The First Quarter 2015 edition of the Ropes & Gray M&A Newsletter. Topics addressed in this edition include:

News from the Courts

  • Chancery Court Denies Enforcement of Drag-Along Right in Transaction Where Notice to Minority Stockholders Improperly Provided After Majority Stockholder Approval
  • Price Paid to, Inc. Stockholders Determined to be Fair, Despite Contrary Arguments from "Appraisal Arbitrage" Investors
  • In Earnout Dispute Cases, Chancery Court Rules on Implied Covenant of Good Faith and Scope of Arbitration
  • Chancery Court Declines to Apply Fee-Shifting Bylaw to Former Shareholder
  • Substantial Damages Awarded for Breach of Contractual Obligation to Negotiate in Good Faith

Delaware Legislative Update

Notable Deals

  • Kraft and Heinz to Merge in Deal Orchestrated by Warren Buffet and 3G Capital
  • Bidding War Ends for Salix Pharmaceuticals

London Update

  • The Small Business, Enterprise and Employment Bill: Timeline for Implementation of Key Corporate Aspects

Asia Update

  • China Continues Foreign Investment Reforms by Revising Foreign Investment Catalogue


Chancery Court Denies Enforcement of Drag-Along Right in Transaction Where Notice to Minority Stockholders Was Improperly Provided After Majority Stockholder Approval

In Halpin v. Riverstone National, Inc., the Chancery Court denied enforcement of customary drag-along rights where the controlling stockholders failed to properly exercise their drag-along rights in accordance with the governing stockholders agreement. The Chancery Court's decision highlights the importance of adhering to the letter of a stockholders agreement when exercising drag-along rights.

In Halpin, the acquisition of the company via a merger was approved by the written consent of the controlling stockholders. The stockholders agreement contained a customary drag-along right that required the minority stockholders to agree to a change of control transaction approved by the majority stockholders. When the company delivered an information statement to the minority stockholders after the merger was effectuated exercising the drag-along right and asking the minority stockholders to consent to the transaction after the fact, the minority commenced an appraisal action in lieu of consenting.

On summary judgment, the Chancery Court rejected the company's argument that the minority holders had waived their appraisal rights by virtue of agreeing to the drag-along rights in the stockholders agreement. The Court characterized the drag-along provision as an agreement by the minority stockholders to take action that, if taken, would have resulted in the waiver of their appraisal rights. But the minority stockholders were never called upon to take that action because the majority stockholders used their unilateral ability to approve the transaction by written consent. Consequently, the voting shares of the minority stockholders were extinguished before they received the information statement regarding the transaction and could be called upon to vote or provide their own consent. Had the majority holders followed the process contemplated by the stockholders agreement and compelled the minority holders to vote or consent in advance there would have been a different result.

The Court's ruling did not address the issue of whether it is possible for common stockholders to affirmatively waive statutory appraisal rights in advance in the form of an explicitly worded drag-along provision. While Delaware case law has held that preferred stockholders can affirmatively waive statutory appraisal rights in that manner, the issue of whether an advance waiver of statutory appraisal rights by common stockholders is enforceable remains unsettled.

Halpin v. Riverstone Nat'l, Inc., C.A. No. 9796-VCG (Del. Ch. Feb. 26, 2015)

Price Paid to, Inc. Stockholders Determined to be Fair, Despite Contrary Arguments from "Appraisal Arbitrage" Investors

In a January 30, 2015 Chancery Court decision, In Re Appraisal of, Inc., Vice Chancellor Glasscock found that the price paid for the $1.6 billion buyout of ("Ancestry") by private equity firm Permira Advisers LLC ("Permira") was fair.

