By his letter opinion of October 28, 2008 (2008 WL 48253), Vice Chancellor Noble disposed of plaintiff’s motion for expedited discovery and defendants’ motion to stay or dismiss the action in favor of an action pending in the United States District Court for the Southern District of New York. I address in this post the Vice Chancellor’s disposition of the motion for expedited discovery, as it illustrates the virtual inevitability of confronting shareholder litigation in M&A transactions, certainly marquee ones such as this merger of Bank of America (“BAC”) and Merrill Lynch (“Merrill”).
A. Background
Much has been written about the fall of Lehman and the weekend negotiations that led to the announcement, on Monday, September 15, 2008, of the stock-for-stock merger of BAC and Merrill, see, e.g., Wall Street Journal, December 29, 2008 (“The Weekend That Wall Street Died,” page 1, column 3). Undoubtedly forests will fall in service of the books and studies that will be written in the years and decades ahead about these events and the housing and credit crises of 2008. In response to the announcement of the merger, shareholder actions were filed in the New York State Supreme Court, in the Delaware Chancery Court, and (by an amendment to a pending action) in the District Court for the Southern District of New York (the “Federal Derivative Action”).
In this Delaware action the plaintiff asserted that the directors of Merrill failed to satisfy their fiduciary duties, and challenged the adequacy of the disclosures set forth in BAC’s and Merrill’s joint proxy statement (as addressed by Vice Chancellor Noble, in preliminary form, as amended October 22, 2008). Plaintiff alleged that, having negotiated and agreed to the merger over a weekend, the directors failed to adequately inform themselves as to the true value of Merrill or the feasibility of securing an alternative transaction. Plaintiff also alleged self-dealing claims, particularly against John Thain, Merrill’s CEO and Chairman.
With respect to the merger agreement, plaintiff claimed that the Merrill board breached its fiduciary duties by its grant of an option to BAC to purchase 19.9% of Merrill’s outstanding shares at a price of $17.09 per share in the event that the merger were not approved by Merrill’s shareholders, and challenged the provision of the merger agreement requiring the board to submit the merger to Merrill’s shareholders even if the board elected to respond to a superior offer and withdraw their support of the BAC merger.
In its attack on the proxy statement, plaintiff alleged omissions of material information, including a failure to adequately describe the events leading up to the merger; insufficient information regarding the selection, compensation, and methodology utilized by Merrill’s financial advisor — its broker-dealer subsidiary; and inadequate disclosure concerning Thain’s negotiation of continuing employment while the merger negotiations with BAC were taking place.
B. Fiduciary Duty Claims
To justify expedited discovery, plaintiff must show good cause why expedited discovery is necessary, which in turn depends upon plaintiff’s articulating a “colorable” claim combined with a sufficient possibility of a threatened irreparable injury to justify imposing on the defendants the burden of expedited discovery and an expedited preliminary injunction proceeding. Letter Opinion (“LO”) at 14-15.
Because plaintiff failed to present a colorable claim that a majority of the Merrill board was self-interested and lacked independence, Vice Chancellor Noble applied the business judgment rule to plaintiff’s claims, rather than heightened scrutiny. Under Delaware’s business judgment rule, the board is presumed to act “with care and loyalty.” LO at 15.
1. Duty of Care Claims.
Not surprisingly, plaintiff alleged that, by approving the merger with BAC over a weekend the Merrill board breached its duty of care. But speed is not dispositive, observed the Vice Chancellor, and Delaware fiduciary law is contextual and can accommodate haste if justified by the circumstances:
“At their essence, these claims merely attack the speed with which the Merger was negotiated, drawing the conclusion that the Merrill board could not satisfactorily inform itself sufficient to justify business judgment rule protection over the course of a weekend. It is clear that ‘no single blueprint’ exists to satisfy a director’s duty of care. While such speed might be suspicious, it is not dispositive. Defendants justify their haste by claiming the existence of severe time-constraints and an impending crisis absent an immediate transaction. They argue that in light of these circumstances, the board exercises sufficiently informed judgment to dispose of their duty to make an informed decision. Such pressures may have existed, and our case law supports shaping fiduciary obligations to reflect such a reality. However, the contextual contours of the directors’ fiduciary obligations are fact driven; and the Court cannot undertake such a nuanced evaluation by way of an informal scheduling motion.”
