San Antonio Fire & Police Pension Fund v. Amylin; Is There a Future For Continuing Director Poison Puts?

In one of his final decisions before his retirement this July, Vice Chancellor Lamb has handed down an important ruling on continuing director poison puts, San Antonio Fire & Police Pension Fund v. Amylin Pharmaceuticals, Inc. (Nasdaq: AMLN), 2009 WL 1337150 (May 12, 2009). A poison put is a contractual provision, typically found in loan agreements or indentures, that triggers adverse consequences to the debtor upon a change-in-control of the debtor. In this case the question was whether the holders of the $625 million 3% convertible notes, due 2014 (the “Convertible Notes”), acting through The Bank of New York Mellon Trust Company, the indenture trustee, would have the right to redeem the Convertible Notes (which were trading at a discount) at face value upon the occurrence of a “fundamental change” in Amylin, defined to include, among other things, a change in the makeup of the board of directors of Amylin such that the “continuing directors” would not constitute a majority of the board. “Continuing directors” included those on the board on the date of issuance of the Convertible Notes — June 2007 — and any successors who are approved by the directors then in office (or their approved successors).

The plaintiff’s allegations and the Court’s treatment of the poison put in the Convertible Notes Indenture and in Amylin’s Credit Agreement with Bank of America raise troubling questions concerning the viability of continuing director poison puts.

A. The Context

This lawsuit was triggered by a proxy contest over the directors to be elected at Amylin’s 2009 annual meeting of shareholders, to be held May 27, 2009. Twelve directors are to be elected. In January 2009 two dissident shareholders — Icahn Partners LP, an 8.8% Amylin stockholder, and Eastbourne Capital Management, L.L.C., a 12.5% stockholder — each nominated a five-person short slate for election to the board. Eastbourne, having done its homework, asked the Amylin board to take action to prevent the adverse consequences that would befall Amylin if the continuing directors’ provision of the Convertible Notes’ Indenture were triggered. Eastbourne’s proposed solution was to ask Amylin to include a “significant” number of nominees from its and Icahn’s slates in management’s slate of directors to be recommended to the stockholders.

Amylin filed its 2008 10-K with the SEC on February 27, 2009. In the 10-K, Amylin highlighted the potential adverse consequences of the continuing directors’ provisions of the Convertible Notes’ Indenture and the BofA Credit Agreement if they were triggered by election of the Icahn and Eastbourne slates. (The BofA Credit Agreement is even more restrictive than the Convertible Notes’ Indenture, in that candidates elected or appointed to the board as a result of an “actual or threatened solicitation of proxies or consents for the election or removal of Amylin directors” would not qualify as continuing directors.)

Promptly after the filing of the 10-K, Eastbourne sent a letter to the Amylin board questioning the “legitimacy” of the continuing directors’ provisions of the Convertible Notes’ Indenture and the BofA Credit Agreement, “calling upon the board to use its power to remove any obstacle to the operation of the stockholder franchise,” and calling upon Amylin to “approve” the dissident slates under the Convertible Notes’ Indenture.

On March 17, 2009, Amylin announced publicly the tentative date for its 2009 annual meeting – May 27, 2009.

B. The Litigation

Plaintiff launched a frontal assault on the continuing director provisions of the Convertible Notes’ Indenture and BofA Credit Agreement. It alleged —

• breaches of the fiduciary duties of care and loyalty by the Amylin board in its 2007 adoption of the Indenture and Credit Agreement, insofar as they both contained continuing directors covenants;

• breaches of the fiduciary duties of care and loyalty by the board in failing to approve the dissident nominees in order to “sanitize” them under the continuing directors provision of the Indenture; and

• breaches of the fiduciary duties of care and loyalty in the allegedly misleading and coercive manner in which the board disclosed the risks presented by the continuing directors provisions in the Indenture and Credit Agreement in the context of the proxy contest in Amylin’s 2008 10-K.

Besides seeking declaratory relief, plaintiff sought a mandatory injunction requiring the directors to approve the Icahn and Eastbourne nominees for director.

The plaintiff filed its class action complaint on March 24, 2009. In April the plot thickened. Clearly made a bit anxious by plaintiff’s allegations, and seeing a relatively harmless settlement strategy, Amylin and its board first filed an answer on April 7, 2009, which included a cross-claim against the Indenture trustee, seeking declaratory relief that the board has the power to approve any or all stockholder nominees at any time up to their election. And, on April 13, 2009, plaintiff and Amylin announced a partial settlement. Under the terms of the settlement, plaintiff withdrew its allegations of breach of the duty of loyalty and lack of good faith by the Amylin board. That withdrawal is important for indemnity and insurance purposes, as under Delaware GCL §102(b)(7), and Amylin’s charter, the personal liability of directors cannot be eliminated for breaches of the duty of loyalty or acts or omissions not taken in good faith. Plaintiff also agreed not to seek damages against Amylin or the board, to dismiss its claim of coercive disclosure in the 2008 10-K, and to dismiss its claim against the board for breach of fiduciary duty in failing to approve the Icahn and Eastbourne nominees. In return, the board, subject to court affirmation of its power to do so, agreed to “approve” the Icahn and Eastbourne nominees solely for the purpose of the continuing directors provision of the Indenture. This is called a clever work-around.

This “approval” did not mean that Amylin would endorse Icahn’s or Eastbourne’s nominees for election: the “approval” was solely to finesse the trigger under the Indenture permitting the Convertible Noteholders to redeem their Notes at face value. Amylin continued to oppose Icahn’s and Eastbourne’s nominees, with vigor.

Plaintiff, Amylin, and BofA also agreed to remove the BofA Credit Agreement continuing director provision from the case. Under this settlement, BofA and its group of lenders agreed to waive any event of default that might be triggered by the election of Icahn’s and/or Eastbourne’s nominees to the Amylin board, in return for — what else — money: a $625,000 fee (payable in the event that the continuing directors provision of the BofA Credit Agreement would otherwise be triggered by the election of the Icahn and/or Eastbourne nominees).

The parties then tinkered with the record before Vice Chancellor Lamb even further. On May 6, 2009, two days after close of the record date for determining the stockholders entitled to vote at the meeting, Amylin notified the Court that Eastbourne had reduced the number of candidates it was nominating to the board from five to three, and Icahn from five to two. Accordingly, even if the dissidents’ nominees are elected to the board, the board will still consist of a majority of continuing directors.

The sole remaining creditor defendant, the Indenture trustee, in response to these developments, at this point pleaded with the Court to dismiss or stay the claims against it, as the issues of the validity of the continuing director provision in the Indenture were now not ripe for determination. Plaintiff and Amylin, on the other hand, asked the Court to proceed because “whether or not the stockholder-nominated directors constitute Continuing Directors may have a significant effect on next year’s annual stockholder meeting.” 2009 WL 1337150 at *6.

C. Vice Chancellor Lamb’s Ruling

The trustee’s argument for application of the continuing directors provision of the Indenture to the Amylin proxy contest was straightforward:

“[t]he Board’s determination not to recommend the election of any of the Dissident Nominees, to recommend its own competing slate, and that the election of the Dissident Nominees would not be in the best interests of the Company—determinations that have not changed as a result of the Partial Settlement—simply cannot be reconciled with the plain meaning of the term ‘approval.’ To the contrary, such determinations by the Board clearly indicate disapproval.”

