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.
Thursday, February 19, 2009
Friday, February 13, 2009
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.
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.
Monday, February 9, 2009
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.
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.
Wednesday, December 31, 2008
County of York Employees Retirement Plan v. Merrill Lynch & Co., Inc.; Why Shareholder Litigation Inevitably Accompanies M&A Transactions
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.
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.
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.
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