2011 was an active year for the Delaware Court of Chancery (the "Court"). The Court issued several significant corporate law decisions that issuers, investment bankers, and their counsel should be aware of. In addition to the highly publicized $1.263 billion damage award in In re Southern Peru Copper Corp. Shareholder Derivative Litigation, there were also other notable opinions in other areas, including master limited partnerships (MLPs), conflicts involving investment banks, poison pills, and general M&A-related litigation. This article highlights five significant decisions by topic.

1. MLPs can eliminate fiduciary duties and provide safe harbors for transactions involving potential conflicts of interest.

In In re K-Sea Transportation Partners L.P. Unitholders Litigation, C.A. No. 6301–VCP, 2011 WL 2520209 (Del. Ch. June 10, 2011), Vice Chancellor Donald Parsons denied the plaintiffs' motion for expedited discovery in a case involving a merger between a Delaware MLP (K-Sea) and an unrelated party (Kirby Corporation). Under the terms of the merger, Kirby would purchase K-Sea for $329 million with $18 million of that specifically allocated to buyout the units and incentive distribution rights (IDRs) held by the ultimate owner of K-Sea's general partner (K-Sea GP). Because this term created a potential conflict between K-Sea GP and K-Sea, K-Sea's board asked a committee of directors independent of K-Sea's GP (known in the MLP context as a conflicts committee) to consider the transaction. The conflicts committee ultimately concluded that the transaction was fair.

After the merger was announced, litigation ensued. The plaintiff unitholders sought to enjoin the transaction (and moved for expedited treatment) for three reasons: (i) the conflicts committee should have separately considered the buyout of K-Sea GP's units and IDRs, rather than consider the transaction in full, (ii) K-Sea's proxy statement was materially misleading, and (iii) the members of the conflicts committee were not sufficiently independent.

Vice Chancellor Parsons found that the first two arguments failed to set forth colorable claims. With respect to the first argument, the Court found that K-Sea's limited partnership agreement (LPA) authorized the conflicts committee to evaluate the fairness of the entire transaction and did not require it to analyze a term that created a potential conflict of interest in isolation. This ruling is significant to the extent an MLP is considering a transaction in which only a piece of it involves a potential conflict of interest, and underscores the importance of reading and following the terms of the applicable LPA in determining how to structure a transaction process.

With respect to the second argument, the Court, relying on Lonergan v. EPE Holdings L.L.C., 5 A.3d 1008 (Del. Ch. 2010), held that the LPA eliminated all fiduciary duties and only obligated K-Sea to provide unitholders a copy of the merger agreement and a summary of it, which K-Sea had done.

With respect to the third argument, the Court found that the pre-transaction granting of a significant amount of phantom units to the conflicts committee members that would vest if the transaction were approved met the low bar for articulating a colorable claim that the members were not sufficiently independent. However, the Court denied expedition finding that any harm could be compensated through monetary damages.

Similarly, in Brinckerhoff v. Enbridge Energy Co., C.A. No. 5526-VCN, 2011 WL 4599654 (Del Ch. Sept. 30, 2011), the Court dismissed claims challenging the fairness of a joint venture transaction between Enbridge Energy Partners, L.P. (EEP), a Delaware MLP, and Enbridge, Inc. (Enbridge), which owned EEP's GP. Of interest, the Brinckerhoff court did not rely directly on EEP's use of a conflicts committee to dismiss the claims, but instead relied on the provision in EEP's LPA that eliminated any liability for monetary damages absent a showing of bad faith. Because EEP had voluntarily utilized its conflicts committee, and its conflicts committee had voluntarily retained legal and financial advisors, the Court found that the plaintiff could not make a bad-faith case. While the Court noted that EEP's LPA provided for a conclusive presumption of good faith if EEP's general partner relied on the opinion of advisors, it did not rely on this provision. And though the Court noted that the terms of this provision extended only to EEP's general partner, it also noted that it would apply to the directors as a practical matter given that directors could not be liable for causing EEP GP to do something that it was permitted to do under its LPA.