2009 WL 1337150 at *7 (footnote omitted) (emphasis in original).


Amylin, on the other hand, argued that “approval” does not mean “endorsement” or “recommendation.” “By Amylin’s reading, therefore, the board may approve a slate of nominees for the purpose of the Indenture (thus sanctioning their nomination for election) without endorsing them, and may simultaneously recommend and endorse its own slate instead.” Id.

The Vice Chancellor concluded that Amylin’s reading of the Indenture was the correct one. Clearly he was motivated by the effect of the continuing director provision upon the stockholder franchise, and he uses terms that should cause all boards considering continuing director poison puts concern:

“A provision in an indenture with such an eviscerating effect on the stockholder franchise would raise grave concerns. In the first instance, those concerns would relate to the exercise of the board’s fiduciary duties in agreeing to such a provision. The court would want, at a minimum, to see evidence that the board believed in good faith that, in accepting such a provision, it was obtaining in return extraordinarily valuable economic benefits for the corporation that would not otherwise be available to it. Additionally, the court would have to closely consider the degree to which such a provision might be unenforceable as against public policy.”

2009 WL 1337150 at *8 (footnotes omitted).

Having concluded that the Amylin board had the power under the Indenture to “approve” a dissident’s slate under the continuing director provision of the Indenture, while at the same time opposing the election of that slate, Vice Chancellor Lamb next turned to the question of whether the Amylin board had properly approved the dissidents’ slates under the Indenture. Relying upon Hills Stores Company v. Bozic, 769 A.2d 88 (Del. Ch. 2000), the Vice Chancellor applied this test:

“… the board may approve the stockholder nominees if the board determines in good faith that the election of one or more of the dissident nominees would not be materially adverse to the interests of the corporation or its stockholders.”

Id. at *8 (footnote omitted).

Here, the Vice Chancellor ran into a problem. There was no evidence before him as to how the Amylin board came to its decision to “approve” Icahn’s and Eastbourne’s nominees or, to be more precise, the evidence before the Vice Chancellor cut the other way. First, and most obviously, the public record was replete with negative comments made by Amylin about the Icahn and Eastbourne nominees, some of which are quoted by the Vice Chancellor in note 39 to his decision. But these negative comments are not dispositive, so concluded the Vice Chancellor, because he recognized that such comments could be election “puffery” in the context of a proxy contest. In other words, the other guys’ nominees could be worse, much worse than management’s nominees, but not bad. That is a fine line to walk. The second unhelpful fact before the Vice Chancellor was the circumstance of the Amylin settlement with the plaintiff, clearly giving rise to the inference that Amylin agreed to “approve” Icahn’s and Eastbourne’s nominees to settle breach of duty and loyalty claims against its board of directors.

Exercising judicial discretion, the Vice Chancellor elected to punt on the question of whether the Amylin board properly “approved” the Icahn and Eastbourne nominees under the terms of the continuing director provision of the Indenture to a later date. It helped the Vice Chancellor in making this decision that the dissidents had reduced their slate of nominees to a number less than a majority of the Amylin board. If the dissidents are elected, and Amylin chooses to do so, then it could return to the Court for sanction of the board’s due care in “approving” the dissident nominees.

D. Did the Amylin Board Breach its Duty of Due Care in Approving the Poison Put?

The one due care issue remaining in the case that the Vice Chancellor did address is one that will give boards and their advisors pause.

The standard applied by the Vice Chancellor is one of gross negligence, that is, was the Amylin board grossly negligent in approving the Indenture with its continuing director provision? Here, the record was somewhat embarrassing, in that, in its consideration of the Indenture, the committee of the board that approved the Indenture was unaware of the poison put! So too were Amylin’s CEO and CFO! Indeed, the poison put proceeded through drafts of the Indenture without comment by Amylin or its counsel. (Indeed, there is more: when counsel was asked by the board committee whether the Convertible Notes were subject to any terms which counsel saw as “unusual or not customary,” Amylin’s counsel responded that they were not.)

Nevertheless, the Vice Chancellor concluded that the Amylin board was not grossly negligent “in failing to learn of the existence of the Continuing Directors provisions…” 2009 WL 1337150 at *10. Focusing on the board, and the advice it had received from “highly-qualified counsel,” the Vice Chancellor observed that “no one suggests that the directors’ duty of care required them to review, discuss and comprehend every word of the 98-page Indenture.” Directors can breathe a sigh of relief at that observation.

But then the Vice Chancellor concludes with words of caution to boards and their advisors:

“This case does highlight the troubling reality that corporations and their counsel routinely negotiate contract terms that may, in some circumstances, impinge on the free exercise of the stockholder franchise. In the context of the negotiations of a debt instrument, this is particularly troubling, for two reasons. First, as a matter of course, there are few events which have the potential to be more catastrophic for a corporation than the triggering of an event of default under one of its debt agreements. Second, the board, when negotiating with rights that belong first and foremost to stockholders (i.e., the stockholder franchise), must be especially solicitous to its duties both to the corporation and to its stockholders. This is never more true than when negotiating with debtholders, whose interests at times may be directly adverse to those of the stockholders. Outside counsel advising a board in such circumstances should be especially mindful of the board’s continuing duties to the stockholders to protect their interests. Specifically, terms which may affect the stockholders’ range of discretion in exercising the franchise should, even if considered customary, be highlighted to the board. In this way, the board will be able to exercise its fully informed business judgment.”

Id. at *10.

E. Plaintiff Appeals

Not satisfied with the Vice Chancellor’s blessing of its strategy for finessing the continuing director provision of the Indenture, plaintiff has appealed the Vice Chancellor’s ruling deferring a decision on whether the Amylin board exercised due care in “approving” the dissidents’ shortened slate of director nominees. Plaintiff essentially doesn’t like the uncertainty created by the Vice Chancellor’s ruling. In its application for an expedited hearing before the Delaware Supreme Court, it argues that, in the absence of an expedited final resolution prior to the date of the stockholder meeting, “stockholders will be coerced from voting for the five stockholder nominees because of the cloud cast by the lower Court’s ruling.” Plaintiff’s Motion for Expedited Scheduling Regarding Dismissal of Count III, dated May 13, 2009, at 2. Justice Jacobs of the Delaware Supreme Court denied the motion for an expedited hearing on May 15.

F. Whither the Continuing Director Poison Put?

If Vice Chancellor Lamb’s decision stands, it is hard to see how continuing director poison puts will survive. If drafted more restrictively, to protect lenders, it could subject a board to claims of entrenchment and thereby implicate the duty of loyalty, stripping from the directors the “due care” waivers permitted in charter provisions such as those permitted by Delaware GCL §102(b)(7). As to existing poison puts, plaintiff’s strategy in this lawsuit provides a roadmap on how to neuter them, although the path that a board must follow is akin to Ulysses’ travels between Scylla and Charybdis: how to “approve” a dissident slate while at the same time slamming them in the heat of battle.

