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.
_____________________
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.
Wednesday, December 31, 2008
Tuesday, December 23, 2008
TravelCenters of America LLC v. Brog (2008 WL 5272861, Del. Ch. Dec. 5, 2008); Snapping At One's Shareholders
Shareholders of TravelCenters, a Delaware LLC, nominated two individuals for election to TravelCenters’ board of directors at the 2008 annual meeting. TravelCenters’ operating agreement sets forth detailed notice requirements for shareholders to follow in nominating candidates for the board, referred to by Chancellor Chandler as “hypertechnical.” Nevertheless, in a decision he handed down in April 2008, the Chancellor found that the shareholders’ notice did not comply with the operating agreement in several respects.
In a clear instance of “take this,” TravelCenters then sought recovery of over $1.5 million in attorneys’ fees and costs (Skadden represents TravelCenters) from the nominating shareholders! The basis of the request is section 10.3 of TravelCenters’ operating agreement:
“To the fullest extent permitted by law, each Shareholder will indemnify and hold harmless the Company (and any Subsidiaries or Affiliates thereof), from and against all costs, expenses, penalties, fines or other amounts, including, without limitation, reasonable attorneys’ and other professional fees, whether third party or internal, arising from such Shareholder’s breach of any provision of this Agreement or any Bylaws, . . . and shall pay such indemnitee such amounts on demand, together with interest on such amounts, which interest will accrue at the lesser of 15% per annum compounded and the maximum amount permitted by law, from the date such costs or the like are incurred until the receipt or repayment by the indemnitee.”
Slip Opinion at 3 note 8.
(This provision itself strikes this observer as overreaching (15% interest?), and should have put prospective shareholders on notice that this might be an investment to pass on.)
Chancellor Chandler sensibly rejected TravelCenters’ request for fee reimbursement. As he explained, there is a distinction between promises and conditions, with only a breach of the former constituting a breach of contract:
“Under principles of contract law, there is a distinction between promises and conditions. Promises give rise to a duty to perform, and conditions are events that must occur before a party is obligated to perform. While the non-performance of a promise or covenant can result in a breach of contract, the non-occurrence of a condition is not considered a breach unless the party promised that the condition would occur. Thus, unless a party was under a duty for a condition to occur, the nonperformance of a condition is not a breach of the agreement.”
Slip Opinion at 6 (footnotes omitted).
The nominating shareholders here violated a condition, not a covenant, and therefore did not breach TravelCenters’ operating agreement.
Moreover, concluded the Chancellor, his reading of the operating agreement comported with “common sense,” given that it defied belief, absent explicit language to the contrary, that TravelCenters’ shareholders had made a promise to be “personally liable” for millions of dollars for any failure to submit a proper notice to nominate directors.
Delaware, like most states, grants members of a LLC broad discretion to establish their rules of governance through the operating agreement. Accordingly, the Chancellor’s disposition of this dispute turned largely on contract interpretation. In a coporate context, undoubtedly public policy considerations would play a larger role, including the Delaware courts’ vigilance in policing measures that interfere with the effectiveness of a stockholder vote. See, e.g., Blasius Industries v. Atlas Corp., 564 A.2d 651 (Del. Ch. 1988).
What will be interesting is how the shareholders of TravelCenters react to this litigation: Will they head for the exits or redouble their efforts next year with a more careful eye to the notice requirements for nominating directors?
In a clear instance of “take this,” TravelCenters then sought recovery of over $1.5 million in attorneys’ fees and costs (Skadden represents TravelCenters) from the nominating shareholders! The basis of the request is section 10.3 of TravelCenters’ operating agreement:
“To the fullest extent permitted by law, each Shareholder will indemnify and hold harmless the Company (and any Subsidiaries or Affiliates thereof), from and against all costs, expenses, penalties, fines or other amounts, including, without limitation, reasonable attorneys’ and other professional fees, whether third party or internal, arising from such Shareholder’s breach of any provision of this Agreement or any Bylaws, . . . and shall pay such indemnitee such amounts on demand, together with interest on such amounts, which interest will accrue at the lesser of 15% per annum compounded and the maximum amount permitted by law, from the date such costs or the like are incurred until the receipt or repayment by the indemnitee.”
Slip Opinion at 3 note 8.
(This provision itself strikes this observer as overreaching (15% interest?), and should have put prospective shareholders on notice that this might be an investment to pass on.)
Chancellor Chandler sensibly rejected TravelCenters’ request for fee reimbursement. As he explained, there is a distinction between promises and conditions, with only a breach of the former constituting a breach of contract:
“Under principles of contract law, there is a distinction between promises and conditions. Promises give rise to a duty to perform, and conditions are events that must occur before a party is obligated to perform. While the non-performance of a promise or covenant can result in a breach of contract, the non-occurrence of a condition is not considered a breach unless the party promised that the condition would occur. Thus, unless a party was under a duty for a condition to occur, the nonperformance of a condition is not a breach of the agreement.”
Slip Opinion at 6 (footnotes omitted).
The nominating shareholders here violated a condition, not a covenant, and therefore did not breach TravelCenters’ operating agreement.
Moreover, concluded the Chancellor, his reading of the operating agreement comported with “common sense,” given that it defied belief, absent explicit language to the contrary, that TravelCenters’ shareholders had made a promise to be “personally liable” for millions of dollars for any failure to submit a proper notice to nominate directors.
Delaware, like most states, grants members of a LLC broad discretion to establish their rules of governance through the operating agreement. Accordingly, the Chancellor’s disposition of this dispute turned largely on contract interpretation. In a coporate context, undoubtedly public policy considerations would play a larger role, including the Delaware courts’ vigilance in policing measures that interfere with the effectiveness of a stockholder vote. See, e.g., Blasius Industries v. Atlas Corp., 564 A.2d 651 (Del. Ch. 1988).
What will be interesting is how the shareholders of TravelCenters react to this litigation: Will they head for the exits or redouble their efforts next year with a more careful eye to the notice requirements for nominating directors?
