Key 2011 Delaware Rulings for M&A, Corporate Governance ...

Key 2011 Delaware Rulings for M&A, Corporate Governance and Alternative Entity Practice Addressing Fiduciary Duties, Managing Conflict of Interest Issues, and Crafting Contracts and Charters

Today’s faculty features:

1pm Eastern | 12pm Central | 11am Mountain | 10am Pacific

The audio portion of the conference may be accessed via the telephone or by using your computer's speakers. Please refer to the instructions emailed to registrants for additional information. If you have any questions, please contact Customer Service at 1-800-926-7926 ext. 10.

THURSDAY, MAY 24, 2012

Presenting a live 90-minute webinar with interactive Q&A

Michael D. Allen, Director, Richards Layton & Finger, Wilmington, Del.

Patricia L. Enerio, Partner, Proctor Heyman, Wilmington, Del.

Patricia O. Vella, Special Counsel, Morris Nichols Arsht & Tunnell, Wilmington, Del.

Conference Materials

If you have not printed the conference materials for this program, please complete the following steps:

• Click on the + sign next to “Conference Materials” in the middle of the left-hand column on your screen.

• Click on the tab labeled “Handouts” that appears, and there you will see a PDF of the slides for today's program.

• Double click on the PDF and a separate page will open.

• Print the slides by clicking on the printer icon.

Continuing Education Credits

For CLE purposes, please let us know how many people are listening at your location by completing each of the following steps:

• In the chat box, type (1) your company name and (2) the number of attendees at your location

• Click the SEND button beside the box

FOR LIVE EVENT ONLY

Tips for Optimal Quality

Sound Quality If you are listening via your computer speakers, please note that the quality of your sound will vary depending on the speed and quality of your internet connection. If the sound quality is not satisfactory and you are listening via your computer speakers, you may listen via the phone: dial 1-888-450-9970 and enter your PIN -when prompted. Otherwise, please send us a chat or e-mail [email protected] immediately so we can address the problem. If you dialed in and have any difficulties during the call, press *0 for assistance. Viewing Quality To maximize your screen, press the F11 key on your keyboard. To exit full screen, press the F11 key again.

www.rlf.com

Key 2011 Delaware Rulings for M&A, Corporate Governance and Alternative Entity Practice

Michael D. Allen

Richards, Layton & Finger, P.A. 920 N. King St.

Wilmington, DE 19801 302-651-7760 [email protected]

May 24, 2012

http://www.rlf.com/�

www.rlf.com

Standards of Review


Copyright © 2010 Richards, Layton & Finger, P.A. All rights reserved.

7

Standards of Review

Revlon application to “end stage transactions” in mixed cash/stock transactions: – In Steinhardt v. Howard-Anderson, C.A. No. 5878-VCL, the Court

concluded that a transaction in which the target’s stockholders received approximately 50% cash and 50% stock of the acquiring company in return for their shares, and owned approximately 15% of the combined entity, was a “final stage” transaction, and reviewed the Board’s actions under Revlon. The Court noted that final stage transactions are “the only chance

that [the target] stockholders have to extract a premium, both in the sense of maximizing cash now, and in the sense of maximizing their relative share of the future entity’s control premium.”

– In In re Smurfit-Stone Container Corp. Sh. Litig., C.A. No. 6164-VCP, the Court found that plaintiffs were likely to prevail on their argument that Revlon scrutiny would apply to the 50/50 cash/stock merger. “There is no 'tomorrow' for approximately 50% of each stockholder's

investment in [Smurfit].”.


8

Standards of Review

Continuing Implementation of “Unified Standard of Review” in transactions involving controlling stockholders or “controlling groups”: – In Kreiger v. Wesco Financial Corporation, C.A. No. 6176-VCL,

the Court of Chancery applied the "unified standard of review" of CNX Gas, under which the business judgment rule presumptively applies where a transaction is (i) negotiated and approved by a special committee and (ii) conditioned on the affirmative vote of a majority of the unaffiliated stockholders.

– In Frank v. Elgamal, C.A. NO. 6120-VCN, the Court of Chancery applied the “unified standard” used in John Q. Hammons to a transaction in which “control group” of insiders rolled-over a portion of their stock into equity of the survivor (while cashing out the majority of their interest) -- entire fairness likely to apply in the absence of robust procedural protections (i.e., special committee and non-waivable majority of the minority vote).

www.rlf.com

M&A Process Considerations



10

M&A Process Considerations

Continuing Focus upon: – Insider Conflicts – Controlling Stockholders

Use of Committee Process to Manage Potential Conflicts

Litigation Context is Often Relevant to Result – Motion to Dismiss – Reluctance to Enjoin in Absence of Competing

Transaction – Post-Trial


11

M & A Process Considerations In In re El Paso Corp. S’holder Litig., C.A. No.