Breaches of continuing director provisions are not, of course, monetary defaults. They provide a signal to lenders of potential trouble. A more classic way of signaling such trouble is through the use of financial covenants, e.g., debt to equity ratios, debt service coverage, or through events of default that foreshadow trouble, such as a rating decline, or through negative covenants such as a requirement to secure the lenders’ consent for any merger, consolidation, etc. Debtors and their counsel will in all likelihood point lenders to reliance upon these types of provisions in lieu of reliance upon continuing director poison puts (assuming, of course, it is the lenders who are the parties requesting continuing director poison puts).

FLI Deep Marine LLC v. McKim; the Futility of Claiming Demand Futility After a Demand Has Been Made

Much of the law can be a trap for the unwary. This is particularly true with procedure. Even experienced counsel can blow it. Such appears to have been the case with plaintiffs’ counsel in this derivative action. By his letter opinion of April 21, 2009 (2009 WL 1204363) Vice Chancellor Noble dismisses this derivative action for plaintiffs’ failure to allow the board of directors of Deep Marine Holdings, Inc. (“DMT”) adequate time to respond to plaintiffs’ litigation demand.

A. Plan Ahead

Plaintiffs complained that DMT had been looted for personal gain for some four years by its controlling shareholders, acting through their controlled directors, also named as defendants in the lawsuit. But plaintiffs filed their action after plaintiffs’ counsel had demanded of the board that it take remedial action and appoint a special litigation committee to investigate the alleged breaches of duty. In response to the demand, the board established a special litigation committee, comprised of two of the defendant directors.

Notwithstanding the making of their demand, in their post-demand lawsuit, plaintiffs alleged that demand on the board was futile and should be excused, notwithstanding that they had already made one!

B. The Law Is the Law

Chancery Rule 23.1 requires that a shareholder seeking to assert a claim on behalf of a Delaware corporation to first make demand on the directors to obtain the action desired, or “state with particularity the reasons for the shareholder’s failure to make such effort.” Letter Opinion at 6-7.

The action of a board in responding to a demand is generally subject to review under the “deferential” business judgment rule, “which presumes that a board is independent, and acts reasonably and in good faith.” Letter Opinion at 7. Where a derivative plaintiff seeks to avoid demand and proceed directly with litigation on behalf of the corporation, then the inquiry focuses on “director independence” and “disinterestedness,” which plaintiff can rebut by alleging particularized facts challenging the independence of the directors and creating “a reasonable doubt that the challenged conduct was a valid exercise of business judgment.” Id.

However, where a shareholder chooses to make a demand upon a board, then the shareholder “concedes the independence of a majority of the board.” Id. at 8. In such circumstances, the Chancery Court “only examines the good faith and reasonableness of the board’s investigation.” Because plaintiffs in this action made a pre-suit demand upon DMT’s board of directors, “they have conclusively conceded the independence of the Board, and are precluded from now arguing that demand should be excused because the directors are conflicted.” Id. at 8. The Vice Chancellor reaches this conclusion notwithstanding plaintiffs’ pleas that, given the makeup of the special committee appointed to respond to their demand, the exercise would be a “mockery,” “contrived,” and a “farce.” While, based upon the allegations of the complaint, plaintiffs might well be correct, too bad: the Court “cannot diverge from settled law.” Id. at 9.

In words that undoubtedly cause plaintiffs’ counsel considerable heartburn, the Vice Chancellor observes that, yes, their demand may very well have been a misstep:

“In light of these facts [plaintiffs’ allegations of the lack of independence of the board], the Plaintiffs’ decision to make a demand upon the Board appears inprovident. The Plaintiffs ask the Court to undo the consequences of their demand; this Court will not part ways with established Delaware law to grant the Plaintiffs relief from a strategic decision they now regret.”

Id. at 10.

C. Spiegel v. Buntrock

This has happened before. It seems to be a habit of derivative plaintiffs. In a similar vein, the Delaware Supreme Court, in Spiegel v. Buntrock, 571 A.2d 767 (1990), likewise concluded that, when a shareholder makes a pre-suit demand, the shareholder “tacitly concedes the independence of a majority of the board to respond.” 571 A.2d at 777. The facts of Spiegel were even more dramatic: Spiegel first filed his derivative action. When respondents protested that he had not made a pre-suit demand, Spiegel dutifully responded by filing a demand! Gotcha! Once such demand is made, then the business judgment rule applies to the board’s response to the demand, and the issues on review of any board decision “are solely the good faith and reasonableness of the committee’s investigation.” 571 A.2d at 778, citing Zapata Corp. v. Maldonado, 430 A.2d 779, 787 (1981). The focus is on process, not the ultimate decision, since that decision is not subject to judicial review. Id.

So it’s back to the drawing boards for plaintiffs in this case. If defendant DMT’s advisors have any brains, the special committee will follow accepted practice, appoint one or more disinterested directors, advised by special counsel, and reach the inevitable decision not to litigate. Only if DMT is foolish enough to leave the decision on how to respond to the demand in the hands of directors who are alleged, through particularized pleading, to have engaged in misconduct, would plaintiffs have a shot at claiming the board’s response was not one made in “good faith.”

Nemec v. Shrader; Redemption of Shares Just Prior to a Transaction

Timing can be everything. Long-time “partners” Joseph Nemec and Gerd Wittkemper of Booz Allen Hamilton Inc. (“Booz Allen”) retired on March 31, 2006 after illustrious careers with the firm. After their retirement, Booz Allen entered into negotiations with The Carlyle Group (“Carlyle”) to sell its government consulting business for over $2 billion. Notwithstanding assurances by Booz Allen’s chairman and CEO to both Nemec and Wittkemper that Booz Allen would not exercise its discretionary option to repurchase their shares prior to consummation of the Carlyle transaction, Booz Allen in fact did so a month before Booz Allen entered into a deal with Carlyle. The early redemption cost Nemec and Wittkemper over $60 million.

Too bad, concluded Chancellor Chandler on this motion of defendants to dismiss (reported at 2009 WL 12043465 (April 30, 2009)). The discretionary redemption did not constitute a breach of the directors’ fiduciary duties to Nemec and Wittkemper, did not breach the implied covenant of good faith and fair dealing between plaintiffs and Booz Allen, and did not constitute unjust enrichment of Booz Allen. It’s a harsh result, which may feed the Chancery Court’s reputation as plaintiff-unfriendly, but undoubtedly the correct decision.

A. The Background

Nemec spent 36 years with Booz Allen. At the time of his retirement on March 31, 2006, he ranked third in seniority among all Booz Allen “partners.” (Although a Delaware corporation, the firm, originally founded as a partnership in 1914, retained the “attitude and culture” of a partnership.) He sat on Booz Allen’s board of directors where, among other things, he served on the audit committee. Wittkemper retired on the same date, March 31, 2006, after some 20 years as a partner of the firm, building the firm’s German business and helping it to expand throughout Europe.

