and insurance coverage for, objection suits: the basics

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© 2013 Edwards Wildman Palmer LLP & Edwards Wildman Palmer UK LLP

Fundamentals of, and Insurance Coverage for, Merger Objection Suits:The Basics

Presented by:

John D. Hughes

Jacquelyn Burke

Gregory D. Pendleton

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Introduction

♦ Typical characteristics of a merger objection lawsuit.

♦ Case Studies.

♦ Insurance implications.

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“For better or worse, after the announcement of a merger oracquisition, stockholder class action suits typically follow likemushrooms follow the rain.”

‐Dias v. Purches, 2012 WL 4503174 (Del. Ch. Oct. 1, 2012).

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Introduction

Hypothetical:

♦ Public Company A is the target of an acquisition by Public Company B.

♦ Company B offers a 30% premium over Company A’s current stock price.

♦ This price is still below the previous 12 month high.

♦ Company A would become a subsidiary of Company B.

♦ All inside directors would remain employees.

♦ All inside directors would receive stock in Company B.

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What is a Merger Objection Lawsuit?

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The shareholders of Company A will almost definitely sue.

♦ These suits have “skyrocketed” in recent years.

♦ In 2007, litigation followed a merger/acquisition in:

♦ 53% of deals over $500 million*

♦ 21% of deals over $100 million*

♦ In 2012, litigation followed a merger/acquisition in:

♦ 96% of deals over $500 million.**

♦ 93% of deals over $100 million.**

♦ Roughly 2/3 of suits filed within 2 weeks of deal announcement.

♦ Settlement on average is reached within two months. * Cornerstone Research, 3/2012 Report**Cornerstone Research, 2/28/2013 Report


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♦ Approximately 80% filed in state court.*

♦ 72% of cases in 2012 filed in multiple states.

♦ Often a lower pleading standard after Ashcroft v. Iqbal, 556 U.S. 662 (2009).

♦ More plaintiff friendly.

♦ Delaware law permits a forum‐selection clause in the corporate charter.

♦ Chevron/FedEx case recently decided by Chancellor Strine.

♦ Delaware‐only forum selection bylaws valid; expect an appeal.

♦ Underwriting tip: Does your insured have this provision?

♦ More than 250 public companies have adopted these in the past several years.

*NERA Economic Consulting Report 7/24/12


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♦ Without a forum selection clause, there is a risk of parallel litigation going forward in different states simultaneously.

♦ See, e.g., NJ Carpenters v. NYSE Euronext, No. 654496/2012 (NY)

♦ Judge Kornreich in New York refused to stay the case despite a parallel case pending before Chancellor Strine in Delaware, suggesting that courts “work together” instead.

♦ In March 2013 New York’s First Department stayed the New York case for 60 days until after preliminary injunction hearing in Delaware; in May 2013, Chancellor Strine denied the injunction.

♦ In June 2013, the shareholders approved the merger.

♦ See also Matter of Topps Co. Inc. Shareholder Lit., 2007 NY Slip Op 52543(U)

♦ “New York clearly has an overwhelming nexus to this controversy and is a highly appropriate forum for its resolution.”

♦ Proceeded in New York and Delaware until settlement.

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♦ Shareholders allege that the directors of the target company breached their fiduciary duties by failing to make an informed decision regarding the adequacy of the purchase price or failed to “shop” the target.

♦ Frequently include claims for misrepresenting or omitting material information in the proxy materials.

♦ These are direct, not derivative, claims because the injury is to the shareholders, not the corporation. See Parnes v. Bally Entertainment Corp., 722 A.2d 1243 (Del. 1999).

♦ But see Hannon’s Inc. vs. Berkshire Hathaway Inc. and H.J. Heinz Company.

♦ The suits often allege an aiding and abetting claim against the acquiring company/firm (e.g., a private equity firm).


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Outcomes

♦ Of merger objection cases filed in 2012 that have been resolved:

♦ 64% settled.

♦ 33% were dismissed.

♦ 3% voluntarily withdrawn.*

♦ For securities class action cases in 2012:

♦ 28% settled prior to ruling on motion to dismiss (after 2.3 years of litigation)

♦ 64% settled prior to ruling on summary judgment (after 3.5 years of litigation)

♦ 6% after that (after 4.9 years of litigation).**

*Cornerstone Research, 2/28/13**Cornerstone Research, 2012 Securities Class Action Settlements

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Outcomes

♦ In 81% of cases that settled in 2012, shareholders received only supplemental disclosures and nothing else, and their attorneys were paid their fees.

♦ Average attorneys’ fees $725,000.♦ $540,000 for disclosure‐only settlements.

♦ Fees influenced by size of settlement; number of suits filed; and overall deal value, among other factors.

