Revlon Duties and Other Board of Director Disclosure Requirements in Mixed Consideration Mergers
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Presenting a live 90‐minute webinar with interactive Q&A
Revlon Duties and Other Board of
Director Disclosure Requirements in
Mixed‐Consideration Mergers
Lessons Learned from Recent Delaware Decisions: Smurfit Stone, Del Monte, Atheros and Other Cases
WEDNESDAY, SEPTEMBER 28, 2011
1pm Eastern | 12pm Central | 11am Mountain | 10am Pacific
T d ’ faculty
Today’s f l features:
f
William Savitt, Partner, Wachtell, Lipton, Rosen & Katz, New York
G. Roth Kehoe, II, Partner, Hunton & Williams, Atlanta
Steven M. Haas, Hunton & Williams, Richmond, Va.
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againRevlon Duties in Mixed-Consideration
Mergers and Other Board of Director
Process and Disclosure Requirements
William S
Willi Savitt
itt
Wachtell Lipton Rosen & Katz
G. Roth
G R th Kehoe
K h II
Steven M. Haas
Hunton & Williams LLPDiscussion Outline
Mixed-Merger Consideration and Revlon Duties
– Smurfit-Stone
Factors to Consider in a Sale Process
– In re Del Monte
– Disclosure and process issues related to financial advisors
– Other
O recent developments
Lessons Learned and Best Practices
Q&A
6Introduction to Revlon Duties
Business Judgment Rule
– Presumption that, in making a business decision, the directors acted on an
informed basis
basis, in good faith and in the honest belief that the action taken
was in the best interest of the company
– Courts must give “great deference” to directors’ decision
– Evaluating
E al ating whether
hether decision was
as rational,
rational not reasonable
Plaintiff generally has the burden to rebut the business judgment rule
– Must show that board breached its fiduciary duties
– If “Revlon” applies, court will employ a higher standard of review and
directors may bear the burden
7Introduction to Revlon Duties
Revlon requires that directors obtain the best price reasonably
available
– See Revlon, Inc. v. MacAndrews & Forbes Holdings, Inc., 506 A.2d 173
(Del. 1986)
– Imposes
p a heightened
g standard of review for “reasonableness”
– Directors’ role changes “from defenders of the corporate bastion to
auctioneers charged with getting the best price for the stockholders at a
sale of the company”
– “No single blueprint” for fulfilling Revlon duties
– Does not require a true auction
– Reasonableness, not perfection, is required by DE courts
8Introduction to Revlon Duties
Revlon applies:
– “(1)
(1) when a corporation initiates an active bidding process
seeking to sell itself or to effect a business reorganization
involving a clear break-up of the company…;
– (2) where, in response to a bidder’s offer, a target abandons its
long-term strategy and seeks an alternative transaction
involving the breakup of the company; or
– (3) when approval of a transaction results in a sale or change of
control ”
control.
In re Santa Fe Pac. Corp. S’holder Litig., 669 A.2d 59, 71 (Del.
1995).
9Introduction to Revlon Duties
What constitutes a “change in control”?
Paramount Communications v. QVC Network, 637 A.2d 34 (Del.
1993)
– Inquiry: whether control of the corporation will remain in a large, fluid,
changeable
g and changing
g g market
– In other words, will the combined company have a controlling stockholder and
relegate the target stockholders to a minority status, thus making the transaction
under review the last chance for stockholders to receive a control premium for
their shares
– See also Arnold v. Society for Sav. Bancorp, Inc., 650 A.2d 1270 (Del. 1994)
(applying the business judgment rule instead of Revlon to a stock-for-stock
merger where, among other things, “plaintiff’s opportunity to receive a control
premium is not foreclosed”)
10Revlon and Mixed Consideration Transactions
When does Revlon apply to transactions where stockholders receive
“mixed consideration”?
