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International In-house Counsel Journal

Vol. 4, No. 15, Spring 2011, 1

International In-house Counsel Journal ISSN 1754-0607 print/ISSN 1754-0607 online

Recent Trends in US Mergers and Acquisitions Litigation

R. SAMUEL SNIDER

Vice President & Lead Acquisition Counsel, LexisNexis, USA,

&

KENNETH R. THOMPSON, II

Senior Vice President and Global Chief Legal Officer, LexisNexis, USA In 2010 mergers and acquisitions (‘M&A’) activity rebounded from recent lows with U.S. activity up 16.3% in 2010 over 2009.

1 With this rebound came a number of new

new structural developments, which generated a number of M&A-related caselaw developments. When combined with a wave of decisions arising from mid-crisis transactions, 2010 was an active year for M&A caselaw on a number of fronts.

This article updates our article ‘Recent Trends in US Mergers and Acquisitions: Litigation and Regulatory Actions’ published in the Spring, 2010 edition of the International In-house Counsel Journal

2, for cases decided during 2010.

I. Breach of Fiduciary Duties

a. Top-Up Options

One peculiarity of U.S. M&A law, particularly that of the State of Delaware where most publicly traded corporations are formed, is that transactions may be consummated more quickly using a tender offer structure in which an acquirer offers to acquire shares directly from a target’s stockholders than under a statutory merger. The tender offer is typically followed by a short-form, or ‘freeze-out’, merger, a statutory device that allows a parent holding more than 90% of the shares of a subsidiary to consolidate the two entities without holding a shareholder vote. Minority shareholders are protected under short-form merger statutes through appraisal rights which allow them to ask a court to appraise the fairness of the price paid to them in connection with the transaction. In modern tender offers, the price per share paid to minority shareholders on the back-end merger is typically identical to that paid to those who tender their shares during the initial tender offer period.

Despite the timing advantages tender offers were disfavoured transaction structures (other than in hostile transactions) for a number of years. Tender offers have returned to vogue in the past few years as a result of a number of changes in both legal and market dynamics, with 23% of 2010 friendly public M&A deals structured as tender offers, up from 7.6% in 2006.

3 As tender offers have made a comeback, a device referred to as a

‘top-up option’ has become commonplace.

The top-up option is a useful tool in friendly tender offer transactions in which the seller

grants to the purchaser an option to buy authorized but unissued shares of the target

sufficient to ‘bump’ its shareholding up above 90% at the same price as the tender offer,

1 CapitalIQ, February 2011. 2 R. Samuel Snider and Kenneth Thompson, II, Recent Trends in US Mergers and Acquisitions: Litigation and

Regulatory Actions, International In-house Counsel Journal, Vol. 3, No. 11, Spring 2010, 1715 (‘Snider & Thompson’).

3 Steven M. Davidoff, Behind the Growing Number of Tender offers, The New York Times DealBook, oct. 14,

2010, http://dealbook. nytimes. com/2010/10/14/behind-the-growing-number-of-tender-offers/.

http://dealbook.nytimes.com/2010/10/14/behind-the-growing-number-of-tender-offers/

2 R. Samuel Snider & Kenneth R. Thompson, II

typically exercisable only if a threshold number of shares are tendered during the tender

offer period. Consideration for the top-up option is typically a note executed by the

purchaser on behalf of the target, which would be cancelled upon consummation of the

back-end merger. There are numerous limitations on the utility of the top-up option

device that are beyond the scope of this article, but assuming a purchaser can obtain in

excess of 88%4 of a target’s outstanding shares during the tender offer, and the target has

sufficient authorized but unissued shares available, the top-up option can be quite helpful

to purchasers looking to complete an acquisition as quickly as possible and ensure that

target company shareholders receive consideration for their shares as quickly as possible.

Prior to 2010, Delaware courts had not provided much guidance on the legality of top-up

options. A number of commentators, however, identified a conceptual concern that top-

up options could significantly dilute the value of non-tendered shares for dissenting

shareholders exercising appraisal rights. Plaintiff’s bar seized on this opportunity to

challenge top-up options, giving Delaware courts an opportunity to review and opine on

the device in detail.

Delaware courts addressed at least four 2010 cases involving top-up options, including

Olson v. EV3, Inc.5, In re ICX Technologies, Inc. Shareholder Litigation

6, In re

Cogent, Inc. Shareholder Litigation7 and In re Protection One, Inc. Shareholder

Litigation8. The courts were unsympathetic to plaintiffs’ claims in each case. In Olson,

which arose when the plaintiff sought to enjoin a merger between ev3, Inc. and Covidien

Group, Vice Chancellor Laster permitted limited discovery to determine potential dilutive

and coercive effects that top-up options might have on minority shareholders, noting that

it was not an issue that Delaware courts had definitively addressed. The court provided

guidance, by noting that the simple solution to appraisal dilution claims would be to

provide that any shares issued pursuant to a top-up option, and the consideration paid for

the option, would not be counted for purposes of making an appraisal.9

Dealmakers got the hint, and in the three subsequent cases each deal included a provision excluding the effect of the top-up option from any appraisal valuation, resulting in ICX, Cogent and Protection One all being dismissed without discovery. The most detailed discussion (and only discussion in a formal written opinion) is found in Cogent, in which Vice Chancellor Parsons focused on the question of whether the Delaware appraisal statute

10 allows parties to define the conditions under which an appraisal will take place.

Parsons finds that both prior case law and public policy suggest that it would be inconsistent with the purpose of the statute to disfavour stipulation of appraisal conditions when the statute and relevant provisions are both designed specifically to benefit minority shareholders.

11 The Cogent court addressed several other claims, including an unrealistic

contention that the top-up option would allow a purchaser to take control of a company even if a majority of its shares were not tendered in the transaction. Vice Chancellor Parsons made short work of this claim, noting that ‘while it technically might be possible … [the] argument depends on the occurrence of more than one highly unlikely event’

12

4 Although theoretically the top-up option could be useful for any percentage above 50%, NYSE and NASDAQ

rules require stockholder approval when a company wishes to issue new shares that would constitute 20% or

more of its outstanding shares, so such an issuance would defeat the timing benefits of the top-up option. See NYSE Listed Company Manual Section 3. 12. 03(c); NASDAQ Stock Market Rules, Rule 5635(d).

5 C. A. No. 5583-VCL (Del. Ch. June 25, 2010). 6 C. A. No. 5769-VCL (Del. Ch. Sept. 17, 2010). 7 C. A. No. 5780-VCP (Del. Ch. October 5, 2010). 8 C. A. No. 5468-VCS (Del. Ch. Oct. 6, 2010). 9 Olson, trans. at 33. 10 Delaware General Corporation Law, Section 262. 11 Cogent, at 24. 12 Cogent, at 29.

Mergers & Acquisitions 3

and thus the argument is too speculative to merit injunctive relief. Finally, in Protection One, Vice Chancellor Strine provided even stronger support for top-up options by positing that appraisal dilution claims likely have no merit as a matter of law. Strine reasons that under DGCL §262(h), the fair value of shares in an appraisal is calculated ‘exclusive of any element of value arising from the accomplishment or expectation of the merger or consolidation.’

13 Because top-up options are part of the accomplishment of the

merger designed to effectuate the completion of the transaction, in Strine’s view the top-up option would be excluded from appraisal calculations by the express language of the statute.

14

While the 2010 top-up option cases do not completely eliminate creative arguments that top-up options can destroy shareholder value, the cases do provide an effective blueprint for utilizing top-up options in Delaware M&A activity: expressly carve-out the effects of top-up options on any appraisal calculation, and provide that the top-up option will only become effective upon the tender of a majority (or super-majority) of the target’s shares.

b. Controlling Shareholder Transactions

In 2009, Delaware courts provided significant guidance to companies considering transactions with a related party or controlling shareholder, particularly with the In Re John Q. Hammons Hotels Inc. S’holder Litig.

