Court Finds Conflicts in Rural/Metro Sale

WarningSignThe Delaware Court of Chancery has found the Board of Directors of Rural/Metro Corporation breached its fiduciary duties to its shareholders in its 2011 sale.  The Court also found the company’s lead adviser liable for aiding and abetting the breach.

The Rural Board was subject to undisclosed conflicts and failed to probe the company’s lead adviser for additional potential conflicts.

This case and prior high profile cases of conflict, such as the Del Monte and El Paso cases, should alert boards to be vigilant.

Click here to go to an article by White & Case, the law firm on JDSupra, the online legal magazine or click on the download button below.

Take Privates with Control Shareholder Rules Clarified

Taking a public company private when this involves a control shareholder has always been fraught with potential conflicts and litigation risk.

Recently, the Delaware Supreme Court upheld a Chancery Court decision setting the conditions under which a board of directors’ decision on a take private transaction with a control shareholder would be evaluated using the business judgement rule.

Katten Muchin Rosenman, the law firm, posted an article on JDSupra, the online legal magazine on this case.  Article excerpt:

In upholding the Chancery Court’s decision, the Delaware Supreme Court held that the business judgment standard of review would apply to a going private acquisition by a controlling stockholder if, but only if, the following facts were established: (1) the controlling stockholder conditioned the transaction on the approval of both a special committee, and a majority-of-the-minority stockholders; (2) the special committee was independent; (3) the special committee was empowered to freely select its own advisors and to say no definitively; (4) the special committee acted with care; (5) the minority vote was informed; and (6) there was no coercion of the minority.

Click here to read the article on JDSupra, by attorneys at Katten Muchin Rosenman LLP.

Click here to read an article on JDSupra by attorneys at Perkins Coie.

Click here to read an article on JDSupra by attorneys at Fenwick & West.

Also, another recent case in the Delaware Chancery Court spells out procedural rules and implications for the parties if there are any defects in the process.

Lathm & Watkins, the law firm, offers the following helpful analysis and recap of the case.  Additional articles from Latham & Watkins are available on its website, www.lw.com.

 

March 2014

 

 

In re Orchard Enterprises, Inc. Stockholder Litigation,
C.A. No. 7840 (Del. Ch. Feb. 28, 2014)

 

 

 

Delaware Court of Chancery applies entire fairness review to a take-private merger with a controlling stockholder, despite approval by a special committee and a majority-of-the-minority, and holds that disclosure claims may give rise to post-closing money damages where the duty of loyalty is at issue.

 

Summary

The Delaware Court of Chancery largely denied summary judgment, thereby paving the way for trial on the merits of a take-private merger in which the common stockholders of The Orchard Enterprises Inc. were cashed out by Orchard’s controlling stockholder. In a 90-page opinion, Vice Chancellor Laster found “evidence of substantive and procedural” unfairness in the process and price negotiated by a five-member special committee of directors and approved by holders of a majority-of-the-minority of the stock. The Court declined to apply business judgment review — or even shift the burden of persuasion under entire fairness review — in light of evidence that the structural protections outlined in In re MFW and CNX Gas may have failed to operate effectively to protect the interests of the minority stockholders.

The controlling stockholder, Dimensional Associates, LLC, held 53 percent of the voting power of Orchard through ownership of 42 percent of the common stock and 99 percent of the Series A convertible preferred stock. In October 2009, Dimensional made a proposal to buy out Orchard’s minority stockholders for $1.68 per share in cash. Orchard’s Board formed a five-member Special Committee, which was fully authorized to negotiate with Dimensional and potential third-party bidders and to hire independent legal and financial advisors. The Court of Chancery found evidence that the lead Special Committee director was neither independent nor disinterested in light of his long-standing relationships with family members of Dimensional’s founder and his solicitation of a post-closing consulting engagement with Dimensional.