– In re Santa Fe Pacific Corp. S’holder Litig., 669 A.2d 59 (Del. 1995)
– No Revlon where 33% of consideration was cash
– In re Lukens Inc. S’holders Litig., 757 A.2d 720 (Del. Ch. Dec. 1, 1999)
– Assumed
A d Revlon
R l applied
li d where
h 62% off consideration
id ti was cash
h
– In re NYMEX S’holder Litig., 2009 WL 3206051 (Del. Ch. Sept. 30, 2009)
– Refused to decide whether Revlon applied where 45% of consideration was
cash because complaint was dismissed due to Section 102(b)(7)
These cases create a “no-man’s land” for deals where consideration is
between 33% and 62% cash
The Delaware Supreme Court has not addressed this issue since
1995
11Mixed Consideration: Smurfit-Stone
Smurfit-Stone/Rock-Tenn Transaction
– $3.5B merger announced on January 23, 2011
Background
– Smurfit-Stone emerged from bankruptcy on June 30, 2010
– Board composed by creditors’ committee
– Included two insiders
– Remainder of ten-person board were outside, independent directors
– Employment
E l t agreements
t
– Negotiated by creditors’ committee and approved by bankruptcy court
– Provided for change-in-control payments to senior executives
– Expired on September 30, 2011
12Mixed Consideration: Smurfit-Stone
Smurfit-Stone’s first expression of interest (September 2010)
– Private equity firm expressed interest in recapitalization and later an all-
cash acquisition
– Board formed special committee
– Composed of all outside directors
– Formed “subcommittee”
subcommittee of three directors
– Hired outside financial and legal advisors
– Special committee rejects private equity firm’s offer of $29/share as
inadequate
13Mixed Consideration: Smurfit-Stone
Rock-Tenn
– Strategic competitor
– Initially proposed an all-stock/no-premium “merger of equals”
– Subsequently revised to provide a premium and 50% cash consideration
– Definitive agreement provided for $35/share, 50/50 cash/stock
consideration
– 27% premium
– Smurfit stockholders would own 45% of combined company
14Mixed Consideration: Smurfit-Stone
Merger agreement with Rock-Tenn
– Customary deal protection provisions that were reciprocal
– No-shop with fiduciary out
– Matching right (3 calendar days)
– Termination fee of $120M (3.4% of equity value)
– Drop-dead date: September 30, 2011
– Same date as expiration of management’s change-in-control agreements
– But also coincided with expiration of Rock-Tenn’s financing commitment
– Stockholder litigation in Delaware challenging transaction
15Mixed Consideration: Smurfit-Stone
Threshold issue for court: Revlon or Business Judgment Rule?
– Court: Revlon applies
– Transaction is an end-game for half of each stockholder’s investment
– “No tomorrow”
– Given lack of Delaware Supreme
p Court pprecedent,, the court noted that its
“conclusion that Revlon applies here is not free from doubt”
– Whether Revlon duties are triggered is assessed as of the time the merger
agreement is approved
– Note: Because the merger agreement did not have a collar, Smurfit-Stone
stockholders were to receive approximately 44% of consideration in cash at time
of litigation
16Mixed Consideration: Smurfit-Stone
Application of Revlon duties
– Board process
– Single-bidder strategy
– Deal protections
– Management’s role
– Challenge to selection of financial advisor
– Price inadequacy
q y claims
Court concludes that plaintiff did not have a reasonable probability of
success in showing board breached its fiduciary duties
17Mixed Consideration Transactions
Steinhardt v. Howard-Anderson, C.A. No. 5878-VCL (Del. Ch. Jan. 24,
2011)
– Transcript ruling from Court of Chancery involving sale of Occam Networks
to Calix, Inc.
– $171M transaction
– 50/50 cash/stock consideration for approximately $7.75/share
– Target stockholders would own 15% to 19% of combined company
18Mixed Consideration Transactions
Steinhardt v. Howard-Anderson (cont’d)
– Court indicated that Revlon applied
– Court focused on directors’ duty to negotiate as great an interest as
possible for target shareholders in the combined entity
“We often talk about, oh, well, but the stockholders
can get a future control premium. That’s all well
and good for the future entity, but what you’re
bargaining over now is how much of that future
premium you’re going to get.”
– Smurfit-Stone did not cite Steinhardt
19Mixed Consideration Transactions
Compare Steinhardt to In re JPMorgan Chase & Co. S’holder Litig.,
906 A.2d 808 (Del. Ch. 2005)
– Similar argument, but made from the perspective of the buyer’s
stockholders:
– “The plaintiffs seek damages in the amount of the merger exchange
ratio
ti premium,
i approximately
i t l $7 billion.
billi Th
They allege
ll th
thatt th
the JPMC
board of directors, by approving the unfavorable merger exchange ratio
and the unnecessary premium, harmed them directly by diluting their
interests in JPMC. If the JPMC board had approved a no-premium
merger exchange
h ratio,
i the
h argument goes, theh plaintiffs
l i iff would ld h
have a
greater stake in the resulting company. Instead, the stockholders of the
pre-merger JPMC now have less of a stake in the post-merger JPMC.”