15 decision, which established a rule that

in mergers in which a controlling shareholder is involved, the Board’s actions with respect to the transaction will be judged under the ‘entire fairness’ standard

16 unless (a)

the transaction was recommended by a strongly independent special committee of independent directors, and (b) the transaction was approved by a fully-informed, non-waivable ‘majority of the minority’ vote.

17 Hammons’ primary contribution to Delaware

law was to extend the entire fairness standard to situations in which a company is sold to a third party but a controlling shareholder of the target is able to negotiate a separate deal for itself as a result of its stronger bargaining position – that is, when the controlling shareholder’s interests were not aligned with those of the minority shareholders. Following Hammons, the Delaware courts in 2010 further extended the entire fairness standard, with important implications for boards of companies with a controlling shareholder considering a strategic transaction.

The most far-reaching controlling shareholder decision in 2010 is Vice Chancellor Laster’s In re CNX Gas Corporation Shareholders Litigation

18 which, like the top-up

option cases, provides valuable guidance on completing deals structured as tender offers. This case arose out of CONSOL Energy, Inc.’s attempt to acquire 100% of the equity in its subsidiary, CNX Gas Corp. The transaction was a two-step transaction in which CONSOL initially launched a tender offer to CNX’s minority shareholders, followed this by a short-form merger to freeze-out the remaining minority shareholders.

Delaware law has long held that the standard of review for freeze out transactions

depends on the structure of the deal – one-step mergers are reviewed under the entire

fairness standard, but two-step freeze out mergers were subject to ‘an evolving standard

less onerous’19

than the entire fairness standard because the standard of review is

determined by whether the transaction is available for the back-end merger, not a review

of the entire transaction. In dicta from 2005’s In re Cox Communications, Inc.

13 Delaware General Corporation Law, Section 262(h). 14 Protection One, at 16. 15 C. A. No. 758-CC (Del. Ch. Oct 2, 2009). 16 For a discussion of the standards of review applied to board of directors conduct in the M&A context see, e.

g. , Snider, Miles and Beleky on Unocal Corp. v. Mesa Petroleum Co. and Unitrin, Inc. et al. v. American

General Corp. , 2008 LEXISNEXIS Emerging Issues 3041. 17 See Snider & Thompson, p. 1724. 18 4 A. 3d 397; 2010 Del. Ch. LEXIS 119 (Del. Ch. May 25, 2010). 19 Id, at 406; 20.


Shareholders Litigation,20

Vice Chancellor Strine sought to resolve this tension by

noting that the business judgment rule should apply when a freeze-out transaction mirrors

the structural protections in an arms-length merger: approval by disinterested directors

and approval by disinterested stockholders.21

In CNX, Vice Chancellor Laster took up

Vice Chancellor Strine’s suggestion, holding that the appropriate standard for

determining whether the business judgment rule or entire fairness standard is applicable

to a two-step freeze-out with a controlling shareholder is whether the ‘first-step tender

offer is both (i) negotiated and recommended by a special committee of independent

directors and (ii) conditioned on the affirmative tender (or vote) of a majority of the

minority shares’.22

Applying this ‘unified standard’, the Court found independent reasons why the business

judgment rule could not apply in CNX. First, although the CNX board did not

recommend against the transaction, it also refused to recommend the transaction to its

shareholders. The court held that this fact ‘alone is sufficient to end the analysis and

impose an obligation on CONSOL to pay a fair price.’23

Second, the court noted that the

special committee of the board was not authorized to seek an alternative transaction,

adopt a rights plan or poison pill, or otherwise challenge the transaction – it was simply

authorized to review and take a position on the transaction. All of these options are

available in an arms-length transaction so their unavailability is inconsistent with the

principle that in order for the business judgment rule to apply in a two-step freeze-out

transaction the structural protections must be identical to a third party arms-length merger

negotiation. Finally, the court was concerned about the fact that the largest minority

shareholder agreed in advance to tender its shares, which called into question the

effectiveness of the majority of the minority voting provision. It is worth noting however

that even with all of these problems at issue in the challenged merger, the court still

refused to enjoin the merger because the plaintiffs failed to establish that an award of

monetary damages would not provide an adequate remedy, and thus the plaintiffs were

required to rely on appraisal rights under Delaware’s merger statute.

CNX is particularly interesting because it conflicts with (indeed, Vice Chancellor Laster

acknowledges the conflict) another 2010 decision, In re Cox Radio, Inc. Shareholders

Litigation24

in which Vice Chancellor Parsons followed the previous line of cases.

Despite the direct conflict between Cox and CNX, the Delaware Supreme Court

subsequently refused to hear an interlocutory appeal, leaving a likely appeal after a final

judgment is rendered.

Gentile v. Rosette25

is another noteworthy controlling shareholder decision from the

Delaware courts in 2010. Unlike CNX, Gentile was a relatively standard issue self-

dealing decision and did not break new ground legally. However, Gentile is notable as it

illustrates the perils facing controlling shareholders and individual directors when

conducting insider transactions.

Gentile arose out of a debt-to-equity conversion orchestrated by the controlling

shareholder of a failing software business toward the end of the technology bubble in the

late 90s. In early 2000, to assist the company in preparing for a potential sale, the

controlling shareholder (and sole source of financing over the company’s history) agreed

to convert $2.2 million of debt into shares at a price of $0.05 per share, resulting in the

20 879 A. 2d 604; 2005 Del. Ch. LEXIS 79 (Del. Ch. 2005). 21 See CNX, at 412; 39. 22 Id, at 413; 41. 23 Id. , at 414; 44. 24 2010 Del. Ch. LEXIS 102 (Del. Ch. May 6, 2010). 25 2010 Del. Ch. LEXIS 123 (Del. Ch. May 28, 2010).


controlling shareholder owning 95% of the company. Shortly thereafter, the company

was sold to a competitor in exchange for stock. The purchaser went bankrupt within 6

months of completing the transaction.

The Court determined that although the company was in severe financial distress at the

time of the transaction, the entire fairness standard applied because Rosette was both the

controlling shareholder and one of only two directors. Both the process of approving the

conversion and the conversion price failed the entire fairness test since the company only

had two directors, did not appoint an independent committee to evaluate the transaction,

and the independent director was not sufficiently sophisticated and did not receive

sufficient assistance to effectively value the transaction. The court found that the

independent director breached his duty of care to the minority shareholders by simply

going along with the controlling shareholder/director’s requirements. The independent

director was absolved from personal liability under Delaware’s exculpatory board

provisions. The key takeaway from Gentile is that the controlling shareholder was found

to have breached his duty of loyalty to the company as a director, and found personally

liable for damages in excess of $300,000.

c. Poison Pill Cases

2010 was also a very active year for Delaware courts in addressing shareholder rights

plans, the infamous ‘poison pills’ originally designed to help a company’s board of

directors react to hostile tender offers.26

In its most pure form, the purpose of a poison

pill is to provide negotiating leverage for a target board to react to a hostile tender offer,

both by providing time for the target board to seek alternative transactions and by diluting

the hostile acquirer’s ownership percentage in the target, making it more difficult for the

hostile acquirer to succeed in a proxy contest. Poison pills cannot, under Delaware law,

be used to completely eliminate any possibility that a hostile tender offer will be

successful.

In 2010, Delaware courts addressed three very different poison pill cases – a fairly

traditional poison pill challenge in Yucaipa American Alliance Fund II, LP v.

Riggio27

, an interesting case examining the appropriate standard of review for poison

pills adopted by privately held companies to defend ‘corporate culture’ in eBay Domestic

Holdings, Inc. v. Craig Newmark and James Buckmaster28

, and an issue of first

impression in which the Delaware Supreme Court ruled that poison pills designed to

protect net operating loss tax benefits can be valid if properly structured in Versata

Enterprises, Inc. and Trilogy, Inc. v. Selectica, Inc.29

,30

26 While a discussion of the intricacies of poison pills is beyond the scope of this article, a brief outline may be

helpful for non-U. S. counsel unfamiliar with the device. Poison pills typically grant to existing stockholders

of a company the right to purchase additional shares of common stock at a deeply discounted price either

upon the launch of a hostile tender offer or if a shareholder actually acquires a specified percentage of the company’s stock and fails to divest itself of shares in excess of such percentage within a given timeframe.