6949-CS, the Court of Chancery declined to enjoin the vote on Kinder Morgan, Inc.'s proposed acquisition of El Paso Corporation – The Court nevertheless concluded that plaintiffs

demonstrated a reasonable probability of success on the merits

The Court indicated that it did not want to deprive stockholders of the chance to take the deal


12

M & A Process Considerations El Paso The Court focused on two conflicts of interest:

– El Paso’s investment banker owned 19% of Kinder Morgan – a $4 billion investment – and is entitled to appoint two directors to Kinder Morgan’s board of directors

– El Paso’s CEO had not disclosed his apparent desire to acquire El Paso’s exploration and production business from Kinder Morgan following consummation of the merger


13

M & A Process Considerations El Paso Contrast with:

– In re OPENLANE, Inc. Shareholders Litigation, C.A. No. 6849-VCN Court denies preliminary injunction and finds no reasonable

likelihood of success on fiduciary claims where (a) lock-up of deal within 24 hours, (b) no fairness opinion from banker, (c) no fiduciary out in merger agreement.

– In re Alloy, Inc. Shareholders Litigation, C.A. No.

5626-VCP Court grants motion to dismiss where (a) 2 members of

management and 15% stockholders (in the aggregate) roll-over equity interests into purchasing entity, (b) investment banker represents both corporation and special committee, and (c) only financial buyers contacted by special committee.


14

M & A Process Considerations Delphi In In re Delphi Financial Group S’holder Litig.

C.A. No.7144-VCG, the Court denied plaintiffs’ motion for preliminary injunction – The Court nevertheless found a reasonable likelihood

of success on the merits with respect to plaintiffs’ allegations against Delphi’s founder and controlling stockholder

The balance of the equities weighed against an injunction – The deal represented a large premium to market – Damages were available as a remedy – No other potential purchaser had emerged


15

M & A Process Considerations Delphi Delphi had two classes of stock The controller owned all of the Class B shares

(high vote) and some of the Class A shares (low vote) – The controller’s overall voting power, however, was

capped at 49.9% Delphi’s charter prohibited disparate treatment

between the Class A and Class B in a merger


16

M & A Process Considerations Delphi The controller negotiated for disparate

consideration: – Class A would receive approximately $45 per share

(76% premium to market) – Class B would receive approximately $54 per share

The transaction was conditioned on a non-waivable vote of a majority of the disinterested Class A stockholders and a charter amendment allowing the disparate treatment


17

M & A Process Considerations Delphi The Court found that the plaintiffs were

reasonably likely to demonstrate that the controller breached his fiduciary duties in negotiating for disparate consideration and only agreeing to support the merger if he received it

But the balance of equities favored allowing the stockholders exercise their franchise (following which they could pursue damages)


18

M & A Process Considerations Southern Peru In In re Southern Peru Copper Corp. S’holder

Derivative Litig, C.A. No. 961-VCS. – Post-Trial Decision: The Court awarded more than $1

billion as damages in a derivative action challenging Southern Peru’s acquisition of another corporation controlled by its controlling stockholder

Stock-for-stock transaction The special committee evaluating the transaction

retained an investment advisor


19

M & A Process Considerations Contrasting Case S. Muoio & Co. LLC v. Hallmark Entertainment

Investments, C.A. 4729-CC – Post-trial decision upholding recap transaction between

controlling SH and corporation. Entire fairness applies, but burden of proof shifted via special committee of independent directors

– Broad delegation to committee, committee is disinterested, thoughtful and robust process

In re John Q. Hammons SH Litig.,C.A. No. 758 (DE Supr.) – Post-trial decision upholding merger in which controlling SH

received disparate consideration. Court finds transaction to be entirely fair – negotiated by independent committee and approved by significant majority of stockholders.


20

Take-Aways Standards of Review coming into focus

Controlling stockholder conduct reviewed closely

More judicial deference/leniency in absence of

significant conflicts

www.rlf.com

Investment Banker Conflicts



22


In In re El Paso Corp. S’holder Litig., Consol. C.A. No. 6949-CS, the Court of Chancery considered Goldman Sachs’s role as advisor to El Paso in connection with a potential spin-off transaction while, at the same time, El Paso was considering a sale transaction with Kinder Morgan. – Goldman Sachs owned 19% of Kinder Morgan and

controlled two board seats on Kinder Morgan’s board of directors.

– The Court stated, among other things, that “because Goldman stayed involved as the lead advisor on the spin-off, it was in a position to continue to exert influence over the Merger.”


23


In In re Del Monte Foods Co. S’holders Litig., Consol. C.A. No. 6027-VCL, the Court of Chancery preliminarily enjoined a stockholder vote for a period of 20 days and further enjoined the defendants from enforcing certain deal protection measures in the merger agreement. – The Court found that, on a preliminary record, the proposed

transaction was potentially tainted by alleged misconduct of its financial advisor, with the alleged knowing participation of the buyers.

In In re Atheros Commc’ns, Inc. S’holder Litig., Consol. C.A. No. 6124-VCN, the Court of Chancery preliminarily enjoined the acquisition of Atheros Communications, Inc. The Court required supplemental disclosure of, among other things, the fact that 98% of the fee to be paid to Atheros’ financial advisor was contingent upon the closing of a transaction.


24


In In re Art Tech. Group, Inc. S’holders Litig., Consol. C.A. No. 5955-VCL, the Court of Chancery enjoined the stockholder vote on Oracle’s acquisition of ATG pending supplemental disclosure of fees Oracle paid to Morgan Stanley in the past, which were substantial. Morgan Stanley was ATG’s financial advisor in this transaction.