20Factors to Consider in a Sale Process:
Del Monte
and Other Banker-Related Decisions
21Financial Advisors
Financial advisors play a key role in M&A
– Provide valuation analysis
– Advise in structuring sale process
– Render fairness opinion
No per se requirements under Delaware law
– But has become a norm
Protection to board
– 8 Del. C. 141(e): Directors are “fully protected” in relying in “good faith” as
to matters the director “reasonable believes are within such [] person’s
professional or expert competence”
– Advisor must be selected with “reasonable care”
22Del Monte: Background
Del Monte involved a $5.3B leveraged buyout led by KKR, Centerbridge and
Vestar
Del Monte retained Barclays as its financial advisor
– Financial advisor ran unsuccessful sale process 6-7 months earlier
– Then rekindled sale process, apparently without Del Monte’s approval and
g agreements
in breach of no-teaming g
– Financial advisor also participated in buy-side financing
– Financial advisor also ran go-shop process
23Del Monte: Background
No-Teaming Provision:
In addition,
addition you agree that
that, without the prior written consent of the Company,
Company you … will
not disclose to any other person (other than your Representatives) the fact that you are
considering a possible transaction with the Company, that this Agreement exists, that the
Confidential Information has been made available to you, that discussions or negotiations
are taking place concerning a possible transaction involving the Company or any of the
terms, conditions, or other facts with respect thereto (including the status thereof)….
Without limiting the generality of the foregoing, you further agree that you will not,
directly or indirectly, share the Confidential Information with or enter into any agreement,
arrangement or understanding, or any discussions which would reasonably be expected to
lead to such an agreement, arrangement or understanding with any other person, including
other potential bidders and equity or debt financing sources (other than your
Representatives as permitted above) regarding a possible transaction involving the
Company without
ih the
h prior
i written
i consent off the
h Company andd onlyl upon suchh person
executing a confidentiality agreement in favor of the Company with terms and conditions
consistent with this Agreement.
24Del Monte: Preliminary Injunction Decision
Important caveat: Decision Based on preliminary record
No-teaming breach
– “[W]hat indisputably crossed the line was the surreptitious and unauthorized
pairing of Vestar with KKR.”
Financial advisor “deceived” board by assembling consortium and actively
seeking buy-side
buy side financing role
Company learned of these “behind the scene” activities as a result of the
litigation and had to amend proxy statement accordingly
“Barclays secretly and selfishly manipulated the sale
process…. In short, it was a fraud upon the board.”
25Del Monte: Court’s Decision—Buy-Side Financing
Board should not have authorized its banker to participate in buy-side
financing without corresponding benefit to stockholders
“Del Monte and KKR had not yet agreed on price.
Barclays’ buy-side participation was not used to extract
a higher price. Nor was it necessary to finance the deal.
No one thought that KKR needed Barclays, and other
banks were already clamoring for their shares.
double-dip.”
Barclays simply wanted to double-dip
26Del Monte: Court’s Decision—Go-Shop
Once buy-side financing was authorized, it was unreasonable for board
to permit banker to run go
go-shop
shop
– “Direct financial conflict” gave Del Monte’s banker an incentive to favor
KKR-led consortium or another private-equity bidder in need of financing
– Banker had a strong disincentive to facilitate strategic bidders
– Consortium already committed to use financing
– Strategic bidders less likely to need financing from Del Monte’s bankers
27Del Monte: Court’s Decision—Consortium
Unreasonable to permit higher bidder in prior sale process to team
with KKR
– Both banker (for initially assembling consortium) and board (for ultimately
approving it) were faulted
No “hard thinking” about implications of pairing
“[M]aterially reduced the prospect of price
Monte ”
competition for Del Monte.