Beyond this basic structure, triggering mechanisms, rights available upon each type of trigger, and most other

elements of the pill can vary substantially. 27 C. A. No. 5465-VCS (Del. Ch. Aug. 11, 2010) (the ‘Barns & Noble case’). 28 C. A. No. 3705 (Del. Ch. Sept. 9, 2010) (‘eBay’). 29 No. 193, 2010 (Del. Oct. 4, 2010) (‘Selectica’). 30 Although it is outside the scope of an article focused on M&A developments in 2010, readers should take

note of the Chancery Court’s decision in Air Products and Chemicals, Inc. v. Airgas, Inc. , C. A. No. 5349-

CC (Del. Ch. Feb. 15, 2011). The Airgas opinion addresses a fundamental question of whether a board can retain a poison pill to the point of denying its shareholders an opportunity to tender in a hostile tender offer,

and is likely to become a seminal case on jurisprudence regarding a board’s duties when reacting to a hostile

transaction.


Yucaipa, or the ‘Barnes & Noble’ case as it’s commonly known, arose out of an

investment by an activist hedge fund led by Ronald Burkle in Barnes & Noble, and a

subsequent fight sparked by Burkle’s rapid purchase of over 18% of Barnes & Noble’s

outstanding shares. In reaction to Burkle’s investment (and a purchase of approximately

17% of Barnes & Noble’s outstanding shares by another hedge fund that frequently

follows Burkle’s lead), the Barnes & Noble board adopted a fairly traditional poison pill

with two exceptions. The first is that the pill ‘grandfathered’ shares owned by Barnes &

Noble’s founder and his family, which amounted to roughly 30% of the outstanding

Barnes & Noble shares (though it prohibited additional share acquisitions by this group

outside certain limited scenarios). The second is that the poison pill would be triggered

by an accumulation of shares, or the formation of a group by holders of shares, in excess

of 20% of the outstanding common stock of the company. Although this threshold

became the target of a number of arguments in the case, it is notable largely because it is

on the higher end of the ‘typical’ range, rather than the ‘more common level of 15%’31

.

The Barnes & Noble case is notable because it applies well-established principles to

some novel arguments posited by Yucaipa. The first of these is that because Riggio

family’s holdings were grandfathered under the poison pill, the transaction should be

treated as an interested party transaction and the entire fairness standard of review should

apply rather than the traditional Unocal standard.32

Having previously found that the

Barnes & Noble board was (narrowly) independent, the Court made short work of this

argument.

The second unusual argument is that the poison pill should be reviewed not under

Unocal, but under a much less board-friendly standard of ‘compelling justification’

developed in the Blasius case.33

The court determined that Blasius is inapplicable

because by its own terms it ‘only applies when directors ‘act[] for the primary purpose of

thwarting the exercise of a shareholder vote,’’34

though Vice Chancellor Strine spent a

significant portion of the opinion examining the history of the Blasius standard and

concluded that barring an extreme set of facts, Blasius is generally subsumed by Unocal

in poison pill cases. While not breaking any new legal ground, the case does provide a

helpful analysis of the Blasius line of cases and its relevance in modern poison pill

jurisprudence.

A third novel argument in Yucaipa is that the beneficial ownership provisions in the

poison pill were ambiguous to the point of making the poison pill itself unreasonable,

thus failing the second prong of the Unocal standard. Yucaipa argued that the definition

of ‘Beneficial Ownership’ in the poison pill was ambiguous because it included a

provision that included securities ‘which are beneficially owned, directly or indirectly, by

any other Person … with which such Person has any agreement, arrangement or

understanding (written or oral) for the purpose of acquiring, holding, voting (except

pursuant to a revocable proxy…or disposing of any voting securities of the Company.35

’

This definition of beneficial ownership tracks the language of Section 13(d) of the

Securities Exchange Act of 1934, and is a relatively standard formulation. Yucaipa

claimed that the provision was ambiguous because ‘no one can be certain what conduct

might trigger the [poison pill],’ and as a result the definition would preclude Yucaipa (or

any investor) from standard proxy contest tactics such as meeting with other investors to

advocate their position. Fortunately for the large number of companies that utilize similar

31 Yucaipa, at 17. 32 Id, at 33. 33 Blasius Industries, Inc. v. Atlas Corp. , 564 A. 2d 651 (Del. Ch. 1988). 34 Yucaipa, at 34, citing Blasius, at 660. 35 Id, at 50.


language in their rights plans, the court held that nothing in this formulation would

prevent an investor from mounting a proxy contest, putting forth its own slate of

directors, otherwise advocating for changes in corporate governance, or holding meetings

to advocate their position. It simply prevented investors from joining with another

investor to do so jointly when the combination would hold voting stock in excess of 20%

of the outstanding shares of the company. The court’s analysis simply followed existing

caselaw and practice, so to that extent it did not break new ground, but it is an important

decision in validating the common formulation for beneficial ownership under most

rights plans currently in existence.

Yucaipa’s final argument follows the traditional Unocal approach, challenging both that

its actions constituted a legitimate threat to Barnes & Noble, and that the Barnes & Noble

board’s response was disproportionate. However, as ultimately posited in a post-trial

brief, even this argument is novel in that it concedes that the board had legitimate

grounds to initially enact the poison pill but that once the situation crystallized the board

was not justified in refusing to raise the trigger for the pill from 20% to 37%.36

Essentially, Yucaipa argued that once it became clear (through Yucaipa’s statements) that

Yucaipa had no intention of launching a hostile bid and simply sought a seat at the table

to discuss the company’s operating plans. Yucaipa’s activities, therefore, did not

constitute a threat to the company’s policies. Even if its actions constituted a threat

Failing to raise the trigger to 37% was disproportionate to the threat and essentially

precluded Yucaipa from a successful proxy contest with the incumbent board. The court

rejected Yucaipa’s arguments as to the latter prong of the Unocal test based on the

circumstances of the case. The court’s discussion of the first prong, however, is important

as it focuses on the threat to the company’s minority holders that Yucaipa, or the results

of Yucaipa’s play, would result in a bloc of three large shareholders, any of whom could

easily obtain majority control of the company without paying a control premium as

would be necessary in a traditional M&A transaction. Although fact-specific, this portion

of the opinion is important as it elucidates a control premium dimension to poison-pill

defences, which will provide additional support to using poison pills to fend off activist

‘creeping takeovers’ as well their more traditional use in hostile takeover situations.

Like the Barnes & Noble case, the second major poison pill decision coming out of

Delaware in 2010 got a tremendous amount of publicity because of the players involved –

eBay and craigslist – two of the most successful online service providers of the 2000s.

The eBay dispute arose from actions taken by Craig Newmark and James Buckmaster,

the founder and CEO of craigslist, respectively, and two of only three craigslist

shareholders, after a falling out with eBay (the third craigslist shareholder) stemming

from eBay’s decision to launch a competing classified ads service. The facts of the case

are somewhat complex, but the brief version is that to ensure that craigslist could never

be purchased by eBay or a similar company focused on profit maximization, the craigslist

board (at the time a two-person board comprised of Newmark and Buckmaster) adopted

three defensive measures – a poison pill, a right of first refusal offer to craigslist

shareholders that resulted in the issuance of new shares to Newmark and Buckmaster that

significantly diluted eBay’s holdings, and a staggered board.