In Steinhardt v. Howard-Anderson, C.A. No. 5878-VCL, the Court of Chancery found that several disclosure issues warranted the issuance of a limited injunction, including that the proxy statement explained the events of a buyer road show, but not how it affected the mix of stock and cash consideration in the transaction, and that the accretion/ dilution analysis was summarized incompletely in the proxy statement.


25

Take-Aways

Discuss banker’s potential interest in participating in buyer financing at engagement stage and consider setting ground rules for such discussions up front.

Ask whether the banker has pitched the company to any prospective purchasers.

Find out whether the banker has provided services to potential buyers.

Find out whether the banker has any ownership interest in either the target or acquiror.

Consider addressing disclosure issues regarding engagement terms and prior services for company and ultimate purchaser at engagement stage.

www.rlf.com

This presentation and the material contained herein are provided as general information and should not be construed as legal advice on any specific matter or as creating an attorney-client relationship. Before relying on general legal information or deciding on legal action, request a consultation or information from a Richards, Layton & Finger attorney on specific legal needs.



May 24, 2012

Patricia L. Enerio Proctor Heyman LLP

300 Delaware Avenue, Suite 200 Wilmington, DE 19801

302-472-7300 [email protected]

Alternative Entities Are Creatures of Contract

“Limited liability companies are creatures of contract, and the parties have broad discretion to use an LLC agreement to define the character of the company and the rights and obligations of its members.”

Kuroda v. SPJS Hldgs., L.L.C., 971 A.2d 872, 880 (Del. Ch. 2009).

“A limited partnership is a creature of both statute and contract. The operative document is the limited partnership agreement and the statute merely provides the 'fall-back' or default provisions where the partnership agreement is silent. Thus, the provisions of the partnership agreement define the rights and responsibilities of those who are parties to the agreement and are afforded significant deference by the Courts.”

Cantor Fitzgerald, L.P. v. Cantor, 2001 WL 1456494, *5 (Del. Ch.).

29

What Duties are Owed?

Duty of Care A party breaches the duty of care when it acts with gross negligence, “which

has been defined as ‘reckless indifference’ or conduct beyond the ‘bounds of reason.’”

Lola Cars Intern. Ltd. v. Krohn Racing, LLC, 2010 WL 3314484, *8 (Del. Ch.) (citations omitted).

Duty of Loyalty Loyalty demands “that any power over the corporation held in a fiduciary

capacity may be exercised only for the purpose of advancing collective/corporate welfare.”

Odyssey P’rs, L.P. v. Fleming Cos., Inc., 1996 WL 422377, *3 (Del. Ch.).

30

What Duties are Owed?

Duty of Good Faith

The duty of good faith is not an independent fiduciary duty, but is considered part of the duty of loyalty.

Kelly v. Blum, 2010 WL 629850, *10 n.65 (Del. Ch.).

“Good faith has been said to require an ‘honesty of purpose,’ and a genuine care for the fiduciary’s constituents . . . .”

In re Walt Disney Co. Derivative Litig., 907 A.2d 693, 753 (Del. Ch. 2005), aff ’d, 906 A.2d 27 (Del. 2006).

31

Who Owes Fiduciary Duties?

“I understand the principle of fiduciary duty, stated most generally, to be that one who controls property of another may not, without implied or express agreement, intentionally use that property in a way that benefits the holder of the control to the detriment of the property or its beneficial owner. There are, of course, other aspects – a fiduciary may not waste property even if no self interest is involved and must exercise care even when his heart is pure – but the central aspect of the relationship is, undoubtedly, fidelity in the control of the property for the benefit of another.”

In re USACafes, L.P. Litig., 600 A.2d 43, 48 (Del. Ch. 1991).

“The theory underlying fiduciary duties is consistent with recognition that a director of a corporate general partner bears such a duty towards the limited partnership.”

Id. at 49. 32

The Acts Permit Elimination of Fiduciary Duties

LLCs

Delaware Limited Liability Company Act (“LLC Act”)

6. Del. C. § 18-1101(c)

“[M]ember's or manager's or other person's duties may be expanded or restricted or eliminated by provisions in the limited liability company agreement; provided, that the limited liability company agreement may not eliminate the implied contractual covenant of good faith and fair dealing.”

LPs

Delaware Revised Uniform Limited Partnership Act (“DRULPA”)

6. Del. C. § 17-1101(c)

“It is the policy of [DRULPA] to give maximum effect to the principle of freedom of contract and to the enforceability of partnership agreements.”

33

Implied Covenant of Good Faith and Fair Dealing

“The implied covenant inheres to every contract, and is ‘best understood as a way of implying terms in the agreement.’ It provides ‘a limited and extraordinary legal remedy’ that addresses only events that could not reasonably have been anticipated at the time the parties contracted. ‘As a result, the implied covenant only applies where a contract lacks specific language governing an issue and the obligation the court is asked to imply advances, and does not contradict, the purposes reflected in the express language of the contract.’”

Great-West Investors LP v. Thomas H. Lee P’rs, L.P., 2011 WL 284992, *10 (Del. Ch.) (citations omitted).