LO at 17-18 (footnotes omitted).
So far, so good for the defendants. But they next run into a rough patch. The Vice Chancellor takes judicial notice, as defendants requested, of “well-known” market conditions, such as the subprime mortgage problems and the credit market and liquidity crises, but declined to accept as true, without further judicial examination, the facts of Merrill’s financial condition as set out in media reports and the proxy statement. “The interests of justice are served,” concluded the Vice Chancellor, “when such essential and critical facts [Merrill’s financial condition at the time the merger was negotiated] are properly developed in a manner recognized and accepted for establishing a factual basis for judicial action.” LO at 19. He articulates this touchstone:
“The need to consummate the deal within a matter of days, or even hours, was a business judgment, entitled to deference only if informed.”
LO at 20 (emphasis added).
Plaintiff alleged that the board’s business judgment in agreeing to the BAC merger was uninformed, and the Vice Chancellor concluded that plaintiff presented a colorable claim of such. “To hold otherwise,” concluded the Vice Chancellor, “would notice as fact the very essence of Defendants’ factual argument, and would allow inference and conjecture to serve as a factual record.” LO at 20.
2. Deal Protection Claims.
Defendants argued that each of the deal protection provisions attacked by plaintiff —the equity termination fee in the form of the stock option (capped at $2 billion, representing 4% of the value of the transaction), the “force-the-vote” provision; and the “no-talk” provision — have each been approved by the Delaware courts. The Vice Chancellor acknowledged the validity of this contention, LO at 21-22, but again resorted to context: “… deal protection devices must be viewed in the overall context; checking them off in isolation is not the proper methodology.” LO at 22. Because Merrill eschewed a pre-agreement market check, and conducted a truncated valuation of itself, plaintiff’s challenges to the deal protection claims were “colorable,” thus allowing plaintiff to proceed with expedited discovery.
3. Irreparable Harm
To proceed with expedited discovery, a plaintiff must allege irreparable harm. While plaintiff in this case did so in, as characterized by the Vice Chancellor, a “cursory” fashion, he concluded that plaintiff met the test: “Where, as here, damages that may be available are difficult to calculate and other uncertainties, such as collectibility exist, a sufficient showing of irreparable harm has been made to warrant expedition.” LO at 23 (footnote omitted).
C. Disclosure Claims
Disclosure claims are strategically important for shareholder plaintiffs, not only because, if meritorious, they necessarily involve irreparable harm; more importantly, they offer plaintiffs an opportunity for an early resolution and settlement of the case (and the award of counsel fees). By agreeing to make corrective disclosures, defendants offer plaintiffs “consideration” (non-monetary) to justify settlement of the case and the award of attorneys’ fees.
Plaintiff thus scored a considerable victory in Vice Chancellor Noble’s conclusion that its allegations regarding disclosures concerning the events leading up to the BAC/Merrill merger were colorable. Specifically, the Vice Chancellor concluded that the proxy statement’s failure to inform Merrill’s stockholders “what (if any) alternative structures to the [BAC] acquisition were discussed, and which (if any) potential acquirers, aside from BAC, Merrill’s board engaged in merger discussion with,” LO at 26-27, presented colorable disclosure claims. Merrill did disclose that it had entered into negotiations with “two other large financial services companies,” but did not disclose their identity. It is troublesome that the Vice Chancellor faulted Merrill for not disclosing the identities of these other companies — it is customary not to disclose the identity of suitors who do not make it to the altar. The Vice Chancellor also faulted Merrill for not disclosing the risks it faced if it failed to reach an agreement with BAC.
As to the other of plaintiff’s disclosure claims, the Vice Chancellor found them not to be colorable. These included plaintiff’s allegations regarding Merrill’s retention of its subsidiary, Merrill, Lynch, Pierce, Finner & Smith, its broker-dealer, to act as its financial advisor, and its purported failure to adequately disclose the negotiations BAC conducted with Thain about his continued employment with Merrill after the merger. The proxy statement, as amended, adequately disclosed the basis for Merrill’s retention of its affiliate (it had provided extensive financial and investment banking services to Merrill during the preceding two years) and adequately disclosed the conflicts presented by Merrill’s retention of its affiliate as its financial advisor.