2. Investment bank independence and a thorough sale process is key in M&A transactions.

In In re Del Monte Foods Co. S'holders Litig., C.A. No. 6027–VCL 25 A.3d 813 (Del. Ch. 2011), Vice Chancellor Travis Laster preliminarily enjoined stockholders of Del Monte Foods Company from voting on the proposed acquisition of the company by a group of private equity firms. The basis of the Court's opinion was a preliminary finding that, despite the good-faith effort of Del Monte's board (the "Board") to fulfill its fiduciary duties, the Board nonetheless breached its duties by failing to provide "serious oversight" of its financial advisor during the sale process.

In November 2010, Del Monte entered into an agreement and plan of merger with three private equity firms for a $5.3 billion leveraged buyout of Del Monte. Before the buyout could be completed, however, Del Monte's stockholders sought injunctive relief to postpone their vote on the merger and suspend the merger agreement's deal protections, on the basis that the Board had breached its fiduciary duties during the sale process. Discovery revealed that Del Monte's financial advisor had concealed information from the Board, including: its prior associations with the bidders; its intentions to provide buy-side financing to the bidders; and its pairing of two interested bidders in violation of the no-teaming provisions of the confidentiality agreement. After the financial advisor partially disclosed some of this information, the Board allowed the financial advisor to provide buy-side financing to the bidders. The Board also permitted the financial advisor to run the go-shop process despite the "apparent bias" of the financial advisor toward the bidders it had paired, given the fees the financial advisor would generate by providing buy-side financing to the teamed bidders.

The Court ruled that the financial advisors "secretly and selfishly manipulated the sale process" to boost their fees and noted that the Board breached its fiduciary duties "by failing to provide the serious oversight that would have checked the investment bankers' misconduct." The Court suspended the stockholder vote and enforcement of certain deal protections in the merger agreement for 20 days to provide Del Monte stockholders the "the opportunity to receive a pre-vote topping bid in a process free of taint from [the financial advisor's] improper activities." Nonetheless, on March 7, 2011, following the expiration of the preliminary injunction period, Del Monte's stockholders voted in favor of the merger and the transaction closed later that week and in December, the Court approved a settlement of the litigation, which provided for an $89.4 million award to Del Monte's shareholders, including $22 million for the shareholders' attorneys.

The Court's ruling in Del Monte compels boards to (1) recognize and reconcile financial advisors' interests in the sale process, (2) scrutinize the source of acquisition financing, and (3) strengthen confidentiality agreements and engagement letters. Del Monte underscores the concern the Court of Chancery first expressed in its 2005 decision in In re Toys "R" Us, Inc. S'holder Litig., 877 A.2d 975 (Del. Ch. 2005) of transactions in which a target's financial advisor provides buy-side financing to acquirers. In Toys "R" Us, the Court noted that the banker's buy-side involvement was "questionable," but did not go so far as to conclude that the bankers "were improperly motivated." Expanding on Toys "R" Us, Del Monte shows that buy-side financing will be viewed skeptically because of the appearance that it could favor certain bidders over others, but it does not create a per se bar against such arrangements. Under certain circumstances, a buy-side financing structure can be quite helpful to facilitate a valuable transaction. However, in considering such financing, care should be given to ensure that the financing does not inappropriately tilt the playing field in favor of any bidder.

3. A poison pill can be a valid anti-takeover defense.

A day after issuing the Del Monte opinion, the Court released its post-trial decision in the year-long takeover battle between Air Products & Chemicals, Inc. (Air Products) and Airgas, Inc. (Airgas). See Air Products & Chemicals v. Airgas Inc., Civil Action Nos. 5249–CC, 5256– CC, 16 A.3d 48 (Del. Ch. 2011). In its lengthy, 153-page opinion, Chancellor Chandler ruled that "the power to defeat an inadequate hostile tender offer ultimately lies with the board of directors."