Thursday, December 18, 2008
Hexion v. Huntsman; The Settlement
The parties settled this litigation on Sunday, December 14. Hexion and various Apollo entities will pay Huntsman $1 billion in return for a settlement of all litigation between the parties and general releases. The early view of the settlement is that it is favorable to Hexion and Apollo, given the resounding defeat they suffered in the declaratory judgment action they filed in the Delaware Chancery Court, as reported in my post of October 7, 2008. As the Wall Street Journal reported in its “Heard on the Street” column of Monday, December 15:
“Huntsman is right to take the money. Legal processees are long, unpredictable affairs, and this is no time to be taking chances. Yet the outcome remains surprising. Apollo, having lost an important court ruling in September, had reason to sweat. That Huntsman’s market value dropped by 49% or $2 billion, Monday [December 15] – the difference between the $3 billion originally sought and the eventual settlement – suggests some of the investors expected a fight to the death.”
Actually, Hexion and Apollo faced damages of even greater than $3 billion, given that, after the Delaware Chancery Court’s decision, Hexion and Apollo were confronting “benefit of the bargain” damages to Huntsman for failure to pursue in good faith a consummation of the merger. As I pointed out in my post of October 29, 2008, reporting on Credit Suisse’s and Deutsche Bank’s decision not to fund the merger:
“Given that the per-share merger consideration is $28.00 in cash (plus 8%), that Huntsman has some 234 million (fully diluted) shares outstanding, and Huntsman’s shares closed on October 28 at $12.28, Hexion is facing potential damages to Huntsman of over $4 billion.”
Nevertheless, as they say, a bird in hand is worth two in the bush. The terms of the settlement are, as one would expect, favorable to Huntsman.
A. Terms of the Settlement
The $1 billion settlement payment comes from various sources:
· Hexion shall pay Huntsman the $325 million breakup fee pursuant to the terms of the July 2007 merger agreement with Huntsman;
· Certain unidentified Apollo entities shall purchase $250 million of 7% convertible notes of Huntsman;
· Unidentified Apollo entities shall pay Huntsman $200 million, in settlement of a counterclaim brought by Huntsman in the Delaware Chancery Court for “commercial disparagement;”
· Hexion and certain unidentified Apollo entities shall pay Huntsman $225 million, also in settlement of Huntsman’s commercial disparagement claim.
Why allocate $425 million of the $1 billion in settlement payments to the resolution of Huntsman’s “commercial disparagement” claim? (Vice Chancellor Lamb, in his decision in the case, concluded that Hexion had willfully violated its merger agreement with Huntsman (a contract violation) — he did not rule on Huntsman’s commercial disparagement counterclaim.) Presumably, this is done to qualify such payments for insurance coverage, although this is speculative on my part.
Hexion intends to fund the $325 million breakup fee by borrowing from Credit Suisse and Deutsche Bank under its existing commitment letter with the banks. In all events, at least $500 million of the settlement payments, including purchase of the convertible notes, is to be made by December 31, 2008, with the balance of the payments due and payable on or before March 31, 2009.
The settlement includes a commitment by the Apollo entities to provide financing to Hexion’s parent in the amount of $200 million (presumably to assist the parent in paying the breakup fee).
The settlement includes a resolution of all pending litigation between the parties and broad releases, conditional upon Hexion and Apollo’s payment in full of the consideration called for by the settlement agreement. Huntsman’s action against Credit Suisse and Deutsche Bank, pending in Texas state court, shall continue, with Hexion and Apollo agreeing to cooperate in the prosecution of that action. If Huntsman’s action against the banks is settled prior to trial, then Huntsman shall pay certain Apollo entities 20% of the settlement in excess of $500 million (after deduction for expenses, including attorneys’ fees), capped at a maximum payment to the Apollo parties not to exceed $425 million. If the case is tried, then Apollo’s interest disappears.
B. The Terms of the Convertible Notes
Affiliates of Apollo will purchase $250 million in convertible senior notes (the “Notes”) from Huntsman. The Notes shall be convertible, at the option of the holder, into shares of Huntsman common stock, initially at $7.86 (135% of the closing price of Huntsman’s common stock on December 10, 2008), subject to anti-dilution protection. The Notes bear interest at the rate of 7% per annum. Huntsman may pay interest either in cash or, at its option, in its common shares (at the then current value of the shares equal to the interest payment). The Notes are due and payable on the 10th anniversary of the issue date, in cash or, at the option of Huntsman, in its common shares at their then market price. The Notes are redeemable prior to their maturity for cash, at any time after the 3rd anniversary of the issue date. There is a one-year lock up period on the Notes during which they are not transferable without Huntsman’s consent to any party unaffiliated with Apollo.
Apollo agrees to broad voting and standstill protections for Huntsman, applicable to any transferee unless the Notes or the shares into which they are converted are broadly distributed or privately sold to persons who, after the sale, own less than 5% of Huntsman’s outstanding voting securities.
______________________
This settlement certainly removes an enormous cloud over Apollo and Hexion. It provides welcome cash benefits to Huntsman and leaves open the possibility of additional recoveries against Credit Suisse and Deutsche Bank. Attention will now, therefore, shift to Huntsman’s Texas state court action against the banks. Given that Apollo precipitated this entire mess by claiming that that the Hexion/Huntsman merger was untenable because the resulting entity would be insolvent, the banks must be fit to be tied at now being the sole remaining defendants in this litigation. If they cannot reach a quick and reasonable settlement with Huntsman, expect them to snarl with vigor at both Huntsman and Apollo in the Texas state court litigation.
“Huntsman is right to take the money. Legal processees are long, unpredictable affairs, and this is no time to be taking chances. Yet the outcome remains surprising. Apollo, having lost an important court ruling in September, had reason to sweat. That Huntsman’s market value dropped by 49% or $2 billion, Monday [December 15] – the difference between the $3 billion originally sought and the eventual settlement – suggests some of the investors expected a fight to the death.”
Actually, Hexion and Apollo faced damages of even greater than $3 billion, given that, after the Delaware Chancery Court’s decision, Hexion and Apollo were confronting “benefit of the bargain” damages to Huntsman for failure to pursue in good faith a consummation of the merger. As I pointed out in my post of October 29, 2008, reporting on Credit Suisse’s and Deutsche Bank’s decision not to fund the merger:
“Given that the per-share merger consideration is $28.00 in cash (plus 8%), that Huntsman has some 234 million (fully diluted) shares outstanding, and Huntsman’s shares closed on October 28 at $12.28, Hexion is facing potential damages to Huntsman of over $4 billion.”