At the time of his retirement from the firm, Nemec owned 76,000 shares of Booz Allen (representing 2.6% of the issued and outstanding stock of the firm), and Wittkemper owned 28,000 shares. Under Booz Allen’s stock plan, a retiree had a “put” right, for a period of two years from the date of his retirement, to sell his shares back to the firm for book value. After expiration of the two-year put period, Booz Allen had the right to redeem part or all of a retired officer’s stock, also at book value (as of the time of redemption). Nemec and Wittkemper (in large part) retained their Booz Allen stock after retirement. In early 2007 Booz Allen commenced discussions with Carlyle over the sale of its government consulting business. Carlyle submitted a bid in November 2007 to purchase the business for $2.54 billion. The negotiations became public in January 2008; it was reported the deal was expected to close by March 31, 2008 (the end of Booz Allen’s fiscal year). If it closed by that date, Nemec and Wittkemper would participate in the benefits of the transaction, to the extent of some $700 per share.

In light of the pending transaction, Booz Allen’s board elected, in March 2008, to preserve the status quo of Booz Allen’s stock ownership, meaning it elected not to redeem any shares so as to maintain the status quo and not “disfavor any existing stockholder.” Slip Opinion at 5-6.

Nemec and Wittkemper, aware of the pending transaction, were of course anxious to participate in its fruits. Booz Allen’s chairman and CEO gave assurance to both of them that they would remain Booz Allen stockholders until the close of the transaction. The CEO stated that this was an “easy moral decision.” Slip Opinion at 6.

Moral, maybe, but on second thought, the board eschewed morality and decided to exercise the firm’s contractual rights under the stock plan and award agreements with Nemec and Wittkemper: in April 2008, before the transaction with Carlyle was formally approved, Booz Allen redeemed the plaintiffs’ shares at the pre-transaction book value — $162.46 per share.

Within weeks of the redemption of Nemec’s and Wittkemper’s shares, the firm moved to cement the transaction with Carlyle. On May 15, 2008, it entered into a merger agreement to sell its government business to Carlyle, which was announced publicly the following day. The directors of Booz Allen, who owned more than 300,000 shares, benefited by the redemption of the plaintiffs’ shares to the tune of $6 million.

B. The Fiduciary Duty Claim

Plaintiffs first claimed that the Booz Allen directors breached their duty of loyalty to plaintiffs by exercising the firm’s option to redeem plaintiffs’ shares at the pre-Carlyle value of the shares. Notwithstanding the personal benefits derived by the directors from this decision, Chancellor Chandler was unimpressed by the claim. First, the dispute fundamentally involved a contract — the award agreement setting forth the firm’s and Nemec’s and Wittkemper’s rights with respect to their stock awards under the stock plan:

“If the ‘fiduciary claims relate to obligations or they are expressly treated’ by contract then this Court will review those claims as breach of contract claims and any fiduciary claims will be dismissed.”

Slip Opinion at 8 (footnote omitted).

The Chancellor’s interpretation of the directors’ action was a matter of contract interpretation:

“Whether the Directors possessed the right to redeem plaintiffs’ shares and whether the Directors properly exercised that right is simply a matter of contract interpretation.”

Slip Opinion at 8-9.

Going beyond where he had to, the Chancellor nevertheless reached plaintiffs’ fiduciary duty claims, and rejected them. Fatal to plaintiffs’ fiduciary duty claim was their assertion that the Booz Allen board, as fiduciaries, owed “unique” duties to them. In fact, the directors’ decision to redeem plaintiffs’ shares benefitted all other shareholders, not just the directors as shareholders. Quoting from Gilbert v. El Paso, Chancellor Chandler noted that in such instances the fact that an action may adversely affect the interests of particular shareholders is of no moment:

“[D]irectors may take whatever action that, in their proper exercise of business judgment, will best serve the interests of the corporation or the entire body of shareholders. That such action may adversely affect the interests of a particular shareholder subgroup, will, in certain instances, be unavoidable. Nonetheless, no wrong doing will have occurred if the directors are able to justify the result as furthering a paramount or overriding corporate or shareholder interest.”

Slip Opinion at 9, quoting from Gilbert v. El Paso, 1998 WL 124325 at *10 (Del. Ch. 1988), aff’d, 575 A.2d 1131 (Del. 1990).

C. Good Faith and Fair Dealing Claim

The strongest of plaintiffs’ claims was that by redeeming their shares Booz Allen violated the implied covenant of good faith and fair dealing. Plaintiffs argued that when a contract confers discretion on a party, that party is required to make the decision reasonably and in good faith. Relying upon the principle that imposing obligations upon contracting parties through the covenant of good faith and fair dealing is “a cautious enterprise and instances [of its application] should be rare,” Slip Opinion at 11, citing Superior Vision Services, Inc. v. ReliaStar Life Ins. Co., 2006 WL 2521426 (Del. Ch. 2006), the Chancellor concluded that no violation occurred here because Booz Allen exercised rights specifically granted to it under the stock plan and award agreements with plaintiffs:

“The Stock Plan is a negotiated instrument entered into freely by both parties. The implied covenant is not implicated simply because Booz Allen, by exercising its option, received the fruits of the agreed to bargain under the stock plan. Nor is the implied covenant implicated because the exercise of the option had a negative effect on plaintiffs’ bottom line.”

Slip Opinion at 12.

D. Unjust Enrichment Claim

Chancellor Chandler tarried only a moment over this claim, noting that it applies only when it would be “unconscionable” to allow a party to retain a benefit, and the Delaware courts “have consistently refused to permit a claim for unjust enrichment when the alleged wrong arises from a relationship governed by contract.” Slip Opinion at 13.

E. What Might Have Been

One cannot read this decision without thinking of the famous case of Jordan v. Duff and Phelps, Inc., 815 F.2d 429 (7th Cir. 1987), discussed in my post of September 6, 2008. Jordan also involved an employee who terminated his employment with his employer (Jordan left to take another job). Unbeknownst to Jordan at the time he quit (he also received the book value of his shares of stock), his employer, Duff and Phelps, was in negotiations to merge. Had Jordan hung around longer, he would have received substantially more for his shares.

In this celebrated decision, in which Judges Easterbrook and Posner took opposing sides (Easterbrook for the majority, Posner in dissent), the Seventh Circuit concluded that, in such circumstances, Duff and Phelps had breached its duty of full disclosure to Jordan in connection with the redemption of his stock.

Jordan would have been in play in this case if Booz Allen had begun negotiations with Carlyle before Nemec and Wittkemper announced their decisions to retire in March 2006. But, as noted by Chancellor Chandler, the negotiations with Carlyle “began to emerge” in early 2007, too late for Nemec and Wittkemper to reach for Jordan v. Duff and Phelps. Too bad. Timing is everything.

Lyondell Chemical Co. v. Ryan; The Limits of Bad Faith Claims

In an en banc decision handed down March 25, 2009, the Delaware Supreme Court took Vice Chancellor Noble to the woodshed for his refusal to grant the Lyondell board summary judgment against plaintiffs over the board’s approval of the merger of Lyondell and a subsidiary of Basell AF (“Basell”) in December 2007 for a cash price of $48 per share. The decision provides important clarification of the Revlon duties of a disinterested board, and makes clear that where a board is disinterested, establishing bad faith is a steep hill to climb.

