ProfessorBainbridge.com

Airgas and the case for director primacy even in takeovers

In Unocal at 20: Director Primacy in Corporate Takeovers, Delaware Journal of Corporate Law, Vol. 31, No. 3, pp. 769-862, 2006, available at SSRN: http://ssrn.com/abstract=946016, I argued that:

In Unocal Corp. v. Mesa Petroleum Co., the Delaware Supreme Court made clear that the board of directors of a target corporation is not a passive instrumentality in the face of an unsolicited tender offer or other takeover bid. To the contrary, so long as the target board's actions are neither coercive nor preclusive, the target's board remains the defender of the metaphorical medieval corporate bastion and the protector of the corporation's shareholders. 

Unocal is almost universally condemned in the academic corporate law literature. Building on his director primacy model of corporate governance and law, however, Bainbridge offers a defense of Unocal in this article. Bainbridge argues that Unocal strikes an appropriate balance between two competing but equally legitimate goals of corporate law: on the one hand, because the power to review differs only in degree and not in kind from the power to decide, the discretionary authority of the board of directors must be insulated from shareholder and judicial oversight in order to promote efficient corporate decision making; on the other hand, because directors are obligated to maximize shareholder wealth, there must be mechanisms to ensure director accountability. The Unocal framework provides courts with a mechanism for filtering out cases in which directors have abused their authority from those in which directors have not.

A key part of that article is devoted to rebutting the arguments by those who would deny target boards of directors their usual discretionary powers in the takeover context. And now we have a case in point:

Airgas is a leading distributor of industrial, medical and specialty gases in the United States, selling canisters of oxygen and other gases to more than a million customers across the country. The deal to sell the company was an eye-opener for corporate America. ...

Wall Street law firms now hold up Airgas as one of the best arguments for management’s right to defend its company. Business schools around the country are seeking to turn the tale into a case study. ...

Despite the long odds, Mr. McCausland prevailed, by winning on appeal at the Delaware Supreme Court. The case preserved the ability of companies to defend themselves against hostile takeovers, without input from shareholders.

Despite the mewling and howling from the takeover industry, activist hedge and pension funds, and their academic allies along the Acela corridor, courts have given boards the power to determine what is in the best interests of the company ... if only the board has the stomach for it.

The complexities of the Yahoo deal

Steven Davidoff Solomon has a great rundown of the complex structure of the Yahoo-Verizon transaction. But inquiring minds still want to know if there might be any Sharon Steel issues.

Did Trados' innovation of entire fairness result from opportunity cost conflicts?

An interesting post and new paper by Abraham Cable argues that the answer to the titular question is "yes":

By way of review, Trados involved claims against the board of a startup company that was sold in a merger transaction.  Plaintiffs, who held common stock of the company, alleged that board members affiliated with the company’s VC investors were conflicted in approving the transaction.  The VC investors held preferred stock that provided for a “liquidation preference” in the event of a company sale.  Because of that liquidation preference, the VC investors received all of the merger consideration while common shareholders received nothing.   In an initial opinion, the court denied defendants summary judgment and determined that the claims should be evaluated under the plaintiff-friendly fairness standard. In a subsequent trial court opinion, the court confirmed applicability of the fairness standard but ultimately found in favor of the defendants because the common stock likely had no value (making zero a fair price). ...

In Opportunity-Cost Conflicts in Corporate Law, I explore a fundamental question: what precisely triggered fairness review in Trados?  Early analysis of the case focused on differences between preferred and common cash flow rights.    Analogizing to creditor-shareholder conflicts, these commentators noted that a fixed claimant (like a creditor) will have different incentives than a residual claimant (like a common shareholder). Fixed claimants may want to act conservatively in situations where residual claimants prefer rolling the dice.  And so a director affiliated with a VC fund holding preferred stock may want to sell the company and collect the liquidation preference while common shareholders might instead want to attempt a risky turnaround with at least some prospect of return to common holders.