Chancellor Chandler unpacked these three measures and evaluated each under a different

standard, with significantly different outcomes. eBay argued that the staggered board

measure should be evaluated under the entire fairness standard because Newmark and

Buckmaster were personally interested in the staggered board amendments as they

benefited the two personally but harmed eBay as a minority stockholder, and because

36 Id, at 60.


they were approved in bad faith with the intent to harm eBay.37

The court, on the other

hand, ruled that neither the entire fairness standard nor Unocal should apply, but rather

the staggered board amendments should be evaluated under the business judgment rule

because although the staggered board amendments eliminated eBay’s mathematical

ability to elect a director utilizing cumulative voting rights, neither a board seat nor

cumulative voting rights are minority shareholder entitlements. Applying the business

judgment rule, the court found that the staggered board amendments were enacted in

good faith to protect craigslist from eBay’s improper use of confidential information

learned during board meetings. 38

Conversely, the court did apply the entire fairness standard to the right of first refusal that

diluted eBay because Newmark and Buckmaster stood on both sides of the transaction,

utilizing the tool to ‘control craigslist’s stockholder composition for their personal and

sentimental benefit at eBay’s expense. ’39

As a result, the court rescinded the right of

first refusal and subsequent dilutive issuance, placing the stockholder composition as it

was prior to those transactions.

The most important holdings in eBay, however, relate to the poison pill. The case

presented two novel questions of Delaware law – what standard of review should be used

to evaluate poison pills enacted by boards of closely held private companies, and whether

poison pills designed to protect a corporate culture alone, with no underlying justification

for enhancing shareholder value, are allowable under Delaware law. Chancellor Chandler

first determined that the Unocal standard should apply, stating that poison pills

‘fundamentally are defensive devices that, if used correctly, can enhance stockholder

value but, if used incorrectly, can entrench management and deter value-maximizing

bidders at the stockholders’ expense. ’40

Seeing no reason that entrenchment concerns

would be lessened in a private company situation if the directors of a private company

held sufficient power to enact a pill in the first place, Chancellor Chandler applied

Unocal to private company poison pills.

Applying the Unocal standard, the court found that the craigslist poison pill failed both

prongs of the test – craigslist failed to prove ‘as a factual matter, the existence of a

distinctly protectable craigslist culture and further failed to prove, both factually and

legally, that they actually decided to deploy the [poison pill] because of a craigslist

culture.41

’ The most interesting portion of the case focuses on whether a distinct,

protectable craigslist culture exists. craigslist argued that the poison pill was necessary to

ensure that, upon the deaths of the two majority stockholders, craigslist would not be sold

to a company that could depart from ‘craigslist’s public-service mission in favour of

increased monetization of craigslist.42

’ While the court noted that this is a laudable goal,

it is inconsistent with the purpose of a for-profit Delaware corporation, the purpose of

which is to enhance shareholder value. This last point is what distinguishes eBay from

the well-known discussion in Paramount Communications, Inc. v. Time Inc.43

in

which the Delaware Supreme Court accepted extensive defensive actions to protect Time

Magazine’s corporate culture of journalistic independence, which ultimately benefited

Time’s shareholders by ensuring a profitable magazine business. Because craigslist

operates as a for-profit entity, and the two founders accepted significant consideration

37 eBay, at 66. 38 Id, at 71. 39 Id, at 85. 40 Id, at 48. 41 Id, at 61. 42 Id, at 56. 43 571 A. 2d 1140 (Del. 1990).


from eBay’s investment in craigslist, the directors remain bound by fiduciary duties to

maximize shareholder value, which the poison pill did not do.

It is worth noting that the court did not completely preclude the concept that a poison pill

could be utilized to protect a corporate culture. If that corporate culture is inextricably

tied to maximizing shareholder value (as such term is understood with respect to for-

profit corporations), a poison pill to protect that culture could be more closely akin to

Time than to eBay.

The final important Delaware poison pill case of 2010 addressed the novel question of

whether a poison pill may be adopted to protect specific corporate assets. In Versata v.

Selectica,44

the Delaware Supreme Court upheld a Court of Chancery decision to apply

the Unocal test to a poison pill designed to protect an estimated $160 million worth of net

operating losses (‘NOLs’)45

that constituted the primary asset of Selectica. The case arose

from a complex situation faced by Selectica’s board in which the loss-making company’s

primary remaining assets were a technology system and its NOLs. A few years before the

case arose a hedge fund invested in Selectica with the intent of arranging a sale of the

company’s operating assets and then seeking a merger partner for the Selectica legal

entity who could capitalize on Selectica’s NOLs. Versata, through a subsidiary, had a

long and contentious relationship with Selectica, with Selectica owing Versata significant

moneys in connection with in intellectual property infringement claim, and also owning a

small stake in Selectica. Due to technical tax requirements, any increase in stockholder

concentration in which a new stockholder obtained 5% or more of the outstanding shares

of Selectica would result in a technical change of control of the company under IRS rules,

and thus significantly impair the value of the NOLs. Becoming aware of this, Versata

sought to acquire Selectica’s assets at a price deemed unfavourable by the Selectica board

and shareholders, and when rebuffed sought to tactically acquire enough Selectica shares

to diminish the value of the NOLs, making Selectica less attractive to other potential

acquirers and strengthening Versata’s hand in acquisition negotiations.

In response, the Selectica board amended its existing poison pill (which previously had a traditional 15% trigger) such that the poison pill would be triggered by any accumulation of shares giving a new stockholder 4. 99% of the outstanding shares of Selectica stock. Versata then intentionally purchased sufficient shares to trigger the poison pill, which the Selectica board utilized to dilute Versata’s holdings from 6.7% to 3.3% and then ‘reloaded’ to protect against additional concentration of Selectica stock.

The Delaware Supreme Court addressed two novel issues in Selectica. First, much like the Court of Chancery in eBay, the Court needed to determine what standard of review should apply to an ‘NOL pill’. The court noted that poison pills were originally intended and approved as anti-takeover devices and that the Unocal standard typically applied to poison pills developed in this context. NOL pills are primarily intended to ‘prevent the inadvertent forfeiture of potentially valuable assets

46’ and are thus distinguishable from

the traditional pills, but the court nevertheless determined that ‘any [poison pill], by its nature, operates as an anti-takeover device’ and thus must be analysed under Unocal ‘because of its effect and its direct implications for hostile takeovers.

47’ After making

this determination, the court relatively quickly determined that the first prong of the Unocal standard was met because the Selectica board reasonably determined that the NOLs were valuable corporate assets under threat from Versata’s action.

44 Versata Enterprises, Inc. and Trilogy, Inc. v. Selectica, Inc. , et al. , No. 193, 2010 (Del. Oct. 4, 2010). 45 Net operating losses are tax losses that a corporation can accrue over time and that may be offset against a

corporation’s income to reduce its tax burden if or when the corporation becomes profitable. 46 Versata, at 32. 47 Id.


The more complicated determination was whether adopting the pill, and then exercising it, was a reasonable and proportional response to Versata’s threat. The key question here was whether reducing the poison pill trigger from the relatively common (and judicially approved) existing 15% threshold to the very low 4.99% threshold was reasonable. Citing the Chancery Court’s trial decision, the Supreme Court felt that this threshold was reasonable because the threat posed by Versata was ‘qualitatively different from the normal corporate control dispute that leads to the adoption of a shareholder rights plan. … Moreover, the 4.99% threshold for the NOL Poison Pill was driven by our tax laws and regulations; the threshold, low as it is, was measured by reference to an external standard… Within this context, it is not for the Court to second-guess the Board’s efforts to protect Selectica’s NOLs.

48’ Thus, at least in the context of protecting an asset

threatened by stockholder concentration in excess of a definitive amount, the Selectica case suggests that a board may establish an NOL trigger far lower than concentration levels appropriate for triggers in typical anti-takeover poison pills. The remainder of the case focused on more fact-specific determinations of reasonableness and whether the poison pill had a preclusive effect on the ability of shareholders to challenge the board, in each case ruling in favour of Selectica.