Nevertheless, as they say, a bird in hand is worth two in the bush. The terms of the settlement are, as one would expect, favorable to Huntsman.
A. Terms of the Settlement
The $1 billion settlement payment comes from various sources:
· Hexion shall pay Huntsman the $325 million breakup fee pursuant to the terms of the July 2007 merger agreement with Huntsman;
· Certain unidentified Apollo entities shall purchase $250 million of 7% convertible notes of Huntsman;
· Unidentified Apollo entities shall pay Huntsman $200 million, in settlement of a counterclaim brought by Huntsman in the Delaware Chancery Court for “commercial disparagement;”
· Hexion and certain unidentified Apollo entities shall pay Huntsman $225 million, also in settlement of Huntsman’s commercial disparagement claim.
Why allocate $425 million of the $1 billion in settlement payments to the resolution of Huntsman’s “commercial disparagement” claim? (Vice Chancellor Lamb, in his decision in the case, concluded that Hexion had willfully violated its merger agreement with Huntsman (a contract violation) — he did not rule on Huntsman’s commercial disparagement counterclaim.) Presumably, this is done to qualify such payments for insurance coverage, although this is speculative on my part.
Hexion intends to fund the $325 million breakup fee by borrowing from Credit Suisse and Deutsche Bank under its existing commitment letter with the banks. In all events, at least $500 million of the settlement payments, including purchase of the convertible notes, is to be made by December 31, 2008, with the balance of the payments due and payable on or before March 31, 2009.
The settlement includes a commitment by the Apollo entities to provide financing to Hexion’s parent in the amount of $200 million (presumably to assist the parent in paying the breakup fee).
The settlement includes a resolution of all pending litigation between the parties and broad releases, conditional upon Hexion and Apollo’s payment in full of the consideration called for by the settlement agreement. Huntsman’s action against Credit Suisse and Deutsche Bank, pending in Texas state court, shall continue, with Hexion and Apollo agreeing to cooperate in the prosecution of that action. If Huntsman’s action against the banks is settled prior to trial, then Huntsman shall pay certain Apollo entities 20% of the settlement in excess of $500 million (after deduction for expenses, including attorneys’ fees), capped at a maximum payment to the Apollo parties not to exceed $425 million. If the case is tried, then Apollo’s interest disappears.
B. The Terms of the Convertible Notes
Affiliates of Apollo will purchase $250 million in convertible senior notes (the “Notes”) from Huntsman. The Notes shall be convertible, at the option of the holder, into shares of Huntsman common stock, initially at $7.86 (135% of the closing price of Huntsman’s common stock on December 10, 2008), subject to anti-dilution protection. The Notes bear interest at the rate of 7% per annum. Huntsman may pay interest either in cash or, at its option, in its common shares (at the then current value of the shares equal to the interest payment). The Notes are due and payable on the 10th anniversary of the issue date, in cash or, at the option of Huntsman, in its common shares at their then market price. The Notes are redeemable prior to their maturity for cash, at any time after the 3rd anniversary of the issue date. There is a one-year lock up period on the Notes during which they are not transferable without Huntsman’s consent to any party unaffiliated with Apollo.
Apollo agrees to broad voting and standstill protections for Huntsman, applicable to any transferee unless the Notes or the shares into which they are converted are broadly distributed or privately sold to persons who, after the sale, own less than 5% of Huntsman’s outstanding voting securities.
______________________
This settlement certainly removes an enormous cloud over Apollo and Hexion. It provides welcome cash benefits to Huntsman and leaves open the possibility of additional recoveries against Credit Suisse and Deutsche Bank. Attention will now, therefore, shift to Huntsman’s Texas state court action against the banks. Given that Apollo precipitated this entire mess by claiming that that the Hexion/Huntsman merger was untenable because the resulting entity would be insolvent, the banks must be fit to be tied at now being the sole remaining defendants in this litigation. If they cannot reach a quick and reasonable settlement with Huntsman, expect them to snarl with vigor at both Huntsman and Apollo in the Texas state court litigation.
Saturday, December 6, 2008
Mervyn's LLC v. Lubert-Adler and Klaff Partners, LP; An Attack on the Use of Special Purpose Entities to Finance a Leveraged Buyout
The complaint filed September 2, 2008 in the Delaware bankruptcy of Mervyn’s (Adversary Proceeding No. 08-51402-KG) represents a frontal attack on a strategy commonly employed in financing a leveraged buyout, namely, the use of special purpose entities to isolate the assets used to finance the buyout. Targets in this action include three buyout funds and their affiliates, Sun Capital Partners, Inc., Cerberus Capital Management, LP, and Lubert-Adler/Klaff Partners, LP. The lawsuit challenges the leveraged buyout of Mervyn’s LLC from Target (Symbol: “TGT”) on September 2, 2004. Ignoring the complicated minutiae of the deal structure, laid out ad nauseam in the complaint, the complaint makes for colorful reading. The defendants have yet to respond.
A. The Transaction
Mervyn’s was sold for all cash, in the amount of $1.175 billion. The form of the transaction was a “stock” purchase whereby Target sold all the equity of Mervyn’s, converted shortly before the closing from a California corporation to a California LLC, to a newly-organized Delaware LLC — Mervyn’s Holdings, LLC (“Mervyn’s Holdings”). In form, at least from Target’s standpoint, the transaction was straightforward, as is reflected in the plain vanilla Equity Purchase Agreement Target entered into with Mervyn’s Holdings on July 29, 2004. The complexity of the deal derives from how the buyers financed the acquisition. They did so in large part through $800 million in financing, secured by Mervyn’s real estate. To isolate the real estate, the complaint alleges that Mervyn’s Holdings, at closing, apparently contributed to its now wholly-owned subsidiary, Mervyn’s, the equity in two newly-organized LLCs, with the result that the newly-organized LLCs became subsidiaries of Mervyn’s. Mervyn’s, now as the parent of the newly contributed LLCs, in turn contributed to the LLCs (which, in turn, contributed several of the properties to subsidiary LLCs) its fee properties and transferable real property leases. Mervyn’s Holdings then caused Mervyn’s to distribute the equity interests in the LLCs to Mervyn’s Holdings, which in turn distributed the LLCs to LLC holding companies controlled by the buyers. Presto: The real estate formerly owned by Mervyn’s was now separated from Mervyn’s and owned by buyers through separate LLC holding companies.