While the trial court did partly embrace this creditor-shareholder analogy, it also identified a second and conceptually distinct source of conflict between a VC-controlled board and common shareholders.  Citing corporate law scholarship, the court noted that VC investors may shut down even moderately successful companies because time is scarce and more promising companies in the VC’s portfolio may require the VC’s attention.  I deem this an “opportunity-cost conflict,” in reference to the bedrock economic principle that the cost of a course of action is the highest value alternative forsaken. ...

The preceding post comes to us from Abraham J. B. Cable, Associate Professor at the University of California Hastings College of the Law.  The post is based on his article, which is entitled “Opportunity-Cost Conflicts in Corporate Law” and available here.

Personal pet peeve: What do "best efforts" and variants mean?

Francis Pileggi reports that:

In an expedited deal litigation matter, in The Williams Companies, Inc. v. Energy Transfer Equity, L.P., C.A. No. 12168-VCG (Del. Ch. June 24, 2016), the Court of Chancery denied a request to enjoin Energy Transfer Equity, L.P. (“ETE”) from evading a deal based on its inability to obtain a tax opinion that was a condition precedent to closing on a deal with The Williams Companies, Inc. ...

One of the key facts of the case was that a condition precedent to consummation of the merger was the issuance of an opinion by the tax attorneys for ETE at the law firm of Latham & Watkins. ... Although Latham initially, at the time the agreement was signed, expected to be able to issue that opinion, after the agreement was signed something changed. Based on changing market conditions and reduced value of the stock on the tax impact, Latham disclosed that it was no longer able to issue such an opinion. One of the claims that Williams maintained against ETE was that it failed to use “commercially reasonable efforts” to secure the Latham opinion and, therefore, materially breached its contractual obligations. ...

Delaware is a contractarian state, and recognizes and respects provisions in contracts that favor specific performance in case of breach. But conditions precedent to a transaction must be enforced as well. ...

The court observed that the phrase “commercially reasonable efforts” was not defined in the agreement, and that even though the phrase has been addressed in other cases – – “the term is not addressed with particular coherence in our case law”. The phrase has also been articulated as “reasonable best efforts” which has been described as “good-faith in the context of the contract at issue.” Citing Hexion Specialty Chemicals Inc. v. Huntsman Corp., 965 A.2d 715 (Del. 2008), the court found that the phrase “commercially reasonably efforts” in the agreement in this case required the purchaser, ETE, to submit itself to a “objective standard to ‘do those things objectively reasonable to produce the desired’ tax opinion in the context of the agreement reached by the parties.”

Which brings me to one of my pet peeves: Lawyers using "best efforts" and its variants without understanding its meaning.

These sort of phrases are routine in commercial and M&A contracts but are almost never defined therein:

Update: In an earlier version of the post, I inadvertently failed to credit the author of the study from which the summary chart was taken. With sincere apologies, I do so now: Kenneth A. Adams, Understanding “Best Efforts” And Its Variants (Including Drafting Recommendations). It's an extremely helpful guide that I strongly recommend. 

In my M&A class, I follow this slide up with the following: 

Bottom line: Lawyers use these phrases without thinking about what they mean or how a court will interpret them. 

What I tell my class is simple: Define the terms (unless you've got a really good strategic reason for not doing so that's been validated by at least two experienced M&A lawyers).

Bainbridge on Davidoff Solomon on the Tesla--Solar City deal

Steven Davidoff Solomon thinks the proposed Tesla Solar City deal is a bad one that amounts to Elon Musk bailing out Solar City:

Solar City is a maker of solar energy products, basically home and business solar panels. Tesla is a maker of battery-powered cars, though some view the company’s battery-making component as its bigger future.

To Elon Musk, the chairman of SolarCity and the chief executive of Tesla, putting together these two different businesses is “blindingly obvious” and a “no-brainer.” A blog post on the Tesla website explained the reasons:

We would be the world’s only vertically integrated energy company offering end-to-end clean energy products to our customers. This would start with the car that you drive and the energy that you use to charge it, and would extend to how everything else in your home or business is powered.