While the Barnes & Noble case is a relatively straightforward application of Unocal to a complex case, eBay and Selectica resolve issues of first impression under Delaware law by both expanding and limiting the situations in which poison pills can be used to protect a corporation from threats not directly related to a hostile takeover transaction.

d. Bylaw Provisions in Contests for Control

Another issue of first impression for Delaware courts in, 2010 arose out of the extraordinary lengthy takeover battle in which Airgas, Inc. ultimately successfully fought a hostile takeover bid from Air Products and Chemicals, Inc. In Airgas, Inc. v. Air Products and Chemicals, Inc.

49 the Delaware Supreme Court was asked to determine

whether a bylaw provision adopted after Air Products’ successful proxy contest that accelerated Airgas’ annual shareholders’ meeting from September, 2011 to January, 2011 was consistent with Airgas’ charter.

Air Products’ initial approach is fairly standard hostile takeover fare – put a target in

play, which shifts the shareholder base from long-term investors to arbitrageurs, seek to

empanel new directors favourable to a transaction who will recommend it to the target

shareholders, and then ideally consummate a newly-friendly transaction including the

waiver of any deal protection devices such as poison pills. Air Products was successful in

its initial proxy contest and won three board seats on Airgas’ 9-member staggered board.

Because the board was staggered, it was necessary for Air Products to wait until the next

annual meeting to empanel 3 more board members and obtain a majority. To avoid

waiting another year after its successful proxy contest at the September 15, 2010, annual

meeting, Air Products proposed an amendment to Airgas’ bylaws setting the 2011 annual

meeting for January, 2011. This bylaw provision was approved by 51.8% of the shares

voting on the provision at the September 15, 2010 annual meeting, but due to non-votes

only approved by 45.8% of shares entitled to vote.50

Airgas challenged the bylaw provision as invalid because it conflicted with Airgas’

charter and DGCL §§ 141 and 211.51

The specific issue facing the court was whether

Article 5, Section 1 of Airgas’ Charter, which provided for a staggered board with each

class of Directors’ terms ‘expiring at the annual meeting of stockholders held in the third

48 Id, at 35. 49 8 A. 3d 1182; 2010 Del. Lexis 582 (Del. Sup. Ct. , November 23, 2010). 50 Id. , at 1187; 11. 51 Id. , at 1187-88; 12.


year following the year of election’52

implied that each class of directors was to have a

term lasting three years, or a term that could terminate at any point during the third

calendar year following the year of election. The Supreme Court agreed with the Court of

Chancery that this language creates ambiguity, so turned to external sources to determine

whether general usage could help identify whether ‘the third year following the year of

election’ should mean ‘a three year term’ or ‘anytime in the third calendar year after

election.’ After an examination of Delaware case law and proxy representations of 80

Fortune 500 companies with staggered boards, the Supreme Court determined that

companies using such bylaw language typically disclose directors as having 3 year terms

in shareholder communications. Likewise, an examination of model code provisions and

other commentaries supported the Supreme Court’s ultimate decision that the Airgas

formulation implies a three year term for each cohort of directors. With that

determination, the Supreme Court turned to the Airgas bylaws and charter, which

requires supermajority shareholder approval for changes to the bylaw provisions

establishing Airgas’ staggered board, and determined that the 2010 bylaw amendment

was ineffective, and that the Airgas shareholders’ meeting must be held within a

reasonable timeframe around September 15, 2011 – a year after the 2010 shareholder

meeting.

While on its face this decision might seem limited to the facts of the Airgas case, it is an

important issue of first impression in Delaware because, as the Supreme Court notes, 58

out of 89 Fortune 500 Delaware corporations have staggered boards and utilize the same

formulation for director terms as Airgas.53

The remaining companies have defined board

terms. As a result, the decision seems to eliminate a somewhat novel approach to packing

boards in connection with hostile takeovers of Delaware corporations, forcing hostile

acquirers either to be willing to wait through two board cycles or have sufficient

shareholder support to call a special meeting of its target shareholders.

e. Revlon Cases

While 2010 saw a number of ‘traditional’ cases involving a target board’s Revlon duties,

two stand out as classic examples of Revlon challenges to to-be-consummated

transactions that reaffirm that boards of Delaware corporations are entitled to discount

nominally higher bids for a variety of reasons and provide further guidance on acceptable

deal protection mechanisms. In re Dollar Thrifty Shareholder Litigation54

arose from a

decision by the board of Dollar Thrifty Automotive Group, Inc. to agree to a merger with

Hertz Global Holdings, Inc. , pursuant to which Hertz would pay $41 per share to acquire

Dollar Thrifty. The deal was the culmination of a process lasting several years in which

Dollar Thrifty had numerous start-and-stop negotiations with both Hertz and Avis – the

two most rational and likely buyers for the company. The plaintiffs’ primary argument in

Dollar Thrifty is that the Dollar Thrifty board breached its Revlon duties by failing to

establish a bidding auction between Hertz and Avis prior to signing the merger agreement

with Avis, and that the Hertz merger agreement contained numerous deal protections that

would preclude Avis from making an intervening bid.55

The plaintiffs made a well-thought argument as to the process that the Dollar Thrifty

board could have followed in negotiating its deal with Hertz, providing several

alternative steps that, the plaintiffs claim, would have led to a higher valuation of the

business and objecting to a number of specific board decisions. After a lengthy discussion

52 Id, at 1185; 6. 53 Id. , at 1191; 22-23. 54 Cons. C. A. No. 5458-VCS (Del. Ch. Sept. 8, 2010). 55 Id, at 42.


of the motivation of the board, the court, however, found that the board was quite willing

to strike a deal with Hertz or Avis, or indeed any other party, and did not show any signs

of being improperly motivated in conducting the deal. As a result, the court reiterated that

Revlon does not prescribe any particular steps a board must take, but rather focuses on

the reasonableness of the board’s actions. Finding no improper motivation, the court held

that the board’s approach to the transaction was reasonable, and that it was entitled to

discount a late-breaking intervening bid from Avis because Avis was unwilling to agree

to the substantial break-up fee and antitrust remedies that were heavily negotiated with

Hertz, and although the Avis bid was nominally higher, the Hertz transaction had a much

greater closing certainty. Additionally, the court held that a break-up fee that constituted

3.5% of the top-line purchase price inclusive of a $200 million special dividend was

reasonable because, although the break-up fee would be a ‘hefty 5.1% of the $1.172

billion value paid by Hertz’56

, any intervening bidder would have to provide equivalent

value for the $200 million special dividend and thus the appropriate measure of the

break-up fee was the percentage of the total consideration paid to Dollar Thrifty

shareholders, not the percentage of the total consideration paid by Hertz.

The court ultimately concluded that it could not enjoin a shareholder vote on the merger

because the Dollar Thrifty board complied with its Revlon duties in running a reasonable

process and agreeing to a merger on reasonable terms, provided Dollar Thrifty

shareholders the ability to make an up-or-down vote on the deal, and made very clear to

Avis what Avis would need to do to make a topping bid that the Dollar Thrifty board

would deem superior. In the court’s words, ‘the Board gave the stockholders the chance

to take a floor price that was very attractive in light of the board’s estimate of the

company’s fundamental value, left them uncoerced to turn down the deal if they preferred

to remain independent because the termination fee is only payable if a higher value deal

is accepted, and lef the door open to a higher bidder.’57

Interestingly, this is exactly what

happened after the case was decided – Avis made a significantly higher offer agreeing to

a number of the points that Dollar Thrifty’s board demanded, the Dollar Thrifty

shareholders voted against the Hertz transaction, and as of this writing, Hertz and Avis

remain in a bidding war for Dollar Thrifty at valuations significantly higher than in the

original Hertz transaction.

