Delaware Court Warns: Future Deal Protections May Cross the Line, Bloomberg Law Reports®
The Delaware Court of Chancery recently addressed an issue of particular significance to M&A practitioners: Where is the point beyond which deal protection devices become invalid? Although the court found that the deal protection devices at issue were reasonable under the circumstances, it noted that “one of these days some judge is going to say ‘no more.’” Perhaps in the future, this remark will be recognized in retrospect as a warning of things to come. In the meantime, this article provides some guidance to avoid crossing this elusive line.
Orchid Board Agrees to Deal Protection Devices
Shareholders of Orchid Cellmark Inc. filed a motion to enjoin a proposed two-step tender offer pursuant to which Orchid would be acquired by Laboratory Corporation of America Holdings, Inc. They alleged, among other things, that the deal protection devices in the acquisition agreement were not reasonably calculated to increase shareholder value. The deal protection devices included:
- a provision prohibiting Orchid from pulling its poison pill for any bidder other than LabCorp without first terminating the acquisition agreement in favor of a superior offer and withdrawing its recommendation of the LabCorp offer;
- a top-up option;
- a no-shop provision, which included a fiduciary out;
- provisions guaranteeing LabCorp the right to match any competing offers and to receive the same information Orchid provided to such bidders; and
- a termination fee payable if Orchid terminated the deal or its shareholders failed to tender a majority of the company’s outstanding shares.
Devices Were Reasonable, Individually and in the Aggregate
The court first determined that none of the devices, standing alone, unreasonably deterred other bidders from coming forward. It concluded that the poison pill provision was reasonable because it did not trigger payment of the termination fee and a “sophisticated and serious” bidder would understand that the board “would likely eventually be required by Delaware law to pull the pill in response to a [s]uperior [o]ffer.” Orchid at 20. The court also rejected the plaintiffs’ use of Orchid’s enterprise value as the basis for assessing the termination fee, noting that “Delaware’s case law . . . teaches that such termination fees are generally measured according to a [c]ompany’s equity value.” Id. at 21. For a more detailed discussion of equity value vs. enterprise value as the basis for assessing a termination fee, click here and view the table entitled “Termination Fees.”
The court then evaluated the aggregate deterrent effect of the devices in light of the circumstances surrounding the proposed transaction, finding that a sophisticated buyer desiring to make a serious bid could overcome these obstacles. It also found that Orchid’s board was informed, independent, and disinterested. Accordingly, the board’s approval of the devices was reasonable and survived scrutiny under Revlon, Inc. v. MacAndrews & Forbes Hldgs., Inc., 506 A.2d 173 (Del. 1986). Based on these factors, the court declined to enjoin the transaction.
At What Point Are Deal Protections Too Much?
Although it found that “the line ha[d] not been crossed here,” the court warned that such a line does exist:
[O]ne of these days some judge is going to say “no more” and, when the drafting lawyer looks back, she will be challenged to figure out how or why the incremental enhancement mattered. It will be yet another instance of the straw and the poor camel’s back. At some point, aggressive deal protection devices—amalgamated as they are—run the risk of being deemed so burdensome and costly as to render the “fiduciary out” illusory.
Id. at 22-23.
There is no bright-line test to avoid crossing this line, but some guidance may be gleaned from prior case law and recent comments by Vice Chancellor Laster:
- Consider Precedent and Circumstances. Arguably, a combination of deal protection devices is more likely to be found reasonable if it has been found reasonable in prior cases. However, this approach is not fail-safe, given that the determination is made “in light of all the circumstances of the [p]roposed [t]ransaction.” Id. at 21.
- Avoid Locking-Up the Deal. A conservative approach cautions against irrevocably locking-up a deal prior to the shareholder vote. In Omnicare, Inc. v. NCS Healthcare, Inc., 818 A.2d 914 (Del. 2003)—a rare case in which deal protection devices were invalidated—the Delaware Supreme Court found that the combination of a force-the-vote provision, voting agreements locking up 65 percent of the shareholder vote, and the absence of an effective fiduciary-out “made it mathematically impossible and realistically unattainable for [the alternative bidder's] transaction or any other proposal to succeed no matter how superior the proposal.” Omnicare at 936 (quotation omitted) (applying Unocal, rather than Revlon). It should be noted, however, that Omnicare was a split decision, and overturned a contrary holding by the Chancery Court. More recently, in Monty v. Leis, 2011 BL 85650 at 7 (Ct. App. 2011), a California court declined to follow Omnicare, noting that ”Omnicare has been criticized even by Delaware courts.” Indeed, the Chancery Court arguably has failed to heed its authority. See WaveDivision Holdings, LLC v. Millennium Digital Media Sys., LLC, No. 2993-VCS, 2010 BL 293750at 38 (Del. Ch. Sept. 17, 2010) (rejecting argument that fiduciary-out was necessary and seemingly alluding to Omnicare in referring to “admittedly odd authority on the subject”); Optima Int’l of Miami Inc. v. WCI Steel Inc., C.A. No. 3833-VCL (Del. Ch. June 27, 2008) (Transcript) at 127 (findingOmnicare to be “of questionable continued vitality”). It may simply come down to what is reasonable under the circumstances. See In re Toys “R” Us, Inc., Shareholder Litigation, 877 A.2d 975, 1016, fn. 68 (Del.Ch. June 22, 2005). Nevertheless, given the lack of clarity and V.C. Noble’s warning inOrchid about “render[ing] the ‘fiduciary out’ illusory,” locking-up a deal with protection devices would entail risk.
- Get Something in Exchange. During a CLE held by the Practicing Law Institute in New York on May 18, panelist Jessica Zeldin of Rosenthal, Monhait & Goddess posed the question: How can plaintiffs’ counsel successfully challenge defensive measures? V.C. Laster responded that the target board should be able to point to something that it received in exchange for the defensive measures. Thus, for example, a plaintiff’s lawyer would want to focus on any facts showing that the measures were put in place only after all the deal terms were fully negotiated. V.C. Laster’s comments should be read in conjunction with V.C. Noble’s comment in Orchid wherein he explained that “deal protection measures are commonplace and, indeed, expected and there is no requirement that the deal price be adjusted through a discrete increase in price solely attributable to agreement to certain deal protections.” Orchid at 22. Read together, it appears that the quid pro quo does not need to be distinct, but it does need to exist.
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