In other words, the deal makes sense because people who buy Tesla’s cars also want solar power. In a combined company, they can get it in the same place.

The market is not buying it.

To investors, it is as if the Walt Disney Company bought a birthing center business to offer “end-to-end” service for its parent customers. It’s not clear that Tesla owners will really want to buy solar panels, or that if they did, it would be in sufficient number.

I don't think the deal is as bad as all that. I happen to be one of those people who thinks Tesla's future is at least as much in the power generation storage domain as the car space. I have no immediate plans to trade in my Jeep on a Tesla, but I do toy with the idea of adding solar power to the roof of my house. If I do so, I'm pretty sure I'll also get the Tesla Powerwall battery system to store excess solar power-generated electricity for use at night or whenever conditions are suboptimal. Not being able to store solar power for use at night has always struck me as a major downside to solar. If that's right, then integrating panel and battery production may well make business sense.

Having said that, Musk has a pattern of moving money around his various imperial domains seemingly at will (see, e.g., the SpaceX bond matter) and otherwise engaging in conflict of interest transactions. Given that track record, if I were Musk's lawyer, I'd want him to dot all the legal Is and cross all the legal Ts to a fare thee well.

Davidoff Solomon apparently is viewing this deal as essentially an interested director transaction subject to DGCL 144(a):

Tesla did announce some procedures to deal with this conflict. Mr. Musk recused himself from the deliberations at Tesla and Mr. Rive said the same thing at SolarCity. In addition, Tesla said that any deal would be subject to approval by a majority of its disinterested shareholders.

This is part of the standard procedure in conflict situations. The general idea is that each company forms a committee of independent directors with its own advisers and legal counsel. This would ensure approval of the disinterested directors. Then any deal itself would be subject to approval of the disinterested shareholders. The State of Delaware, where a majority of American companies are incorporated, technically requires only that either the disinterested directors or disinterested shareholders approve the deal, but the standard practice is to do both.

In contrast, I would view this deal as being akin to a freeze-out merger by a controlling shareholder (it's not exactly that but I think the analogy works). As such, if I were advising Musk, I'd advise him to adopt the full panoply of prophylactic measures approved by the Delaware Supreme Court in Kahn v. M & F Worldwide Corp., 88 A.3d 635 (Del. 2014):

To summarize our holding, in controller buyouts, the business judgment standard of review will be applied if and only if: (i) the controller conditions the procession of the transaction on the approval of both a Special Committee and a majority of the minority stockholders; (ii) the Special Committee is independent; (iii) the Special Committee is empowered to freely select its own advisors and to say no definitively; (iv) the Special Committee meets its duty of care in negotiating a fair price; (v) the vote of the minority is informed; and (vi) there is no coercion of the minority.

If those conditions are not met, the burden of proof would be on Musk to show that the transaction was entirely fair to the minority shareholders. Trust me, you do not want to be a defendant with the burden of entire fairness in a conflict of interest case. Granted, the choice between the business judgment rule and entire fairness standards of review "is not outcome-determinative and ... defendants prevail under [the fairness] standard of review with some degree of frequency." In re Ezcorp Inc. Consulting Agreement Derivative Litig., No. CV 9962-VCL, 2016 WL 301245, at *28 (Del. Ch. Jan. 25, 2016), reconsideration granted in part, (Del. Ch. Feb. 23, 2016), and appeal refused sub nom. MS Pawn Corp. v. Treppel, 133 A.3d 560 (Del. 2016), and appeal refused sub nom. Roberts v. Treppel, 133 A.3d 560 (Del. 2016). But even so the entire fairness standard is "the most exacting form of review." In re Cysive, Inc. Shareholders Litig., 836 A.2d 531, 557 n.40 (Del. Ch. 2003). "The burden of establishing entire fairness has been perceived as extremely difficult to meet." 6 No. 10 M & A Law. 9 (2003).

Is a sale of stock qualitatively different than a sale of other assets?