Practice is mixed on the disclosure of the amount of compensation payable by merger parties to their financial advisors. Generally, amounts are not specified, unless the transaction is a going-private transaction or, upon review by the staff of the SEC, specific disclosure is required. In its initially-filed proxy statement, Merrill did not disclose the amount of the fee it agreed to pay its affiliate upon conclusion of the merger, just the fact that it agreed to compensate the affiliate contingent upon consummation of the merger. As observed by Vice Chancellor Noble, under Delaware law, “the precise amount of consideration need not be disclosed, and that simply stating that an advisor’s fees are partially contingent on the consummation of the transaction is appropriate.” LO at 33 (footnote omitted). Nevertheless, Merrill mooted the point by disclosing the fee in the amended proxy statement. The Vice Chancellor also concluded that there is no requirement under Delaware law for a party to disclose the precise methodology utilized by its financial advisor in its valuation, including disclosure of financial projections considered by Merrill’s or BAC’s financial advisors. The staff of the SEC will, however, require the disclosure of projections (typically as exhibits to Schedule 13E-3) utilized by financial advisors in going-private transactions.
The plaintiff faulted Merrill for not adequately disclosing the nature and substance of the discussions that occurred between BAC and Thain concerning his continued employment post-merger. But Merrill did disclose Thain’s (and the other executive officers’) financial interest in the transaction, including the details of their compensation packages. Such disclosure was adequate; defendants need not engage in “self-flagellating commentary”:
“The Plaintiff’s allegations of disclosure violations amount to nothing more than quibbles over the absence of self-flagellating commentary accompanying the compensation and employment disclosures. But, as discussed, the disclosures in the proxy and amended proxy sufficiently inform the shareholders of the Chairman’s interest in the transaction. It is well-established Delaware law ‘that to comport with its fiduciary duty to disclose all relevant material facts, a board is not required to engage in ‘self-flagellation’ and draw legal conclusions implicating itself in a breach of fiduciary duty from surrounding facts and circumstances prior to a formal adjudication of the matter.”
LO at 38 (citing Stroud v. Grace, 606 A.2d 75, 84 note 1 (Del. 1992)).
D. The Settlement
Not surprisingly, this litigation and the associated Federal Derivative Action (as to the merger) were settled within a month after the Vice Chancellor’s decision granting expedited discovery, and before the special meeting of the shareholders of BAC and Merrill called to approve the merger on December 5, 2008 (both companies’ shareholders did so). The parties entered into a Memorandum of Understanding (“MOU”) on November 21, 2008, filed with the Court and publicly disclosed by Merrill’s 8-K report of the same day. Also not surprisingly, the MOU focuses on corrective disclosures, both those set forth in Merrill’s October 22nd amended preliminary proxy statement, prompted, in part, by plaintiff’s complaint in this action, and the disclosures Merrill made in its November 21, 2008 8-K report, responsive to certain of plaintiff’s disclosure claims.
The MOU contemplates that the parties will negotiate and execute a definitive stipulation of settlement for presentation to and approval by the Delaware court. As part of that proceeding, plaintiff will seek an award of attorneys’ fees, the amount of which is to be negotiated between the parties or, failing agreement, by plaintiff’s petition to the Court. Thus will end this litigation. The path traveled is so well worn that one might almost conclude that a certain segment of the plaintiff’s bar specializing in challenging M&A transactions are an integral part of the deal teams.
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As he did in his ruling on defendants’ motion for summary judgment in Ryan v. Lyondell Chemical Company, 2008 WL 2923427 (July 29, 2008) (discussed in my posts of September 11 and 15, 2008), Vice Chancellor Noble demonstrates in this Letter Opinion an aversion to reaching definitive conclusions before he has before him a complete factual record developed after trial. In Ryan this reluctance proved fatal to defendants’ motion (which the Vice Chancellor denied); in this case, it served to permit plaintiff to proceed with expedited discovery. It was clear sailing after that.
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