In recent years, certain hedge funds have pursued an investment strategy known as "appraisal arbitrage" pursuant to which they acquire stock of a public company after a merger is announced, in the hope that the Chancery Court will determine that the fair value of such stock is actually higher than the merger price. Under Section 262 of the Delaware Code, dissenting stockholders who have perfected appraisal rights have the right to a judicial determination of the fair value of their stock based on the value of the acquired firm as a going concern. The returns associated with appraisal arbitrage can be substantial, including because the statutory interest rate for appraisal awards (which begins to accrue as of the merger's effective date) is the Federal Reserve discount rate plus 5%. In 2012, for example, Orchard Enterprise Inc. was ordered to pay hedge funds that successfully exercised appraisal rights more than twice the per share merger price. Appraisal arbitrage is not, however, without its risks. In assessing fair value, the Chancery Court may also determine that the fair market value for shares of an acquired company is at or below the merger price.

The acquisition of Ancestry by Permira was announced on October 22, 2012 at a price of $32 per share, which represented a 41% premium above the trading price of Ancestry's stock. Ancestry subsequently received written demands for appraisal on behalf of hedge fund stockholders collectively holding approximately 1.4 million shares. On December 27, 2012, Ancestry's stockholders approved the transaction, with 99% of the shares present and voting at the meeting voting in favor of the transaction.

Acknowledging that he found the approach taken by valuation experts on either side to be "less than fully persuasive," Vice Chancellor Glasscock nevertheless determined that "fair value" was "best represented by the market price," noting that the discounted cash flow valuation came close to the market price and gave comfort that "no undetected factor skewed the sales process." The Chancery Court allowed the petitioners to collect interest, limiting their potential losses.

Many see In Re Appraisal of, Inc. as a blow to the practice of appraisal arbitrage. There is language in the decision underscoring that the Chancery Court will look closely to the market in assessing fair value, barring exceptional circumstances, such as a poorly run sale process. In a transaction resulting from an arm's length process between independent parties where there are "no structural impediments" that might materially distort "objective market reality," the Court is likely to give "substantial evidentiary weight to the merger price as an indicator of fair value."

In a separate ruling earlier in January against Ancestry, the Chancery Court confirmed that for purposes of determining legal standing it is the record holder, not the beneficial owner, who must not have voted the shares for which appraisal is being sought. Furthermore, in the case of shares held in fungible bulk by a record owner, a record holder need only have at least as many shares not voted for in favor of a merger as those for which appraisal is being sought. Below, our Delaware Legislative Update summarizes some recently proposed amendments to the appraisal statute in response to the increasing prevalence of appraisal arbitrage.

In Re Appraisal of, Inc., C.A. No. 8173-VCG (Del. Ch. Jan. 30, 2015).

In Re Appraisal of, Inc., C.A. No. 8173-VCG (Del. Ch. Jan. 5, 2015).

In Earnout Dispute Cases, Chancery Court Rules on Implied Covenant of Good Faith and Scope of Arbitration

Even the most carefully drafted earnouts can become fertile ground for legal battles. In two recent decisions, the Delaware Chancery Court explored legal issues that are commonly implicated in earnouts.

In Fortis Advisors LLC v. Dialog Semiconductor PLC, the Court considered an earnout construct under which the acquirer of the business was required to use "commercially reasonable best efforts" to achieve the earnout targets. The merger agreement also included a number of specific obligations and prohibitions on the acquirer in connection with its operation of the business during the earnout period. Although the fact-intensive issue of whether the acquirer met the standards of the earnout provision still remains to be litigated, the Court dismissed the seller's alternative theory that the acquirer's conduct had breached the implied covenant of good faith and fair dealing. The Court noted that the implied covenant only applies where the written contract has left a gap that must be filled, with the covenant being violated if one party acts in a way that is clearly contrary to what the parties would have agreed had they addressed the gap. In Fortis, however, the Court found that the earnout provision left no gaps in defining the standard for the acquirer's conduct during the earnout period, and as a result the implied covenant was not implicated. Fortis confirms that plaintiffs cannot use the implied covenant of good faith and fair dealing as an end-run around a clearly drafted standard of conduct in an earnout provision.