34

The Elimination of Fiduciary Duties Must Be Express

“[A]ny restriction on the fiduciary duties of a general partner [must] be stated clearly in the partnership agreement and . . . the general partner [must] comply with the substitute contractual standard of conduct as a prerequisite to taking advantage of the contractual alleviation of his fiduciary duties.”

Gelfman v. Weeden Investors, L.P., 859 A.2d 89, 117 (Del. 2004).

“[U]nless the LLC agreement in a manager-managed LLC explicitly expands, restricts, or eliminates traditional fiduciary duties, managers owe those duties to the LLC and its members and controlling members owe those duties to minority members. . . . Having been granted great contractual freedom by the LLC Act, drafters of and parties to an LLC agreement should be expected to provide parties and anyone interpreting the agreement with clear and unambiguous provisions when they desire to expand, restrict, or eliminate the operation of traditional fiduciary duties.”

Kelly v. Blum, 2010 WL 629850, *10 n.70 (Del. Ch.).

35

Contract v. Fiduciary Duties

“[W]here a dispute arises from obligations that are expressly addressed by contract, that dispute will be treated as a breach of contract claim. In that specific contest, any fiduciary duty claims arising out of the same facts that underlie the contract obligations would be foreclosed as superfluous.”

Great-West Investors LP v. Thomas H. Lee P’rs, L.P., 2011 WL 284992, *10 (Del. Ch.) (citation omitted).

36

What impact will the 2011 Delaware rulings have on alternative entities?

Gatz clarifies that default fiduciary duties do exist in the LLC context.

• Note: Gatz is currently on appeal to the Delaware Supreme Court

Paige Capital and Enbridge continue the USACafes line of precedent that a director, member, or officer of a corporate entity serving as the general partner of a limited partnership who exercises control over the partnership's property owes fiduciary duties to the partnership and its limited partners.

Creditors of insolvent LLCs do not have standing to pursue derivative claims under the LLC Act.

37

Auriga Capital Corp. v. Gatz Properties, LLC

___ A.3d ___, 2012 WL 361677 (Del. Ch.).

38

The Peconic Bay LLC Agreement

Section 15 of the LLC Agreement provided as follows: “Neither the Manager nor any other Member shall be entitled to cause the

Company to enter . . . into any additional agreements with affiliates on terms and conditions which are less favorable to the Company than the terms and conditions of similar agreements which could be entered into with arms-length third parties, without the consent of a majority of the non-affiliated Members (such majority to be deemed to be the holders of 66-2/3% of all Interests which are not held by affiliates of the person or entity that would be a party to the proposed agreement).”

Gatz, 2012 WL 361677, at *11.

The Court interpreted Section 15 of the LLC Agreement as follows: “[T]he LLC Agreement makes clear that the manager could only enter into a self-

dealing transaction, such as its purchase of the LLC, if it proves that the terms were fair. In other words, the LLC Agreement essentially incorporates a core element of the traditional fiduciary duty of loyalty.”

Id. at *2.

39

LLC Act Provides for Principles of Equity to Apply

“The Delaware LLC Act does not plainly state that the traditional fiduciary duties of loyalty and care apply by default as to managers or members of a limited liability company. In that respect, of course, the LLC Act is not different than the DGCL [Delaware General Corporation Law], which does not do that either.”

Gatz, 2012 WL 361677, at *8.

Section 18-1104 of the LLC Act provides as follows: “In any case not provided for in this chapter, the rules of law and

equity, including the law merchant, shall govern.”

6 Del. C. § 18-1104.

40

Managers of LLCs are Fiduciaries

“It seems obvious that, under traditional principles of equity, a manager of an LLC would qualify as a fiduciary of that LLC and its members.”

Gatz, 2012 WL 361677, at *8.

41

Default Fiduciary Duties Do Exist in the LLC Context

“Thus, because the LLC Act provides for principles of equity to apply, because LLC managers are clearly fiduciaries, and because fiduciaries owe the fiduciary duties of loyalty and care, the LLC Act starts with the default that managers of LLCs owe enforceable fiduciary duties.”

Gatz, 2012 WL 361677, at *8.

42

The Court of Chancery Found that Section 18-1101(c) Supported Its Analysis

“The fact that the legislature enacted these liability-limiting measures against the backdrop of case law holding that default fiduciary duties did apply in the LLC context, and seemed to have accepted the central thrust of those decisions to be correct, provides further weight to the position that default fiduciary duties do apply in the LLC context to the extent they are not contractually altered.”

Gatz, 2012 WL 361677, at *9.

43

The Gatz Court’s Conclusion

“The statute incorporates equitable principles. Those principles view the manager of an LLC as a fiduciary and subject the manager as a default principle to the core fiduciary duties of loyalty and care. But, the statute allows the parties to an LLC agreement to entirely supplant those default principles or to modify them in part. Where the parties have clearly supplanted default principles in full, we give effect to the parties’ contract choice. Where the parties have clearly supplanted default principles in part, we give effect to their contract choice. But, where the core default fiduciary duties have not been supplanted by contract, they exist as the LLC statute itself contemplates.”

Gatz, 2012 WL 361677, at *9 (citations omitted).