I had occasion today to be working on a project involving Katz v. Bregman, 431 A.2d 1274 (1981). As informed readers will now, of course, in it Plant Industries sold off a series of unprofitable divisions. When it proposed to sell one of its principal remaining subsidiaries, however, a shareholder sued claiming the transaction would entail a sale of all or substantially all the remaining assets. Through its various subsidiaries, the company had been in the business of manufacturing steel storage and shipping drums. Using the proceeds of its various sales, the company planned to go into the business of manufacturing plastic shipping and storage drums.

The legal issue presented was whether the transaction constituted a sale of substantially all Plant Industries’ assets, such that shareholder approval was required under DGCL § 271(a). In assessing whether shareholder approval was required, the Chancellor began with quantitative metrics. The subsidiary to be sold represented 51% of the firm’s remaining assets, which generated 44.9% of total revenues and 52.4% of pre-tax earnings. Turning to qualitative measures, the court opined that the planned switch from steel to plastic drums would be “a radical departure,” by which the corporation would sell off the core part of the business in order to go into an entirely new line of business. Taken together, the nature of the transaction, plus the fairly high percentage of assets being sold, satisfied the “all or substantially all” standard and shareholder approval therefore was required.

Here's the part that caught my eye. The court noted in passing that “in the case of Wingate v. Bercut (C.A. 9) 146 F.2d 725 (1945), in which the Court declined to apply the provisions of 8 Del.C. § 271, it was noted that the transfer of shares of stock there involved, being a dealing in securities, constituted an ordinary business transaction.” Should a sale of stock be treated any differently than a sale of any other asset?

There’s no obvious reason that a sale of stock should be treated differently than a sale of any other asset. Suppose Holding Corp. has three unincorporated divisions: Alpha (80% of Holding’s assets), Beta (10%), and Charlie (%%), with 5% consisting of headquarters assets. If Holding sells all of the assets of Alpha to a buyer, it is likely to be deemed a sale of substantially all Holding’s assets. Why should the answer change if the subsidiaries were separately incorporated and Holding sold all of the stock of Alpha?

Wingate is properly understood as holding that the stock in question, “although a principal asset of the Holding Company, was not ‘all its property and assets, including its good-will and corporate franchises’”[1] on the facts of the specific case before it. It should not be understood as holding that sales of stock are somehow qualitatively different than sales of other assets.

[1] Wingate v. Bercut, 146 F.2d 725, 729 (9th Cir. 1944) (quoting the lower court decision).

When an acquirer spots red flags: Should Microsoft's board beware?

The NY Times report on Microsoft's planned acquisition of Linkedin contains a phrase corporate lawyers hate to see:

Satya Nadella, the Microsoft chief executive, may have abandoned his prudent approach.

His $26.2 billion deal to buy LinkedIn could reinvigorate the software giant’s slipping grip on corporate computer systems and employee interactions. Paying a nearly 50 percent premium for a flawed business raises several red flags, however.

Numerous Delaware cases (mostly arising in the oversight context, of course) hold that independent directors will be liable for acting in bad faith only when they ignore alleged “red flags” that are “either waved in one’s face or displayed so that they are visible to the careful observer.” Rattner v. Bidzos, 2003 WL 22284323 at 13 (Del. Ch. 2003), quoting In re Citigroup Inc. S’holders Litig., 2003 WL 21384599, at *2 (Del. Ch. 2003).

Of course, this is a different situation than those in the Caremark lineage. Here we have an acquisition with potential red flags. Acquirer boards are rarely sued in M&A cases and almost never lose. Yet, there have been some red flag cases in the M&A context. 

As a result, before approving the deal, Microsoft's board would be well advised to explore such issues as:

• The 30% drop in LinkedIn's stock price since its high.
• Well-publicized warnings about slowing growth.
• The security breach.
• Microsoft's history of overpaying in acquisitions.

