United States: December 2014 Corporate Alert

The Herrick Advantage

Corporate partner Richard M. Morris was a guest on The Stoler Report, a weekly television show that airs on PBS focused on real estate and business trends in the tri-state region. Mr. Morris discussed the impact of the SEC new crowd funding and revised Regulation D regulations and provided perspective on how crowd funding differs from other investment vehicles.  

To watch the full video, follow this link.

Delaware Chancery Court Refuses to Enforce Post-Merger Stockholder Obligations

The Delaware Chancery Court refused to enforce certain obligations created under a letter of transmittal for a merger transaction. The letter of transmittal provided for (i) a broad release of claims in favor of the acquirer and (ii) an indemnity in favor of the acquirer covering the breach of certain representations and warranties made by the target company in the merger agreement. The case arose out of the acquirer's refusal to pay merger consideration to a target company stockholder that declined to execute the letter of transmittal.

In finding for the selling stockholder, the court refused to enforce the release due to lack of consideration. In particular, once the merger was effected, the selling stockholder held a vested right to receive the merger consideration. The release contained in the letter of transmittal was not supported by the payment of additional consideration. As to the indemnity provision, the court ruled that the provision was unenforceable because it allowed the acquirer to receive indemnity payments with no limit as to time or amount. In so ruling, the court stated that the open-ended indemnity provision violated Section 251(b)(5) of the Delaware General Corporation Law which requires that a merger agreement set forth a fixed amount of merger consideration.

Cigna Health and Life Ins. Co. v. Audax Health Solutions, Inc., C.A. No. 9405-VCP (Del. Ch. Ct. Nov. 26, 2014)

Delaware Limited Liability Company Not Required to be a Signatory to be Bound by its Operating Agreement

The Delaware Chancery Court ruled that a limited liability company could implement the fee shifting provision in its operating agreement without being a signatory thereto.  Under this provision, the prevailing party in an action has the right to recover its reasonable litigation expenses from the other party. The limited liability company sought to recover its reasonable litigation expenses under this provision. The other party obligated under the provision refused to make payment on the ground that since the limited liability company had not signed the operating agreement, it was not a "party" thereunder for purposes of litigation expense recovery.  The court rejected the foregoing defense as a matter of law. The court relied upon Section 101(7) of the Delaware Limited Liability Company Act which provides, in pertinent part, that "a limited liability company is bound by its limited liability company agreement whether or not the limited liability company executes the limited liability company agreement."

Seaport Village Ltd. v. Seaport Village Oper. Co., LLC, C.A. No. 8841-VCL (Del. Ch. Ct. Sept. 24, 2014)

Delaware Chancery Court Refuses to Dismiss Excessive Merger Termination Payment Claim

The Delaware Chancery Court dismissed a merger-based claim brought against the directors of a target company for failure to conduct an adequate sales process which resulted in inadequate merger consideration. The court, however, refused to dismiss a separate claim that the directors agreed to unreasonable deal protection measures.

The court analyzed the first claim under the Revlon standard since the merger was a sale of control transaction. Under this standard, the directors of the target company are obligated to maximize the merger consideration payable to the target company stockholders. The court, in ruling in favor of the directors, based its decision upon (i) all, but one of the directors being disinterested and (ii) the significant stock holdings of the directors which served to align their interests with the target company stockholders.

As to the second claim, the court found that the termination fee provision contained in the merger agreement may have been excessive thereby precluding the possibility of a superior or topping bid from being made by a third party. The merger agreement provided for a two-tier termination fee structure under which the target company would pay the acquirer a termination fee if the target company entered into a superior transaction with a third party. The termination fee payable in such event was dependent upon whether the "go-shop" period had expired. Additionally, if the termination payment was required to be made, then the target company would (i) reimburse the acquirer for its transaction expenses in an amount up to $1.5 million and (ii) pay the acquirer $3 million on account of bridge financing provided by the acquirer. The court determined that the foregoing payments, when viewed in the aggregate, could have had an unreasonably preclusive effect on potential bidders who might otherwise have topped the acquirer's offer. The court made its determination by comparing the percentage of the target company's enterprise value represented by the payments due to the acquirer against the range of enterprise value percentages Delaware courts have found to be reasonable.

