Delaware Corporate Law Update

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

Chancery Rules on Revlon Standard For Mixed Cash/Stock Deals

On May 20, the Court ruled in In re Smurfit-Stone Container Corp. Shareholder Litigation  that a merger transaction with consideration of 50% cash and 50% stock was subject to heightened “Revlon” scrutiny.  In two previous cases, the Delaware Supreme Court had ruled that a 33% cash deal was not, while the Court of Chancery had assumed without deciding that a 62% cash deal was.  Smurfit-Stone provides more guidance from the Court on the circumstances in which heightened “Revlon” scrutiny will apply in mixed cash/stock deals, assuming the target does not have a controlling stockholder or stockholder group.  Such scrutiny will apply where either (i) a stockholder or stockholder group will control the combined entity; or (ii) some large portion of the consideration is cash.  As to how much cash will trigger heightened scrutiny, Smurfit-Stone asks whether a “substantial” part of the stockholders’ investment has been cashed out, implying that Revlon may apply even where the percentage of cash is below 50%.

In Smurfit-Stone (opinion available here), plaintiffs moved for a preliminary injunction to block a merger between target Smurfit-Stone Container Corp. and a subsidiary of acquiror Rock-Tenn Company.  A board with a majority of outside directors approved the transaction after negotiations with Rock-Tenn and one another potential acquiror, but without a market-check.  Smurfit-Stone shareholders were to receive, for each share, $17.50 in cash and a percentage of a share of Rock-Tenn common stock worth approximately $17.50 at its closing price immediately prior to the announcement of the deal.

Vice Chancellor Donald F. Parsons, Jr. first determined whether Revlon applied.  Revlon has been held to apply, among other circumstances, when the transaction effects a “sale or change of control”.  Plaintiffs claimed that the merger would cause a sale or change of control.

The Court noted that all-cash deals have been held to constitute changes of control because there is “no tomorrow” for the stockholders: they are forever shut out of future corporate profits or the possibility of obtaining a control (or increased control) premium.  All-stock deals do not — unless the combined entity has a controlling stockholder or stockholder group in which case, again, the stockholders have lost the ability to obtain a control premium in future transactions.

The Court then discussed two Delaware cases concerning mixed cash/stock deals.  In In re Santa Fe Pacific Corp., 669 A.2d 59 (Del. 1995), the Delaware Supreme Court ruled Revlon inapplicable to a deal with 33% cash consideration (plaintiff had also not shown that the combined entity would have a controlling stockholder).  In In re Lukens, 757 A.2d 732 (Del. Ch. 1999), the Court of Chancery had ruled Revlon did apply to a deal in which each stockholder had the right to elect to receive consideration in cash, up to a maximum of 62% of the total deal, even though (again) the combined entity would have no controlling stockholder.

The Court held that its reasoning in Lukens applied to this case as well. Defendants had argued that Lukens did not apply because a majority of stockholders could conceivably have elected to cash out entirely in Lukens, but not here.  The Court disagreed:  “while no Smurfit-Stone stockholder will be cashed out 100%, 100% of its stockholders who elect to participate in the merger will see approximately 50% of their Smurfit-Stone investment cashed out.”  The Court characterized the “reasoning of Lukens” as concerning the Court’s need “to scrutinize under Revlon a transaction that constitutes an end-game for all or a substantial part of a stockholder’s investment in a Delaware corporation.” (emphasis added).

While the Court applied Revlon scrutiny, it went on to hold that the actions of the Smurfit-Stone board withstood this heightened scrutiny and, thus, denied plaintiffs’ motion for a preliminary injunction.

Smurfit-Stone reaffirms the result in Lukens that, in a mixed cash-stock consideration merger, Revlon may apply even if control of the resulting entity remains in the hands of public stockholders.  It also extends the holding in Lukens that 63% cash consideration will trigger Revlon to 50%, under the reasoning that Revlon governs any transaction in which “a substantial part” of stockholders’ investments are cashed out.

Furthermore, Smurfit-Stone suggests that Revlon may apply at cash consideration levels even below 50% — such consideration is certainly “substantial” under the plain meaning of the word.  Moreover, the Revlon analysis itself asks whether there has been a “change of control”.  Under Delaware law, a stockholder can be deemed “controlling” so as to incur fiduciary duties to the other stockholders even where its percentage stock-holding is below 50% (where actual control by the stockholder can be established factually).  Delaware courts have interpreted Revlon to be substantively less stringent over the years and more flexible to a good faith process implemented by an active board of directors, suggesting that they may, to a certain degree, be more willing to extend the doctrine.  (Indeed, it has been reported that in January 0f this year Vice Chancellor J. Travis Laster suggested that Revlon should apply in any end-stage transaction involving the last opportunity to negotiate a premium, including when that premium is paid in stock of the combined entity).

Notably, the actions giving rise to the case were filed in both Delaware and Illinois.  On the suggestion of defendants the Delaware and Illinois courts conferred, resulting in the Illinois court’s decision to stay the actions before it pending resolution of the Delaware action.  Such interactions between Delaware judges and judges in other jurisdictions seem to be becoming more common, particularly given recent disputes in Delaware courts about multidistrict litigation.  Such communication seems generally beneficial in eliminating duplicative work and expense for the courts and parties, as well as conflicts between the Delaware judicial system and that of other states.


Filed under: Court of Chancery, Preliminary Injunction, Revlon

“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.

Filed under: Court of Chancery, Preliminary Injunction

Supreme Court Sets Standard For Preliminary Injunction Security

One of the practicalities of a motion for preliminary injunction is that the party enjoined may request the other side provide security for damages resulting from the injunction should it later be determined to have been wrongfully granted.  The standard governing such a request has, however, rarely been the subject of a written opinion in Delaware.  A recent opinion from the Supreme Court,  Guzzetta v. Service Corporation of Westover Hills, No. 34, 2010 (Del. Nov. 9, 2010) (attached), sheds some light on this subject.

Court of Chancery Rule 65(c) requires a party seeking an injunction to provide security “for the payment of such costs and damages as may be incurred or suffered by any party who is found to have been wrongfully enjoined.”   (Security typically takes the form of a bond, often costing only a small portion of its face amount).   In Guzzetta, the Court had granted a bond ultimately in the amount of $10,000, rejecting defendants’ request for a significantly higher one.  The Court ultimately determined the injunction to have been wrongfully granted and awarded defendants the amount of the bond.

The amount of the security sets the ceiling for damages the enjoined party may recover should the trial court ultimately rule in that party’s favor.  Thus, Guzzetta states that the trial court should “err on the high side” and set bond in an amount “likely to meet or exceed a reasonable estimate of potential damages.”  The Court noted, however, that the party seeking the bond must support its application with “facts of record or . . . some realistic as opposed to a yet-unproven legal theory from which damages could flow to the party enjoined.”  The Court held that, “If necessary,” the trial court could hold an evidentiary hearing to determine whether there was “some credible basis” for the estimated damages.

In applying that standard to the case at bar the Court affirmed the trial court’s rejection of certain items of possible damage as without merit.  The trial court had not explained, however, why it had rejected other items totaling more than twice the amount of the bond granted.  The Court thus reversed and remanded for further proceedings in light of its opinion.

Filed under: Delaware Supreme Court, Preliminary Injunction, Security




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.