Confidentiality Agreements: Lessons from Delaware
By Frank Aquila, Krishna Veeraraghavan, and Mimi Butler, Sullivan & Cromwell LLP
Recently the Delaware courts have focused on a number of interesting situations relating to the enforcement of certain provisions of confidentiality agreements. The first of these cases, In re Martin Marietta Materials, Inc. v. Vulcan Materials Co., dealt with the use of confidential information in the context of a hostile takeover bid.1 Despite the absence of an express standstill provision in the nondisclosure agreement at issue in Martin Marietta, the Delaware Chancery Court effectively read one into the agreement through its interpretation of the use and disclosure provisions contained in the nondisclosure agreement and blocked the bidder’s hostile bid. The second set of cases focused on the use of “Don’t Ask, Don’t Waive” provisions in standstills. The two decisions, In re Complete Genomics, Inc. Shareholder Litigation2 and In re Ancestry.com Inc. Shareholder Litigation,3 both handed down as bench rulings, took different approaches on the issue of the validity of “Don’t Ask, Don’t Waive” provisions. While Vice Chancellor Laster enjoined the enforcement of the provision in Genomics, implying in his decision that such provisions were unenforceable as a matter of law, in Ancestry.com, Chancellor Strine did not hold the provisions to be unenforceable per se and instead required additional disclosure to the corporation’s shareholders regarding the presence of the provision in the standstills the defendant corporation had negotiated. Together, these three decisions shed light on the status of an important (but sometimes overlooked) piece of any merger transaction.
Use of Confidential Information: A Backdoor Standstill
For approximately 18 months, Martin Marietta Materials, Inc. (“Martin Marietta”) and Vulcan Materials Company (“Vulcan”)engaged in discussions regarding a negotiated business combination. In order to facilitate these discussions, the parties entered into a nondisclosure agreement as well as a separate joint defense agreement intended to protect the disclosure of the parties’ antitrust analysis of the potential transaction.
In December 2011, following Vulcan’s decision to end these discussions, Martin Marietta launched an unsolicited exchange offer for Vulcan shares and commenced a proxy contest to elect new members to Vulcan’s board of directors. In connection with its proxy campaign and exchange offer, Martin Marietta filed a proxy statement and registration statement on Form S-4 with the U.S. Securities and Exchange Commission (the “SEC”), which disclosed certain background information related to prior merger discussions between the parties as well as synergy and antitrust analysis based on information provided by Martin Marietta to Vulcan.
Concurrently with the launch of its hostile offer, Martin Marietta commenced an action in the Delaware Chancery Court seeking a declaration that its hostile offer did not violate the parties’ nondisclosure agreement, and thereafter Vulcan filed a counterclaim claiming that Martin Marietta had breached the terms of the nondisclosure and joint defense agreements by disclosing confidential information in making its bid and seeking an injunction to prevent Martin Marietta from pursuing its hostile offer for the remaining term of the nondisclosure agreement.
Chancellor Strine concluded that the confidential information had in fact been used to evaluate the hostile transaction, noting several elements of the process that supported this determination. First, although Martin Marietta’s bankers had determined a way to get to the relevant synergies without using nonpublic information, the team had been working backward from levels it was aware of only because of nonpublic information.4 Second, although it would in theory have been possible to derive the analysis from only public information, “once things are learned and done, it is difficult to unlearn and undo them, especially when the old information is still being circulated.”5 Finally, Martin Marietta had failed to utilize a “clean team” to evaluate the hostile transaction.6
While the nondisclosure agreement contained no explicit standstill requirement, it did provide that confidential information obtained through the negotiation process could only be used in the context of a “Transaction”, defined in the nondisclosure agreement to mean “a possible business combination transaction …between” the two companies or their subsidiaries. Although this definition did not explicitly preclude use of the information for a hostile business combination, Chancellor Strine looked to extrinsic facts to determine that the parties had nevertheless intended that the confidential information obtained through their discussions only be used in the context of a friendly business combination. Thus the Court determined that Martin Marietta had violated the nondisclosure agreement by using confidential information obtained from Vulcan in connection with its hostile exchange offer and proxy contest.
Martin Marietta argued that the nondisclosure agreement permitted it to disclose Vulcan’s confidential information if the disclosure was legally required, that the SEC filings made in connection with the exchange offer and proxy solicitation were required by law (i.e., the federal securities laws) and that it was not required to comply with the procedural notice and vetting procedures contained in the nondisclosure agreement because those procedures only applied to disclosure made in response to “external demands” (defined as “oral questions, interrogatories, requests or documents in legal proceedings, subpoena, civil investigative demand or other similar process”).7 The nondisclosure agreement contained three provisions related to Martin Marietta’s argument. First, the nondisclosure agreement prohibited the party receiving disclosure of the other party’s “Evaluation Material”(the non-public information about the other party) from disclosing such Evaluation Material other than to its representatives and advisors. Second, the nondisclosure agreement prohibited either party from disclosing “Transaction Information” (the fact that the parties were in discussions about a potential transaction or facts related to such discussions) other than as “legally required” and only after complying with certain notice and vetting procedures. Lastly, the non-disclosure agreement permitted disclosure of Evaluation Material in response to External Demands after complying with the notice and vetting procedures.
