Originally published on Law360, Securities Law, June 16, 2010
Recently, the Delaware Chancery Court issued a preliminary injunction blocking the closing of a merger until corrective disclosures were made on three issues in the corporation's proxy statement. In Maric Capital Master Fund, Ltd. v. Plato Learning, Inc., 2010 WL 1931084 (Del. Ch., May 13, 2010), the Court enjoined the cash acquisition of Plato Learning, Inc. by Thoma Bravo, LLC (TB) for $5.60 per share just six days before the scheduled stockholder meeting to approve the transaction and two weeks before the termination date under the merger agreement. Earlier in the day, the Court had rejected Maric Capital Master Fund's request for a preliminary injunction on the grounds that the Plato directors had failed to comply with their Revlon duties in seeking to sell the company. This case provides a useful reminder that the Delaware courts will closely scrutinize any transaction that is challenged by disaffected stockholders and that involves the sale of a controlling interest in a Delaware corporation.
The Court determined that there was a credible threat that stockholders were being asked to vote without complete and accurate information and, as a result, could suffer irreparable injury. First, Plato's proxy statement presented a materially misleading description of the investment bank's fairness opinion. Specifically, the Court found that the proxy statement inaccurately stated that the bank had selected a range of discount rates to use in its discounted cash flow (DCF) analysis based upon Plato's actual weighted average cost of capital (WACC). In fact, the bank had calculated two estimates of Plato's WACC, one using a variation of the capital asset pricing model and one using a comparable companies analysis. The range of discount rates generated by those analyses was presented to the special committee of the board. However, the bank adjusted Plato's range of discount rates significantly higher for its DCF analysis because the WACC of comparable companies is higher and Plato is a relatively illiquid micro-cap company. The Court found no evidence that the bank had told the special committee about the adjustments to Plato's WACC related to its DCF analysis. As a result, the Court concluded that the proxy statement presented a range of values suggesting that the merger price was far more attractive than the bank's actual valuation would suggest on the basis of Plato's actual WACC. The Court concluded that the merger could not go forward unless the proxy statement was supplemented with a corrective disclosure.
Next, the Court determined that the proxy statement selectively disclosed projections relating to Plato's future performance. In particular, the proxy statement inexplicably omitted the free cash flow estimates made by Plato's management and provided to its investment bank. The Court said that, in a cash merger, management's best estimate of the future cash flow of a corporation that is proposed to be sold is clearly material information that must be provided to stockholders. Since the value of a company's stock traditionally is based upon expected future cash flows of the company, the Court reasoned that the question for Plato's stockholders was whether the merger price is fair compensation for expected future cash flows. The Court concluded that the merger could not proceed unless management's free cash flow estimates were provided to Plato's stockholders.
Finally, the Court determined that the proxy statement mischaracterized the nature of discussions between TB (the purchaser) and Plato's senior officers regarding their future employment arrangements. The proxy statement said that the special committee and the board of directors of Plato, in reaching their decision to approve the merger, considered the fact that TB had not negotiated terms of employment with the corporation's senior management for the period after the merger closed. Thus, according to the proxy statement, the decision whether to sell Plato to TB was unaffected by any understandings between TB and the company's management about future economic arrangements. The Court found that although no formal negotiations may have taken place regarding an employment agreement with the CEO of Plato, the reality was that he had extensive discussions with TB about the "typical incentive package" that TB would give to Plato's management. During these discussions, the CEO also asked and received assurance that TB typically liked to keep existing management in place after an acquisition. Concluding that the proxy statement created a materially misleading impression that management was given no expectations regarding the treatment its members would receive from TB after the merger closed, the Court ordered that the proxy statement be corrected to clarify the extent of actual discussions between Plato's CEO and TB.
The Court ordered the parties to collaborate on drafting an implementing order and said that the injunction would be lifted after timely and satisfactory disclosures were made in a manner that gave the Plato stockholders an opportunity to adequately digest them before a final vote on the merger.
This case serves as an important reminder that the Delaware courts will not rubber stamp management's merger proxy statement. Under Delaware law, stockholders cannot be asked to make a tender or voting decision on the basis of materially misleading or inadequate information without suffering irreparable injury. The upshot is that Delaware courts will apply the same disclosure standards in a private merger context that the Securities and Exchange Commission applies in a public merger context.
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