The worst thing a board--acquirer or target--can do in the M&A context is to just rubber-stamp the CEO's plans. When the financial press is warning that "Concrete indications of the deal’s financial benefits are in worryingly short supply," the board needs to be especially careful in conducting a deliberative process.

“The Structure of M&A Contracts”

Ken Adams' excellent guide to drafting M&A contracts is now available as a print book, which is a lot easier (for the most part) to read than the ebook version, with one important exception:

... the print version uses a small format, so the figures are small, with small type. And the figures are a big part of the book. So go here for a PDF version of the figures; if you buy the print version of the book, you might want to consult a printout of the PDF. You’re welcome.

Will Trulia Drive “Merger Tax” Suits Out Of Delaware?

Anthony Rickey and Keola Whittaker tackle the titular question in a WLF Backgrounder. It concludes:

While there are some preliminary indications of a short-term decline in merger litigation, this may not last. Trulia’s influence will be clearer once courts outside of Delaware consider its reasoning and explicitly adopt or reject its approach. However, if non-Delaware courts remain willing to approve disclosure-only settlements and generous fee awards, Trulia may simply drive weak claims to other jurisdictions.

Given recent trends, enterprising plaintiff's attorneys may file merger-related shareholder lawsuits outside of Delaware as vehicles for disclosure-only settlements precluded by Trulia. In turn, Delaware defendants may decide not to adopt or enforce a Delaware forum-selection clause so that they may obtain a broad release in a more settlement-friendly jurisdiction.

Christina Hurt on "The Hostile Poison Pill"

Christine Hurt weighs in on NOL pills with a skeptical analysis:

Whether one ascribes to the agency theory of shareholder primacy or the contractarian theory of director primacy, boards of directors have great discretion in determining whether, when, and how to sell the corporation.  Defensive tactics, like poison pills, can be tools in wielding that discretion in the service of creating shareholder value.  However, a poison pill designed either to oppress a minority shareholder, as in eBay v. Newmark,[1] or to minimize the impact of activist shareholders, as in Versata Enterprises, Inc. v. Selectica, Inc.,[2] seems to exceed the “maximum dosage” of the pill.  The “tax benefits preservation plan,” or net operating loss (NOL) poison pill, while facially plausible as a tool to protect tax assets from impairment caused by a Section 382 “ownership change,” may be a low-trigger anti-shareholder wolf tactic in Unocalsheep’s clothing.  ...  A brief look at issuers that adopted NOL poison pills between 1998 and 2014 and an analysis of how Section 382 of the Internal Revenue Code works suggests that preserving NOLs may not be the chief concern of boards adopting tax benefits preservation plans.

She goes on to say: "Instead of warding off uninvited potential acquirers, the [NOL] pill could ward off even low-level shareholder voice," as if that were a bad thing.

Christine also makes the apt observation that:

NOL poison pills do not work.  Traditional pills work:  the deterrence value of diluting a 15% or 20% shareholder keeps that shareholder at bay.  The deterrence value of diluting a 5% shareholder who wants to acquire the company eventually is very small.  That shareholder values the NOLs at zero because an acquisition will trigger Section 382 anyway, and that shareholder, particularly in the microcap space, will not find dilution a large loss.  And of course, an NOL pill does not deter either an accidental share purchase or a saboteur.  In fact, the only shareholder that the NOL poison pill effectively deters is the activist shareholder, suggesting that the use of the poison pill in these cases may be “hostile.”

It's an important contribution to the literature.

I've got a Revlon corporate law question

Suppose a board of directors of a corporation incorporated in Delaware initiates a Revlon auction by initiating an active bidding process seeking to sell itself. After a special committee of independent and disinterested directors conducts a fair and reasonable process, the company gets two offers. After consulting with independent financial advisors, the special committee recommends that the board reject both offers as inadequate. What standard of review applies if a shareholder and/or one of the offerors sues the board for breach of fiduciary duty? What result?

Would your answer change if the confidentiality agreement signed by both bidders includes a don't ask don't waive 3-year standstill provision?