*All stats from Cornerstone Research, 2/28/13

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♦ In re Transatlantic Holdings Inc. Shareholder Litigation, DE Chancery Court No. 6574‐CS

♦ Bench ruling by Chancellor Leo E. Strine, Jr. on 2/28/13♦ Harbinger of the future or merely a “bump in the road”?

♦ Plaintiffs sought to enjoin a vote by Transatlantic stockholders on the Allegheny transaction in light of alleged deficiencies in the proxy statement.

♦ Transatlantic filed an 8‐K with supplemental disclosures. ♦ Strine found that these supplemental disclosures did not “contradict or meaningfully affect the flow of information in a way that is different from what the board is suggesting.”

♦ Plaintiffs’ request for attorneys’ fees denied.

Outcomes

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Outcomes

♦ Koehler v. Netspend Holdings Inc., DE Chancery Court No. 8737‐VCG

♦ Ruling by Chancellor Glasscock on 5/21/13

♦ Plaintiffs sought to enjoin the acquisition of NetSpend by Total System Services.

♦ Injunction denied, because “stockholders will lose their chance to receive a substantial premium over market…and because no other potential bidders have appeared.”

♦ However, plaintiffs showed a reasonable likelihood that the sales process “was not designed to produce the best price for stockholders” because of deal protection provisions and a lack of market checks.

♦ This ruling may encourage a big settlement after the vote.

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♦ Two large settlements in 2012 (for 2011 transactions):♦ $110 million in El Paso/Kinder Morgan.♦ $49 million in Delphi Financial/Tokio Marine.

♦ In September 2011, Del Monte settled for $89.4 million, including $22.3 million in attorneys’ fees.

♦ Average settlement 2003‐2009: $36 million.

♦ Average settlement 2010‐2012: $78 million.

*All stats from Cornerstone Research, 2/28/13

Outcomes

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Back to the Hypothetical

♦ What should the board of Company A do?

♦ Evaluate the offer and make a recommendation to the shareholders.

♦ A majority of the shareholders must approve the sale. 8 Del. C. § 271(a).

♦ What is the standard by which the offer should be measured?

♦ What are the fiduciary duties the board members are bound by?

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Delaware Law

♦ 39% of M&A suits in 2012 were filed in Delaware.*

♦ Uptick from just 25% as recently as 2011.*

♦ Delaware corporate law provides the framework for analyzing the duties of the directors and the shareholders’ claims.

*Cornerstone Research, 2/28/2013 Report

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What is the Standard for Measuring the Offer?

♦ Directors have a duty to seek and attain the highest immediate value reasonably attainable to stockholders.

♦ Known as the “Revlon” duty.

♦ See Revlon v. MacAndrews & Forbes, 506 A.2d 173 (Del. 1985).

♦ A fairness opinion from a disinterested investment banker is crucial.

♦ Directors should perform a “market check” to be sure they are getting the best price.

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What Are the Directors’ Fiduciary Duties?

♦ Duty of Care

♦ Duty of Good Faith

♦ Duty of Loyalty

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♦ Duty of care:

♦ Directors are required to act reasonably to maximize value for shareholders.

♦ This usually means performing a pre‐ or post‐signing market check to assure the highest price available has been obtained.

♦ Section 102(b)(7) of the Delaware code protects directors from monetary damages for breach of the duty of care (and only the duty of care).

♦ Duty of good faith: “conscious disregard of duty.”

♦ In re Walt Disney Co., 906 A.2d 27 (Del. 2006).


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♦ Duty of Loyalty: Anti‐conflict of interest rule.

♦ A majority of directors must be both (1) disinterested (money) and (2) independent (relationships).

♦ Cede & Co. v. Technicolor, Inc.

♦ “Independence” means that the directors will not benefit financially, or through job security or other intangibles, from their new position at the acquirer.

♦ Absence of conflict applies to the board’s advisers: legal, financial.

♦ In re Del Monte.


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♦ Delaware has three tiers for evaluating director decision making:

♦ The Business Judgment Rule

♦ Enhanced Scrutiny

♦ Entire Fairness

What is the Standard for the Court’s Evaluation?

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♦ As a suit begins, the court first asks:

♦ Was the board independent of the acquirer?

♦ Or, was there a special board committee that was independent?

♦ Did the board or the committee receive independent legal and financial advice?

♦ If the directors can establish this independence, the decision of the directors is entitled to the protection of the business judgment rule.

♦ In re Synthes, Inc. Shareholder Litigation, 967 A.2d 640, (Del. Ch. 2008).

What is the Standard for the Court’s Evaluation?

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The Business Judgment Rule

♦ “The rule posits a powerful presumption in favor of actions taken by the directors, in that a decision made by a loyal and informed board will not be overturned by courts unless it cannot be attributed to any rational business purpose…. A shareholder plaintiff assumes the burden of providing evidence that directors…breached any one of the triad of their fiduciary duty—good faith, loyalty or due care. If a shareholder plaintiff fails to meet this evidentiary burden, the business judgment rule attaches to protect corporate officers and directors and the decisions they make, and our courts will not second guess these business decisions.”