28Del Monte: Court’s Decision—Directors
Plaintiffs likely to succeed on merits on breach of fiduciary duty claims
against Del Monte’s directors
– “Buck
Buck stops with the Board”
Board
– But chance of directors being held personally liable was
“vanishingly small”
– No evidence of bad faith by directors
– Protected by Section 102(b)(7)
– Directors cannot be held personally liable for a breach of the duty of care
29Del Monte: Aiding & Abetting Liability
Plaintiffs had reasonable probability of success in proving that private
equity bidders aided and abetted breach of fiduciary duty in
connection with financial advisor
– Barclays was later named as an additional defendant
Potential
P t ti l liliability:
bilit a “fair
“f i price”
i ” that
th t would
ld h
have resulted
lt d ffrom an
untainted process?
Third-party defendants do not have directors’ defenses (such as
Section 102(b)(7))
30Del Monte: Court’s Remedy
Enjoined stockholders’ meeting for 20 days
Also enjoined enforcement of no-shop, matching right, and break-up
fee provisions
Extraordinary remedy
– Goal was to replicate pre
pre-signing
signing period (when no deal protections existed)
for third-party bidders
– Exposed deal to market risk
– No
N ttopping
i bid emerged
d and
d ttransaction
ti was consummated
t d
– In the absence of disclosure violations or topping bids, DE courts do not enjoin
transactions
31Del Monte: Fall-Out
$2.75M fee award to plaintiffs’ counsel for supplemental disclosures
– Award based on company’s
company s voluntary disclosures arising out of litigation
– Court has not yet addressed fees relating to injunction
Antitrust
– Private plaintiffs brought civil claims under antitrust laws against the
bidding consortium and financial advisor alleging bid-rigging
32Del Monte: Court’s Remedy
Important Caveat about the Del Monte decision
– Barclays was not a party to the litigation at the time the motion was briefed
and argued
– Did not get a chance to tell its side of the story
– Motion based on p
preliminary
y record before the court
– Based on reasonable probability of success
– No definitive findings of fact
33Del Monte: Implications
Reputational concerns
Potential liability to stockholder-class and to company
Increased scrutiny of bankers’ activities prior to engagement
Increased scrutiny of bankers’ activities during sale process
Buy-side financing and other conflicts face increasing scrutiny
34Del Monte: Implications for Engagements
Full disclosure of pre-engagement marketing activities and potential conflicts
of interest
Conflicts can be bidder-specific
p ((Co. A vs. Co. B)) or based on category
g y of
bidder (e.g., financial vs. strategic buyer)
Confirm indemnification for stockholder lawsuits
Second banker to provide fairness opinion seems like a “must”
must in event of
material conflict of interest
– Companies may seek fee deductions to offset cost of second banker
Second banker must run go
go-shop
shop where initial banker has conflict favoring
initial bidder or category of bidders
Expect new provisions regarding conflicts and client’s consent
– Express prohibitions against providing financing without client’s
client s consent
Buy-side: Focus on compliance with no-teaming arrangements
35Stapled/Buy-Side Financing
No per se rule, but courts have been skeptical
– In re Toys R’ Us; Ortsman v. Green
Staple is permissible where it benefits the company
– In re Lear: Initial banker offered staple during go-shop to facilitate bids
while a second banker was retained to help run go-shop
go shop process
– Second banker issues after Del Monte
– Q: Should the “conflicted” banker still render a fairness opinion?