The complaint further alleges that once Mervyn’s was separated from its real estate, the buyers caused Mervyn’s, now a lessee of its stores, to pay additional rent to the property owning LLCs to finance the purchase money indebtedness and to make distributions to the buyers. Mervyn’s was also charged “notional rent” on those leases that could not be transferred out of Mervyn’s (to bring the rent payable under these non-transferable leases to market) in the form of distributions to Mervyn’s Holdings. As a result, Mervyn’s rent burden, by these machinations, increased, according to the complaint, by some $80 million annually.
Since the buyout, the complaint alleges that the buyers “have taken more than $400,000,000 in payments or distributions from Mervyn’s.” Complaint ¶ 66 (footnote omitted).
As summarized by the complaint:
“73. In sum:
· Mervyn’s real estate assets were transferred from Mervyn’s to the Realty Owners [the separate LLCs form to own Mervyn’s real estate].
· The Realty Owners are owned and controlled by the Realty Parents [the real estate LLC holding companies].
· The Realty Parents are owned and controlled by the PE [private equity fund] Sponsors.
· The PE Sponsors own and control MH [Mervyn’s Holdings].
· MH owns and controls Mervyn’s.
· Mervyn’s was paid nothing for the transfer.”
As the complaint editorializes, reflecting on the complexity of the transfers that occurred at closing:
“These multiple transfers and transactions are complex machinations that seem to have no purpose or effect other than to attempt to secure the blatantly fraudulent transfer that occurred at the closing of the 2004 transaction.
… Mervyn’s began the day of the closing with more than $1,000,000,000 of real estate and, within the blink of an eye, it was gone. Mervyn’s received nothing in return.”
Complaint ¶¶ 75-76.
B. The Legal Attack
The debtors, Mervyn’s Holdings and its subsidiary, Mervyn’s LLC, bring this action against the buyers, their affiliated funds that participated in the buyout, the lenders that provided financing for the buyout, and Target. The complaint alleges that the stripping away of Mervyn’s real estate and the increase in its rental obligations deprived Mervyn’s of valuable assets, for no consideration, and significantly increased its operating costs. Moreover, by bundling properties that were previously owned in fee by Mervyn’s or separately rented into only three master leases, the deal made it more difficult for Mervyn’s to close stores, thus restricting its operating flexibility. As summarized by the complaint:
“Rather than simply maintaining Mervyn’s retail operations and the integrated real estate assets at which the retail stores were operated intact within Mervyn’s and leveraging the real estate assets as would have been done under a traditional LBO transaction, instead, the PE Sponsors insisted upon physically separating the real estate assets from Mervyn’s at the moment of the closing of the EPA thereby converting Mervyn’s from a retailer with valuable below market leases and valuable owned real estate into a shrunken operating company whose remaining capital consisted largely of inventory, cash, credit card receipts, and intellectual property.”
Complaint ¶ 93.
The debtors’ counsel, Friedman Kaplan Seiler & Adelman LLP, New York, New York, and Bayard, P.A. (Delaware) make interesting use of the legal opinion rendered by the property holding LLCs (the “Realty Owners”) to the buyout lenders. The opining counsel, not identified in the complaint, rendered a “true lease” opinion to the lenders on the three consolidated real estate leases entered into at closing between the (now separate) real estate holdings LLCs and Mervyn’s. The complaint quotes at length from the opinion to establish that the buyers were well aware of the economic aspects of the transaction and its consequences upon Mervyn’s. No doubt the extensive quotations from its opinion is causing opining counsel some discomfort (the quotations from the opinion occupy some five pages of the complaint).
To establish that the transfers of Mervyn’s real estate assets to the special purpose LLCs and their separation from Mervyn’s represented fraudulent transfers, the complaint alleges that Mervyn’s did not receive reasonably equivalent value or fair consideration in exchange for transferring its real property interests to the property holding LLCs. As a result, Mervyn’s, so the complaint alleges,
“… (a) was engaged or was about to engage in a business for which its remaining assets and/or capital were unreasonably small in relation to [its] business; (b) intended to incur, or reasonably should have believed that it would incur, debts beyond its ability to pay as they became due; and/or (c) was insolvent or would be rendered insolvent by the transactions undertaken in connection with the 2004 buyout.”
Complaint ¶ 109.
The debtors also allege that the transfers were in violation of the Uniform Fraudulent Transfer Act, violating at least six of the eleven factors to be considered in assessing a transfer as fraudulent under that Act. Complaint ¶ 112.
The debtors also allege breach of fiduciary duty, including against Target, asserting that, by reason of the buyout transaction, Mervyn’s became insolvent or entered the “zone of insolvency,” thus triggering fiduciary duties by Target to Mervyn’s unsecured creditors. Complaint ¶¶ 142, 151.
The debtors seek, by their prayer for relief, the avoidance of the real estate transfers made by Mervyn’s in the buyout or, alternatively, the value of the real estate assets transferred by Mervyn’s or, alternatively, an amount equal to the purchase price paid by buyers to Target for the real estate assets ($1,166,700,000) or the proceeds of the loan made by the lenders ($800,000,000).
This will be an interesting case to follow if it is not quickly settled. Given the nature of the allegations and the amount demanded as damages, a quick settlement would appear unlikely.
A. The Transaction
Mervyn’s was sold for all cash, in the amount of $1.175 billion. The form of the transaction was a “stock” purchase whereby Target sold all the equity of Mervyn’s, converted shortly before the closing from a California corporation to a California LLC, to a newly-organized Delaware LLC — Mervyn’s Holdings, LLC (“Mervyn’s Holdings”). In form, at least from Target’s standpoint, the transaction was straightforward, as is reflected in the plain vanilla Equity Purchase Agreement Target entered into with Mervyn’s Holdings on July 29, 2004. The complexity of the deal derives from how the buyers financed the acquisition. They did so in large part through $800 million in financing, secured by Mervyn’s real estate. To isolate the real estate, the complaint alleges that Mervyn’s Holdings, at closing, apparently contributed to its now wholly-owned subsidiary, Mervyn’s, the equity in two newly-organized LLCs, with the result that the newly-organized LLCs became subsidiaries of Mervyn’s. Mervyn’s, now as the parent of the newly contributed LLCs, in turn contributed to the LLCs (which, in turn, contributed several of the properties to subsidiary LLCs) its fee properties and transferable real property leases. Mervyn’s Holdings then caused Mervyn’s to distribute the equity interests in the LLCs to Mervyn’s Holdings, which in turn distributed the LLCs to LLC holding companies controlled by the buyers. Presto: The real estate formerly owned by Mervyn’s was now separated from Mervyn’s and owned by buyers through separate LLC holding companies.