A. The Weakness of the Vice Chancellor’s Decision

I commented on Vice Chancellor Noble’s Lyondell decision by my posts of September 11, 12 (comparing the Vice Chancellor’s decision in Ryan with Vice Chancellor Strine’s decision In re Lear Corporation Shareholder Litigation) and 15, 2008. As I noted in my post of September 11:
“Given that a finding that a board has failed to act in good faith ‘requires conduct that is qualitatively different from, and more culpable than, the conduct giving rise to a violation of the fiduciary duty of care (i.e., gross negligence),’ Stone v. Ritter, 911 A.2d 362, 369 (Del. 2006) (footnote omitted), the most surprising aspect of Vice Chancellor Noble’s opinion is that he devotes only three pages of his 73-page opinion to disposing of the defendants’ argument that, even if they breached their Revlon duties, Lyondell’s certificate and GCL § 102(b)(7) precluded an award of damages.
. . . .

What is surprising about the Vice Chancellor’s conclusion is that he devotes almost no effort to explicating Stone v. Ritter’s use of the word ‘conscious’ before ‘disregard for their responsibilities . . .’ as applied to Ryan. It’s almost as if, at this point in his struggle over this decision, he had little left to analyze whether additional culpability were required from the Lyondell board to find not only a breach of Revlon duties but also a conscious violation of their Revlon duties.”

B. The Supreme Court’s Rebuff

The Delaware General Corporation Law permits the inclusion, in a certificate of incorporation, of provisions limiting the personal liability of directors of a Delaware corporation for due care violations (including gross negligence), but not “for acts or omissions not in good faith, which involve intentional misconduct or a knowing violation of law . . .” Because this was a case where Vice Chancellor Noble concluded that on the evidence before him the Lyondell board was independent and not motivated by self-interest or ill will, the issue was whether the directors breached their duty of loyalty to Lyondell by failing to act in good faith.

Reviewing its prior decisions in Disney (In re Walt Disney Derivative Litigation, 906 A.2d 27 (Del. 2006)) and Stone v. Ritter, 911 A.2d 362 (Del. 2006), the Supreme Court, in an opinion by Justice Berger, emphasized the scienter required to establish bad faith by a Delaware board:

“Stone also clarified any possible ambiguity about the directors’ mental state, holding that ‘imposition of liability requires a showing that the directors knew that they were not discharging their fiduciary obligations.’”

Slip Opinion at 11.

In concluding that Vice Chancellor Noble erred on the record before him in refusing to grant the defendants’ summary judgment, the Supreme Court crucially disagreed with the Vice Chancellor that the board’s Revlon duties began with Basell’s filing of a Schedule 13D in May 2007. In response to the filing, the Lyondell board took a “wait and see” approach, for which they were faulted by Vice Chancellor Noble. In this the Vice Chancellor was wrong:

“The problem with the trial court’s analysis is that Revlon duties do not arise simply because a company is ‘in play.’ The duty to seek the best available price applies only when a company embarks on a transaction – on its own initiative or in response to an unsolicited offer – that will result in a change of control. [The Lyondell board’s ‘wait and see’ approach] was an entirely appropriate exercise of the directors’ business judgment. The time for action under Revlon did not begin until July 10, 2007, when the directors began negotiating the sale of Lyondell.”
Slip Opinion at 14-15 (footnotes omitted).

Vice Chancellor Noble, after his review of the Revlon line of cases, concluded that directors must engage actively in a sales process, and must establish that they have obtained the best available price “either by conducting an auction, by conducting a market check or by demonstrating ‘an impeccable knowledge of the market.’” Slip Opinion at 16-17 (quoting from the Vice Chancellor’s opinion).

The Lyondell board admittedly did not conduct an auction or a market check before signing up with Basell, and Vice Chancellor Noble found that they could not demonstrate that they had an “impeccable” market knowledge of Lyondell’s industry and propects. But the Vice Chancellor’s analysis was directed at the wrong question. The issue is not whether the Lyondell board exercised due care, but whether the board failed to act in good faith. That is a very different analysis, and using that analysis, the record before the Vice Chancellor mandated entry of judgment in favor of the directors.

At this point the Supreme Court took the opportunity to quote (and thereby praise) Vice Chancellor Strine from his decision in Lear, discussed in my post of September 12, 2008. The following language will surely be quoted by all defendant directors in future claims alleging disloyalty:

“Directors’ decisions must be reasonable, not perfect. ‘In the transactional context, [an] extreme set of facts [is] required to sustain a disloyalty claim premised on the notion that disinterested directors were intentionally disregarding their duties.’ [Quoting Vice Chancellor Strine in Lear.] The trial court denied summary judgment because the Lyondell directors’ ‘unexplained inaction’ prevented the court from determining that they had acted in good faith. But, if the directors failed to do all that they should have under the circumstances, they breached their duty of care. Only if they knowingly and completely failed to undertake their responsibilities would they breach their duty of loyalty. The trial court approached the record from the wrong perspective. Instead of questioning whether disinterested, independent directors did everything that they (arguably) should have done to obtain the best sale price, the inquiry should have been whether those directors utterly failed to attempt to obtain the best sale price.”

Slip Opinion at 18-19 (footnotes omitted).

C. Observations

Lyondell illustrates the crucial protection provided directors by charter document exculpatory provisions such as those allowed by Section 102(b)(7) of the GCL and by the corporation laws of other states. With such provisions, directors’ exposure for monetary damages for breach of due care claims can be virtually eliminated. While these provisions do not prevent claims seeking injunctive relief for due care violations, they provide critical protection to directors against damages for due care violations. Indeed, an individual would be ill advised to join a board without exculpatory protections such as those permitted by Section 102(b)(7) or like provisions in other jurisdictions.

The other lesson of Lyondell is the benefit of accelerated deal negotiations. Dan Smith, Lyondell’s CEO, in response to overtures by Basell’s controlling shareholder, Leonard Blavatnik, negotiated what appeared to be a fully-priced deal (getting Blavatnik to raise his offer from $40 per share to $48 per share). In response, Blavatnik insisted that the deal be accepted and a merger agreement entered into in one week. While the accelerated schedule, the lack of a market check, the board’s acceptance of Smith’s price-raising efforts without its further insistence on further price enhancements, and the board’s acceptance of deal enhancement features (hefty break-up fee, no-shop covenant, and limited poison pill waiver) deeply troubled Vice Chancellor Noble, they did not, on the full record, trouble the Delaware Supreme Court, certainly not on the question of whether the Lyondell board acted in conscious disregard of its fiduciary duties. It of course did not hurt the directors’ cause that no competing suitor surfaced during the four months between the announcement of the merger agreement and the stockholders’ meeting, or that the stockholders approved the deal by more than 99% of the voted shares, or that, as is now common knowledge, Basell, in light of the cratering of the world economy, has put Lyondell in Chapter 11.

So, as a result of the Court’s decision in Lyondell, I would expect suitors, certainly in deals believed to be fully priced, to insist upon an accelerated deal schedule, at least to the point of negotiating and announcing an agreed-upon merger agreement.

CSX v. TCI; Sacre Bleu! Christopher Hohn Elects Not to Stand for Re-Election to the CSX Board

After over a year of effort, the expenditure of over $10 million in legal fees, the burden of engaging in bare-knuckles litigation, and the humiliation of being “dressed down” by an outraged Judge Lewis Kaplan (CSX v. TCI, 562 F. Supp. 2d 511 (S.D.N.Y. 2008)), Christopher Hohn won his proxy contest with CSX, seating himself and three others on the CSX board at the shareholders’ meeting held June 25, 2008 (CSX did not sit Hohn until September 2008).