 

The effect of the Zillow/Trulia decision

Congratulations to Fordham Law Professor Sean Griffith, whose outstanding crusade against the pernicious wave of disclosure-only settlements is now coming to fruition. As Forbes reports:

Plaintiff lawyers were warned last year, and now a Delaware judge has delivered a potentially crippling blow to “disclosure-only” settlements that reward lawyers with rich fees but give their clients nothing.

In a detailed, 42-page ruling issued today, Chancery Court Judge Andre Bouchard formally rejected a settlement lawyers at Rigrodsky & Long and several other firms  negotiated with Zillow last year over its $3.5 billion takeover of Trulia. That settlement, as is typical with these sorts of cases, provided nothing for their shareholder clients except for “supplemental disclosures” of information beyond the 200-page proxy statement they had already received detailing the terms of the merger. It did promise something of great value to Zillow: a global release of all claims stemming from the merger, including “unknown claims” the plaintiffs weren’t even aware of yet.

Going forward, plaintiff lawyers won’t be able to staple such broad releases to their settlement deals. And that means those lawyers won’t have nearly as much leverage to negotiate their fees, since one of the main things they had to offer in exchange was court-approved protection from any further litigation.

“From the perspective of some defendants in some cases, this isn’t so good because they just lost their $400,000 global release,” said Sean Griffith, a professor at Fordham Law School who successfully challenged the Zillow settlement. “But for defendants overall, it will mean fewer cases challenging mergers.”

I think Prof. Griffith is right that this decision may be a game changer. A new study of takeover litigation by Matthew Cain and Steven Davidoff Solomon finds that:

Takeover litigation was substantially disrupted in 2015 by the Delaware courts' willingness to challenge "disclosure only" settlements. For the full year, lawsuits were brought in 87.7% of completed takeovers versus 94.9% in 2014. However, the lawsuit rate dropped precipitously in the fourth quarter of 2015 to 21.4% of all transactions in the wake of Delaware's challenge. There were also substantial delays in the approval of litigation settlements and attorneys' fee awards. Multi-jurisdictional litigation continued its sharp decline, falling approximately 50% from its 2012 high. Despite the higher rates of dismissals, large awards and settlements were give in litigation arising from the Rural/Metro, Dole and Freeport-McMoRan transactions, among others.

Another likely outcome will be accelerated adoption of forum selection clauses. Indeed, investors now have a strong incentive to insist that companies adopt such bylaws, so that their companies are less subject to meritless litigation and so that there is less incentive for plaintiff lawyers to settle meritorious cases on terms that benefit only themselves and the defendants who get global releases in return for a few worthless disclosures. And that's a good thing, because as Chancellor Bouchard observed, under the current regime:

... far too often such litigation serves no useful purpose for stockholders. Instead, it serves only to generate fees for certain lawyers who are regular players in the enterprise of routinely filing hastily drafted complaints on behalf of stockholders on the heels of the public announcement of a deal and settling quickly on terms that yield no monetary compensation to the stockholders they represent.

So how will these cases be handled in the future? Bouchard explained the problem to which he was responding as follows:

In such lawsuits, plaintiffs’ leverage is the threat of an injunction to prevent a transaction from closing. Faced with that threat, defendants are incentivized to settle quickly in order to mitigate the considerable expense of litigation and the distraction it entails, to achieve closing certainty, and to obtain broad releases as a form of “deal insurance.” ...

Once the litigation is on an expedited track and the prospect of an injunction hearing looms, the most common currency used to procure a settlement is the issuance of supplemental disclosures to the target’s stockholders before they are asked to vote on the proposed transaction. The theory behind making these disclosures is that, by having the additional information, stockholders will be better informed when exercising their franchise rights. Given the Court’s historical practice of approving disclosure settlements when the additional information is not material, and indeed may be of only minor value to the stockholders, providing supplemental disclosures is a particularly easy “give” for defendants to make in exchange for a release.

