United States: The Ropes Recap: Mergers & Acquisitions Law News - Second Quarter 2016


Delaware Court of Chancery Rejects Transaction Price as the Best Measure of Fair Value in Dell Appraisal Litigation

On May 31, 2016, the Delaware Court of Chancery released its post-trial opinion in the closely-watched appraisal action that arose from the buyout of Dell Inc. by Michael Dell, its founder, and a private equity backer. Despite finding that the transaction resulted from a disinterested, fair, and robust process that would have "sailed through" a traditional fiduciary duty review, Vice Chancellor Travis Laster nonetheless held, after a four-day trial featuring 1,200 exhibits and extensive witness testimony, including from five experts, that the $13.75 per share transaction price did not provide Dell stockholders with fair value for their shares.

The Dell opinion is notable in that, contrary to the recent trend in Delaware, the court did not accept the transaction's market price as presumptively representative of fair value. Vice Chancellor Laster refused to view the market price as determinative for a number of reasons, including the fact that the transaction was a management buy-out, evidence showing a gap between Dell's intrinsic value and its share price, and certain limitations in the transaction process, including the lack of meaningful pre-signing price competition and the limitations of the go-shop provision.

The Court instead employed a discounted cash flow (DCF) analysis to render an independent conclusion. Interestingly, the Court rejected the company's internal projections as overly optimistic, and instead focused on projections prepared by the special committee's financial advisor, the Boston Consulting Group, Inc., in connection with the transaction, as well as projections provided to the buyout group's lenders. The Court also rejected many of the conclusions offered by the parties' experts concerning the proper DCF inputs, seeing them as litigation-driven. Ultimately, the Court selected different inputs from each of the experts, and valued Dell at $17.62 per share, an approximate $6 billion increase from the total consideration paid. However, because so few stockholders participated in the appraisal action, Dell likely will pay former stockholders only $35 million as a result.

The Dell opinion reminds merger parties that although deal price may be the best indicator of fair value in most instances, it is not determinative. The Delaware Court of Chancery will scrutinize the transaction process to evaluate whether it is a reliable measuring stick for assessing fair value.

And even if that process would pass muster under a traditional fiduciary duty analysis, it may not be deemed the best measure of value. Here, the contrast between the market's "myopic" valuation of Dell and management's long-view assessment of the company raised concerns that the transaction price was artificially low and resulted from asymmetric information. Mr. Dell's role in the buyout also raised concerns about conflicts of interest and fairness. While some may view this opinion as breathing life into Delaware appraisal actions, the facts and circumstances surrounding the Dell transaction suggest that it may be an anomaly confined to its unusual facts. In a merger presenting none of these concerns, the Court of Chancery might very well follow its recent practice of giving substantial (often determinative) weight to a transaction price fairly and rigorously set. (In re: Appraisal of Dell, Inc., C.A. No. 9322-VCL (Del. Ch. May 31, 2016)).

Delaware Court Rejects Claim of Bad Faith Where Board Instructed Financial Advisor to Ignore Management's Optimistic Financial Projections

On May 20, 2016, Vice Chancellor Glasscock of the Delaware Court of Chancery issued a ruling in In Re Chelsea Therapeutics International Ltd. Stockholders Litigation granting dismissal of breach of fiduciary duty claims brought against the directors of Chelsea Therapeutics arising from a tender offer and intermediate merger under Section 251(h) of the Delaware General Corporation Law. The plaintiffs contended that the directors acted in bad faith by knowingly selling the company for an amount substantially below its standalone value, including by instructing the company's financial advisors to ignore a more optimistic internal financial model in favor of projections prepared by a consulting firm when conducting their fairness analysis.

The plaintiffs, however, failed to allege that the directors were interested in the transaction or otherwise lacked independence. Because the Chelsea directors were not alleged to have lacked independence in connection with the transaction, and because Chelsea's governing documents included a Section 102(b)(7) exculpatory provision, the Court focused its ruling on the narrow question of whether the plaintiffs had sufficiently alleged a non-exculpated claim that the directors had breached their duty of care. The Court noted that the plaintiffs were required to show an extreme set of facts to establish either that "disinterested directors were intentionally disregarding their duties" or that the Board's decision was "so far beyond the bounds of reasonable judgment that it seems essentially inexplicable on any ground other than bad faith." Scrutinizing the plaintiffs' allegations against that high bar, Vice Chancellor Glasscock dismissed the complaint because it was well within the bounds of reason for directors to decline to use optimistic projections of speculative value as indicators of the company's value.

In reaching its decision, the Court expressly declined to decide whether the holding of Corwin v. KKR Financial Holdings LLC—which held that the business judgment rule protects the conduct of directors in connection with transactions approved by a vote of fully informed, uncoerced, and disinterested stockholders—would apply to a transaction effected pursuant to Section 251(h). In declining to do so, the Court noted that it is unclear under Corwin whether a stockholder vote cleanses a board action in bad faith, even if the act is disclosed to stockholders before the vote. Second, the rule in Corwin applied to one-step mergers, not tender offers where there is no formal vote. (Note that the Chancery Court's subsequent decision in the Volcano case summarized below did apply the rule in Corwin to tender offers.) Given the particular difficulty of alleging a non-exculpated breach of fiduciary duties, this opinion highlights the deference Delaware courts will continue to extend to disinterested and independent directors not otherwise shown to be intentionally disregarding their duties in the conduct of a sale process. (In Re Chelsea Therapeutics Int'l Ltd. S'holders Litig., Consol. C.A. No. 9640-VCG (Del. Ch. May 20, 2016)).

