In Koehler v. NetSpend Holdings Inc., decided last year, the Delaware Chancery Court discussed the duties of directors in a change-of-control transaction executed with a single-bidder process.
NetSpend conducted an initial public offering in 2010 for a price of $11 per share. In the following year, the share price fell to less than $4. After two rounds of share repurchases in 2011 and 2012, the board of directors explored several possibilities for enhancing shareholder value, including additional stock repurchases, a self-tender offer or a possible sale of the company. At that time, the board concluded that it was in the shareholders' best interest to maintain the company as an independent, publicly owned entity.
In the fall of 2012, NetSpend's two dominant shareholders informed the board of their intention to sell all or a significant portion of their shares. The board assisted the shareholders in their selling efforts. While noting that the entire company was not for sale, the board authorized the disclosure of financial projections to two private equity firms. For this purpose, the company executed confidentiality agreements with standstill provisions containing "Don't Ask Don't Waive" (DADW) clauses. In a nutshell, the clauses prevented the private equity firms from asking NetSpend to amend or waive any provision of the standstill provisions. Further, the standstill agreements did not terminate upon the announcement of another transaction.
At the same time, NetSpend started to explore a possible sale to Total Systems Services Inc. (TSYS). In December 2012, TSYS transmitted an Indication of Interest for an all-cash tender offer for all of NetSpend shares at $14.50 per share and NetSpend thus terminated its discussions with the private equity firms. Following negotiations, NetSpend and TSYS agreed in January 2013 on the fundamental aspects of the transaction, including a price of $16 per share, a no-shop clause with a fiduciary out for a superior proposal and a 3.98% of the equity value termination fee. While it was unsuccessful in negotiating a go-shop clause, the board decided to forgo shopping the company during the due diligence process because of confidentiality concerns. In addition, NetSpend agreed not to waive any standstill agreements, including those with the private equity firms.
In February 2013, the board approved the sale of the company. Though the price of $16 represented a 45% premium over NetSpend's stock price one week before the deal, the fairness opinion indicated that the price was below one of the valuation methods, namely the discounted cash flow model. The plaintiff thus filed an injunction asking the Chancery Court to enjoin the transaction, alleging breaches by the board of its Revlon duties.
The Court decision
Noting that the board of NetSpend had engaged in a change-in-control transaction, the Court held that it was subject to the duty to secure the best value reasonably attainable for the shareholders. Thus, "directors have a duty to act in a fully informed manner, and in good faith, to obtain the best deal available". However, they "need not follow a particular path to maximize stockholder value, but the directors' path must be a reasonable exercise toward accomplishing that end".
For the Court, the directors' motivations were properly aligned with the interest of shareholders in achieving the highest price reasonably available. With respect to process, the Court considered that the board acted reasonably in allowing NetSpend's CEO to negotiate with TSYS. The CEO's interests were aligned with those of shareholders. The board instructed the CEO not to discuss management's retention agreements until after the material aspects of the transaction had been agreed upon. Further, the board was heavily involved in the negotiation process.
Likewise, the Court found that it was not unreasonable per se for the board to conduct a single-bidder process. It referred to previous Delaware cases that held that a board may forego a market check where it possesses a body of reliable evidence with which to evaluate the fairness of a transaction. With respect to the board of NetSpend, the Court remarked that its directors were sophisticated professionals with extensive business and financial expertise. They understood the financial dimensions of the transactions and were assisted by highly regarded financial advisors that provided them with unbiased advice. Overall, the Court found that the board was "well-informed about the process of selling the Company".
Having chosen a single-bidder strategy, the board had to ensure that the overall process was reasonable. In this respect, the Court identified a number of flaws in the sale process. First, the Court held that the fairness opinion was weak in that it relied on NetSpend's volatile stock price, as well as comparables of limited utility. In addition, the discounted cash flow analysis indicated that "TSYS offer was grossly inadequate". Thus, the fairness opinion proved a poor substitute for a market check. Second, the deal protection measures did not deter a serious suitor. However, the no-shop clause was problematic given the short period of time before closing, with the Court stating that "the Board cannot have intended that a leisurely post-agreement, pre-closing period would provide an adequate alternative to a market check". Finally, the Court criticized the board's failure to remove the DADW clauses once negotiations with TSYS had started.
Ultimately, the combination of these deficiencies led the Court to conclude that the plaintiff had a reasonable probability of success on her Revlon claim, i.e. that the sale process as a whole was unreasonable in that it was not designed to produce the best price for the stockholders. Nevertheless, the Court did not issue the injunction to enjoin the transaction since no other suitors had appeared since the public announcement of the TSYS agreement.
The NetSpend decision is of interest for boards of directors of Canadian corporations even though the legal environment governing change-of-control transactions is somewhat different north of the border. Indeed, following the BCE decision, the fiduciary duty of directors in a change-of-control context remains cast broadly, as the duty to act in the best interest of the corporation. However, in pursuing this goal, boards must follow a reasonable decision-making process in accordance with their duty of care. From this perspective, NetSpend provides useful guidance for boards deciding to pursue a single bidder strategy, and also serves as an important reminder with respect to the limits of fairness opinions.
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