Hohn, whose hedge fund, the Children’s Investment Master Fund, rose like a shooting star among activist hedge funds, carefully examined CSX and the opportunity a change in management at the company might represent, and presented a well researched and effective campaign for shareholder votes. In its “case for change,” TCI stated its belief that:

• CSX could be the best railroad in America; and

• Its earnings power could be double what the management of CSX had targeted to achieve.

The question, TCI asked, “shouldn’t be ‘Where has CSX come from?’ but ‘Where should CSX be?’” Hohn’s nominees would “refresh” the CSX board, and bring more railroad experience and more business experience to CSX than the five directors TCI’s group hoped to supplant, and bring to the CSX board “the perspectives of large and engaged shareholders.”

This was slick stuff. Given TCI’s reputation for shaking things up, which Hohn had done with Deutsche Börse and ABN Amro, the campaign succeeded.

But “engaged” Hohn no longer is: in a brief announcement on February 10, 2009, CSX disclosed that Hohn had notified the Governance Committee of CSX’s Board that he did not wish to be included as a nominee for re-election as a director at the annual meeting scheduled for May 6, 2009. CSX reports that Hohn “informed the Company that this decision resulted from his responsibilities in managing his business interests.”

Hohn’s possible burnout with activist investing was foreshadowed last fall in an article in Alpha (September 19, 2008), entitled “Christopher Hohn Rethinks Activism.” Spending over $10 million going against incumbent management, and losing money, as TCI has done with Deutsche Börse, will do that to you. Given the current economy, TCI has not done too well at CSX either. On June 25, 2008, the date of CSX’s 2008 annual meeting, CSX closed at $63.23. Yesterday, February 18, 2009, CSX closed at $27.83, a 56% decline since the shareholder meeting. And Hohn’s perception of the CSX opportunity — that its monopolistic position would benefit from a combination of global economic growth and higher energy costs, has vaporized in the current downturn.

Hohn, and other activist investors, have undoubtedly grown to appreciate the power of incumbency. As Hohn ruefully observed for the Alpha article:

“Buffett has always said that he looks for good management teams, because they’re easier to work with,” Hohn says. “We’ve often done just the opposite. We’ve frequently looked for excellent companies with underperforming management — Deutsche Börse, Euronext, CSX. Activism has been profitable for us, but it’s getting much harder; the political and regulatory environment is changing.”

In with a big bang, out with a whimper.

And we are still awaiting the decision of the Second Circuit Court of Appeals on Judge Kaplan’s searing decision finding TCI had violated the Exchange Act in its campaign to replace five members of the CSX board (the panel promptly ruled with Judge Kaplan that, even if TCI had violated the Exchange Act, the votes that it obtained for its slate would not be nullified, but its full opinion on this issue and on Judge Kaplan’s judgment on liability has yet to be handed down).

For my prior commentary on this case, see my posts of November 11, September 15, August 23, August 13, August 1, July 30, July 26, July 17, June 24, and June 23, 2008.

Gantler v. Stephens; Board's Failure to Accept Merger Proposal to Pursue Reclassification of Stock Not Entitled to Presumption of Business Judgment

The Delaware Supreme Court’s en banc decision in Gantler v. Stephens, 2009 WL 188828 (January 27, 2009) illustrates the hazards of pursuing change of control transactions lackadaisically and the risks in alienating a sitting director. As a result, decisions that might normally be protected by the business judgment rule received more exacting entire fairness review. Under the more exacting standard, the Delaware Supreme Court concluded, in an opinion by Justice Jacobs, that the defendants’ motion to dismiss had been improperly granted by Vice Chancellor Parsons. In the course of its decision, the Supreme Court takes the occasion to confirm that officers are subject to the same fiduciary duties as directors under Delaware law, and clarifies the application of the doctrine of shareholder ratification.

A. How Not to Run a Transaction

First Niles Financial, Inc. (“First Niles” or the “Company”) is a Delaware corporation headquartered in Niles, Ohio. It is a holding company formed as the result of the demutualization of a single branch S&L (the “bank”) located in Niles. Its board of directors was insular, consisting of First Niles’ long-time Chairman, President and CEO William L. Stephens, plaintiff Leonard T. Gantler (director from April 2003 through April 26, 2006 and a CPA), James Kramer, president of a local heating and air conditioning company that provided services to the bank and for whom the bank was a major client, Ralph Zuzolo, principal in a Niles law firm that provided legal services to the bank and the sole owner of a real estate title company that provided title services for nearly all of the bank’s real estate transactions, and a fifth director.

In August 2004 the board decided to put the Company up for sale. It retained Keefe, Bruyette & Woods as its financial advisor.

Demonstrating its lack of enthusiasm for the proposal, management, headed by Stephens, advocated abandoning the search at the very next meeting of the board and proposed, instead, that the Company go private. The board took no action on management’s proposal. Three potential purchasers surfaced. Two of them were explicit that they would replace the Company’s board. Keefe Bruyette advised the board that all three bids reasonably valued the Company.

Notwithstanding the board’s direction to management and Keefe Bruyette to conduct due diligence in connection with two of the proposals, management failed to provide due diligence materials to one of the bidders, resulting in its withdrawal of its proposal. The remaining bidder, First Place Financial Corp. (“First Place”), after itself being delayed with its due diligence requests, proposed a stock-for-stock transaction which, as revised, represented an 11% premium over First Niles’ stock price. Keefe Bruyette opined that the offer was within an acceptable range.

Here is the Court’s recitation of the sum and substance of the board’s consideration of First Place’s revised proposal:

“On March 8, First Place increased the exchange ratio of its offer to provide an implied value of $17.37 per First Niles share. At the March 9 special Board meeting, Stephens distributed a memorandum from the Financial Advisor describing First Place’s revised offer in positive terms. Without any discussion or deliberation, however, the Board voted 4 to 1 to reject that offer, with only Gantler voting to accept it. After the vote, Stephens discussed Management’s privatization plan and instructed Legal Counsel to further investigate that plan.”

Slip Opinion at 7.

B. Management’s Reclassification Proposal

After the board rejected First Place’s offer, it thereafter considered management’s privatization proposal which included, among other components, reclassifying the shares of holders of 300 or fewer shares of the Company’s common stock into a new issue of Series A Preferred Stock, which would pay higher dividends but not carry any voting rights (except in the event of the proposed sale of the Company) (the “Reclassification Proposal”). In December 2005, after hearing a presentation from Powell Goldstein LLP, Atlanta, as special counsel retained for the privatization, the board elected to proceed with the Reclassification Proposal by a vote of three to one, with Gantler dissenting.

After Gantler resigned from the board in April 2006, the board elected to proceed with the Reclassification Proposal in June of 2006, which, because it entailed an amendment to the Company’s Certificate of Incorporation, required stockholder approval.