The complaint further alleges that once Mervyn’s was separated from its real estate, the buyers caused Mervyn’s, now a lessee of its stores, to pay additional rent to the property owning LLCs to finance the purchase money indebtedness and to make distributions to the buyers. Mervyn’s was also charged “notional rent” on those leases that could not be transferred out of Mervyn’s (to bring the rent payable under these non-transferable leases to market) in the form of distributions to Mervyn’s Holdings. As a result, Mervyn’s rent burden, by these machinations, increased, according to the complaint, by some $80 million annually.
Since the buyout, the complaint alleges that the buyers “have taken more than $400,000,000 in payments or distributions from Mervyn’s.” Complaint ¶ 66 (footnote omitted).
As summarized by the complaint:
“73. In sum:
· Mervyn’s real estate assets were transferred from Mervyn’s to the Realty Owners [the separate LLCs form to own Mervyn’s real estate].
· The Realty Owners are owned and controlled by the Realty Parents [the real estate LLC holding companies].
· The Realty Parents are owned and controlled by the PE [private equity fund] Sponsors.
· The PE Sponsors own and control MH [Mervyn’s Holdings].
· MH owns and controls Mervyn’s.
· Mervyn’s was paid nothing for the transfer.”
As the complaint editorializes, reflecting on the complexity of the transfers that occurred at closing:
“These multiple transfers and transactions are complex machinations that seem to have no purpose or effect other than to attempt to secure the blatantly fraudulent transfer that occurred at the closing of the 2004 transaction.
… Mervyn’s began the day of the closing with more than $1,000,000,000 of real estate and, within the blink of an eye, it was gone. Mervyn’s received nothing in return.”
Complaint ¶¶ 75-76.
B. The Legal Attack
The debtors, Mervyn’s Holdings and its subsidiary, Mervyn’s LLC, bring this action against the buyers, their affiliated funds that participated in the buyout, the lenders that provided financing for the buyout, and Target. The complaint alleges that the stripping away of Mervyn’s real estate and the increase in its rental obligations deprived Mervyn’s of valuable assets, for no consideration, and significantly increased its operating costs. Moreover, by bundling properties that were previously owned in fee by Mervyn’s or separately rented into only three master leases, the deal made it more difficult for Mervyn’s to close stores, thus restricting its operating flexibility. As summarized by the complaint:
“Rather than simply maintaining Mervyn’s retail operations and the integrated real estate assets at which the retail stores were operated intact within Mervyn’s and leveraging the real estate assets as would have been done under a traditional LBO transaction, instead, the PE Sponsors insisted upon physically separating the real estate assets from Mervyn’s at the moment of the closing of the EPA thereby converting Mervyn’s from a retailer with valuable below market leases and valuable owned real estate into a shrunken operating company whose remaining capital consisted largely of inventory, cash, credit card receipts, and intellectual property.”
Complaint ¶ 93.
The debtors’ counsel, Friedman Kaplan Seiler & Adelman LLP, New York, New York, and Bayard, P.A. (Delaware) make interesting use of the legal opinion rendered by the property holding LLCs (the “Realty Owners”) to the buyout lenders. The opining counsel, not identified in the complaint, rendered a “true lease” opinion to the lenders on the three consolidated real estate leases entered into at closing between the (now separate) real estate holdings LLCs and Mervyn’s. The complaint quotes at length from the opinion to establish that the buyers were well aware of the economic aspects of the transaction and its consequences upon Mervyn’s. No doubt the extensive quotations from its opinion is causing opining counsel some discomfort (the quotations from the opinion occupy some five pages of the complaint).
To establish that the transfers of Mervyn’s real estate assets to the special purpose LLCs and their separation from Mervyn’s represented fraudulent transfers, the complaint alleges that Mervyn’s did not receive reasonably equivalent value or fair consideration in exchange for transferring its real property interests to the property holding LLCs. As a result, Mervyn’s, so the complaint alleges,
“… (a) was engaged or was about to engage in a business for which its remaining assets and/or capital were unreasonably small in relation to [its] business; (b) intended to incur, or reasonably should have believed that it would incur, debts beyond its ability to pay as they became due; and/or (c) was insolvent or would be rendered insolvent by the transactions undertaken in connection with the 2004 buyout.”
Complaint ¶ 109.
The debtors also allege that the transfers were in violation of the Uniform Fraudulent Transfer Act, violating at least six of the eleven factors to be considered in assessing a transfer as fraudulent under that Act. Complaint ¶ 112.
The debtors also allege breach of fiduciary duty, including against Target, asserting that, by reason of the buyout transaction, Mervyn’s became insolvent or entered the “zone of insolvency,” thus triggering fiduciary duties by Target to Mervyn’s unsecured creditors. Complaint ¶¶ 142, 151.
The debtors seek, by their prayer for relief, the avoidance of the real estate transfers made by Mervyn’s in the buyout or, alternatively, the value of the real estate assets transferred by Mervyn’s or, alternatively, an amount equal to the purchase price paid by buyers to Target for the real estate assets ($1,166,700,000) or the proceeds of the loan made by the lenders ($800,000,000).
This will be an interesting case to follow if it is not quickly settled. Given the nature of the allegations and the amount demanded as damages, a quick settlement would appear unlikely.
Thursday, November 13, 2008
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.
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.
Tuesday, November 11, 2008
CSX v. TCI; Oral Argument Before the Second Circuit (August 25, 2008)
The oral argument on the parties’ cross-appeals in this case was heard before judges Calabresi, Newman, and Winter on August 25, 2008. We are still awaiting the Court’s decision. As I reported in my post of September 15, 2008, the panel issued a summary order on September 15 affirming Judge Kaplan’s ruling not to enjoin the voting of CSX shares by TCI and 3G. The effect of that order was to seat four of the five nominees for the CSX board put forth by TCI and 3G. The panel’s explanation of its summary order, and its ruling on Judge Kaplan’s findings of liability and his entry of a permanent injunction restraining TCI and 3G from future violations of Section 13(d) of the Exchange Act will be addressed in its forthcoming opinion that fully disposes of the parties’ appeals.