Chancellor Strine rejected Martin Marietta’s argument on two alternative grounds: (1) based on extrinsic facts due to the potentially ambiguous reading of the Transaction Information and disclosure of Evaluation Material provisions, the legally required exception requires an External Demand, which the SEC filings were not and (2) based on the unambiguous reading of these two provisions, the Transaction Information provision did not permit disclosure of Evaluation Material under the “legally required” argument and the disclosure of Evaluation Material provision only permitted disclosure if in response to an External Demand and after complying with the notice and vetting procedures.8
Based on its finding that Martin Marietta had breached the nondisclosure and joint defense agreements, the Court granted Vulcan the injunctive relief it had sought and enjoined Martin Marietta from proceeding with the hostile exchange offer and proxy contest or any other actions seeking corporate control for a four month period, which was the remaining term of the nondisclosure agreement at the time the hostile bid was initiated. The granting of this remedy was based on the terms of the nondisclosure and joint defense agreements, each of which contained provisions that provided that breaches of its terms would cause irreparable harm and that the non-breaching party would be entitled to injunctive relief, as well as the determination that investors were better served by the specific enforcement of the nondisclosure and joint defense agreements as opposed to considering Vulcan’s takeover proposal.
The Court’s decision provides practitioners with a number of important lessons. Although the decision creates no new law, it reinforces Delaware’s policy to enforce confidentiality agreements and accept the parties’ assertions of irreparable harm from breaches. The Martin Marietta decision also highlights the importance of clarity in the terms of an agreement, including attention to the definition of “Transaction” and the permissible use of information, as well as exceptions to such limitations on use.
As evidenced by the decision, a lack of such clarity can lead to a standstill provision being read into a nondisclosure agreement, even where one has not be explicitly included or negotiated among the parties. In order to avoid liability, the bidder wishing to leave open the option of a subsequent hostile transaction ought to find ways to protect itself from this type of backdoor standstill, such as using a clean team to evaluate the possible hostile transaction.
Finally, the Martin Marietta decision leaves open the question of whether a bidder can unilaterally create the legal requirement that compels disclosure. Although this question was not resolved in this case, it appears that Strine was favorably disposed to the argument that the exception would not apply by analogy to the doctrine that a legal prohibition preventing performance is not a defense if the prohibition arose as a result of the acts of the party asserting the defense, stating in a footnote that such an argument was “colorable.”9
Don’t Ask, Don’t Waive
In addition to the Martin Marietta decision, the court also considered confidentiality agreements in two other cases this year, this time with the emphasis on a specific provision of the agreement. During the last quarter of 2012, the Delaware Chancery Court handed down two bench rulings concerning injunctions of “Don’t Ask, Don’t Waive” standstill provisions, which are standstill provisions that prohibit bidders from publicly or privately seeking a release of the standstill obligation from the target company counterparties. The first, In re Complete Genomics, Inc. Shareholder Litigation, was issued by Vice Chancellor Laster in November, and enjoined the enforcement of a single such provision. In December, Chancellor Strine took a different stance in In re Ancestry.com Shareholder Litigation, refusing to enjoin the enforcement of the “Don’t Ask, Don’t Waive” provisions at issue, but requiring disclosure of their existence to shareholders before a shareholder vote on the merger. Both cases shed new light on a powerful tool in the confidentiality arsenal.
In June 2012, Complete Genomics, Inc. (“Genomics”), a NASDAQ listed company, publicly announced that it was exploring its strategic options and began soliciting bids from interested bidders. Genomics entered into nine confidentiality agreements, four of which contained standstills. Of the four confidentiality agreements that contained standstills, three prohibited the bidders from publicly requesting a waiver of the standstill and one contained a “Don’t Ask, Don’t Waive” provision (a “DADW provision”)that prohibited the bidder from privately requesting a waiver of the standstill. In September, Genomics agreed to be acquired by bidder BGI-Shenzen (“BGI”) in a transaction structured as a tender offer followed by a second-step merger. Several stockholders sued to enjoin the transaction, moving for a preliminary injunction on September 21, 2012. While the Vice Chancellor addressed a number of Delaware corporate law issues, the most significant aspect of his ruling was the injunction he issued prohibiting the enforcement of the DADW provision. In reaching this decision, the Court focused on the similarity of that restriction to a “no-talk” provision, noting that both of these protections impermissibly preclude the flow of information to the board, which has a duty to “take care to be informed of all material information reasonably available.”10 By disallowing a bidder to privately request a waiver, the provision effectively prevented the board from becoming aware of the information that a bidder wishes to make another bid. This was at odds with the board’s “ongoing statutory and fiduciary obligations to properly evaluate a competing offer, disclose material information, and make a meaningful merger recommendation to stockholders,”and the Court therefore found that the plaintiffs had established a reasonable probability of success on the merits that the DADW provision would violate the board’s fiduciary duties.11 For that reason, Vice Chancellor Laster enjoined enforcement of the DADW provision.
