Edward McNally notes an interesting new Delaware Chancery Court decision:
As this decision points out again, when a board of directors is disinterested in the transaction, its decision to accept the first offer for its company does not run afoul of the Revlon doctrine just because there was no pre-agreement market check. Instead, their decision is subject to the business judgment rule.
Francis Pileggi elaborates:
This case addressed the claims that the duties of the directors in connection with the sale of the company, based on the seminal Delaware Supreme Court decision in Revlon, were breached. TheRevlon duties of a board, in essence, are fiduciary duties that require the directors to get the best price for the company when it is determined to be for sale, and the procedures employed by the board in connection with the sale or merger will be scrutinized to determine if they were consistent with the board’s obligations. This case recited the contours and parameters of those obligations, but reiterates that there is no formal script or procedures that the directors need to follow. Certain types of procedures and processes have been addressed over the many years that Revlon has been applied, however, and this opinion builds on that extensive jurisprudence.
Select Highlights of Legal Rulings
This decision provides additional guidance on two points in particular: Neither: (i) absence of a special committee, nor (ii) the absence of a pre-market check, will, per se, amount to a violation ofRevlon duties. Of course, this finding needs to be tethered to the facts of this case which include a board that: (i) was experienced in the oil and gas industry, (ii) was adequately involved in the negotiations, and (iii) had 7 out of 8 directors who were independent and disinterested.
This strikes me as half right. On the one hand,the holding that there is "no formal script or procedures that the directors need to follow" is clearly correct.
On the other hand, I am disappointed to once again see the Chancery Court apply Revlon simply because part of the consideration was paid in cash:
The Defendants do not dispute that Revlon applies to the Plaintiffs’ claim. See In re Smurfit- Stone Container Corp. S’holder Litig., 2011 WL 2028076, at *11-16 (Del. Ch. May 20, 2011) (applying the Revlon standard to a 50 percent stock and 50 percent cash merger). (p. 10 n.32)
As I explained at great length in The Geography of Revlon-Land, a transaction does not trigger Revlon simply because a substantial part of the consideration is in the form of cash:
The most directly relevant Delaware Supreme Court precedent is In re Santa Fe Pac. Corp. S’holders Litig. Santa Fe and Burlington were both publicly held Delaware corporations. After negotiations, they agreed to a complicated deal in which the two companies would make a joint tender offer for up to 33% of Santa Fe’s shares at $20 per share in cash. If successful, the offer would give Burlington 16% of Santa Fe’s remaining outstanding shares. If the offer succeeded, a freeze-out merger in which remaining Santa Fe shareholders would get Burlington shares in exchange for their Santa Fe stock would follow it. All the while, Santa Fe’s board of directors was fending off an unsolicited takeover bid by Union Pacific.
The Supreme Court rejected the plaintiffs’ argument that the deal triggered Revlon duties for Santa Fe’s directors, on grounds that plaintiffs “failed to allege that control of Burlington and Santa Fe after the merger would not remain ‘in a large, fluid, changeable and changing market.’” The clear implication is that the form of consideration was not the relevant issue. Instead, the issue was whether the Burlington shareholders would remain dispersed “in a large, fluid, changeable and changing market.”
Yet, in NYMEX, the Chancery Court characterized Santa Fe as simply setting a floor—33% cash—below which one did not enter Revlon-land. As for higher ratios, the Chancery Court 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.”
This characterization of Santa Fe is hard to square with the Supreme Court’s analysis in the case, which makes no reference to floors or ceilings, but rather to the post-deal “stock ownership structure of Burlington.” It is even more difficult to square with the three checkpoints established by Arnold v. Soc’y for Sav. Bancorp, Inc.
The Smurfit court finessed Arnold in the first instance by selective quotation of the key passage setting out the three checkpoints. The Smurfit court quoted it as follows:
The[SB1] Delaware Supreme Court has determined that a board might find itself faced with such a duty in at least three scenarios: “(1) when a corporation initiates an active bidding process seeking to sell itself or to effect a business reorganization involving a clear break-up of the company[ ]; (2) where, 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; or (3) when approval of a transaction results in a sale or change of control [.]”