I took the occasion over this past weekend to listen to a CD of the oral argument, as presented by Chris Landau of Kirkland & Ellis for TCI and 3G and by Rory Millson of Cravath for CSX. The argument was spirited, running for about an hour. The panel was clearly well prepared and peppered counsel with questions. Indeed, the exercise reinforced the observation that an effective litigator requires a steely determination and focus, since the last thing this panel allowed counsel to do was to complete a sentence. I am sure the transcript of the oral argument reads like Joyce’s Ulysses, with the beginning of a thought appearing on one page, the middle of the thought appearing many pages later, and the conclusion of the thought appearing somewhere near the end of the transcript.
While predicting the outcome of an appeal based upon a panel’s questions is hazardous, it struck this observer that Judge Winter had difficulty with CSX’s position and will therefore vote to overturn Judge Kaplan’s decision that, by entering into cash-settled equity swaps, TCI and 3G violated Section 13(d) of the Exchange Act. Judge Calabresi, who was the most active questioner (interrupter), and Judge Newman appeared more skeptical of TCI and 3G’s position, although by several of his questions Judge Calabresi expressed concern that Judge Kaplan’s findings of fact may not have been sufficient to serve as a predicate for a finding beneficial ownership by TCI and 3G in the CSX referenced shares.
By his questioning Judge Newman focused on the realities of the relationship between TCI and the banks. He directed Landau’s attention to the passage of Judge Kaplan’s decision where the Judge quotes from the SEC’s 1977 release adopting the beneficial ownership disclosure requirements:
“It therefore is not surprising that the SEC, at the very adoption of Rule 13d-3, stated that the determination of beneficial ownership under Rule 13d-3(a) requires
‘[a]n analysis of all relevant facts and circumstances in a particular situation … in order to identify each person possessing the requisite voting power or investment power. For example, for purposes of the rule, the mere possession of the legal right to vote securities under applicable state or other law … may not be determinative of who is a beneficial owner of such securities inasmuch as another person or persons may have the power whether legal, economic, or otherwise, to direct such voting.’”
Slip Opinion at 49-50 (citing to Exchange Act Release No. 34-13291) (footnote omitted, emphasis added).
What interested Judge Newman was the reference to “otherwise” in the quoted passage and what type of “otherwise” power the SEC was referring to. Given that counterparty banks are generally indifferent to the voting of any shares they may purchase to hedge their exposure to a swap, doesn’t the long party have “otherwise” power to direct the voting of such shares? In response Landau referred to the Division of Corporation Finance’s amicus letter to Judge Kaplan of June 4, 2008, in which the Division stated clearly that “economic incentives do not constitute a sufficient basis for establishing any such [voting or investment] powers.” Judge Newman appeared to dismiss the Division’s letter as not having the authority of an SEC release, such as the one he pressed Landau on. Judge Newman even posed this hypothetical to Millson, CSX’s counsel — what if TCI had asked Deutche Bank to vote the CSX shares and Deutche Bank had said, “Sure, we’ll vote with you.” (Apparently CSX did not have the opportunity to put that question to a representative of Deutche Bank.)
Millson, repeating the stance taken in CSX’s briefs, took the position that a long party who enters into a swap referencing more than 5% of an issuer’s shares, with the intent of exercising or influencing control of the issuer, is a beneficial owner of the referenced shares. The panel appeared clearly unreceptive to adopting this position. The panel pressed Millson on Judge Kaplan’s absence of any finding that TCI and 3G “influenced” the voting by its counterparties of their CSX shares. While Judge Kaplan concluded (Slip Opinion at 61) that there is “reason to believe that TCI was in a position to influence the counterparties, especially Deutche Bank, with respect to the exercise of their voting rights,” Millson had to concede that that was not a finding of influence.
Landau pressed the panel with TCI’s argument that Rule 13d-3 cannot extend beyond Section 13(d) of the Exchange Act and that a party must have “beneficial ownership” of shares before a reporting obligation under Section 13(d) arises. Judge Newman in particular appeared to have trouble with this claim, particularly in the context of the “plan or scheme” language of Rule 13d-(b), which extends “beneficial ownership” of shares to any “trust, proxy, power of attorney, pooling arrangement or any other contract, arrangement, or device with the purpose or effect of … preventing the vesting of … beneficial ownership as part of a plan or scheme to evade the reporting requirements of Section 13(d) or 13(b) of the [Exchange] Act, …” (Emphasis added.) (The Division of Corporation Finance, in its amicus letter of June 4, 2008, stated its belief that Rule 13d‑3, “properly construed, is narrower in coverage than the statute.”) How, asked Judge Newman, can actual beneficial ownership be a predicate to a trigger for Section 13(d) reporting if the trigger includes arrangements or devices to “prevent” the vesting of beneficial ownership?
It is hard to say where this will come out. If I had to read the tea leaves, I would guess that Judge Calabresi would opt for sending the case back to Judge Kaplan for further findings, Judge Newman would affirm, and Judge Winter would reverse.
Or the panel, with judges Calabresi and Newman in the majority, could affirm Judge Kaplan’s finding of violation on grounds suggested by Professor Coffee, as discussed in my post of August 23, 2008:
“The ‘voting power’ prong [of Rule 13d-3(a)] has, however, greater promise. Most swaps dealers do not vote the shares they buy to hedge their position for a variety of reasons: because they have no economic motive to vote, because they fear losing Schedule 13G eligibility, or because it is more profitable to lend their shares to short sellers. Those that do vote often divide their votes, voting both ways according to some formula or according to the recommendations of a proxy advisory firm. Thus, the repeated act of recalling shares just prior to the record date and relending the shares immediately afterward does distinguish Deutsche Bank in this case from the vast majority of swaps dealers. A narrower decision, written on this rationale, could find a violation [of Schedule 13(d)] without generally deeming the ‘long’ side of an equity swap to be the beneficial owner of the referenced shares held by the dealer.”
Coffee, “The Wreck of the CSX: Transparency and Derivatives,” NY Law Journal (July 17, 2008).
