My article The Geography of Revlon-Land (forthcoming 81 Fordham L Rev ___ (2013)), explains that when a target board of directors enters Revlon-land, the board’s role changes from that of “defenders of the corporate bastion to auctioneers charged with getting the best price for the stockholders at a sale of the company.”
A critical question then is to identify the checkpoints at which target boards cross the border into Revlon-land. My article argues that a number of Chancery Court decisions in the last decade have erred by holding that certain cases fall within the borders of Revlon-land even though both binding Delaware Supreme Court precedents and sound policy argue that those cases do not do so.
The cases towards which my analytical ire are directed are In re Lukens Inc. Shareholders Litig., 757 A.2d 720 (Del. Ch. 1999); In re NYMEX Shareholder Litig., 2009 WL 3206051 (Del. Ch. 2009); In re Smurfit-Stone Container Corp. S’hlder Litig., 2011 WL 2028076 (Del. Ch. 2011); Transcript of Ruling of the Court on Plaintiffs’ Motion for a Preliminary Injunction, Steinhardt v. Howard-Anderson, C.A. No. 5878-VCL (Del. Ch. Jan. 24, 2011) (copy on file with author).
Properly understood, there are three checkpoints through which one enters Revlon-land. Checkpoint #1 requires the target corporation to initiate “an active bidding process seeking to sell itself or to effect a business reorganization involving a clear break-up of the company,” with it being unclear whether the reference to a “break-up” modifies both halves of this checkpoint or only the latter. Checkpoint #2 requires that, “in response to a bidder’s offer, a target abandons its long-term strategy and seeks an alternative transaction involving the break-up of the company.” Checkpoint # 3 requires “a sale or change of control” of the target. See Arnold v. Soc’y for Sav. Bancorp, Inc., 650 A.2d 1270, 1289-90 (Del. 1994).
It is the third checkpoint that has been the problem child. It is well-settled law that in a merger of equals of publicly held companies in which the shareholders receive stock of the post-transaction combined entity there is no sale or change of control because control of the combined entity after the merger remained “in a large, fluid, changeable and changing market.” But what if some or all of the merger consideration were cash? Would that change the result? In my article, I put forward three variants of this hypothetical:
In this hypothetical, change the facts by changing the form of consideration. Version A entails a merger between Acme and Ajax in which Ajax shareholders get cash for their stock. Version B entails a triangular merger between Ajax and a wholly owned Acme subsidiary in which the Ajax shareholders get cash. Version C is a tender offer for any and all Ajax shares for cash to be followed by a freeze-out merger in which and remaining Ajax shareholders will be squeezed out in return for cash.
Checkpoint # 1 is not triggered on the bare facts of any of these versions of the hypothetical. Ajax did not initiate an active bidding process seeking to sell itself. Likewise, none of the transactions will result in a business reorganization involving a clear break up of the company.
Checkpoint # 2 is not triggered, inter alia, because none of Ajax’s actions were responsive to an unwanted offer.
As for checkpoint # 3, the key issue is whether a cash sale constitutes “a sale or change of control.” A going private transaction in which the target is acquired for cash by a private equity firm obviously would enter Revlon-land via this third portal, but what if the acquirer is publicly held and has no controlling shareholder? To answer that question, one must know whether control modifies both “sale” and “change” or only modifies “change.” If the former, cash sales do not trigger Revlon duties if the acquirer is publicly held.
Lukens and its progeny have found Revlon duties to be triggered by transactions in which all or part of the acquisition consideration consisted of cash. As noted, my article argues that Lukens and progeny misapply binding precedents (most notably In re Santa Fe Pac. Corp. S’holder Litig., 669 A.2d 59 (Del. 1995)), and also get the policy wrong.
I am delighted to report, however, that not all of the Chancellors are going down the Lukens road. In an opinion issued last Friday (how's that for being up to date?), In re Synthes, Inc. S’holder Litig., C.A. No. 6452 (Del. Ch. Aug. 17, 2012) (copy on file with author), Chancellor Leo Strine held that:
[P]laintiffs are also wrong on the merits of their argument that Revlon applies. Their sole basis for claiming that Revlon applies is that the Synthes stockholders are receiving mixed consideration of 65% J&J stock and 35% cash for their Synthes stock, and that this blended consideration represents the last chance they have to get a premium for their Synthes shares. But under binding authority of our Supreme Court as set forth in QVC and its progeny, Revlon duties only apply when a corporation undertakes a transaction that results in the sale or change of control. … [T]he mixed consideration Merger does not qualify as a change of control under our Supreme Court’s precedent. A change of control “does not occur for purposes of Revlon where control of the corporation remains, post-merger, in a large, fluid market.” Here, the Merger consideration consists of a mix of 65% stock and 35% cash, with the stock portion being stock in a company whose shares are held in large, fluid market. In the case of In re Santa Fe Pacific Corp. Shareholder Litigation, the Supreme Court held that a merger transaction involving nearly equivalent consideration of 33% cash and 67% stock did not trigger Revlon review when there was no basis to infer that the stock portion of that consideration was stock in a controlled company. That decision is binding precedent.