The observant reader will note that the Chancery Court thereby omitted the critical qualifier Arnold adds to checkpoint # 3. To emphasize the point, let us quote the pertinent part of Arnold again in full: “(3) when approval of a transaction results in a sale or change of control. In the latter situation, there is no sale or change in control when [c]ontrol of both [companies] remain[s] in a large, fluid, changeable and changing market.”
Arnold’s clear implication is that an acquisition by a publicly held corporation with no controlling shareholder that results in the combined corporate entity being owned by dispersed shareholders in the proverbial “large, fluid, changeable and changing market” does not trigger Revlon whether the deal is structured as all stock, all cash, or somewhere in the middle. The form of consideration is simply irrelevant.
The Delaware Supreme Court’s more recent opinion in Lyondell confirms this reading of both Santa Fe and Arnold. In addition to the substantive errors made by the Chancery Court in Lyondell, the Chancery Court also took too expansive an approach to when Revlon-duties are triggered by holding that the target board enters Revlon-land when it “undertakes a sale of the company for cash.”
Checkpoint # 1 was inapplicable on Lyondell’s facts, because the target board had not initiated “an active bidding process,” let alone one that would involve a break up of the company. Checkpoint # 2 was inapplicable because the transaction did not involve a hostile offer or an abandonment of the target’s long-term strategy or a break up of the company.
Checkpoint # 3, however, was triggered once the target board decided to sell the company to Access, because Access was a privately held corporation. The transaction therefore would have involved a change of control from disperse public shareholders in “a large, fluid, changeable and changing market” to a single controlling shareholder. Although the Supreme Court did not quote that now proverbial standard, it did hold that one does not enter Revlon-land simply because a prospective target company is “in play.” Instead, one does so “ only when a company embarks on a transaction—on its own initiative or in response to an unsolicited offer—that will result in a change of control.”
Fairly read, this confirms that in the phrase “sale or change of control,” as used in checkpoint # 3, control must be understood to modify both the words sale and change. Accordingly, Lyondell confirms that the interpretation of Arnold and Santa Fe set out above is the correct one rather than that offered by the Chancery Court.
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[SB2] 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 any event, as the discussion in Part III.C makes clear, the relevant policy concern is not whether there is a tomorrow. To be sure, QVC spoke of “an asset belonging to public shareholders”; i.e., “a control premium.” As we saw above, although he did not cite QVC, Vice Chancellor Laster implicated this concern by holding that Revlon was triggered because the transaction at issue was the “only chance [the target shareholders would] have to have their fiduciaries bargain for a premium for their shares.”
If QVC is properly understood, however, the Supreme Court was not showing concern for whether there will be a tomorrow for the shareholders. Instead, as discussed above, the court was concerned in QVC with the division of gains between target and acquirer shareholders because the post-transaction company would have a dominating controlling shareholder.
As the analysis of QVC in Part III.C.2 explained, the relevant concern thus is the potential that conflicted interests will affect the target’s board of directors’ decisions. Indeed, as we have seen, even Vice Chancellor Lamb’s opinion in Lukens recognized that the motivating concern underlying Revlon is “the omnipresent specter that a board may be acting primarily in its own interest, rather than those of the corporation and its shareholders.” Curiously, however, Vice Chancellor Lamb brought that policy concern into play only with respect to whether the directors had satisfied their Revlon duties, while ignoring it when deciding whether those duties have triggered. But nothing in Revlon or QVC suggests that that policy is limited to the former issue rather than both inquiries.
Because the conflict of interest policy concern is the underlying driver of both aspects of Revlon, the Chancery Court in Lukens and its progeny should have considered whether the all- or partial-cash transactions necessarily implicate conflicts of interest akin to those at issue in Revlon and QVC. If the various Vice Chancellors had done so, they would have recognized that, so long as acquisitions of publicly held corporations are conducted by other publicly held corporations, diversified shareholders will be indifferent as to the allocations of gains between the parties. In turn, those shareholders also will be indifferent as to the form of consideration.
In contrast, if the transaction results in a privately held entity, a diversified shareholder cannot be on both sides of the transaction. If the post-transaction entity remains publicly held, but will be dominated by a controlling shareholder, there is a substantial risk that the control shareholder will be able to extract non-pro rata benefits in the future and get a sweetheart deal from target directors in the initial acquisition. In either situation, the division of gain matters a lot. As such, investors would prefer to see gains in such transactions allocated to the target. It is in these situations that Revlon therefore should come into play.