For my prior commentary on this case, see my posts of September 15, August 23, 13, and 1, July 30, 26, and 17, and June 24 and 23.
I took the occasion over this past weekend to listen to a CD of the oral argument, as presented by Chris Landau of Kirkland & Ellis for TCI and 3G and by Rory Millson of Cravath for CSX. The argument was spirited, running for about an hour. The panel was clearly well prepared and peppered counsel with questions. Indeed, the exercise reinforced the observation that an effective litigator requires a steely determination and focus, since the last thing this panel allowed counsel to do was to complete a sentence. I am sure the transcript of the oral argument reads like Joyce’s Ulysses, with the beginning of a thought appearing on one page, the middle of the thought appearing many pages later, and the conclusion of the thought appearing somewhere near the end of the transcript.
While predicting the outcome of an appeal based upon a panel’s questions is hazardous, it struck this observer that Judge Winter had difficulty with CSX’s position and will therefore vote to overturn Judge Kaplan’s decision that, by entering into cash-settled equity swaps, TCI and 3G violated Section 13(d) of the Exchange Act. Judge Calabresi, who was the most active questioner (interrupter), and Judge Newman appeared more skeptical of TCI and 3G’s position, although by several of his questions Judge Calabresi expressed concern that Judge Kaplan’s findings of fact may not have been sufficient to serve as a predicate for a finding beneficial ownership by TCI and 3G in the CSX referenced shares.
By his questioning Judge Newman focused on the realities of the relationship between TCI and the banks. He directed Landau’s attention to the passage of Judge Kaplan’s decision where the Judge quotes from the SEC’s 1977 release adopting the beneficial ownership disclosure requirements:
“It therefore is not surprising that the SEC, at the very adoption of Rule 13d-3, stated that the determination of beneficial ownership under Rule 13d-3(a) requires
‘[a]n analysis of all relevant facts and circumstances in a particular situation … in order to identify each person possessing the requisite voting power or investment power. For example, for purposes of the rule, the mere possession of the legal right to vote securities under applicable state or other law … may not be determinative of who is a beneficial owner of such securities inasmuch as another person or persons may have the power whether legal, economic, or otherwise, to direct such voting.’”
Slip Opinion at 49-50 (citing to Exchange Act Release No. 34-13291) (footnote omitted, emphasis added).
What interested Judge Newman was the reference to “otherwise” in the quoted passage and what type of “otherwise” power the SEC was referring to. Given that counterparty banks are generally indifferent to the voting of any shares they may purchase to hedge their exposure to a swap, doesn’t the long party have “otherwise” power to direct the voting of such shares? In response Landau referred to the Division of Corporation Finance’s amicus letter to Judge Kaplan of June 4, 2008, in which the Division stated clearly that “economic incentives do not constitute a sufficient basis for establishing any such [voting or investment] powers.” Judge Newman appeared to dismiss the Division’s letter as not having the authority of an SEC release, such as the one he pressed Landau on. Judge Newman even posed this hypothetical to Millson, CSX’s counsel — what if TCI had asked Deutche Bank to vote the CSX shares and Deutche Bank had said, “Sure, we’ll vote with you.” (Apparently CSX did not have the opportunity to put that question to a representative of Deutche Bank.)
Millson, repeating the stance taken in CSX’s briefs, took the position that a long party who enters into a swap referencing more than 5% of an issuer’s shares, with the intent of exercising or influencing control of the issuer, is a beneficial owner of the referenced shares. The panel appeared clearly unreceptive to adopting this position. The panel pressed Millson on Judge Kaplan’s absence of any finding that TCI and 3G “influenced” the voting by its counterparties of their CSX shares. While Judge Kaplan concluded (Slip Opinion at 61) that there is “reason to believe that TCI was in a position to influence the counterparties, especially Deutche Bank, with respect to the exercise of their voting rights,” Millson had to concede that that was not a finding of influence.
Landau pressed the panel with TCI’s argument that Rule 13d-3 cannot extend beyond Section 13(d) of the Exchange Act and that a party must have “beneficial ownership” of shares before a reporting obligation under Section 13(d) arises. Judge Newman in particular appeared to have trouble with this claim, particularly in the context of the “plan or scheme” language of Rule 13d-(b), which extends “beneficial ownership” of shares to any “trust, proxy, power of attorney, pooling arrangement or any other contract, arrangement, or device with the purpose or effect of … preventing the vesting of … beneficial ownership as part of a plan or scheme to evade the reporting requirements of Section 13(d) or 13(b) of the [Exchange] Act, …” (Emphasis added.) (The Division of Corporation Finance, in its amicus letter of June 4, 2008, stated its belief that Rule 13d‑3, “properly construed, is narrower in coverage than the statute.”) How, asked Judge Newman, can actual beneficial ownership be a predicate to a trigger for Section 13(d) reporting if the trigger includes arrangements or devices to “prevent” the vesting of beneficial ownership?
It is hard to say where this will come out. If I had to read the tea leaves, I would guess that Judge Calabresi would opt for sending the case back to Judge Kaplan for further findings, Judge Newman would affirm, and Judge Winter would reverse.
Or the panel, with judges Calabresi and Newman in the majority, could affirm Judge Kaplan’s finding of violation on grounds suggested by Professor Coffee, as discussed in my post of August 23, 2008:
“The ‘voting power’ prong [of Rule 13d-3(a)] has, however, greater promise. Most swaps dealers do not vote the shares they buy to hedge their position for a variety of reasons: because they have no economic motive to vote, because they fear losing Schedule 13G eligibility, or because it is more profitable to lend their shares to short sellers. Those that do vote often divide their votes, voting both ways according to some formula or according to the recommendations of a proxy advisory firm. Thus, the repeated act of recalling shares just prior to the record date and relending the shares immediately afterward does distinguish Deutsche Bank in this case from the vast majority of swaps dealers. A narrower decision, written on this rationale, could find a violation [of Schedule 13(d)] without generally deeming the ‘long’ side of an equity swap to be the beneficial owner of the referenced shares held by the dealer.”
Coffee, “The Wreck of the CSX: Transparency and Derivatives,” NY Law Journal (July 17, 2008).
For my prior commentary on this case, see my posts of September 15, August 23, 13, and 1, July 30, 26, and 17, and June 24 and 23.