In re Comverge, Inc. S'holder Litig. C.A. No. 7368-VCP (Del. Ch. Nov. 25, 2014).

Delaware Chancery Court Finds 17% Stockholder May Be a Controlling Stockholder

The Delaware Chancery Court, in refusing to dismiss breach of fiduciary duty claims, ruled that a 17.3% stockholder could be considered a controlling stockholder. The claims arose out of merger transaction initiated by the company's chief executive officer who held 17.3% of the target company's stock. The chief executive officer offered to purchase the remaining shares for $13.50 per share. In response to this offer, the company's board of directors formed a special committee which then engaged its own financial advisor and initiated a market check. The market check resulted in a third party making a non-binding bid at $15.00 per share. This bid, however, was subject to the chief executive officer's participation in the merger. The bid failed after the chief executive officer declined to participate.

The board of directors ultimately approved the merger transaction proposed by the chief executive officer even though the financial advisor was unable to render a fairness opinion. The approval of the merger was conditioned upon a 60-day go-shop period and a majority-of-the-minority approval vote. The go-shop period did not result in a superior bid and the merger was approved by a majority of the minority stockholders.

The court, after evaluating the facts and circumstances underlying the claim, ruled that the chief executive officer could be considered a controlling stockholder even though he owned only 17.3% of the company. The court, in reaching its ruling, relied upon disclosures contained in the company's Form 10-K filing that implied the chief executive officer possessed latent control because he could exercise significant influence over stockholder approval matters and had active control over the company's day-to-day operations.

In re Zhongpin Inc. S'holders Litig., C.A. No. 7393-VCN (Nov. 26, 2014)

Delaware Supreme Court Lifts Temporary Injunction to Block Merger Transaction

The Delaware Supreme Court reversed the Chancery Court's decision to temporarily enjoin a merger transaction. The temporary injunction was issued after the Chancery Court found that the target company's board of directors did not shop the company either before or after signing the merger agreement. The Chancery Court ordered that a go-shop process be initiated (even though such a process was prohibited under the merger agreement). In explaining its reason for issuing the order, the Chancery Court stated that it was "plausible" that the directors violated their Revlon duties to seek the highest value for the target company's stockholders.

The Delaware Supreme Court, however, ruled that the conduct of market check is not a prerequisite to finding that the directors have fulfilled their Revlon duties. In so ruling, the Supreme Court reaffirmed that no one specific sales procedure needs to be followed by directors in satisfying such duties.

C & J Energy Servs. Inc. v. City of Miami Gen. Emps.' Ret. Trust, No. 655/657 (Del. Sup. Ct. (en banc) Dec. 19, 2014)

U.S. Justice Department Settles "Gun Jumping" Charges Based on Hart-Scott Rodino Act Violation

The Antitrust Division of the U.S. Department of Justice filed a lawsuit against parties to an abandoned merger transaction. The Antitrust Division claimed that the acquirer had acquired operational control over the target company prior to the expiration of the statutory pre-merger waiting period under the Hart-Scott Rodino Act (the "HSR Act").  The HSR Act requires that parties to qualifying merger and acquisition transactions notify the federal antitrust agencies and observe a statutory waiting period.

The Antitrust Division alleged that the parties, instead of observing the waiting period, coordinated a business plan to close one of the target company's wood product mills and move the customers of such mill to a wood product mill operated by the acquirer.  The fact that the merger transaction was subsequently abandoned was of no consequence to the Antitrust Division. The parties to the abandoned merger transaction settled the lawsuit by agreeing to pay substantial civil penalties. The settlement serves as a reminder that competitors to a transaction subject to the HSR Act must remain competitors until such time as the transaction has received clearance under such Act.

Dept. of Justice Rel. No. 14-1246 (Nov. 7, 2014)

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