In February 2010, Air Products launched a public tender offer for all outstanding shares of Airgas stock. After several price bumps and offer extensions, the tender offer stood at a "best and final offer" of $70 per share. The Airgas board of directors (Airgas Board) maintained that Airgas was worth at least $78 per share in a sale transaction and, in any event, far more than the $70 per share offered by Air Products. To that end, the Airgas Board utilized, in addition to its classified board and other takeover defenses, a shareholder rights plan with a 15 percent triggering threshold to ward off the unwanted offer. Air Products and certain shareholder plaintiffs sought the removal of these defenses to Air Products' hostile tender offer.

After a weeklong trial and supplemental evidentiary hearing, the Court issued its ruling.

The issue before the Court was whether "a board of directors, acting in good faith and with a reasonable factual basis for its decision, when faced with a structurally non-coercive, all-cash, fully financed tender offer directed to the stockholders of the corporation, [may] keep a poison pill in place so as to prevent the stockholders from making their own decision about whether they want to tender their shares even if . . . the stockholders are fully informed as to the target board's views on the inadequacy of the offer?" And, "if so, does that effectively mean that a board can 'just say never' to a hostile tender offer?"

The answer to the latter: No, "a board cannot 'just say no' to a tender offer." Rather, under Delaware law, a board must first pass through the two prongs of exacting judicial scrutiny required by the well-known Unocal standard of review, under which a judge will evaluate the actions taken by, and the motives of, the board.

Under Unocal, only a board of directors found to be acting in good faith, after reasonable investigation and reliance on the advice of outside advisors, may address the perceived threat of a hostile tender offer by blocking the offer and forcing the hostile bidder to elect a board majority of directors that supports its bid.1 The Court concluded that the Airgas Board had no duty to redeem its poison pill to allow shareholders to determine whether to accept Air Products' $70 per share takeover bid. Chancellor Chandler found that the Airgas Board acted in good faith and fulfilled its fiduciary duties when it determined that $70 per share was inadequate consideration, despite the fact that Airgas stock has been trading in the low $60's, the merger arbitrageurs (who represent a majority of Airgas shareholders) had been pushing for a sale, and the Airgas Board did not produce a better deal in the one year the takeover fight had been ongoing. The Chancellor noted that "[t]rial judges are not free to ignore or rewrite appellate Court decisions." Thus, because "the Delaware Supreme Court has recognized inadequate price as a valid threat to corporate policy and effectiveness . . . and also made clear that the selection of a time frame for achievement of corporate goals . . . may not be delegated to the stockholders," the Chancellor applied Unocal's heightened scrutiny, and upheld the board's continued use of the Airgas rights plan.

After the Court's ruling, Air Products withdrew its bid.

Airgas makes clear that a fully-functioning board, acting in good faith, cannot be forced into Revlon mode "any time a hostile bidder makes a tender offer that is at a premium to market value." If the target's board of directors is careful to observe its fiduciary duties and believes in good faith that the hostile bidder's price is inadequate, it is not obligated to redeem its pill even after a prolonged period of time has failed to produce a better offer. Thus, the "long understood respect for reasonably exercised managerial discretion, so long as boards are found to be acting in good faith and in accordance with their fiduciary duties (after rigorous judicial fact-finding and enhanced scrutiny of their defensive actions)" will continue to be upheld.

4. Heightened review under Revlon may not be required in a stock-for-stock transaction where the majority shareholders and the board of directors had sufficient control to provide the statutorily required consent.

In In re OPENLANE, Inc., 2011 WL 4599662, C.A. No. 6849–VCN (Del. Ch. Sept. 30, 2011), the Court upheld the use of written consents by a majority of stockholders shortly after the target company board entered into a merger agreement. In April 2010 and again in May 2011, OPENLANE signed an engagement agreement with a financial advisor to undertake a market outreach to a limited number of strategic acquirers. On August 11, 2011, the board unanimously approved the merger and on August 15, 2011, entered into an agreement and plan of merger whereby the buyer, KAR, agreed to acquire OPENLANE for $210 million in cash plus any excess cash over necessary working capital at closing. The next day OPENLANE received consents from a majority of the preferred and common shareholders sufficient under Delaware law and the charter of OPENLANE to approve the merger agreement. The merger agreement with KAR provided that as a condition to closing, the holders of at least 75 percent of the outstanding shares of stock shall have executed and delivered written consents approving the merger, although that condition could have been waived by KAR. The merger agreement also included a no-solicitation provision and provided that $36 million would be held in escrow for at least 18 months to cover numerous contingencies.