Chancery Court Equates Tender of Shares to a Stockholder Vote in Determining the Standard of Judicial Scrutiny for Board of Directors Who Approved Volcano Corp. Merger

In a recent case, the Delaware Chancery Court held that business judgment review irrebuttably applies to board decisions in mergers where a majority of holders of a company's outstanding stock express their consent to a merger by tendering their shares in a "two-step" merger pursuant to Section 251(h) of the Delaware General Corporation Law (DGCL). Although such tenders offers are not formal stockholder votes, the Court held that the acceptance of a tender offer by a majority of the stockholders will have the same cleansing effect on board decisions under Delaware law as the approval of a merger by a vote of the majority of the stockholders.

The case arose from the acquisition of Volcano Corporation by Phillips Holding USA through a two-step merger pursuant to Section 251(h) of the DGCL. Certain shareholders of Volcano filed suit alleging that (among other things) the board breached its duties of care and loyalty because (1) the board members were motivated by certain benefits that they received in the transaction and (2) the board relied on the "flawed advice" of its conflicted financial advisor, Goldman, Sachs & Co., who had previously entered into a series of hedging transactions with Volcano in 2012. In its analysis of the standard applicable to the board's decision, the Chancery Court reviewed the recent Delaware Supreme Court decisions in Gantler v. Stevens and Corwin v. KKR Financial Holdings LLC and determined that business judgment review applies to mergers when a majority of a corporation's fully informed, un-coerced, and disinterested stockholders approve the merger though a statutorily-required vote. The Court went on to hold that, although there was no formal stockholder vote in this case, a tender offer commenced and consummated pursuant to Section 251(h) had a similar "cleansing effect" as a statutorily required stockholder vote. Citing the policy rationales for applying business judgment review to mergers that are approved by a statutory vote of the stockholders, the Volcano court held that there was no basis for distinguishing a statutory stockholder vote and a tender offer accepted by the majority of the stockholders pursuant to Section 251(h).

The Court's decision in Volcano makes clear that, if properly executed, the tender offer that comprises the first step of a two-step merger pursuant to Section 251(h) will be viewed in the same manner as a statutorily-required stockholder vote with respect to the standard of review for board decisions regarding such a transaction. Thus, so long as a majority of disinterested and fully informed stockholders have accepted such a tender offer, Delaware courts will apply business judgment review in examining the board decision relating to the tender offer. (In re Volcano Corp. Stockholder Litig., C.A. No. 10485-VCMR (Del. Ch. June 30, 2016)).

New York Court of Appeals Adopts Delaware Law, Affirming Business Judgment Deference for Kenneth Cole's Controlling Stockholder Transactions Structured with Minority Protections

On May 5, 2016, New York's highest court confirmed that, under New York law, business judgment deference—rather than the more searching "entire fairness" review—applies to controlling stockholder transactions that are approved by a duly empowered special committee of independent directors and that receive a "majority of the minority" vote from stockholders not affiliated with the controlling party. In In the Matter of Kenneth Cole Productions Inc. Shareholder Litigation, a case in which plaintiffs challenged the take-private of a New York corporation by its controlling stockholder, the New York Court of Appeals affirmed the trial court's dismissal of the case and adopted the Delaware Supreme Court's 2014 holding in Kahn v. M&F Worldwide Corp. (MFW). In adopting the MFW framework, the Court of Appeals aligned New York law with Delaware law, making the MFW mechanism available to New York corporations and offering a path for New York corporations to reduce litigation risk in connection with controlling party transactions.

The Kenneth Cole Productions litigation arose in 2012 after Mr. Kenneth Cole, the controlling stockholder of the prominent fashion retailer bearing his name, offered to purchase all of the outstanding Kenneth Cole stock that he did not already own. He also made clear that he would not sell his shares to another potential acquiror. In response, the company formed a special committee of independent directors to negotiate with Mr. Cole. The special committee engaged in successful negotiations to increase Mr. Cole's offer, and a deal was ultimately approved by the special committee and a majority of the non-controlling stockholders. Nonetheless, several stockholders sued in New York State court, challenging the transaction as unfair. In view of the protections afforded the non-controlling stockholders—an independent special committee and a majority of the minority vote—the trial court applied business judgment review and dismissed the consolidated action. After the intermediate Appellate Division affirmed and endorsed business judgment review, the plaintiff appealed to the State's highest court, the Court of Appeals, which similarly affirmed the trial court's determination.

The decision makes business judgment review available to controlling-party transactions involving New York corporations where the transaction at the outset is conditioned on its approval by both (1) a special committee comprised of independent, duly empowered directors and (2) a majority of the minority stockholders in a fully informed vote. To avoid application of business judgment review at the motion to dismiss stage, the burden is now on the plaintiff challenging such a transaction to "sufficiently and specifically allege" that the protections afforded the minority were not adhered to. Absent such allegations (or sufficient allegations of fraud or bad faith), New York law requires business judgment review for challenges to going-private transactions between a company and its controlling stockholder that are structured with the requisite minority protections, and transaction planners for New York corporations can now be confident that New York is aligned with Delaware in deferentially reviewing these types of transactions. (In the Matter of Kenneth Cole Productions, Inc., Shareholder Litigation, No. 54 (N.Y. May 5, 2016)).

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