United States: Delaware Supreme Court Reverses Order Enjoining Stockholder Vote And Requiring Company To Solicit Alternative Proposals

On December 19, 2014, the Delaware Supreme Court reversed an injunctive order issued by the Court of Chancery temporarily enjoining a stockholder vote on the merger of C&J Energy Services, Inc. (C&J) with a subsidiary of Nabors Industries Ltd. (Nabors), requiring C&J to engage in a "go-shop" process by soliciting alternative purchase proposals despite provisions in the merger agreement between C&J and Nabors prohibiting such solicitation by C&J, and stating that such solicitations and resulting negotiations would not constitute a breach of the merger agreement. In reversing the order, the Delaware Supreme Court found that the Court of Chancery misapplied the standard of review for a preliminary injunction, based its analysis and ruling on "the erroneous proposition that a company selling itself in a change of control transaction is required to shop itself to fulfill its duty to seek the highest immediate value," and failed to apply the correct procedural standard for entering a mandatory injunction requiring C&J to engage in the go-shop process. C&J Energy Services, Inc. v. City of Miami General Employees' and Sanitation Employees' Retirement Trust, No. 655/657, 2014 (Del. Dec. 19, 2014).

Upon consummation of the proposed merger transaction, C&J will merge with a new subsidiary of Nabors that, following the transaction, will be owned 53 percent by Nabors and 47 percent by C&J's former stockholders. Because Nabors will own a majority of the surviving entity, the Court of Chancery applied Revlon, which requires a board in a change of control transaction to maximize the company's value for the benefit of the company's stockholders, in analyzing the transaction and issuing its injunctive order.

According to the Delaware Supreme Court decision, the plaintiffs contended, among other things, that (1) C&J's board did not recognize that it was entering into a change of control transaction and accordingly failed to conduct an active market check for other potential buyers, (2) C&J's Chief Executive Officer, chairman and founder, who was negotiating the merger transaction, failed to keep the board adequately informed, and (3) C&J's board failed to fulfill its fiduciary duties under Revlon by approving a change of control transaction without conducting an active market check. In response, the defendants contended, among other things, that (1) the merger transaction, which is "a highly favorable, strategic transaction," was approved by a disinterested board, (2) C&J's board was appropriately informed regarding the transaction, (3) Revlon does not apply, but even if it did, the board satisfied the Revlon requirements, and (4) the Court of Chancery misinterpreted Revlon by granting a preliminary injunction requiring C&J's board to engage in the go-shop process.

For purposes of its analysis, the Delaware Supreme Court assumed that Revlon applies because Nabors will own a majority of the surviving entity's voting shares following completion of the transaction. However, even with a proper application of Revlon, the Delaware Supreme Court determined that the Court of Chancery's injunctive order must be reversed for the reasons described below.

In reversing the order issued by the Court of Chancery, the Delaware Supreme Court found that the Court of Chancery misapplied the standard of review for a preliminary injunction by finding that there was "a plausible showing of a likelihood of success on the merits as to a breach of the duty of care, and that goes to an absence of an effort to sell" rather than a reasonable probability of success on the merits (which is the proper standard of review). The Delaware Supreme Court further noted that the Court of Chancery's decision itself, which outlines arguments against granting the injunction and highlights the lack of "rival bidders" during the five-month period after the transaction was announced, indicates that the plaintiffs did not meet the burden of demonstrating a reasonable probability of success on the merits.

In addition, the Delaware Supreme Court found that the Court of Chancery based its analysis and ruling on an erroneous understanding of Revlon, which "does not require a board to set aside its own view of what is best for the corporation's stockholders and run an auction whenever the board approves a change of control transaction." The Delaware Supreme Court also confirmed that that "Revlon and its progeny do not set out a specific route that a board must follow when fulfilling its fiduciary duties, and an independent board is entitled to use its business judgment to decide to enter into a strategic transaction that promises great benefit, even when it creates certain risks. When a board exercises its judgment in good faith, tests the transaction through a viable passive market check, and gives its stockholders a fully informed, uncoerced opportunity to vote to accept the deal, we cannot conclude that the board likely violated its Revlon duties." The Court also emphasized the importance of an effective market check process in which an interested bidder is provided with a fair and reasonable opportunity to present a higher-value alternative proposal and of ensuring that the board has the ability to accept such an alternative proposal.

In concluding that the Court of Chancery failed to apply the proper legal analysis in imposing the injunction, the Delaware Supreme Court noted several key factors: (1) the Court of Chancery's finding that the board had no improper motive and was well-informed with respect to the value of C&J, (2) the C&J board was aware that the transaction would result in a change of control and took steps to mitigate the effects of that change of control by including various protective provisions in the bylaws of the surviving entity, (3) the C&J board had negotiated a broad "fiduciary out" provision which would have allowed termination of the transaction in connection with a superior alternative proposal, and (4) there was sufficient time between the announcement of the transaction and the proposed closing date for an interested bidder to present an alternative proposal to C&J. Following this analysis, the Delaware Supreme Court stated that that the Court of Chancery could not have found a reasonable probability of success on the merits when applying Revlon correctly and should not have issued any injunction at all.

Finally, the Delaware Supreme Court found that the Court of Chancery also failed to apply the correct procedural standard for entering a mandatory injunction, which, in this case, required C&J to engage in a go-shop process in violation of the merger agreement and provided that such solicitations and resulting negotiations would not constitute a breach of the merger agreement. The Delaware Supreme Court further concluded that "[t]o blue-pencil an agreement to excise a provision beneficial to a third party like Nabors on the basis of a provisional record and then declare that the third party could not regard the excision as a basis for relieving it of its own contractual duties involves an exercise of judicial power inconsistent with the standards that govern the award of mandatory injunctions under Delaware law."

In summary, this Delaware Supreme Court decision serves as a useful reminder that, under Revlon, "there is no single blueprint that a board must follow to fulfill its duties" and a board can "pursue the transaction it reasonably views as most valuable to stockholders, so long as the transaction is subject to an effective market check." This decision further re-affirms that "[s]uch a market check does not have to involve an active solicitation, so long as interested bidders have a fair opportunity to present a higher-value alternative" and the board has the ability to accept such higher-value alternative in lieu of the originally proposed transaction. This decision also highlights the limitations imposed on a Delaware court's equitable authority – particularly where that equitable authority is being used to "blue-pencil" an agreement in a manner that will divest a third party of its contractual rights, while holding that third party to its contractual obligations.

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