• Cede & Co. v. Technicolor, Inc., 634 A.2d 345 (Del. 1993)

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Enhanced Scrutiny

♦ Enhanced scrutiny applies when directors face potentially subtle or situational conflicts that do not rise to a level triggering entire fairness review, but also do not comfortably permit expansive judicial deference, i.e., the business judgment rule.

♦ In re Del Monte Foods Shareholders Litigation, 25 A.3d 813, 831 (2011)

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Entire Fairness

♦ If a majority of the board of directors or the committee were not independent or did not get independent advice, the burden shifts to the directors.

♦ Also invoked when the acquirer is already the majority shareholder.

♦ The directors now have to demonstrate that the share price met the two prongs of the “entire fairness” standard.

♦ Fair process: considering alternatives, consulting experts, disclosing facts.

♦ Fair price: “within the range of fairness.”

♦ See, e.g., Weigand v. Berry Petroleum Co., C.A. No. 9316 (Del. Ch. Mar. 27, 1991).

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Entire Fairness

♦ In deals that involve an acquisition by a controlling shareholder, defendants can shift the burden of proving “entire fairness” by showing either that the transaction was approved by:

♦ A “well‐functioning” committee of independent directors; or

♦ An “informed vote” of a majority of the minority shareholders.

♦ See, e.g., Americas Mining Corp. v. Thibeault, 51 A.3d1213, 1218‐19 (Del. 2012).

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Typical Procedural Posture

♦ Shareholders move to enjoin the transaction, alleging:

♦ Share price was too low.

♦ Board breached a duty by recommending a price based on conflicted or bad advice.

♦ The recommendation made by the board was misleading because there were insufficient disclosures, or the timing of the disclosure harmed certain shareholders.

♦ Thus, the adequacy of the disclosures is fought at the time the injunction is sought.

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♦ In order to close the deal, the defendants will often: ♦ Agree to supplemental disclosures.♦ Revise procedures relating to the transaction.

♦ i.e., an extended period to solicit bids.♦ Not oppose plaintiffs’ request for an award of attorneys’ fees.

♦ Attorneys’ fees are awarded under the “corporate benefit” doctrine.♦ Exception to the American Rule. ♦ Delaware looks at the benefit conferred; judges have discretion over

fee award.


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♦ After the deal closes, the litigation often continues over the recommendation of the board and plaintiffs can seek damages based on the allegedly suppressed purchase price.


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Case Study: In re El Paso

Background facts

♦ El Paso to be sold to Kinder Morgan for $21.1 billion.

♦ Plaintiffs alleged breach of fiduciary duty due to two conflicts, sought injunction against deal:

♦ El Paso CEO negotiated the sale, but did not disclose that he wanted to buy certain aspects of the El Paso business from Kinder Morgan.

♦ El Paso board relied on advice from Goldman Sachs, which owned 19% of Kinder Morgan.

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Outcome

♦ Injunction denied.

♦ Chancellor Strine: Shareholders could vote to deny, or seek money damages, without court intervention.

♦ Sale went forward with 95% of shareholders approving.

♦ Kinder Morgan ultimately paid a total of $136 million.

♦ $110 million to El Paso shareholders.

♦ Goldman forewent $20 million fee; instead went to shareholders.

♦ $26 million in plaintiffs’ attorneys’ fees.

Case Study: In re El Paso

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Case Study: Del Monte

Background Facts

♦ PE firms KKR, Vestar, and Centerview sought to buy Del Monte.

♦ Plaintiff shareholders sought preliminary injunction, alleging that Barclays both advised Del Monte and provided financing to the buyers.

♦ Injunction granted; 20‐day window to solicit higher bids.

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Outcome

♦ No higher bids were made.

♦ Sale went forward with 75% of shareholders approving.

♦ Del Monte ultimately paid $65.7 million to shareholders.

♦ Barclays paid $23.7 million.

♦ $22 million in plaintiffs’ attorneys’ fees.

Case Study: Del Monte

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Background Facts

♦ Berkshire Hathaway and 3G seek to take over Heinz.

♦ Offered $72.50/share, a 20% premium.

♦ On February 13, 2013, shareholders sued in Pennsylvania federal court to block the deal in two suits.

♦ Brought derivatively per Pennsylvania law.

Case Study: Heinz

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Case Study: Heinz

Alleged Shareholder Problems with Merger Agreement

♦ “No solicitation” and “no shop” provisions: Heinz cannot shop to other potential bidders.

♦ “Information rights” provision: Heinz must share information on any other bids with Berkshire Hathaway.

♦ “Matching rights” provision: Heinz must tell Berkshire how to match any other bid.

