Delaware Corporate Law Update

Updates on Delaware Corporate Law by Evan O. Williford, Esq., Delaware Corporate Litigation Attorney.

“Close Calls” on Disclosing Management Projections And Expressions of Interest

On May 10, the Court of Chancery denied an expedited application to preliminarily enjoin a cash tender offer by a subsidiary of Laboratory Corporation of America Holdings, Inc. (“LabCorp”) for all stock in Orchid Cellmark Inc.  An interlocutory appeal to the Delaware Supreme Court followed but was refused.

Plaintiffs argued that the Orchid board should have disclosed to stockholders: (1) management’s projections which were more optimistic than the financial advisor’s (disclosed) “base case” projections; and (2) more information regarding expressions of interest by other parties.  The Court characterized these two arguments as “close calls” but ultimately rejected them for factual reasons.

Key Facts

Orchid CEO Thomas Bologna was the only insider on its six-member board.  After an indication of interest from LabCorp, ultimately for $2.80 per share, the board appointed a special committee and hired Oppenheimer & Co. as financial advisor.  Oppenheimer solicited six other potential buyers.

Several expressed interest only in Orchid’s UK business, for seven to eight times UK EBITDA.  According to Oppenheimer, when combined with Orchid’s substantial cash on hand this equaled $2.74 to $3.04 per share, or approximately $2.93.  Oppenheimer advised the board that it believed Orchid “could get a higher price from a U.K. buyer than the [LabCorp bid but] there would be attendant transactional execution risk.”

Oppenheimer’s internal financial analysis provided to the board included projections by the CFO in connection with a proposed deal with LabCorp and endorsed by Bologna, who opposed the transaction.  (At the proposed price at least some of Bologna’s Orchid options were underwater).  These projections were included originally as the “management” case, later (pas Oppenheimer came to regard them as optimistic)  as the “upside” case alongside “base” and “downside” cases.

The board deliberated about a sale of the UK operations and ultimately determined that the risks and uncertainties of pursuing a UK transaction did not maximize shareholder value.  The board, other than Bologna, ultimately voted to recommend the LabCorp offer to stockholders.

Orchid’s Recommendation Statement to stockholders disclosed that such a transaction was considered, but that Oppenheimer had advised the board that it presented certain risks, including financing availability, that made it unattractive.  It reported that Oppenheimer had stated to the board that “no third party would likely propose a bid for the company that would yield a result for the stockholders” higher than the LabCorp indication of interest.”  The Recommendation Statement disclosed Oppenheimer’s “base case,” but not management’s, projections.

The Court’s Rulings

Plaintiffs argued that the alternative of selling only the UK operations were inadequately disclosed.  The Recommendation Statement disclosed that the board considered such a transaction but not that Orchid received expressions of interest, nor that they were in a range which on average exceeded the tender offer price.  The Court determined that the omitted facts were not material, reasoning among other things that the offer price fell within the range of prices for the expressions of interest.  But the question was a “very close one.”

Plaintiffs also argued that the management projections should have been disclosed.  The Court distinguished the general rule that management cash flow estimates are material for disclosure purposes, noting that the management projections had been prepared and submitted in response to the transaction (one Bologna opposed) and finding that his underwater options gave him an incentive to argue that Orchid was worth more.  Again the issue was a “close one.”

Lessons from Orchid

Orchid reaffirms the ability of the Delaware Court of Chancery and Supreme Court to render decisions in a short time when necessary, including by detailed, fact-specific opinions when appropriate.  The tender offer expired on May 17.  The 37-page Orchid opinion was released on May 12, after a hearing earlier that same day.  An interlocutory appeal was submitted the day afterwards, a Friday, May 13; a three-justice panel of the Delaware Supreme Court reviewed and decided the application on Monday, May 16.

Orchid shows that even in the disclosure setting courts may give more deference to boards that are independent and engaged.  This was not a conflicted transaction, and it is apparent that the board and the special committee devoted a lot of time and energy to the process leading up to the transactions. The board further demonstrated independence by disagreeing with and outvoting the CEO.  These facts seemed to have significantly influenced the Court:  “In sum, this is an informed board, guided by competent legal and financial advisors.  It is independent and disinterested.  Its actions have been reasonable.  Perhaps there was a better path, but that seems unlikely.”

Certain facts, including regarding the UK expressions of interest, did not seem fully developed, although it is unclear whether that is because they were not brought out by the parties, not included in the opinion due to the expedited timeframe, or for some other reason.  Orchid reminds that if a plaintiff does not fully bring out the facts of a transaction that allegedly make it wrongful the defendant is likely to prevail.

It is unclear exactly why a UK transaction was not pursued.  Notwithstanding Orchid, it is risky for a board or special committee not to adequately explore an indication of interest or offer/bid — and if it does not it should be prepared to justify its decision in litigation.  In transactions such as this one where control of an entity is being sold, the heightened “Revlon” standard (not the business judgment rule) applies, making good faith exploration or consideration of all reasonably available alternatives even more of a focus.

Disclosures (or lack thereof) regarding projections and alternative bidders are typically significant and will be closely inspected.  As the Court noted, both issues were “close calls;” another court could conceivably have ruled differently, particularly upon a more complete record.  Since management projections are often prepared pending a proposed deal, that fact may not be determinative in the future, as noted in this lengthy, insightful summary of Orchid by Tom Bayliss of Abrams & Bayliss.

Advertisements

Filed under: Court of Chancery, Preliminary Injunction

Pages

Disclaimer

Delaware Corporate Law Update solely reflect the views of Evan Williford of The Williford Firm, LLP. Its purpose is to provide general information concerning Delaware law; no representation is made about the accuracy of any information contained herein, and it may or may not be updated to reflect subsequent relevant events. This website is not intended to provide legal advice. It does not form any attorney-client relationship and it is not a substitute for one.