– In re Transatlantic Holdings (Bench ruling) (Del. Ch. Aug. 22, 2011):
Court suggested that conflicted banker gets the best of both worlds if it
can earn high fees without rendering a fairness opinion
36Disclosure of Financial Advisor Conflicts of Interest
Disclosure Issues
R l ti
Relating tto Fi
Financial
i l Ad
Advisors
i
37Disclosure of Financial Advisor Conflicts of Interest
Art Technology (2010)
– Sale of Art Technology to Oracle
– Merger enjoined until target disclosed fees paid by buyer (Oracle) to
target’s financial advisor (Morgan Stanley)
– Significant relationship between Morgan Stanley and Oracle was revealed
during discovery and caused court’s
court s concern
– Court required actual dollar amount of fees paid
Conflict analysis
y is ongoing—prior
g g to engagement,
g g throughout
g
process, and with respect to final buyer
38Disclosure of Financial Advisor Conflicts of Interest
Zenith National (2010)
– Court decided not to enjoin transaction on “close issue” of whether target
needed to disclose unrelated work that its financial advisor was performing
for buyer
– Court said its refusal to enjoin should not be understood as “bless[ing]
same banker working for target side, having six months ago worked for
bidder side”
For large banks, this may always be a problem
– Look for overlapping deal
deal-teams/relationship
teams/relationship person
39Disclosure of Financial Advisor Conflicts of Interest
In re Atheros Communications, Inc. S’holder Litig. (Del. Ch. Mar. 4,
2011)
– Proxy statement disclosed that a “substantial portion” of the investment
banker’s fees was contingent on consummation of the merger
– Court held this was misleading where 98% of banker’s fees were
contingent
– Disclaimed any evidence of wrongdoing, but noted the “extraordinary
incentive” created by fee arrangement
40Disclosure of Financial Advisor Conflicts of Interest
In re Ness Techn. Inc. S’holders Litig. (Del. Ch. Aug. 3, 2011)
– Court granted motion to expedite proceedings
– Proxy statement disclosed that target’s and special committee’s respective
investment bankers had performed work for the buyer
– Court found that plaintiff had “articulated
articulated a sufficiently colorable claim
claim” to
justify expedited proceedings
– Court focused on two potential claims: (1) process-based claim and (2)
alleged
g disclosure violations:
– Proxy statement did not disclose “how much business the financial advisors
have done, are doing, or might expect to do in the future with [the buyer] or its
affiliates” or whether “the amount of business involved would be material to
either of the advisors”
– Litigation settled with supplemental disclosures regarding fees received
from the buyer
41Other Sale Process Issues
Other Sale Process Issues
Relating to
Financial Advisors
42Other Sale Process Issues Relating to Financial Advisors
Preparation of Fairness Opinions
– Sunbelt Beverage (2010)
– Court scrutinized private company sale process
– Fairness opinion was produced in one week and while lead appraiser
was working on another significant matter on other side of country
– Appraisal action valued stock at almost 2.5 times the merger price
Fairness opinion “was
was a mere afterthought
afterthought,
pure window dressing intended by
defendants to justify the preordained result
of”
f” the
h merger price.
i
43Other Process Issues Relating to Financial Advisors
Sufficient Capabilities of Advisor and Quality of its Advice (cont’d)
– Recall that in Smurfit-Stone,, plaintiffs
p challenged
g company’s
p y selection of
its financial advisor because the advisor allegedly lacked M&A experience
in the paper and fiberboard industry
– Allegations “largely unfounded”
– Special committee knew advisor had significant general M&A experience
– Advisor did not have any relationships with buyer or special committee
– Advisor advised Smurfit-Stone during its bankruptcy – it knew the company
44Other Process Issues Relating to Financial Advisors
Smurfit-Stone plaintiffs also challenged financial advisors’ contingency
fee
– Argument: contingency fee was inappropriate where there was no auction
and company’s choice was between selling to one buyer and remaining
independent
Court: No reasonable probability of success
– “Contingent fees for financial advisors in a merger context are somewhat
‘routine’ and p
previously
y have been upheld
p by
y Delaware courts”
Recall Atheros: Focus was on disclosure of amount of fee that was
contingent
45Other Process Issues Relating to Financial Advisors
Attorney-Client Privilege
– State-by-state rule on whether presence of banker in discussions or email
communications loses privilege
Delaware: Recently confirmed no automatic loss of privilege by
copying investment banker on email
– Need to examine whether, in the circumstances, the person making the
disclosure regarded it as confidential and whether there was an
expectation of confidentiality
– See 3Com Corp. v. Diamond II Holdings, Inc. (C.A. No. 3922-VCN)