Thursday, November 6, 2008
Comet Systems, Inc. v. MIVA, Inc.; Are Change-of-Control Bonuses Properly Deductible in Calculating Earnout Payments?
Comet was merged into a subsidiary of MIVA. The merger consideration consisted, in part, of a potential $10 million earnout, which could be earned over 2004 and 2005. The earnout was based upon Comet’s performance relative to three performance goals. One of the goals was a function in part of cost, defined in the merger agreement as “Operating Costs Excluding Amortization and One-time, Non-recurring Expenses.”
In anticipation of a potential transaction, Comet had adopted a bonus plan providing for the award of bonuses solely in the event of an acquisition or similar transaction. Under the plan, Comet paid out bonuses in connection with the MIVA merger, from the merger proceeds. MIVA deducted the payments as a cost in calculating the earnout, resulting in a reduced earnout payment.
A. The Bonuses Were Not A Proper Deduction
Vice Chancellor Lamb, in his opinion of October 22, 2008 (2008 WL 4661829), had little difficulty siding with the former stockholders of Comet in concluding that the “cost” of the merger bonuses was not an “operating cost” as defined in the merger agreement.
Delaware follows the “objective” theory of contracts whereby a contract’s construction should be that which would be understood by an objective, reasonable third party. The contract terms themselves are controlling when they establish the parties’ common meaning so that a reasonable person in the position of either party would have no expectation inconsistent with the contract language. Slip Opinion at 10-11, quoting Eagle Industries, Inc. v. DeVilbiss Healthcare, Inc., 702 A.2d 1228, 1232 (Del. 1997). MIVA argued that the merger bonuses qualified as an “ordinary” cost of doing business because they contribute to employee retention during a sales process. Responded Vice Chancellor Lamb:
“But the fact than an expense qualifies as an ordinary cost of business does not preclude treatment of that expense as one-time and non-recurring. Black’s Law Dictionary defines a ‘one-time charge’ as ‘[a]n ordinary cost of business excluded from income calculations.’ Thus, simply qualifying a cost as ordinary is not sufficient to dispositively determine that the cost is not one-time and non-recurring.”
Slip Opinion at 11.
The Vice Chancellor’s explanation of earnouts is instructive:
“Earnouts are typically used where the buyer and seller cannot agree on a price because the seller is more optimistic about the future prospects of a business than is the buyer. As a result, charges and costs which occur as a result of the merger and are not expected to be representative of future costs in the business are reasonably excluded. The natural reading ‘one-time, non-recurring expenses’ is to exclude exactly such charges.”
Slip Opinion at 11-12 (footnotes omitted).
B. Time For Performance
MIVA delayed an earnout payment it calculated was due, from March 2005 until June 2006. It argued that because there was no time specified for payment of any earnout amount in the merger agreement, the Court should not award interest on the amount due to the delay in its payment.
A specific payment covenant was not necessary, ruled the Vice Chancellor, because in every contract there is implied a promise or duty to perform with reasonable expediency the thing agreed to be done, and a failure to do so is a breach of contract. Slip Opinion at 18, citing Williston On Contracts. Therefore, MIVA had a duty to make the earnout payment within a “reasonable” time in the absence of a contractual term to the contrary. MIVA therefore should have made the payment within 90 days of its determination, and accordingly the plaintiff stockholders were entitled to interest on the overdue payment, notwithstanding the silence of the merger agreement on the time for payment.
In anticipation of a potential transaction, Comet had adopted a bonus plan providing for the award of bonuses solely in the event of an acquisition or similar transaction. Under the plan, Comet paid out bonuses in connection with the MIVA merger, from the merger proceeds. MIVA deducted the payments as a cost in calculating the earnout, resulting in a reduced earnout payment.
A. The Bonuses Were Not A Proper Deduction
Vice Chancellor Lamb, in his opinion of October 22, 2008 (2008 WL 4661829), had little difficulty siding with the former stockholders of Comet in concluding that the “cost” of the merger bonuses was not an “operating cost” as defined in the merger agreement.
Delaware follows the “objective” theory of contracts whereby a contract’s construction should be that which would be understood by an objective, reasonable third party. The contract terms themselves are controlling when they establish the parties’ common meaning so that a reasonable person in the position of either party would have no expectation inconsistent with the contract language. Slip Opinion at 10-11, quoting Eagle Industries, Inc. v. DeVilbiss Healthcare, Inc., 702 A.2d 1228, 1232 (Del. 1997). MIVA argued that the merger bonuses qualified as an “ordinary” cost of doing business because they contribute to employee retention during a sales process. Responded Vice Chancellor Lamb:
“But the fact than an expense qualifies as an ordinary cost of business does not preclude treatment of that expense as one-time and non-recurring. Black’s Law Dictionary defines a ‘one-time charge’ as ‘[a]n ordinary cost of business excluded from income calculations.’ Thus, simply qualifying a cost as ordinary is not sufficient to dispositively determine that the cost is not one-time and non-recurring.”
Slip Opinion at 11.
The Vice Chancellor’s explanation of earnouts is instructive:
“Earnouts are typically used where the buyer and seller cannot agree on a price because the seller is more optimistic about the future prospects of a business than is the buyer. As a result, charges and costs which occur as a result of the merger and are not expected to be representative of future costs in the business are reasonably excluded. The natural reading ‘one-time, non-recurring expenses’ is to exclude exactly such charges.”
Slip Opinion at 11-12 (footnotes omitted).
B. Time For Performance
MIVA delayed an earnout payment it calculated was due, from March 2005 until June 2006. It argued that because there was no time specified for payment of any earnout amount in the merger agreement, the Court should not award interest on the amount due to the delay in its payment.
A specific payment covenant was not necessary, ruled the Vice Chancellor, because in every contract there is implied a promise or duty to perform with reasonable expediency the thing agreed to be done, and a failure to do so is a breach of contract. Slip Opinion at 18, citing Williston On Contracts. Therefore, MIVA had a duty to make the earnout payment within a “reasonable” time in the absence of a contractual term to the contrary. MIVA therefore should have made the payment within 90 days of its determination, and accordingly the plaintiff stockholders were entitled to interest on the overdue payment, notwithstanding the silence of the merger agreement on the time for payment.
Subscribe to:
Posts (Atom)
Posts