Id. at 42-43 (footnotes omitted). Accordingly, Chancellor Strine held, “plaintiffs are also wrong on the merits of their argument that Revlon applies.” Id. at 42. Chancellor Strine’s holding is fully consistent with the understanding of Revlon and its progeny advanced in my article.
Curiously, Chancellor Strine failed to discuss my article! (I am, of course, jesting.) Even more curiously, however, Chancellor Strine did not discuss any of the contrary Chancery Court precedents. Perhaps the issues were not properly briefed?
In any case, I do wish the Chancellor had engaged Lukens and its progeny. Among other reasons, those cases tried to finesse Santa Fe by treating that case as simply setting a floor—33% cash—below which one did not enter Revlon-land. As for higher ratios, the Chancery Court in NYMEX relied on Lukens for the proposition that the Delaware “Supreme Court has not set out a black line rule explaining what percentage of the consideration can be cash without triggering Revlon.” It would have been helpful if Chancellor Strine had addressed that interpretation.
Chancellor Strine also could have addressed another argument advanced in Lukens and progeny. As I explain in my article:
The logic of the Chancery Court decisions rests on the policy that target shareholders who get cash have no opportunity to participate in the potential post-acquisition gains that may accrue to shareholders of the combined company:
Defendants emphasize that no Smurfit–Stone stockholder involuntarily or voluntarily can be cashed out completely and, after consummation of the Proposed Transaction, the stockholders will own slightly less than half of Rock–Tenn. … Defendants lose sight of the fact that while no Smurfit–Stone stockholder will be cashed out 100%, 100% of its stockholders who elect to participate in the merger will see approximately 50% of their Smurfit–Stone investment cashed out. As such, like Vice Chancellor Lamb’s concern that potentially there was no “tomorrow” for a substantial majority of Lukens stockholders, the concern here is that there is no “tomorrow” for approximately 50% of each stockholder’s investment in Smurfit–Stone. That each stockholder may retain a portion of her investment after the merger is insufficient to distinguish the reasoning of Lukens, which concerns the need for the Court to scrutinize under Revlon a transaction that constitutes an end-game for all or a substantial part of a stockholder’s investment in a Delaware corporation.
As we have seen, however, this concern makes no sense. As long as the acquirer is publicly held, shareholders who get cash could simply turn around and buy stock in the post-acquisition company. They would then participate in any post-transaction gains, including any future takeover premium. Only if there has been a change of control is that option foreclosed.
In Synthes, the plaintiffs likewise argued that Revlon was triggered by a deal “represent[ing] the last chance they have to get a premium for their [target company] shares.” Id. at 43. Chancellor Strine rejected that argument, holding that the plainitffs were “wrong on the merits.” Id. at 42. At least implicitly, Chancellor Strine thus rejected the focus in Steinhardt on the final period aspect of the transactions at bar. It would have been helpful, however, if he had squarely rejected Smurfit et al.
Finally, in a newly added section of the article, I ask whether the Chancery Court is groping towards a new understanding of Revlon, which would necessitate a broader application to a wider array of transactions. I argue that, if so, this evolutionary process is misguided. In Synthes, Chancellor Strine reminds us that it is not the Chancery Court's role to overturn Supreme Court precedents. The Chancellor explicitly based his holding on the “binding authority of our Supreme Court as set forth in QVC and its progeny,” pursuant to which “Revlon duties only apply when a corporation undertakes a transaction that results in the sale or change of control.” Id. at 43. A few lines later he referred to Santa Fe as "binding precedent." As suggested by his use of the word “binding,” trial courts are supposed to follow higher court precedents even when they disagree with them.
The trouble is that Lukens et al claim fidelity to Santa Fe. Hence, once again, it would have been helpful if Strine had met those cases head on. Are they consistent with the binding Supreme Court precedent or not? (Perhaps Strine feels a reprimand for his Chancery cooleagues also should come from the Supreme Court.)
In any event, this is a strong opinion that gets it exactly right (IMHO). Chancellor Strine has done it again.