Plaintiffs sought to preliminarily enjoin the merger and argued that the sales process was flawed because the board only contacted three potential buyers, failed to perform an adequate market check, failed to receive a fairness opinion, and relied on scant financial information, which led to a transaction that failed to maximize shareholder value. The plaintiffs also argued that the members of the board breached their fiduciary duty by (i) agreeing to improper deal protection devices such as the no-solicitation clause, (ii) approving the transaction despite the fact that management owned a majority of the shares, which made shareholder approval almost certain, and (iii) failing to provide a fiduciary-out provision.

The Court declined to enjoin the merger, even though it noted that "the Board's decision-making process was not a model to be followed." Applying the traditional Revlon analysis, the Court noted that there is no single path for a board to follow in order to maximize stockholder value, but the directors must follow a path of reasonableness which leads to that goal. The Court observed that "if a board fails to employ any traditional value maximization tool, such as an auction, a broad market check, or a goshop provision, that board must possess an impeccable knowledge of the company's business for the Court to determine that it acted reasonably."

In this regard, the Court observed that OPENLANE appears to be one of the "few corporations that is actually 'managed by' as opposed to 'under the direction of' its board of directors." Moreover, OPENLANE was a small public company with more in common with a private company. Accordingly, the Court found that "the record supports the conclusion that this is one of those few boards that possess an impeccable knowledge of the company's business." However, it was careful to observe that the smallness of a company does not modify core fiduciary duties. Even so, when a small company is managed by a board possessing an impeccable knowledge of the company's business, the court may consider the size of the company in determining what is reasonable and appropriate. In addition to the board members' impeccable knowledge of the company, the board held over 59 percent of OPENLANE's outstanding stock, and the board and OPENLANE's current executives held over 68 percent. Thus, the board's ownership interests suggested that the board was motivated to get the best price reasonably available — another helpful fact in defeating the injunction motion.

With regard to plaintiffs' allegation that the merger was improperly locked-up, the Court contrasted this case with Omnicare in that the merger was not a fait accompli.2 There was no voting agreement under which stockholders had promised to vote for the merger, as was the case in Omnicare; rather, the record "merely suggest[ed] that, after the Board approved the Merger Agreement, the holders of a majority of shares quickly provided consents." Similarly, the Court held that the no-solicitation clause was not preclusive because the board was free to terminate the entire merger agreement if OPENLANE's shareholders did not consent to the merger within 24 hours. The Court similarly concluded that the lack of a fiduciary out does not prevent a topping offer from emerging. "Enjoining a merger when no superior offer has emerged is a perilous endeavor because there is always the possibility that the existing deal will vanish, denying shareholders the opportunity to accept any transaction." Here, there was no competing offer — importantly, none that was arguably superior — and that suggested to the Court that caution should be exercised before enjoining a transaction with no viable alternative. Results depend upon the facts of each case.

Footnotes

1 Under Unocal, directors must show that they had reasonable grounds for believing that a danger to corporate policy and effectiveness existed, and demonstrate that their defensive response was reasonable in relation to the threat posed. Unocal Corp. v. Mesa Petroleum Co., 493 A.2d 946, 954 (Del. 1985).

2 In Omnicare, the Delaware Supreme Court held that shareholder lock-up agreements were unenforceable because they were not coupled with a fiduciary out — a provision allowing the target to accept a superior offer after the original deal is signed but before it is closed. Omnicare, Inc. v. NCS Healthcare, Inc., 818 A.2d 914 (Del. 2003).

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