013 Cleary Gottlieb Steen & Hamilton LLP. All rights reserved. Throughout this presentation,...

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Transcript of © 2013 Cleary Gottlieb Steen & Hamilton LLP. All rights reserved. Throughout this presentation,...