C. The Company’s Proxy Statement

In its proxy statement distributed to its stockholders soliciting their approval of the Reclassification Proposal and the amendment to the Company’s Certificate of Incorporation, the proxy statement acknowledged that the Company’s directors and officers were subject to a conflict of interest with respect to the Reclassification Proposal. In disclosing the alternatives the board had considered to the Reclassification Proposal, the proxy statement stated, with respect to the First Place proposal, that “[a]fter careful deliberations, the board determined in its business judgment the proposal was not in the best interests of the Company or our shareholders and rejected the proposal.” Slip Opinion at 10.

57.3% of the outstanding shares voted in favor of the Reclassification Proposal, although, with respect to shares held by stockholders not affiliated with management, the proposal passed by a bare 50.28% majority vote.

D. Business Judgment Standard Not Available to the Company’s Board

In reviewing Vice Chancellor Parsons’ grant of defendants’ motion to dismiss, the Supreme Court reviewed plaintiffs’ complaint “in the light most favorable to the non-moving party, accepting as true its well-pled allegations and drawing all reasonable inferences that logically flow from those allegations.” Slip Opinion at 12-13 (footnote omitted).

The Supreme Court first agreed with Vice Chancellor Parsons that the Unocal standard of review did not apply (Unocal v. Mesa Petroleum Co., 493 A.2d 946 (Del. 1995)) because the conduct challenged did not involve any “defensive” action by the Company’s board:

“The Court of Chancery properly refused to apply Unocal in this fashion. The premise of Unocal is ‘that the transaction at issue was defensive.’ Count I [alleging breach of fiduciary duty in the conduct of the sales process] sounds in disloyalty, not improper defensive conduct. Count I does not allege any hostile takeover attempt or similar threatened external action from which it could reasonably be inferred that the defendants acted ‘defensively.’”

Slip Opinion at 17 (footnotes omitted).

But the Supreme Court did find that Vice Chancellor Parsons misapplied the business judgment rule. A board is entitled to the protection of the business judgment rule unless the plaintiff pleads facts supporting either a breach of the board’s duty of loyalty or its duty of care. Here plaintiffs alleged that the First Niles board improperly rejected a “value-maximizing” bid from First Place and terminated the sales process to preserve personal benefits and valuable outside business opportunities for management and the interested directors.

While a board’s decision not to pursue a merger opportunity is normally reviewed within the traditional business judgment framework, that framework is not available to defendants where plaintiffs plead facts establishing a cognizable claim that a board acted disloyally. Here the plaintiffs did so. The Supreme Court had little difficulty in finding that three of the four directors who rejected the First Place bid acted, on the facts pled, disloyally: Stephens, by his failure to cooperate with the bidders; Kramer because he suffered from a “disqualifying” conflict by reason of his dependence upon the bank as a major client of his service company; and Zuzolo likewise because of his heavy reliance upon the bank for his income.

In the course of its analysis, the Supreme Court takes the occasion to expressly affirm that officers of Delaware corporations owe the same fiduciary duties to stockholders as directors do:

“In the past, we have implied that officers of Delaware corporations, like directors, owe fiduciary duties of care and loyalty, and that the fiduciary duties of officers are the same as those of directors. We now explicitly so hold."

Slip Opinion at 24 (footnotes omitted).

(In so holding, the Court notes that corporate officers, unlike corporate directors, are not expressly included in Section 102(b)(7) of Delaware’s GCL, permitting the certificate of incorporation of a Delaware corporation to include a provision eliminating or limiting the personal liability of a director to the corporation or its stockholders from monetary damages for breach of fiduciary duty, subject to specified exceptions. Expect this omission to become an agenda item for the Delaware Legislature. The Court’s holding also points up the importance of indemnification agreements for officers.)

E. Clarification of the Shareholder Ratification Doctrine

The Supreme Court also takes the occasion of this decision to clarify the application of Delaware’s shareholder ratification doctrine. Vice Chancellor Parsons concluded that the approval by the stockholders of First Niles of the Reclassification Proposal “ratified” the board’s decision to pursue it, thereby entitling it to business judgment protection. The Supreme Court reversed this decision and takes the occasion to clarify that the shareholder ratification doctrine is limited to its “classic” form, meaning that it applies only where shareholders vote to approve director action that is not legally required of the shareholders in order for the action to become legally effective:

“To restore coherence and clarity to this area of our law, we hold that the scope of the shareholder ratification doctrine must be limited to its so-called ‘classic’ form; that is, to circumstances where a fully informed shareholder vote approves director action that does not legally require shareholder approval in order to become legally effective. Moreover, the only director action or conduct that can be ratified is that which the shareholders are specifically asked to approve. . . . the ‘cleansing’ effect of such a ratifying shareholder vote is to subject the challenged director action to business judgment review, as opposed to ‘extinguishing’ the claim altogether (i.e., obviating all judicial review of the challenged action).”

Slip Opinion at 33-34 (footnotes omitted) (emphasis in original).
_____________________________

There are two sets of losers as a result of the Supreme Court’s reversal of Vice Chancellor Parsons’ ruling. First there are the defendants, whose management of the First Niles sales process and consideration and adoption of the Reclassification Proposal comes across as amateurish and transparently self-interested. The second loser is Vice Chancellor Parsons himself, whose rulings and reasoning are treated brusquely by the Supreme Court, almost as if they concluded he had been tone deaf to the self-interested conduct of the First Niles board. Vice Chancellor Parsons took some seven months to prepare his opinion below (the case was submitted to the Vice Chancellor on July 11, 2007 and he decided it on February 14, 2008): his bosses showed little regard for all that work.

Rohm and Haas Company v. The Dow Chemical Company; Rohm and Haas Sues For Specific Performance of Merger Agreement -- Dow Responds: "Let's Do Therapy"

A. Rohm and Haas’ Complaint

Rohm and Haas’ complaint, filed in the Delaware Chancery Court on January 26, 2009, is well-drafted and to the point: Rohm and Haas and Dow (through a wholly-owned subsidiary organized solely for the purpose of facilitating the merger) entered into a merger agreement on July 10, 2008 calling for the combination of the two companies in consideration of the cash payment by Dow of $78 for each share of Rohm and Haas common stock (Rohm and Haas’ common closed today, February 9, at $56.28). All conditions to completion of the merger, including Federal Trade Commission (“FTC”) clearance, were satisfied by January 23, 2009. Notwithstanding that the merger was teed up for closing, Dow has refused to close.

Because the merger was negotiated when the credit markets were already in turmoil, Rohm and Haas negotiated measures designed to provide certainty of closure, including (i) the absence of any financing condition, (ii) securing from Dow a representation that it would have sufficient funds at closing to consummate the merger, (iii) a restrictive MAC definition (thus limiting the circumstances under which Dow could back out of the merger), and (iv) an explicit acknowledgement by Dow that ROH would be entitled to specific performance to enforce the merger agreement:

“The parties agree that irreparable damage would occur in the event that any of the provisions of this Agreement were not performed in accordance with their specific terms or were otherwise breached and that the parties would not have any adequate remedy at law. It is accordingly agreed that the parties shall be entitled to an injunction or injunctions to prevent breaches or threatened breaches of this Agreement and to enforce specifically the terms and provisions of this Agreement . . . The foregoing is in addition to any other remedy to which any party is entitled at law, in equity or otherwise.”

