From Clare O’Brien and Rory O’Halloran, partners at Shearman & Sterling LLP:
The terms of public company merger agreements typically require the target’s board of directors to recommend that its stockholders either vote in favor of the proposed merger or tender their shares into the tender offer or exchange offer, as applicable, and contain limitations on the target board’s ability to subsequently withdraw or qualify its recommendation. The merger agreement will, however, typically have exceptions, referred to as “fiduciary outs,” that permit the board to change its recommendation in certain circumstances. Although market practice, as well as Delaware case law, supports the view that some restrictions on a target board’s ability to change its recommendation are consistent with directors’ discharge of their fiduciary duties—including the board’s disclosure obligations under Delaware’s duty of candor—the scope of those permissible restrictions will depend on the particular terms (and other relevant facts and circumstances) of each transaction. Market practice in this regard has also evolved over the last several years, particularly with respect to the introduction, and then increasing use, of a so-called “intervening event” (discussed below) as a trigger for a board’s ability to change its recommendation. ...
Target companies are continuing to agree to restrictions on the ability of their board to change its recommendation. Upon review of the terms of 81 public merger agreements governed by Delaware law signed from July 1, 2014 to July 21, 2015, and valued at over $1 billion[9], 59 (or 73%) of the transactions limited the ability for a board to change its recommendation to circumstances in which the target receives a superior proposal or in which an intervening event occurs, and another four (or 5%) of the transactions limited the ability for a board to change its recommendation only to circumstances in which the target receives a superior proposal. Only 17 (or 21%) of the transactions provided for a broad fiduciary out that may be exercised upon a determination by a target board that not changing its recommendation would be inconsistent with its fiduciary duties. For one transaction involving an all-stock combination of two affiliated parties, the merger agreement provided for no fiduciary out. In light of these findings, it appears that target companies and their advisors typically allow some restrictions on a board’s ability to change its recommendation.
As mentioned above, Delaware courts have not directly addressed the extent to which restrictions agreed between parties to a merger agreement that limit a target board’s ability to change its recommendation are inconsistent with directors’ fiduciary duties. However, there is some commentary in the public domain that may be instructive. For example, at a 2009 panel discussion at the Tulane Corporate Law Institute at which restrictions on a target board’s ability to change its recommendation were discussed, Leo Strine (now Chief Justice of the Delaware Supreme Court, but then-Vice Chancellor of the Delaware Court of Chancery) was reported in the media to be “openly skeptical” of whether certain restrictions would be consistent with Delaware law. [10]
More recently, in In re NYSE Euronext Shareholders Litigation, then-Chancellor Strine of the Delaware Court of Chancery, in a bench ruling following oral argument, declined to issue a preliminary injunction on a stockholder vote to approve the proposed merger between NYSE Euronext (“NYSE Euronext”) and IntercontinentalExchange, Inc. (“ICE”). While noting that the definition of “superior proposal” in the merger agreement would have excluded a hypothetical alternate transaction proposal from a bidder who sought to acquire discrete businesses of NYSE Euronext, then-Chancellor Strine stated that he shared the plaintiffs’ skepticism that “contractual promises to lie in the future have any real commercial utility.” [11]
The problem I have with Strine's analysis is that the so-called "lie" is an artifact of Delaware's consistent hostility towards the use of precommitment devices. I wrote about this some years ago in Dead Hand and No Hand Pills: Precommitment Strategies in Corporate Law (October 30, 2002), available at SSRN: http://ssrn.com/abstract=347089, in which I argued that:
Corporations frequently make use of precommitment strategies. Examples include such widely used devices as negative pledge covenants and change of control clauses in bond indentures, fair price shark repellents, no shop and other exclusivity provisions in merger agreements, mandatory indemnification bylaws, and so on. This paper argues that poison pills also can be understood as a form of precommitment, by which the board of directors commits to a policy intended either to negotiate a high acquisition price or to maintain the corporation's independence.
In Quickturn Design Sys., Inc. v. Mentor Graphics Corp., the Delaware supreme court invalidated a no hand poison pill on grounds that a board of directors lacks authority to adopt such devices. In doing so, the court misinterpreted relevant Delaware law. It unjustifiably called into question the validity of a host of corporate precommitment strategies. Finally, and perhaps most troublingly, it called into question the central tenet of Delaware corporate law; namely, the plenary authority of the board of directors.
This article argues that the Delaware supreme court's decision was wrong both as a doctrinal and a policy matter. There simply is no firebreak between the sorts of board self-disablement deemed invalid by Quickturn and the host of other precommitment strategies routinely used by corporate boards of directors. The Delaware supreme court's conclusion that the former are invalid for lack of statutory authority thus threatens to invalidate all of the latter. The article concludes by arguing that the Delaware supreme court should have analyzed the no hand pill under standard fiduciary duty principles rather than creating a new prophylactic ban on precommitment strategies.
The idea that boards have continuing fiduciary duties that preclude them from entering into a binding precommitment has been the source of much bad law and, as a result, much unnecessary transactional gimcrackery.