44

The Court Found that There Would Be Issues If It Decided that Equity Should be

“Judicially Excised” from the LLC Act

“[T]hose who crafted LLC agreements in reliance on equitable defaults that supply a predictable structure for assessing whether a business fiduciary has met his obligations to the entity and its investors will have their expectations disrupted.”

Gatz, 2012 WL 361677, at *10. “Reasonable investors in Delaware LLCs would, one senses, understand even more clearly

after [Section 18-1101(c) was passed] that they were protected by fiduciary duty review unless the LLC agreement provided to the contrary, because they would of course think that there would have been no need for our General Assembly to pass a statute authorizing the elimination of something that did not exist at all.”

Id. “The current LLC Act . . . promises investors that equity will provide the important

default protections it always has, absent a contractual choice to tailor or eliminate that protection. Changing that promise is a job for the General Assembly, not this court.”

Id.

45

Paige Capital Mgmt., LLC v. Lerner Master

Fund, LLC

2011 WL 3505355 (Del. Ch.).

46

A Director, Member, or Officer of a Corporate Entity Serving as the General Partner of a Limited Partnership Who

Exercises Control Over the Partnership’s Property Owes Fiduciary Duties to the Partnership

“To the extent that what is necessary to impose fiduciary duties on Michele Paige, the managing member of the Hedge Fund’s general partner (i.e., Paige General Partner, a limited liability company), is the control she exerted over the Hedge Fund’s assets, i.e., the Lerner Fund’s invested capital, Michele Paige would qualify under a line of Delaware precedent that began with In re USACafes, L.P. Litigation.”

Paige Capital, 2011 WL 3505355, at *30 (citations omitted).

47

The Court Refuses to Extend the Control Rule

“. . . I refuse to go further and hold that someone like Christopher Paige, who is not even an officer, director, or member of the governing fiduciary is a direct fiduciary of the limited partnership and its investors.”

Paige Capital, 2011 WL 3505355, at *30.

48

The Court Also Noted Its Concerns Regarding the USACafes Precedent

“[I]t is a bit of an oddment that our alternative entity law has treated a director of a corporation that is the general partner of a limited partnership as a fiduciary owing fiduciary duties to the limited partnership and its investors, i.e., limited partners. That step was taken in USACafes without much analysis of why the investors in the limited partnership were not required, in the absence of a reason for veil piercing, to look solely to the entity they knew was their fiduciary for relief.”

Paige Capital, 2011 WL 3505355, at *30.

See also Gelfman v. Weeden Investors, L.P., 792 A.2d 977, 992 (Del. Ch. 2001) (“[The defendants’] argument in this regard raises yet again the awkward position occupied by directors of corporate General Partners. . . . Do they owe fiduciary duties to limited partners akin to those owed by corporate directors to stockholders, even though it is the corporate general partner which is the core fiduciary?”); Gotham P’rs, L.P. v. Hallwood Realty P’rs, L.P., 2000 WL 1476663, *20 (Del. Ch.) (“When limited partners contract to join a limited partnership run by a corporate general partner, a rote traditional approach would impose fiduciary duties solely upon the corporate general partner as an entity. After all, it is the entity that the limited partners agreed would manage their assets.”).

49

Brinckerhoff v. Enbridge Energy Co., Inc.

2011 WL 4599654 (Del. Ch.).

50

Fiduciary Duties Are “Tethered” to Control

“[T]his Court has determined that certain entities affiliated with a corporate general partner, such as its board of directors and controller, also owe fiduciary duties to the limited partnership that the general partner manages. In delineating the entities, besides the general partner, who owe fiduciary duties to a limited partnership, however, this Court has been careful to tether duties to control.”

Enbridge, 2011 WL 4599654, at *7 (citation omitted).

“The Complaint fails to allege that EES exercises any control over EEP. EES is a private corporation entirely owned by Enbridge that employs the people who work at EEP, EEP GP, and Enbridge Management. EES has no direct say in how EEP is managed, nor does it exercise any control over an entity that does. Thus, EES does not owe any fiduciary duties to EEP.”

Id. at *8.

51

Implied Covenant Only Binds The Parties to An Agreement

“The implied covenant . . . only potentially binds the parties to an agreement. The only parties to the LPA were EEP GP and EEP’s LP unit holders. Thus, the only defendant that could possibly be liable for breaching the implied covenant in the LPA is EEP GP.”

Enbridge, 2011 WL 4599654, at *8.

52

CML V, LLC v. Bax

28 A.3d 1037 (Del. 2011).

53

The Right to Bring a Derivative Action is Governed by

Section 18-1001 of the LLC Act

“A member or an assignee of a limited liability company interest may bring an action in the Court of Chancery in the right of the limited liability company to recover a judgment in its favor if managers or members with authority to do so have refused to bring the action or if an effort to cause those managers or members to bring the action is not likely to succeed.”

6. Del. C. § 18-1001.

54

The Proper Plaintiff in an LLC Derivative Action is Governed by Section 18-1002 of the LLC Act

“In a derivative action, the plaintiff must be a member or an assignee of a limited liability company interest at the time of bringing the action and: • (1) At the time of the transaction of which the plaintiff

complains; or • (2) The plaintiff ’s status as a member or an assignee of a

limited liability company interest had devolved upon the plaintiff by operation of law or pursuant to the terms of a limited liability company agreement from a person who was a member or an assignee of a limited liability company interest at the time of the transaction.”