3922 VCN) (Del. Ch.
July 9, 2009)
– DE courts have also recognized importance of involving financial advisors
in providing legal advice
46Other Process Issues Relating to Financial Advisors
Attorney-client privilege rules vary among states
– Contrast Delaware with Massachusetts
– Massachusetts has treated a lawyer-client communication that includes a
non-lawyer as a waiver
– Presence of third party must be “necessary” for “effective consultation” between
client and attorney
– See Commission of Revenue v. Comcast, 901 N.E.2d 1185 (Mass. 2009)
Lesson: Be careful
47Other Recent Process and Disclosure Issues
Other Recent Developments:
Sale Process and Disclosure
Issues
48Other Recent Developments: Orchid Cellmark
In re Orchid Cellmark Inc. S’holder Litig., C.A. No. 6373 (Del. Ch. May
12,, 2001))
Company ran limited pre-signing market check
– Formed special committee
– Considered 3 strategic buyers and 3 financial buyers
– Considered sale of UK assets
– But directors determined sale of entire company
p y was more desirable
– Court denied motion for preliminary injunction
49Orchid Cellmark
Management’s Projections
– Management
Management’s
s projections were considered the “upper
upper case”
case
– Projections were revised downward by Special Committee’s financial advisor
– Special committee viewed the revised “base case” as more reliable
– Plaintiff challenged directors’
directors decision to rely on more conservative
projections (directors allegedly “massaged” projections to justify deal)
– Court refused to second-guess decision
– “In evaluatingg the fairness and advisability
y of this tender offer,, the Special
p
Committee and its financial advisor are not precluded from considering
various sets of financial projections before determining that one set
reflects the best estimate of future performance.”
– Court also rejected alleged disclosure violation for failing to disclose “upper
upper
case” projections
50Orchid Cellmark
CEO’s Opposition to Merger
– Unusual example where board recommendation was not unanimous
– As a legal matter, board action generally is accomplished by a majority vote of
the directors at a meeting at which a quorum is present
– Merger contracts provide that board’s recommendation to shareholders is
unanimous
“unanimous”
– But unanimity is not a per se legal requirement
– Court: Internal dissent does not constitute breach of duty
– Independent directors were informed of CEO’s
CEO s views
– “[T]he Board simply disagreed with his optimism toward Orchid’s remaining as a
stand-along company”
51Orchid Cellmark
Deal Protections in Merger Agreement
– No-solicitation clause (“no-shop”)
– Matching rights
– Termination fee payable
– 3% equity value (4.6% enterprise value)
– Covenant to maintain existing rights plan (“poison pill”) in place
“The Company
“Th C shall
h ll not… (v)
( ) amendd or waive
i theh Rights
Ri h
Agreement, redeem the Rights or take any action which would
allow any Person other than [the acquiror] to acquire beneficial
ownership of 20% or more of the shares of Common Stock
without
ih causing
i a “Distribution
“Di ib i Date,”
D ” a “Triggering
“T i i Event,”
E ” or
a “Stock Acquisition Date” (each as defined in the Rights
Agreement) to occur….”
52Orchid Cellmark
Rights Plan Covenant
– Although no express “fiduciary
fiduciary out”
out to exempt a third party under the rights
plan, the company had the ability to terminate the merger agreement to
accept a superior proposal
– Would require payment of termination fee
– Court also rejected notion that rights plan covenant discouraged potential
topping bids
“[A] sophisticated and serious bidder would
understand that the Board would likely eventually be
required by Delaware law to pull the pill in response
to a Superior Offer.
Offer Thus,
Thus the deterrent effect of
these provisions is minimal.”
53Orchid Cellmark
Deal protections are reviewable under Unocal
– Must be a threat to corporate policy or effectiveness
– Example: Loss of premium offer to stockholders
– Deal protection must be reasonable and proportionate to the threat
– Not preclusive or coercive
– Fall within a range of reasonableness
54Orchid Cellmark
Deal Protections – Reviewable in the aggregate
– Court
C reviewed
i d ““cumulative
l i effect”
ff ” off allll d
deall protections
i
– Although court found that deal protections, in the aggregate,
were reasonable,, it offered a warning:
g
– “[O]ne of these days some judge is going to say ‘no more’ and, when
the drafting lawyer looks back, she will be challenged to figure out how
or why the incremental enhancement mattered. It will be yet another
instance of the straw and the poor camel
camel’s s back
back. At some point,
point
aggressive deal protection devices… run the risk of being deemed so
burdensome… as to render the ‘fiduciary out’ illusory”
55LESSONS LEARNED
LESSONS LEARNED
AND
BEST PRACTICES
56Conclusion
William Sa
Savitt
itt G Roth
G. R th Kehoe
K h II Steven M.
M Haas
(212) 403-1329 (404) 888-4056 (804) 788-7217
WDSavitt@wlrk com
WDSavitt@wlrk.com rkehoe@hunton com
rkehoe@hunton.com shaas@hunton.com
The views and opinions expressed in the discussion and in these slides are of the presenters individually and not necessarily
those of their firms or clients.
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