♦ A $750 million termination fee should another buyer be found.

♦ Main complaint is that the deal allowed directors to turn illiquid stock into $400 million in cash, skewing their incentives.

♦ Stock is at an all time high, future of the company is bright.

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♦ After expedited discovery, both federal plaintiffs filed for voluntary dismissal.

♦ Federal court granted the motions on April 10 and 12.

♦ “The consideration being offered in the merger is within the range of financial fairness.”

–Motion for Voluntary Dismissal

♦ State court suits dismissed on April 30, 2013.

♦ Court followed the recommendations of the SLC set up by Heinz, as they were “within the province of the board of directors.”

♦ 95% of shareholders then voted to approve the merger.

Case Study: Heinz

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Insurance Issues

Two options for coverage:

♦ Coverage under target company’s D&O Policy, through a run‐off endorsement.

♦ “The Insured shall have the right to a period of 6 years following the Effective Time in which to give written notice to the insurer…”

♦ Acquiring company can be added to the run‐off as an additional insured.

♦ The acquiring company agrees to maintain D&O insurance for the directors of the former company.

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♦ The directors are the defendants on the claims for breach of fiduciary duties, not the target entity.

♦ Coverage under Side A for directors.

♦ Entity coverage under Side B for indemnified claims.

♦ Side B retention can be problematic for directors, depending upon trigger for Side A coverage.

♦ Typically, no entity coverage under Side C because M&A objection suits are not “Securities Claims.”

♦ Defense costs for the directors are likely covered.

Insurance Issues

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Insurance Issues: Bump‐Up Exclusion

♦ Any indemnity payments for an increase in the share price are likely not covered under a “bump up” exclusion.

♦ Example: “In the event of a Claim alleging that the price or consideration paid or proposed to be paid for the acquisition or completion of the acquisition of all or substantially all the ownership interest in or assets of an entity is inadequate, Loss with respect to such Claim shall not include any amount of any judgment or settlement representing the amount by which such price or consideration is effectively increased; provided, however, that this paragraph shall not apply to Defense Costs or to any Non‐Indemnifiable Loss in connection therewith.”

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If present in the target company’s D&O policy, does the foregoing exclusion bar coverage for damages caused by breach of fiduciary duty by the target company’s directors?

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♦ Judges have applied the bump‐up exclusion to preclude coverage, in slightly different contexts.

♦ Case law is still developing; the language of the exclusion is key.

♦ Genzyme Corp. v. Federal Ins. Co., 2010 WL 3991739 (1st Cir. Oct. 13, 2010).

♦ Unusual facts.

♦ Exclusion there applied only to amounts paid to settle claims against company, not for indemnity of Ds & Os.

♦ Delta Financial Corp v. Westchester Surplus Insurance Co., 378 F. App’x 241 (3d Cir. 2010).


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♦ The award of plaintiffs’ attorneys’ fees is not excluded.

♦ See, e.g., Safeway Stores v. National Union Fire Ins. Co., 64 F.3d 1282 (9th Cir. 1995).

♦ See also Carolina Cas. Ins. Co. v. Merge Healthcare Solutions, Inc., 2012 WL 123987 (N.D. Ill. 2012)

♦ Even multiplied portion of attorneys’ fees covered because policy did not expressly preclude them.

Insurance Issues: Attorneys’ Fees

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♦ These suits are increasingly frequent, and have increasingly higher costs.

♦ In a three day stretch in June 2013, three more suits were filed:

♦ Hulsebus et al. v. Belo Corp. et al. (Dallas County, TX, Jun. 14) ($2.2B deal)

♦ Liu v. Asianfo‐Linkage, Inc., et al. (Del. Chancery, Jun. 11) ($890M deal)

♦ Crescente v. StellarOne Corp., et al. (W.D. VA, Jun. 14) ($445M deal)

♦ High stakes cases litigated on an extremely expedited schedule.

♦ Frequently, several different state court class actions not subject to a motion to consolidate.

♦ Even if merger objection cases have a lower severity than securities cases, the primary insurer could be affected by their rate of recurrence, while the excess layers may have less exposure.

Takeaways

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♦ From a claims handling perspective, an early opinion from defense counsel on what standard of review (business judgment, enhanced scrutiny, or entire fairness) the court will apply, and the reasons why, is critical.

♦ It is important to ask if there is anything that the board was advised to do by its legal or financial advisors that it failed to do in advance of the merger.

Takeaways

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QUESTIONS?

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Contact Us

John D. HughesPartnerEdwards Wildman Palmer LLPBoston, [email protected]

Jacquelyn BurkeAssociateEdwards Wildman Palmer LLPBoston, [email protected]

Greg PendletonAssociateEdwards Wildman Palmer LLPBoston, [email protected]

and insurance coverage for, objection suits: the basics

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