Exelon Corporation v. Cosgrove; Enlisting the Delaware Chancery Court to Play Matchmaker

Exelon (NYSE: EXC) has launched an exchange offer for all of the outstanding shares of NRG Energy, Inc. (NYSE: NRG). Exelon is offering 0.485 of its common shares for each NRG share. The exchange offer follows a proposal made by Exelon to the NRG board on October 17. At that time, the exchange offer represented a 37% premium over NRG’s share price, albeit well below NRG’s 12-month high of $45 a share. NRG’s shares closed yesterday, November 12, at $21.60. Based upon yesterday’s closing price of Exelon ($50.57), the deal currently has a value of $24.53 per NRG share, down from a value of $26.43 on October 17.

Concurrently with its launch of the exchange offer, Exelon filed a complaint in the Delaware Chancery Court against NRG and its board of directors, seeking declaratory and injunctive relief. The basis for Exelon’s action is NRG’s rejection of Exelon’s October 17, 2008 deal proposal. NRG rejected the proposal by its letter dated November 9, 2008.

Exelon is miffed at the time NRG took to evaluate Exelon’s offer and reject it—20 whole days! It asserts by its complaint ((no. CA 4155) assigned to Vice Chancellor Lamb) that it has received “positive feedback” on its proposal “from a number of sources, including a number of NRG’s stockholders.” Complaint ¶ 3.

Exelon initiated discussions over a transaction with NRG on September 26, 2008, which was followed on September 30, 2008 by a meeting among the principals in New York. Apparently impatient at the slow pace of discussions, Exelon elected to make a formal proposal on October 19, 2008 and to publicly disclose it. Notwithstanding several attempts to engage in substantive discussions over the proposal with NRG, so Exelon asserts, NRG refused to do so. The rejection of Exelon’s proposal came in the form of NRG’s letter of November 9.

NRG has a somewhat different take on the matter, as detailed in its rejection letter. For present purposes, it is enough to note that NRG’s view is that Exelon’s proposal is “opportunistically timed” and “grossly undervalues NRG on both an absolute basis and relative to Exelon’s share value…” NRG’s CEO and Chairman point out to Exelon that, based upon the proposed fixed exchange ratio of 0.485, “NRG stockholders would own 17% of the combined company while contributing 30% of a combined company recurring cash flow in 2008.”

And, for good measure, Messrs. Crane and Cosgrove of NRG object to Exelon’s negotiating style, eschewing “private negotiation” and pursuing NRG “in a highly public and preemptive manner…” Since the proposal is for an exchange offer, Messrs. Crane and Cosgrove point out, for good measure, certain “risks and concerns” concerning Exelon as a company and as an investment by NRG’s stockholders.

Exelon’s Complaint.

By its complaint, Exelon asserts these claims:

· That NRG’s board’s rejection of Exelon’s proposal represents a breach of the board’s fiduciary duties to NRG stockholders, and will cause irreparable harm to Exelon and to NRG’s stockholders;

· The adoption of any defensive measure by the NRG board (including, for example, a poison pill) would itself be a breach of the NRG board’s fiduciary duties to NRG’s stockholders; and

· The NRG board’s anticipated refusal to render Section 203 of Delaware’s General Corporation Law (Delaware’s business combination statute) inapplicable to the Exelon proposal itself is a breach of the board’s fiduciary duties to NRG’s stockholders.

Exelon seeks, by way of relief, an order from the Chancery Court declaring that the board of directors of NRG has breached its fiduciary duties in rejecting Exelon’s proposal; declaring that the board’s failure to declare Section 203 inapplicable to the Exelon proposal is a breach of its fiduciary duties; compelling NRG to approve Exelon’s proposal for purposes of Section 203; declaring that the adoption of any measure which would thwart or frustrate Exelon’s proposal would be a breach of the board’s fiduciary duties; and enjoining NRG and its officers and agents from adopting any measure that would interfere or frustrate Exelon’s proposal.

The first question is whether Exelon has standing to assert fiduciary duty breaches against the NRG board. Generally companies such as NRG owe no fiduciary duties to takeover prospectors, and that would be true here, but for the fact that Exelon owns 500 shares of NRG common stock. While nominal, that should be sufficient to confer standing upon Exelon to assert its fiduciary duty claims against the NRG board:

“Delaware courts have shown considerable latitude in entertaining fiduciary duty litigation brought by stockholders who are also themselves bidders for control. The only consistent limitation placed on those persons is that they also be stockholders at all relevant times and, thus, among those to whom a duty was owed, even if they only own one share. Of course, this rule is not based on the economic significance of such a bidder’s investment, which often is immaterial. Instead, it is based on a purely legal or equitable notion that limits to those having a relationship with the corporation the right to sue over its internal affairs.”

Omnicare, Inc. v. NCS Healthcare, Inc. 809 A.2d 1163, 1172 (Del. Ch. 2002) (footnote omitted).

So standing should not be a barrier to the assertion by Exelon of its claims, but ripeness should be. Exelon’s claims are wildly premature. Undoubtedly they have been brought to open one front in what undoubtedly will be a long campaign between Exelon and NRG. The campaign includes not only Exelon’s exchange offer and this lawsuit, but also its threatened proxy contest for NRG’s scheduled 2009 annual meeting (May 14, 2009) at which Exelon has announced that it will seek to expand the size of NRG’s board such that the directors to be elected at that meeting will constitute not less than 50% of the NRG board, and will nominate candidates to fill the newly created vacancies.

That the campaign will be a long one is virtually assured by the nature of Exelon and NRG, heavily regulated power companies. Among other approvals for the deal listed by Exelon in its S-4 preliminary offering prospectus are approvals from the Federal Energy Regulatory Commission, the Nuclear Regulatory Commission, the Pennsylvania Public Utilities Commissions, the New York Public Service Commission, the California Energy Commission, the California Public Utilities Commission, and the Public Utility Commission of Texas.

So among those cheering this battle are Wall Street lawyers and bankers.