Shortly after Dollar Thrifty was decided, the Court of Chancery issued a strikingly

similar decision in In re Cogent, Inc. Shareholder Litigation58

, previously discussed in

the top-up options section above. As in Dollar Thrifty, Cogent had spent several years

exploring strategic alternatives, with a sales process interrupted by the financial crisis in

2007 and 2008. After two of the four bidders in an auction process in 2010 walked away,

Cogent negotiated with 3M and another bidder – Company D, with 3M submitting an

offer to acquire Cogent for $10.50 per share. Shortly after 3M’s offer, Company D

submitted a nonbinding indication of interest with a range of $11-12 per share, subject to

a number of contingencies including a due diligence out. After several failed attempts to

engage Company D and an ultimatum from 3M, Cogent signed a merger agreement with

3M that included a matching right, a no-shop with fiduciary out, a $28 million

termination fee and the above-discussed top-up option.

Plaintiffs sued, alleging two primary Revlon claims: ‘that the purchase price received

was too low as a result of an inadequate and unfair sales process’, and that ‘the Merger

56 Id, at 72. 57 Id, at 6. 58 FN 7.


Agreement contain[ed] a number of preclusive deal protection devices.59

‘ The court

engaged in a lengthy examination of the process undertaken by the Cogent board,

ultimately finding that the board engaged in a robust sales process without any

compelling indication of improper motivations. Turning to the substantive purchase price

claims, the Court first rejected plaintiffs contention that the price was insufficient,

holding that in the context of a voluntary tender offer ‘inadequacy of price alone is not a

proper basis for a preliminary injunction60

’ – in other words, if the shareholders have

adequate information to make an informed decision and are not improperly constrained in

voting down a transaction, the court will not substitute its judgment of the adequacy of

the purchase price for the judgment of the shareholders in an unencumbered vote. The

court noted that plaintiffs’ strongest challenge was the potentially higher offer from

Company D. The court noted that ‘if both 3M’s offer and Company D’s offer were

identical in all other respects, it would be difficult for Cogent’s board, consistent with its

Revlon duties, to justify taking the lower offer.61

’ However, because Company D’s bid

had significant contingencies, including as broad a contingency as the satisfactory

completion of due diligence, the Court held that the board was reasonable in taking such

factors into account and agreeing to the 3M transaction.

Finally, the court examined the suite of deal protection mechanisms in the transaction,

ultimately holding that neither any individual deal protection mechanism nor their

cumulative strength was likely to preclude a topping bid. The merger agreement

contained a number of deal protection mechanisms – a no-shop with matching rights, a

$28 million termination fee, the top-up option previously discussed, a set of retention and

bonus agreements with certain Cogent employees, and a voting and tender agreement

with Cogent’s founder who owned 38.88% of the company. The termination fee

discussion reiterates the logic of Dollar Thrifty that a termination fee should be judged

on the amount of consideration ultimately to be received by the shareholders, as opposed

to the amount to be funded by the acquirer, and thus upheld the break-up fee that

constituted 3% of the equity value of the company (the value to be received by the

stockholders), but 6.6% of the enterprise value of the company (because a substantial

portion of the consideration to be received by the stockholders would be funded by

Cogent’s sizeable cash holdings).

f. ‘Preferred v. Common’ Cases

An interesting trend over 2009 and 2010 was a series of cases involving challenges to

transactions in which the interests of a target’s preferred and common stockholders

differed.

In In re Trados Incorporates Shareholder Litigation62

, plaintiff, a common

shareholder of Trados, brought suit against Trados’ board alleging that the board

breached its fiduciary duties in approving a sale of the company for $60 million to SDL,

plc, in which Trados’ preferred shareholders would receive roughly $52 million (of a

roughly $57 million total liquidation preference) and three of Trados’ executives would

receive transaction bonuses of roughly $8 million, collectively. The transaction resulted

in Trados’ common stockholders receiving no consideration. Plaintiff argued that the

preferred stockholders’ interests were substantially different from those of the common

because the company’s business was recovering and profitable, and a sale would only

59 Id, at 11. The plaintiffs also alleged that Cogent’s Recommendation Statement contained inadequate

disclosures based on several material admissions, but this claim and the court’s treatment is outside the scope

of this discussion. 60 Id, at 18. 61 Id, at 19. 62 C. A. No. 1512-CC (July 24, 2009).


benefit preferred holders interested in exiting their investment rather than maximizing

value to common shareholders.63

In approving the transaction, the board improperly

favoured the preferred stockholders above the common stockholders, thereby breaching

its fiduciary obligations to the common stockholders. Plaintiff supported its argument by

pointing out that four of Trados’ seven directors were designees of the preferred

stockholders, and either employees or principals of those same stockholders, making the

transaction an interested party transaction with respect to those directors.

Noting that ‘generally it will be the duty of the board, where discretionary judgment is to

be exercised to prefer the interests of common stock … to the interests created by the

special rights, preferences, etc. of preferred stock, where there is a conflict’, the court

determined that it is at least possible that a director could breach a duty by favouring the

interests of preferred over common where those interests diverge.64

Because the case was

at a motion to dismiss stage, the court held that the plaintiff’s case was sufficiently pled

to support a reasonable inference that the preferred and common stockholders’ interests

diverged, as well as an inference that the defendant plaintiffs were interested parties to

the transaction and that, as a result, the business judgment rule would not apply to the

transaction.

It is important to note that Trados was decided at a motion to dismiss stage, and the court

was careful to point out that the plaintiff-friendly inferences required at this stage may

not be those most likely to hold the day at trial. Nevertheless, the case is somewhat

disconcerting for boards of directors of companies with substantial preferred stockholders

facing transactions in which common stockholders are unlikely to receive significant

consideration.

The Delaware courts faced an opposite challenge in LC Capital Master Fund, Ltd. v. James

65, in which the plaintiff was a preferred stockholder claiming that the board of

QuadraMed Corporation breached its fiduciary duties to preferred stockholders by allocating merger consideration based on a contractual conversion right rather than the value of additional contractual rights that the preferred stock had under QuadraMed’s certificate of designation, such as dividend rights and liquidation preferences that were not, by their direct terms, applicable in a merger context.

In LC Capital, the plaintiff preferred stockholders had negotiated a certificate of designation that granted certain rights to preferred stock, including class voting rights upon any amendment to the certificate of designation materially adversely affecting their voting rights, the creation of any senior or pari pasu class of shares, and the incurrence of debt in excess of $8 million; a quarterly dividend payable only when, as and if authorized and declared by the board; and a liquidation preference of $25 per share.

66 However, the

preferred stock did not have class voting rights in other circumstances, could not force a liquidation, and the liquidation preference specifically did not apply in a merger context. Rather, in a merger the preferred stockholders were entitled to receive (a) receive consideration determined by the board in a merger agreement, or (b) exercise their right to convert their shares into common shares using a conversion formula and receive the same consideration as the common stockholders.

67 The board of directors provided in the

merger agreement that the preferred stockholders would receive consideration on an as-

63 Id, at 16-17. 64 Id, at 19-20. 65 C. A. No. 5214-VCS (Del. Ch. Mar. 8, 2010). 66 Id, at 6. 67 Id, at 6-7.


converted basis, such that each share of preferred stock would receive $13.7097 in cash, with each share of common stock receiving $8.50 in cash.

68

The plaintiffs argued that the QuadraMed board breached its fiduciary duties of care and loyalty to the preferred stockholders by not taking into account the value of the dividend rights, liquidation preference, and other rights to which the preferred shareholders were entitled to increase the percentage of the purchase price allocated to the preferred stockholders (thus decreasing the portion of the purchase price allocated to the common stockholders). After an extensive analysis of existing Delaware caselaw on the duties a board owes to preferred stockholders, Vice Chancellor Strine concluded that the rights of preferred stockholders are primarily contract-based, though preferred stockholders are owed the same fiduciary duties as common stockholders to the extent that there is a gap in a company’s certificate of designation or charter that doesn’t provide a baseline contractual obligation to a preferred stockholder. In this case, since the certificate of designation provided a baseline right – to receive consideration on an as-converted basis using an established conversion formula –the preferred stockholders were not owed anything more. The court did concede in a lengthy footnote that there could very well be situations in which a board would have to provide a ‘back stop’ function to determine the consideration payable to preferred stockholders, noting prior caselaw to that effect, but was clear that this duty would only arise if a company’s governing documents failed to address a specific situation.