Vice Chancellor Laster’s ruling seems to imply that DADW provisions are unenforceable under Delaware law at a time when a target company’s board of directors has a duty to make a recommendation regarding a transaction to its stockholders, especially in light of his statement describing the provision as a “promise by a fiduciary to violate its fiduciary duty.”12 However, Chancellor Strine’s opinion less than a month later offers a different conclusion.
In June 2012, Ancestry.com Inc. (“Ancestry”) engaged Qatalyst Partners (“Qatalyst”) to conduct an auction of its business. Qatalyst worked with 17 potential merger partners, and Ancestry signed 12 nondisclosure agreements, each of which included a DADW provision. In late June, the field was narrowed from 12 to three potential bidders, including Permira Advisors LLP (“Permira”), the ultimate auction winner. Following entry into the merger agreement with Permira, several of Ancestry.com’s shareholders sued to enjoin the deal.
In a bench ruling, Chancellor Strine found, among other things, that the lack of disclosure to the shareholders about the presence of the DADW provisions was problematic and enjoined the shareholder vote pending additional disclosure relating to these and other unrelated facts.13 While, the Chancellor acknowledged the usefulness of a DADW provision as a powerful means to bring an auction to a conclusion and to maximize the value of bids from the auction participants, he concluded that such a provision could only be used when the participants making decisions are aware of the existence and implications of the provision. The evidence presented to the Court indicated that the Ancestry.com board of directors was not aware that the provision had been included in the confidentiality agreements nor of the ramifications of the inclusion of the provisions, which the Court concluded was probably a violation of the board’s duty of care. Moreover, when such provisions are included in confidentiality agreements, Chancellor Strine concluded that shareholders had a right to know about them. Unlike Vice Chancellor Laster, Chancellor Strine insisted that it was not the Court’s place to create a bright line rule on the issue, saying that “Per se rulings where judges invalidate contractual provisions across the bar are exceedingly rare in Delaware, as they should be.”14 Chancellor Strine, in fact, refers to the Genomics decision and states that he does not believe that it is a per se ruling on the issue, but rather that it was a complicated situation, and that the court must always be hyper vigilant in Revlon cases.15
The key takeways for M&A participants of the Ancestry.com decision in terms of confidentiality agreements are the importance of educating a target company’s board in the event that DADW provisions are included in confidentiality agreements, including on the proper use of such provisions consistent with the board’s duty of care and Revlon duties if applicable, and the need to disclose the existence of such provisions to a target company’s shareholders similar to other deal protection devices.
In addition, when such provisions are used, a target company (and the acquirer) may be well-served to waive the restrictions contained in the DADW provisions prohibiting the counterparty from requesting a private waiver of the provision from the target company.
Taken together with the Genomics decision, participants should also take note that while DADW provisions are not per se invalid, Delaware courts will closely scrutinize such provisions in order to ensure that they are used equitably and as a meaningful tool to enhance the results of a sales process, rather than as a hindrance to the board’s fiduciary duties.16
It is perhaps a coincidence that three of the major Delaware cases in 2012 related to confidentiality agreements. Nevertheless, together, these three cases remind us of the importance of these agreements, the potency of certain provisions and how they must be drafted and negotiated thoughtfully and carefully in the takeover context.
Although not necessarily groundbreaking, the Martin Marietta decision evidences the importance of careful drafting to avoid unintended constraints on the use of information. Genomics, together with Ancestry.com, highlights the importance of process, and ensuring that powerful provisions such as a DADW provision should be used with the utmost attention to detail, including adequate disclosure about the purpose and effects of the provision. Both lawyers and management would do well to heed the reminder that these cases offer.
Frank Aquila is a partner in the Sullivan & Cromwell LLP Mergers & Acquisitions Group, resident in the firm’s New York office. Krishna Veeraraghavan is a partner in S&C’s Mergers and Acquisitions Group. Mimi Butler is an associate in S&C’s General Practice Group.
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