6. Del. C. § 18-1002.

55

The Delaware Supreme Court Found that Section 18-1002 Limited Derivative Standing

to Members or Assignees

“The plain language of 6 Del. C. § 18-1002 is unambiguous and limits derivative standing in LLCs exclusively to ‘member[s]’ or ‘assignee[s].’”

Bax, 28 A.3d at 1041.

56

The Delaware Supreme Court Relied on the

Plain Language of the LLC Act

“According to CML, the combination of sections 18-1001 and 18-1002 shows that the General Assembly merely intended to take the corporate rule of derivative standing for creditors of insolvent corporations and apply it in the LLC context. We disagree. When statutory text is unambiguous, we must apply the plain language without any extraneous contemplation of, or intellectually stimulating musings about, the General Assembly’s intent.”

Bax, 28 A.3d at 1042.

57

Patricia L. Enerio Proctor Heyman LLP

300 Delaware Avenue, Suite 200 Wilmington, DE 19801



May 24, 2012

© Morris, Nichols, Arsht & Tunnell LLP

5923041

Patricia O. Vella Morris, Nichols, Arsht & Tunnell LLP

1201 N. Market Street Wilmington, DE 19801


pve www.mnat.com

Martin Marietta Materials, Inc. v. Vulcan Materials Co., C.A. No. 7102-CS (Del. Ch. May 4, 2012)

After a week-long trial and a full day of post-trial arguments, the Delaware Court of Chancery enjoined for four months an Exchange Offer made to the stockholders of Vulcan Materials Company, a New Jersey Corporation (“Vulcan”), and Proxy Contest, finding violation of confidentiality agreements by the offeror, Martin Marietta Materials, Inc., a North Carolina corporation (“Martin Marietta”)

The case proceeded in the Delaware Court of Chancery because the confidentiality agreements at issue were governed by Delaware law and the primary confidentiality agreement contained a Delaware choice of forum provision

Note: Martin Marietta filed the declaratory judgment action in Delaware, while Vulcan filed in federal court in Alabama, where it is headquartered. Parties agreed that the Delaware case would proceed first, ahead of the Alabama action and fiduciary duty and securities cases pending in New Jersey

60

Background

In the spring of 2010, CEOs of Martin Marietta and Vulcan began discussing potential merger

Martin Marietta and Vulcan entered into non-disclosure agreement on May 3, 2010 (“NDA”)

In May and June of 2010, counsel for Martin Marietta and Vulcan meet to work on antitrust analysis

Parties entered into common interest, joint defense and confidentiality agreement, effective as of May 18, 2010 (“JDA”) to facilitate analysis of antitrust implications of a merger

In March 2011, CFOs of Martin Marietta and Vulcan meet to discuss synergies, which resulted in Martin Marietta increasing its synergies estimate

61

Background (cont’d.)

Between April 2010 and March 2011, Vulcan’s stock prices declines by 21% while Martin Marietta’s declines by only 10%, thereby leading Martin Marietta to conclude that it could acquire Vulcan

June 27, 2011: Vulcan CEO tells Martin Marietta that Vulcan is no longer interested in a merger

August 16-17, 2011: Martin Marietta board authorized management to consider alternatives to a negotiated deal

December 12, 2011: Martin Marietta sends Vulcan a public bear hug letter

62

Terms of Agreements

NDA provided that “Evaluation Material” could be used “solely for the purposes of evaluating a Transaction”

“Transaction” was defined in the NDA as a possible “business combination transaction” that was “between” the parties

JDA provided that “Confidential Materials” could be used “solely for purposes of pursuing and completing the Transaction”

“Transaction” was defined in the JDA as “a potential transaction being discussed by [the parties] . . . involving the combination or acquisition of all or certain of their assets or stock”

NDA precluded Martin Marietta from revealing publicly that parties had engaged in merger discussions “other than as legally required” and prohibited Martin Marietta from revealing any of the Evaluation Material unless Martin Marietta received an “External Demand,” i.e., was “required” in the sense of having received “oral questions, interrogatories, requests for information or documents in legal proceedings, subpoena, civil investigative demand or similar process,” in which case it was required to comply with the “Notice and Vetting Process”

63

Vulcan’s Arguments

Vulcan argued that Martin Marietta breached the NDA and JDA by using Evaluation Material to formulate a hostile bid and that a hostile bid does not qualify as a “business combination transaction between” Vulcan and Martin Marietta because that phrase requires a contract “between” the two companies leading to a combination

Vulcan argued that even if Martin Marietta was free to launch a hostile bid, it could not reveal publicly its prior discussions with Vulcan or any of the Evaluation Material unless the requirement to do so came from an External Demand AND, since no External Demand, Martin Marietta was not permitted to disclose the information because it unilaterally chose to make the Exchange Offer which then triggered SEC Rules requiring certain disclosures

Vulcan also argued that even if Martin Marietta was permitted to use the Evaluation Materials to prepare a hostile bid and was required to disclose prior discussion with Vulcan, Martin Marietta went further and disclosed the information when it was not legally required—in investor conference calls and communications to the press