The court also addressed a claim by the plaintiffs that the fact that several board members owned common stock made them interested parties to the transaction. The court made short work of this argument on the facts, noting that all but one director would be entitled to de minimus consideration based on their common stockholdings, and that the impact of even a significant realignment of consideration to the preferred stockholders would be unlikely to have a material impact on any director. More importantly, however, Vice Chancellor Strine noted that Delaware courts have long encouraged devices tying a director’s interests to those of a company’s common stockholders, and thus it would be counter to the prevailing philosophy of Delaware business law to suggest that the mere fact that a director holds common stock would make that director an interested party as against preferred stockholders.

The key takeaway from Trados and LC Capital is that Delaware courts are inclined to treat preferred stockholders, who have the opportunity to bargain for contractual rights prior to making an investment in a target, as sophisticated investors who are bound by the bargain that they made. In the absence of clearly negotiated contract provisions addressing a particular situation a board must act to protect the interests of both the preferred stockholders and common stockholders, conceivably going so far as to establish two independent committees authorized to retain their own advisors to negotiate on behalf of each, but only in extraordinary circumstances. For companies considering either making preferred investments or receiving preferred investments, then, the clear message is that parties in any preferred investment should carefully negotiate the terms of their deal, addressing as many situations as possible, and be prepared to live with the terms of that deal.

Having addressed cases brought against directors by both common and preferred stockholders, the Delaware courts had the opportunity to address the third, typically most frustrated, party to any ‘preferred v. common’ dispute – the acquirer. In Morgan v. Cash,

69 the Delaware Court of Chancery dismissed a claim brought by a common

stockholder of Voyence, Inc. , claiming that EMC aided and abetted the Voyence board members in breaching their duties to their common stockholders by agreeing to a transaction in which the common stockholders received no consideration.

68 Id, at 4. 69 C. A. No. 5053-VCS (Del. Ch. July 10, 2010).


After engaging in a robust auction, seeing a close competitor sold to one of their most likely buyers, seeing all other bidders drop away, and seeing their remaining bidder drop the purchase price from $53 million to $42 million after poor quarterly results, the Voyence board agreed to a merger with EMC which resulted in a slight haircut to the preferred stockholders on their liquidation preference and no consideration payable to the common stockholders. The plaintiff made several claims similar to those in Trados – that as designees of the preferred stockholders the board was comprised of interested parties, that the post-closing employment agreements granted to certain executives who also were directors were improper, and that the board therefore failed to fulfil their Revlon duties as the transaction gave no consideration to common stockholders.

70

The actual decision in Morgan, however, does not address those claims. It addresses a second set of claims in which Morgan argued that EMC aided and abetted the Voyance board in breaching its fiduciary duties. Specifically, Morgan claimed that (1) EMC’s offer of post-closing employment to two Voyence executives induced them to support EMC’s lowered offer price, and (2) EMC knew that Voyence directors were the designees of, or themselves, preferred stockholders and exploited a conflict of interest between these directors and the common stockholders.

71 Even recognizing that in a

motion to dismiss the court must interpret a plaintiff’s pleadings in the light most favourable to the plaintiff, the court made short work of Morgan’s first claim, noting that the post-closing employment offers were on essentially the same terms that the two executives had with Voyence, and thus unlikely to provide a significant incentive for those executives to attempt to sway the board in favour of EMC’s offer, and further nothing that there was no indication that the executives actually attempted to do so.

The court spent more time on Morgan’s second claim, acknowledging existing Delaware caselaw in which plaintiffs survived motions for summary judgment when claiming that purchasers exploited board conflicts. However, the court noted that in those cases the plaintiffs pled facts ‘suggesting how and why the acquirer actually used its knowledge of the target board’s conflicts to collude with the target board at the expense of the target’s shareholders.’

72 Ultimately, the court concluded, the plaintiff did not show any facts that

would suggest that the board would have not welcomed a higher bid, or that EMC actually attempted to exploit the alleged conflicts. As Vice Chancellor Strine describes the action, ‘What Morgan asks is that this court hold that the mere fact that a bidder knowingly enters into a merger with a target board dominated by preferred holders at a price that does not yield a return to common stockholders creates an inference that the bidder knowingly assisted in fiduciary misconduct by the target board. That is not and should not be our law, particularly when the plaintiff cannot even plead facts suggesting that the bidder was paying materially less, or in this case even anything at all less than, fair market value.

73’

The key takeaway from Morgan v. Cash is that Delaware courts recognize that it is common for corporate boards to be comprised of representatives of preferred stockholders, it is also common for companies to be sold for less than an amount that would generate a return for common stockholders, and that buyers are under their own duties to maximize value to their own stockholders. Thus, the decision reaffirms that Delaware courts are cognizant of market realities, and acquirers should not be hamstrung by the fact that the price they are willing to pay may not generate returns for all target stockholders.

70 Id, at 8. 71 Id. 72 Id, at 14. 73 Id, at 17.


II. Unintended Consequences

In PharmAthene, Inc. v. SIGA Technologies, Inc.,74

the Delaware Court of Chancery denied a defendant’s summary judgment motion to dismiss a claim that a letter of intent created a binding licensing agreement. The case arose out of negotiations for SIGA to license to PharmAthene a smallpox drug that SIGA had the right to commercialize, but for which SIGA lacked commercialization expertise and funding. The parties had negotiated a term sheet (the ‘License Term Sheet’) and were negotiating a definitive license agreement when SIGA suggested a merger. PharmAthene preferred to first execute the license agreement and then discuss a merger, but SIGA’s chairman objected to ‘spending money on a bunch of lawyers to sit around to work on a License Agreement that will never be used’

75 and suggested that the License Term Sheet be attached to a term

sheet for the proposed merger, stating ‘don’t worry – you’re going to get the license or you’re going to get a merger. . . You’ve got the [merger term sheet], the [License Term Sheet] is attached…and this is as good as a definitive agreement.’

76 PharmAthene

accepted this approach and the parties negotiated and executed a merger agreement term sheet and, eventually, a merger agreement. Prior to closing the merger, SIGA ran into cash flow challenges and PharmAthene provided a $3 million bridge loan and significant assistance to SIGA in the commercialization process.

After the merger agreement was signed, SIGA and PharmAthene continued to work together to commercialize the smallpox drug, which turned out to be a major success passing several major clinical and development thresholds and making it appear to be a ‘home run’ drug. SIGA then terminated the merger agreement, publicly announced the results of its clinical trials and saw it stock soar, obtained $9 million in private financing, and approached PharmAthene to repay the bridge loan. PharmAthene in turn approached SIGA to negotiate a definitive license agreement pursuant to the terms of the License Term Sheet, as contemplated by the merger agreement and bridge loan documents in the event that the merger did not close. SIGA replied that it did not consider the License Term Sheet binding and sought to substantially alter the financial terms of the license (in some cases by orders of magnitude).

PharmAthene asserted several claims, including under unjust enrichment and promissory estoppel theories. Most interestingly from an M&A perspective is the court’s treatment of PharmAthene’s claim that the License Term Sheet constituted a binding agreement. The court first noted that in general, Delaware law ‘prevents the enforcement of a term sheet as a contract if it is subject to future negotiations because it is, by definition, a mere agreement to agree.’

77 However, the court also noted that ‘a dispute over the

enforceability of a term sheet or MOU typically involves two questions: (1) whether the parties intended to be bound by the document; and (2) whether the document contains all essential terms of an agreement.’

78 In this instance, the court found that PharmAthene

had a reasonable chance of proving both of these elements, and in each case the court’s decision turned on statements made by the chairman of SIGA’s board.