Merger Agreement § 8.5(a); quoted in Complaint ¶ 17.

One of the events precipitating Dow’s cold feet was the failure of “K-Dow,” a planned joint venture between Dow and Petrochemical Industries Company of Kuwait, a wholly-owned subsidiary of Kuwait’s state oil company. That joint venture, announced December 2007 (before the announced merger of Dow and Rohm and Haas) would have provided Dow with $9.5 billion in cash proceeds, which would have been available to Dow to consummate the merger with Rohm and Haas. However, formation of K-Dow was not a condition to close of the Dow/Rohm and Haas merger. Furthermore, Dow secured debt and equity financing commitments totaling $17 billion in connection with the proposed merger with Rohm and Haas, more than enough to fund the $15 billion plus cost of the merger, although, again, the securing of such debt and equity financing was not a condition to Dow’s obligation to close the merger.

B. Dow’s Response

Dow’s response, filed with the Chancery Court on February 3rd, is one of the strangest pleadings this reader has ever reviewed. It reads more like a John McPhee essay intended for William Shawn’s New Yorker than a legal pleading. It essentially asks Chancellor Chandler (to whom the case has been assigned) to adopt a “holistic” approach to the dispute, taking into account, so urges Dow, not only the interests of Rohm and Haas’ stockholders but also the other constituencies that might be affected by a Dow/Rohm and Hass merger — the companies’ employees, creditors, suppliers, and the communities in which the companies operate. A few selections from the 62-page answer illustrate Dow’s pitch:

“. . . Rohm and Haas turns a blind eye to the very difficult issue that the Court now confronts — whether the forced integration of tens of thousands of jobs and the judicial creation of a new entity is equitable considering all of the relevant legal interests. [Emphasis in original.] Contrary to the Complaint’s suggestion, the interests of Rohm and Haas shareholders who control the company today would have no contractual rights whatsoever to consummation of the merger — and no stake in its future prospects — are not dispositive.

This is a case with strongly competing interests that have to be weighed. There are no black and white hats or simple answers, only intimidating and evolving uncertainties that must be thoroughly understood before any irreversible action is taken. . . . .

. . . .

Dow has charted a path forward, urged Rohm and Haas . . . to walk with it down that path, and is prepared to work in like fashion with the Court as well, so that this case enhances rather than impedes progress towards a business solution. Forcing a merger under the present circumstances will cause irreparable harm to both Dow and Rohm and Haas. Prudence dictates that the welfare of all legitimate stakeholders be considered and that a fair and a workable solution be found.”

Answer at pages 1-2.

“It [the merger between Dow and Rohm and Haas] was to be a merger made in heaven and for one very important reason — ‘synergy’ — that is easy to articulate but hugely difficult to execute successfully in practice. What’s required is the seamless combination of two very large and complex organizations into a community of people who work as one and will then build on their complementary strengths and resources to achieve a level of cooperation and performance that, if achieved, will produce huge new value.”

Answer ¶ 6.

“The Complaint misses the essence of Dow’s approach to the problems both Dow and Rohm and Haas face. Dow’s approach to this transaction is totally grounded in necessity. It is necessary first of all to get control of the basic building blocks of any future course by stabilizing credit ratings, obtaining workable financing and maintaining liquidity. Turning then to future action, the first order of business is to account and plan for uncertainties affecting Dow’s market, Rohm and Haas’s business, and the market for the merged entities. The overwhelming problem here is uncertainty. And it is unknown when and how those uncertainties will be resolved.”


Answer ¶ 38.


“Any forced merger at any time is an extreme, external intervention in a business process that can actually work only if it makes sense internally. It must be driven by the desires and goals of the people who go to work every day rather than by artificially (and hastily) imposed mandates. These basic human facts are all the more dominant where, as here, the merger depends upon the creation of new value through synergies.”

Answer ¶ 42 (emphasis in original).

By its answer Dow details the disasters that have been experienced by both Dow and Rohm and Haas with the crumbling economy, including the loss of business and substantial employee layoffs. Dow makes a reasonably convincing case that were it forced to merge with Rohm and Haas, it could quickly breach one or more covenants in the short-term debt financing it has secured to facilitate the merger, thus triggering cross-defaults in its other funded debt.

All of this triggers sympathy, but the obvious question is: so what? Dow does not claim a MAC permitting it to back out of the deal, nor does it assert that it could not secure the financing necessary to close (as Hexion asserted in its battle with Huntsman, that it decisively lost in Vice Chancellor Lamb’s court— see my prior posts on the Hexion v. Huntsman case).

The closest Dow comes to founding its answer (and refusal to close) on the July 10, 2008 merger agreement is the FTC’s antitrust clearance. Dow’s position is that the FTC order clearing the merger (which order requires certain divestitures by Dow) is not final and will not become so until after a 30-day comment period, and therefore this condition to the merger has not been satisfied. Answer at pages 24-26. This position seems contrary to the Commission order itself, which, in the FTC’s press release announcing it (also quoted in Rohm and Haas’ complaint) states that under the consent order the “transaction may proceed.” Moreover, the merger agreement itself does not require that any antitrust order be final, in the sense claimed by Dow, only that “[a]ny applicable waiting period under the HSR Act shall have expired or been earlier terminated, . . .” Merger Agreement § 6.1(c)(i). So even this defense appears to be a stretch. And even if it is valid, the order could very well become final by the end of February 2009, thus mooting this defense by the time the action is tried (scheduled for March 9, 2009).

Essentially Dow’s defense is that the merger won’t work and therefore the Chancery Court should not force its consummation. This position is expressed throughout Dow’s answer, often in language (including that cited above) that is jarring to the reader of legal prose:

“At bottom, these unforeseen and unforeseeable events have—for the time being—eradicated the essential purpose of this transaction: creating a viable merged organization, one that will combine tens of thousands of employees who must work together to create the synergies that made this acquisition make sense. Forcing them together in an over-leveraged, hobbled deal would do no equity to Dow, to Rohm and Haas, or to their employees, communities, customers and suppliers.”

Answer ¶ 49.

It is hard to believe that Chancellor Chandler will take Dow’s answer seriously. Dow’s plea for cosmic equity should fall on deaf ears. Chancellor Chandler is more likely to take the position that his role is to enforce a contract in a dispute brought by a party to that contract (Rohm and Haas), which party clearly has standing to allege a breach of the contract. While equitable considerations might be appropriate in the normal course, given the fact that the parties to this contract explicitly negotiated the provision (Section 8.5(a) of the merger agreement, quoted above) calling for specific performance in the event of breach, it is also hard to believe that the Chancellor will tarry long over the equities of enforcing the contract, should he find a breach.

Chancellor Chandler has scheduled trial in the case for March 9, 2009, rejecting Dow’s request for delay. Moreover, there are now press reports that Dow is shopping assets to provide funding to consummate the merger without tripping debt covenants, including the possible sale of one of its crown jewels, Dow AgroSciences. See the Deal Pipeline, February 6, 2009 (“Dow Considers Sale of Crown Jewel”).

So, in the unlikely event this case actually goes to trial, it will be of great interest to see how the Chancellor handles Dow’s plea for mercy.