Once an agreement-in-principle is struck to settle for supplemental disclosures, the litigation takes on an entirely different, non-adversarial character. Both sides of the caption then share the same interest in obtaining the Court’s approval of the settlement. ...

It is beyond doubt in my view that the dynamics described above, in particular the Court’s willingness in the past to approve disclosure settlements of marginal value and to routinely grant broad releases to defendants and six-figure fees to plaintiffs’ counsel in the process, have caused deal litigation to explode in the United States beyond the realm of reason. ... [PB: Kudos to the Chancellor for taking accountability and responsibility for his court having helped create the problem.]

So here's the solution:

... practitioners should expect that disclosure settlements are likely to be met with continued disfavor in the future unless the supplemental disclosures address a plainly material misrepresentation or omission, and the subject matter of the proposed release is narrowly circumscribed to encompass nothing more than disclosure claims and fiduciary duty claims concerning the sale process, if the record shows that such claims have been investigated sufficiently. In using the term “plainly material,” I mean that it should not be a close call that the supplemental information is material as that term is defined under Delaware law.

In addition, Bouchard specifically endorsed the emergent practice of mootness dismissals in which "defendants voluntarily decide to supplement their proxy materials by making one or more of the disclosures sought by plaintiffs, thereby mooting some or all of their claims." The defendants then move to dismiss the case on mootness grounds.  In response, it is increasingly common for the plaintiffs to dismiss their actions without prejudice to the other members of the putative class (which has not yet been certified)." The Chancery Court then "reserves jurisdiction solely to hear a mootness fee application." As Bouchard pointed out, "[i]n that scenario, where securing a release is not at issue, defendants are incentivized to oppose fee requests they view as excessive."

 

Is Pep Boys' Termination Fee too Big?

Anne Tucker Anne Lipton writes:

The Pep Boys – Manny, Moe & Jack (NYSE:  PBY) merger triangle with Bridgestone Retail Operations LLC and Icahn Enterprises LP is proving to be an exciting bidding war.  The price and the pace of competing bids has been escalating since the proposed Pep Boys/Bridgestone agreement was announced on October 16, 2015.  Pep Boys stock had been trading around $12/share. Pursuant to the agreement, Bridgestone commenced a tender offer in November for all outstanding shares at $15.  

Icahn Enterprises controls Auto Plus, a competitor of Pep Boys, the nation's leading automotive aftermarket service and retail chain.  Icahn disclosed an approximately 12% stake in Pep Boys earlier in December and entered into a bidding war with Bridgestone over Pep Boys.  The price climbed to $15.50 on December 11th, then $17.00 on December 24th. Icahn Enterprises holds the current winning bid at $18.50/share, which the Pep Boys Board of Directors determined is a superior offer.  In the SEC filings, Icahn Enterprises indicated a willingness to increase the bid, but not if Pep Boys agreed to Bridgestone's increased termination fee (from $35M to 39.5M) triggered by actions such as perior proposals by third parties.  Icahn challenged such a fee as a serious threat to the auction process.

Regardless of which company ends up claiming control over Pep Boys, this is a excellent example of Revlon principles in action and also shows the effect of merger announcements (and the promised control premiums) have on stock price.

Which raises the question: If Icahn sued, would Pep Boys' increased termination fee (standing alone) violate Revlon? I don't think so. Pp Boys has 55 million shares outstanding. At $18.50 per share, the deal currently has a value of $1,017,500,000. A $39.5M termination fee thus is only 3.88% of the deal value, which is well within the range courts have approved.

In the corporate world, termination fees are a common and generally accepted method to “reimburse the prospective purchaser for expenditures incurred in pursuing the transaction.” Gray v. Zondervan Corp., 712 F.Supp. 1275, 1276-77 n. 1 (W.D.Mich.1988).

Cancellation fee provisions typically require the [seller] to pay the bidder a specified dollar amount. * * * [T]he fee ordinarily ranges from one to five percent of the proposed acquisition price. A cancellation fee reduces the risk of entering a negotiated merger by guaranteeing the initial bidder reimbursement for the out of pocket costs associated with making the offer and, in some instances, for the bidder's lost time and opportunities. Accordingly, they are increasingly common in negotiated acquisitions.