The Court found that the ‘intent to be bound’ prong was proven by SIGA’s chairman’s statement to PharmAthene that ‘you’re going to get the license or you’re going to get a merger. . . You’ve got the [merger term sheet], the [License Term Sheet] is attached to the thing and this is as good as a definitive agreement’

79. The more challenging element

for PharmAthene was proving that the term sheet contained all essential elements of a contract. The Court first noted that this prong is determined in light of what the

74 2010 Del. Ch. LEXIS 234 (Del. Ch. Nov. 23, 2010). 75 Id, at 7. 76 Id, at 8. 77 Id. , at 21. 78 Id, at 22. 79 Id, at 7.


contracting parties themselves believe to be essential, and then turned to the factual record to make this assessment. Both parties provided experts as to whether the contract contained each essential term, but the court seemed most swayed by a call late in the License Term Sheet negotiations in which SIGA’s chairman called PharmAthene’s VP of business development and said that the two sides ‘were very close but that two changes were necessary ‘and if those changes are OK with [PharmAthene], we have a final term sheet.’’

80 Since this statement could be taken to define the universe of elements that the

parties believed to be essential to the contract, and since PharmAthene agreed to SIGA’s positions, it was reasonable to infer that a deal had been struck. Finding that PharmAthene had a reasonable chance of proving both elements, the court denied SIGA’s motion for summary judgment.

PharmAthene does not appear to fundamentally change Delaware law on when preliminary documents will create binding agreements. It does, however, provide an excellent reminder of the ways in which statements that seem relatively innocuous can become very expensive for a party to negotiations. A key element of the case for the party seeking to enforce a term sheet is some variation of ‘if you agree to the following points, we’ve got a deal’ – something that it is very difficult to avoid during the ebb and flow of negotiations. This highlights the need to pay close attention to mid-negotiation agreements as ‘subject to finalization of the definitive agreement’, and ensure that it is clear that until all of conditions of a transaction have been met, no definitive deal exists. This is particularly true when communicating via e-mail or on any other written communication.

While PharmAthene was a relatively straightforward application of existing Delaware law to a complex fact pattern, in a recent case the U.S. First Circuit Court of Appeals significantly altered the landscape of M&A transactions by finding an implied obligation on the part of acquirors to maximize earnout payments in certain situations. In Sonoran Scanners v. PerkinElmer Inc.

,81 the First Circuit heard an appeal of a summary

judgment in favor of PerkinElmer, dismissing several claims brought by Sonoran arising from PerkinElmer’s failure to pay an earnout following the acquisition of Sonoran’s assets. In 2001 PerkinElmer acquired Sonoran’s ‘computer-to-plate’ printing business, which involved a novel technology for newspaper printing. PerkinElmer paid $3.5 million at closing, and the deal included an earnout with potential payments of up to $3.5 million based on post-closing sales of the CTP product. The CTP product was a failure, with PerkinElmer only selling 1 product during the 3 years following closing, and PerkinElmer ultimately sold the technology to a third party and shut down the business after having invested an additional US$5 million to support the CTP operations.

Sonoran and its founder/principal shareholder sued PerkinElmer on several contract-based claims, including a claim that PerkinElmer breached an ‘implied reasonable efforts term’ of the purchase agreement that obligated PerkinElmer to ‘exert reasonable efforts to develop and promote Sonoran’s technology.’

82 The district court granted summary

judgment in favor of PerkinElmer on all claims as a matter of law, and the First Circuit upheld that judgment on all but one. To the surprise of most commentators, the First Circuit reversed the dismissal of Sonoran’s ‘implied reasonable efforts’ claim. In doing so, the First Circuit extended to earnouts a line of cases originally developing in patent licenses and extended to other licensing and exclusive dealing arrangements holding that ‘the promise to pay … [a portion] of the profits and revenues resulting from the exclusive agency … was a promise to use reasonable efforts to bring profits and revenues into

80 Id, at 5. 81 585 F. 3d 535; 2009 U. S. App. LEXIS 23852 (1st Cir. , October 29, 2009). 82 Id. At 542, 18.


existence.’83

Thus, PerkinElmer owed Sonoran a duty to use reasonable efforts to maximize the profits and revenues associated with the CTP business.

Because of the procedural standing of the case this holding is limited to identifying the existence of this legal obligation in an earnout context. The case was remanded to the district court to determine whether PerkinElmer actually violated the obligation, and the First Circuit noted that it would likely be difficult for Sonoran to prove that PerkinElmer had not utilized reasonable efforts, so the case may not have lasting substantive impact on M&A jurisprudence. However, it does create a new obligation under Massachusetts law that must be considered when structuring a transaction in Massachusetts.

Earnouts can be a powerful tool in bridging a valuation gap with a seller. However, this case is yet another example of the headaches that earnouts can create. As this line of cases develops over time in Massachusetts the parameters of what constitutes ‘reasonable efforts’ to maximize an earnout payment will become more clear, but for the time being there are a few actionable takeaways:

Minimize the size of the earnout compared to the size of the closing date payment. The Sonoran Scanners court seemed to feel that because the earnout was potentially equal to the closing date payment, and the shareholders would receive 100% of any earnout payments (whereas the majority of the closing date consideration went to creditors), the selling shareholders had a much greater interest in the post-closing operations than they would have had the earnout been a smaller percentage of the overall purchase price, and this weighed in favor of the existence of an implied covenant.

Include express language in the purchase agreement disclaiming any implied covenant or obligation to operate the business to maximize an earnout payment. While an express disclaimer would likely be a non-starter in negotiations, if parties agree on post-closing operational restrictions or obligations, an acquirer would be well-served to include language that they have no additional obligations beyond those specifically enumerated in the agreement.

Sam Snider is Vice President and Lead Acquisition Counsel for LexisNexis. Sam's

practice focuses on LexisNexis' global merger, acquisition and divestiture activities. Sam

leads LexisNexis internal and external legal teams, and coordinates between divisional

management teams and global LexisNexis management, on mergers, acquisitions and

divestitures by all of LexisNexis' divisions, including numerous recent acquisitions in the

United States, Europe and Asia. Prior to joining LexisNexis, Sam practiced in the M&A

department of the Atlanta office of Paul, Hastings, Janofsky & Walker, a large

international law firm. He is a frequent writer and speaker on corporate law and M&A

matters and has been named a Georgia Rising Star by Atlanta Magazine and Georgia

Super Lawyers-Rising Star Edition. Sam is based in Atlanta, Georgia, and is a member of

the American Bar Association and the Georgia Bar Association. In his free time, Sam is

an avid whitewater kayaker, motorcycle enthusiast and home-brewer.

Ken Thompson is the Global Chief Legal Officer and Senior Vice President for

LexisNexis Legal & Professional. He is a member of the Management Committee and the

principal legal advisor to the Global CEO.

Ken joined LexisNexis in 2001 after 15 years of private practice, and he is admitted in

Ohio and Kentucky as well as to the U.S. Supreme Court, the U. S. District Court for the

Southern District of Ohio, the U.S. Court of Appeals for the Sixth Circuit, and the U.S.

Tax Court.

83 Id. , citing Wood v. Lucy, Lady Duff-Gordon, 222 N. Y. 88, 118 N. E. 214 (N. Y. 1917).

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Ken is based in Cincinnati, Ohio and is a member of the International, American, Ohio,

Kentucky and Cincinnati Bar Associations. He is currently the co-chair of Corporate

Social Responsibility Committee of the International Bar Association and is a member of

the Corporate Pro Bono Advisory Board, a pro bono partnership between ACC and PBI.

Ken frequently speaks on a range of legal issues, including best practices for in-house

attorneys, intellectual property, acquisitions and divestitures, corporate responsibility and

corporate pro bono.

LexisNexis® is a leading global provider of content-enabled workflow solutions

designed specifically for professionals in the legal, risk management, corporate,

government, law enforcement, accounting, and academic markets. LexisNexis originally

pioneered online information with its Lexis® and Nexis® services. A member of Reed

Elsevier, LexisNexis serves customers in more than 100 countries with more than 15,000

employees worldwide.

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