64

Martin Marietta’s Arguments

Martin Marietta argued that Vulcan was attempting to read a standstill into the NDA and JDA, which contained no explicit standstill

Martin Marietta argued that the NDA and JDA allowed either side to use the Evaluation Material for the consideration of any business combination transaction between the parties, regardless of whether the combination is effected through a friendly, negotiated merger or a back-end merger after a successful hostile exchange offer and proxy contest

Martin Marietta argued that “legally required” was not limited to circumstances when a party received an External Demand, but included any time disclosure was legally required, even if triggered by a party’s own discretionary actions, and that once the information was disclosed in SEC filings, Martin Marietta was free to disclose in other forms

65

Court’s Factual Findings

Evidence was replete with examples of Martin Marietta CEO being concerned about confidentiality and that information would only be shared for a consensual deal

Martin Marietta used Evaluation Material in launching and formulating the terms of its hostile bid and helping convince Vulcan stockholders to accede to the Exchange Offer and Proxy Contest

66

Court’s Legal Analysis

Court concludes that the Exchange Offer and Proxy Contest did not constitute a “Transaction” as defined under either the NDA or JDA Court looked to definitions of “business combination transaction” in the DGCL and

SEC Rules and concluded that the term “business combination transaction” does not have a single, clear meaning

Court also found that “between” could reasonably mean a negotiated transaction between the parties, as Vulcan had argued, or an eventual outcome of the transaction involving the mingling of Vulcan and Martin Marietta’s assets, as Martin Marietta had argued, and, therefore, found “between” to be ambiguous

Court found that extrinsic evidence supported Vulcan’s interpretation of the meaning of the term “business combination transaction between” Vulcan and Martin Marietta, relying on the parties’ negotiating history, objective manifestations of their intent when entering into the NDA and course of conduct of Martin Marietta, which showed that Martin Marietta thought the use of the Evaluation Materials was prohibited in a hostile transaction

67

Court’s Legal Analysis (cont’d.)

Court found that Martin Marietta breached the limitations on use of Evaluation Material set forth in the NDA by using Evaluation Material in furtherance of the Exchange Offer and Proxy Contest

Court found the “legally required” language to be ambiguous and based on extrinsic evidence, such as the drafting history and objective intent of Martin Marietta’s CEO to prevent disclosure and have a maximum confidentiality,” rejected Martin Marietta’s argument that it was “legally required” to disclose certain information publicly because its discretionary actions gave rise to the legal requirement, finding that Vulcan’s interpretation was the proper one

68

Court’s Legal Analysis (cont’d.)

Court found that Martin Marietta’s S-4, with 10 pages of the parties’ negotiating history, was information covered by the NDA and was not filed in response to an External Demand, and, therefore, Martin Marietta breached its non-disclosure obligations under the NDA

Court also found that even if Martin Marietta was required to disclose certain information it breached its obligations in such circumstances to provide minimal disclosure

Court also stated that even if the disclosure in the S-4 was “legally required,” Martin Marietta was not then free to disclose the same information to the media and on investor conference calls, and the disclosure in such cases constituted a breach of the NDA

69

Remedy

Court enjoined Martin Marietta’s hostile bid for four months, thereby preventing Martin Marietta from running its slate of directors for election at Vulcan’s June 1, 2012 meeting

The four-month period was selected by Vulcan by reference to the date that Martin Marietta launched the Exchange Offer (December 12, 2011) and the expiration of the NDA (May 3, 2012)

70

Lessons for Practitioners

Carefully consider standstill obligations—even without express standstill provision, other provisions of agreements can operate as a backdoor standstill Focus on restrictions on use of “Evaluation Material”—consider definition of

“transaction” Focus on required versus discretionary actions

Carefully document deliberations—handwritten notes and internal memoranda may be used in court’s fact-finding

Consider consistency in drafting across agreements

71

Survival Clauses - GRT, Inc. vs. Marathon GTF Technology, Ltd., C.A. No. 5771-CS (Del. Ch. July 11, 2011)

Survival Clause in Joint Venture Agreement provides, “all other representations and warranties . . . will survive for twelve months after the Closing Date, and will thereafter terminate, together with any associated right of indemnification . . . or the other remedies” provided in the Agreement

Court, emphasizing that the agreement states both representations and sole remedies survive for twelve months, holds that the Survival Clause shortened the statute of limitations with respect to the representations

72

Survival Clauses (cont’d)

Court discusses four ways to draft contract “addressing the life span” of reps and warranties Reps and warranties terminate at closing: “No basis for a post-closing suit seeking

a remedy for an alleged misrepresentation” Contract silent on survivability: Unclear result Discrete Survival Period: Limits time period for which a claim for breach of reps

and warranties may be filed Survives Indefinitely: Generally, courts will treat this “as establishing that the

ordinarily applicable statute of limitations governs the time period in which actions for breach can be brought” Extending statute of limitations generally viewed as violating Delaware public

policy

73

Survival Clauses (cont’d)

Warnings on GTF: Court suggests that in certain jurisdictions (including California), where “clear and

explicit” language is necessary to treat a survival clause as a statute of limitations, language may need to be included “expressly stating that the parties intend the language to operate as a contractual statute of limitations”