In Weiner v. Milliken Design, Inc., the Court refused to rule on certain issues relating to an earnout dispute where the earnout provision of the purchase agreement required the parties to submit earnout disputes to an arbitrator. The Court reasoned that, given that the parties' clearly expressed intention to arbitrate earnout disputes, the Court would not interfere with the arbitrator's discretion to adjudicate the dispute. Weiner illustrates that, as we described in our report on Garda USA v. SPX in the First Quarter 2013 edition of the Ropes Recap, Delaware Courts will give effect to arbitration provisions and parties should be aware that entrusting an arbitrator to interpret earnout or (in the case of Garda) purchase price adjustment provisions may result in a different interpretation than what might have been provided by a court.

Fortis Advisors LLC v. Dialog Semiconductor PLC, C.A. No. 9522-CB (Del. Ch. Jan. 30, 2015); Weiner v. Milliken Design, Inc., C.A. No. 9671-VCP (Del. Ch. Jan. 30, 2015).

Chancery Court Declines to Apply Fee-Shifting Bylaw to Former Shareholder

In deciding what it characterized as an issue of "first impression," the Chancery Court recently held a fee-shifting bylaw to be inapplicable due to the timing of the bylaw's adoption. The plaintiff in the action, Strougo v. Hollander, challenged the fairness of a 10,000-to-1 reverse stock split completed by First Aviation Services, Inc. ("First Aviation") on May 30, 2014. The transaction had the effect of involuntarily cashing out the plaintiff and making First Aviation a privately-owned company controlled by its chairman and chief executive officer. A few days later, on June 3, 2014, the company's board of directors adopted a fee-shifting bylaw modeled after the bylaw considered in ATP Tour, Inc. v. Deutscher Tennis Bund, 91 A.3d 554 (Del. 2014).

Applying contract principles, Chancellor Bouchard held that the fee-shifting bylaw could have no application to the plaintiff because it was adopted after his interest in the corporation had been eliminated and he therefore was no longer a party to the bylaws at the time of the fee-shifting provision's adoption. The Court further reasoned that the omission of "former" stockholders from the text of Section 109(a) of the Delaware General Corporation Law indicated that that Section 109(a) only authorizes bylaws relating to the rights or powers of current stockholders.

The Court took care to emphasize that it was not called upon to decide broader issues involving the bylaw's application, including the "serious policy questions implicated by fee-shifting bylaws in general." As discussed below in our Legislative Update, the validity of fee-shifting bylaws remains subject to ongoing debate.

Strougo v. Hollander, C.A. No. 9770-CB (Del. Ch. Mar. 16, 2015).

Substantial Damages Awarded for Breach of Contractual Obligation to Negotiate in Good Faith

The Second Quarter 2013 edition of the Ropes Recap summarized SIGA Technologies, Inc. v. PharmAthene, Inc., a case in which the Delaware Supreme Court affirmed that a contractual obligation to negotiate in good faith is enforceable. In that case, SIGA Technologies and PharmAthene had negotiated a "nonbinding" license agreement term sheet. After the negotiation of the term sheet, PharmAthene provided SIGA Technologies with a bridge loan and the parties subsequently negotiated and executed a merger agreement. Both the bridge loan and the merger agreement contemplated that the parties would "negotiate in good faith with the intention of executing" a license agreement should the merger fail. The merger ultimately did fail, and in its May 2013 decision the Delaware Supreme Court affirmed the Chancery Court's conclusion that SIGA Technologies breached its contractual obligation to negotiate a license agreement in good faith after such failure.

On January 15, 2015, the Delaware Chancery Court held that SIGA Technologies was liable to PharmAthene for a total judgment of $195 million, consisting of expectation damages of $113 million, plus pre-judgment interest, legal fees, costs and expenses. The Chancery Court further ordered that the remaining claims and counterclaims made by SIGA Technologies and PharmAthene be dismissed with prejudice, including claims by PharmAthene for specific performance related to the license agreement and term sheet. The resolution of this case serves as a reminder of the magnitude of the damages that can result from an agreement to negotiate in good faith set forth in a letter of intent.

PharmAthene v. SIGA Techs., Inc., C.A. No. 2627-VCP (Del. Ch. Jan. 15, 2015).

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