Stephen M. Bainbridge, Exclusive Merger Agreements and Lock-Ups in Negotiated Corporate Acquisitions, 75 Minn.L.Rev. 239, 246 (1990).

St. Jude Med., Inc. v. Medtronic, Inc., 536 N.W.2d 24, 27 (Minn. Ct. App. 1995).

To be sure, while Delaware courts have "upheld termination fees of greater than three percent of total deal value," the courts have also made clear that "[t]hough a '3% rule' for termination fees might be convenient for transaction planners, it is simply too blunt an instrument, too subject to abuse, for this Court to bless as a blanket rule." Louisiana Mun. Police Employees' Ret. Sys. v. Crawford, 918 A.2d 1172, 1181 n.10 (Del. Ch. 2007). Instead, "plaintiffs must specifically demonstrate how a given set of deal protections operate in an unreasonable, preclusive, or coercive manner, under the standards of this Court's Unocaljurisprudence, to inequitably harm shareholders." But it's hard to see how a termination fee of less than 4% is going to be deemed preclusive or coercive if it's the only deal protection device in play.

Under Unitrin, a defensive measure is disproportionate and unreasonable per se if it is draconian by being either coercive or preclusive. A coercive response is one that is “aimed at ‘cramming down’ on its shareholders a management-sponsored alternative.”

 

A defensive measure is preclusive where it “makes a bidder's ability to wage a successful proxy contest and gain control either ‘mathematically impossible’ or ‘realistically unattainable.’ ”

Versata Enterprises, Inc. v. Selectica, Inc., 5 A.3d 586, 601 (Del. 2010). Given that Icahn is already the superior bidder, it's hard to see how such a small termination fee crams the Bridgestone offer down on Pep Boys' shareholders. Likewise, it hardly precludes Icahn from obtaining control. Indeed, why would a mere $4.5M bump in the fee's size scare Icahn off from raising the bid? So Icahn's complaint seems to be mere puffery.

Anabtawi on Predatory Management Buyouts

My friend, UCLAW colleague, coauthor, and office next door neighbor Iman Anabtawi has a post up at CLS' Blue Sky Blog discussing her new article on predatory management buyouts.

Even where the business judgment rule does not apply in the first instance because its preconditions are not satisfied, Delaware corporate law allows the use of ex ante procedural protections to avoid ex post substantive judicial review. D. Gordon Smith makes this point in “The Modern Business Judgment Rule,” which is forthcoming in the Research Handbook on Mergers and Acquisitions. In my forthcoming article, “Predatory Management Buyouts,” I analyze the related question whether the procedural mechanisms that, under Delaware law, boards may implement in order to “sanitize” the conflict-of-interest taint present in management buyout (MBO) transactions are adequate to achieve parity between transactions in which the business judgment rule attaches in the first instance and MBOs that invoke a procedural route back to the business judgment rule. The article raises a broader issue that I plan to address in future work whether, when we round-trip from the business judgment rule and back again via procedural mechanisms, we always end up in the same place.

Highly recommended.

Activist bidder teams face new insider trading problems

Alison Frankel has the details on pending litigation involving claims that "pharmaceutical company Valeant’s partnership with Bill Ackman’s Pershing Square in a bid for Allergen" involved illegal insider trading. Raider-activist alliances must surely rank very high on target management's list of nightmare scenarios, but as Frankel points out:

Pershing’s Allergan profit was the product of the stealth it maintained by acquiring shares through options deals that carried the added benefit, under Pershing’s thinking, of insulating the hedge fund from insider trading liability to Nomura counterparties. Judge Carter’s decision strips away the insulation, putting Pershing’s profit at risk.

If hedge funds can’t count on short-term profits from stealth partnerships with hostile bidders, why team up with them? For the longer term? Just ask Ackman how that’s working out for him and Valeant.