Court suggests that in certain jurisdictions (including California), where the “discovery rule” may be applied such that a cause of action does not accrue until plaintiff discovers the breach, outcome could be different

One Delaware case cited in GTF, although written in terms of claims “expiring,” treats providing notice (as opposed to filing a claim) within the survival period as sufficient In that case, Escrow Agreement required a notice to be delivered, which may

have influenced Court

74

Non-Assignment Provisions and Reverse Triangular Merger

Meso Scale Diagnostics, LLC v. Roche Diagnostics GmbH, C.A. No. 5589-VCP (Del. Ch. Apr. 8, 2011) (denying defendants’ motion to dismiss claim that they breached the nonassignment provision of an agreement, holding that a reverse triangular merger may constitute an assignment by operation of law, at least where plaintiffs allege that more than mere change of ownership has occurred) Dispositive motion practice scheduled for Fall 2012; possible trial in February 2013

75

Anti-Reliance Provisions: Is ABRY Still Good Law?

ABRY Partners V, L.P. v. F & W Acquisition LLC, C.A. No. 1756-N (Del. Ch. Feb. 14, 2006) (stating that a “party cannot promise, in a clear integration clause of a negotiated agreement, that it will not rely on promises and representations outside of the agreement and then shirk its own bargain in favor of a ‘but we did rely on those other representations’ fraudulent inducement claim” but permitting a fraud claim to proceed, notwithstanding an exclusive remedies provision, for intentional lies within the four corners of the agreement).

OverDrive, Inc. v. Baker & Taylor, Inc., C.A. No. 5835-CC (Del. Ch. June 17, 2011) (holding anti-reliance clause in joint venture agreement was unambiguous, but as matter of public policy would not exculpate parties from pre-contractual statements that were not embodied in the agreement but were (i) related directly to terms in the agreement and (ii) about the material facts on which the contract was premised)

76

SI Investment Partners, LLC vs. ThoughtWorks, Inc., C.A. No. 2724 (Del. Nov. 15, 2011)

Delaware Supreme Court affirmed Court of Chancery decision that ThoughtWorks did not have to comply with redemption rights of preferred stock because company did not have sufficient surplus

77

Terms of Preferred Stock

Preferred stock provided that if no IPO has occurred by fifth anniversary of investment, preferred stockholders were entitled to “require the Corporation to redeem [the preferred stock] for cash out of any funds legally available therefor”

Terms of stock also provided:

“For the purpose of determining whether funds are legally available for redemption . . . , the Corporation shall value its assets at the highest amount permissible under applicable law”

78

ThoughtWorks – Court of Chancery Decision

Is “funds legally available” equivalent to “surplus”? Surplus test looks to balance-sheet insolvency with amount of capital (usually par

value), rather than insolvency, used as cut-off (i.e., are net assets greater than capital)

Court of Chancery determines “funds legally available” goes beyond surplus Funds: Cash Available: On hand or readily accessible through sales or borrowing Legally: Can be deployed without violating the DGCL or other statutory or

common law restrictions, including the requirement that the corporation be able to continue as a going concern and not be rendered insolvent by the distribution Court observes that, under Delaware law, insolvency is both “balance sheet

insolvency” (i.e., liabilities exceed assets) and “cash-flow insolvency” (i.e., unable to pay debts as they come due)

NOTE: Supreme Court affirmance does not address this prong of Court’s analysis.

79

ThoughtWorks – Court of Chancery Decision (cont’d.)

Court of Chancery rules in alternative that, even if “funds legally available” were equivalent to “surplus”, Board’s decision as to surplus was entitled to deference Plaintiff’s expert “never considered how making an eight-figure redemption

payment would affect ThoughtWorks’ ability to operate and achieve the projections on which her analyses relied”

Board decision on surplus entitled to deference absent showing that the board (1) acted in bad faith, (2) relied on unreliable methods and data, or (3) made a determination so far off the mark as to constitute actual or constructive fraud Valuation Provision “does not eliminate the need for judgment” when determining

“funds legally available” Supreme Court affirms solely on this prong of Court of Chancery’s analysis

80

ThoughtWorks – Court of Chancery Decision (cont’d.)

Key fact in ThoughtWorks:

“The Company’s employees . . . are its most valuable asset”

Because employees likely to depart in liquidation, ThoughtWorks’ assets would have a materially lower value in liquidation than as part of a going concern

As a result, value assumptions underlying a DCF analysis to calculate surplus would not be sustainable if redemption occurred

81

Other Contract Cases

Winshall v. Viacom International, Inc., C.A. No. 6074-CS (Del. Ch. Nov. 10, 2011) (granting notice to dismiss good faith and fair dealing claim brought by former stockholders of acquired corporation arising out of earn-out provisions of merger agreement)

Coughlan v. NXP B.V., C.A. No. 5110-VCG (Del. Ch. Nov. 4, 2011) (applying the step transaction doctrine in finding that a triggering event occurred in the transaction at issue)

82

Key 2011 Delaware Rulings for M&A, Corporate Governance ...

Documents

Transcript of Key 2011 Delaware Rulings for M&A, Corporate Governance ...