Valuation of Dimensional’s Series A was a pivotal fact in the Court’s analysis. The Special Committee’s financial advisor preliminarily valued the common stock at $4.84, based on total equity value divided by the outstanding common stock — and assuming that the Series A would be converted to common stock and participate on a pro rata basis. This assumption effectively valued the Series A at about $7 million. Allegedly at the direction of the Special Committee, the financial advisor later changed its approach and valued the Series A based on a $25 million liquidation preference. The Court of Chancery found that, although Orchard’s charter entitled the Series A to a $25 million liquidation preference in a dissolution, asset sale or sale to third-party, none of these circumstances applied to a take-private transaction with Dimensional. Nonetheless, the price negotiation reflected Dimensional’s bargaining leverage given the unlikely scenario that any third party would value Orchard high enough to pay the $25 million Series A preference and pay a price for the common stock that would be undiminished by the preference payment.

Orchard’s public announcement of Dimensional’s initial proposal of $1.68 per share led to third party interest and generated a higher offer by a third party. Dimensional assured the Special Committee that Dimensional would be willing to support a sale to a third party if it received the full liquidation preference. The Special Committee allowed Dimensional to negotiate directly with the third party and at least one other bidder — but no deal was reached. The Court of Chancery found evidence that Dimensional may have misled the Special Committee by negotiating with the third parties for a premium above the Series A liquidation preference.

Meanwhile, in the negotiations between the Special Committee and Dimensional, Dimensional offered $2.10 per share without a majority-of-the-minority approval condition, but eventually agreed on a price of $2.05 per share with a go-shop and a majority-of-the-minority condition. The Special Committee’s financial advisor issued an opinion that the price was fair from a financial point of view to Orchard’s common stockholders — but the advisor assumed that the Series A should be allocated $25 million of the equity value of Orchard with the rest allocated to the common stock.

Orchard’s proxy statement recommended approval of the merger and of an amendment to the Series A Certificate to enable the merger (which otherwise would have prohibited a change of control via a take-private transaction with Dimensional). In July 2010, holders of a majority of the common stock not controlled by Dimensional approved the merger and the transaction closed. After closing, certain stockholders brought an appraisal action. In 2012, then-Chancellor Strine of the Court of Chancery (now Chief Justice of the Delaware Supreme Court) ruled that the merger did not trigger the Series A liquidation preference and appraised the common stock at $4.67 based on an assumed pro rata participation by the Series A on an as-converted basis. Two months later, other stockholders brought a class action challenging the process and price of the transaction.

Vice Chancellor Laster issued a 90-page opinion analyzing issues presented in dueling motions for summary judgment brought by plaintiffs and defendants.

The Court granted summary judgment to the plaintiffs on their claim that the proxy statement contained materially misleading disclosures regarding whether the merger triggered the Series A liquidation preference. The Court found that the proxy statement incorrectly stated in two places that the liquidation preference would be triggered unless the amendment was approved. One of those incorrect disclosures was material as a matter of law because the inaccuracy appeared in the description of the amendment to the Series A Certificate, which is a statutorily required disclosure under Section 242(b)(1) of the Delaware General Corporation Law (DGCL).

The Court also granted summary judgment to the plaintiffs on their arguments that the entire fairness standard of review should apply at trial, finding that Dimensional’s failure to agree at the outset to approval by both the Special Committee and a majority-of-the-minority precluded review under the business judgment rule. Furthermore, the Court held that neither of those protective measures, even though ultimately deployed, warranted shifting the burden of persuasion from defendants to plaintiffs because (a) the stockholder vote was tainted by the disclosure violation and (b) plaintiffs had raised triable issues of fact as to the integrity of the Special Committee process, including the issues with the chairman described above.

The Court of Chancery rejected the Special Committee members’ argument that they were automatically shielded from liability by the DGCL § 102(b)(7) exculpation clause in Orchard’s certificate of incorporation. That provision only immunizes directors for breach of the duty of care. Given the context of a controlling stockholder transaction subject to entire fairness review, where there was evidence of both procedural and substantive unfairness, the Court was unable to conclude, as a matter of law, that the evidence did not also implicate the duty of loyalty for all directors. Therefore, the four members of the Special Committee whose independence and disinterestedness had not been challenged by the plaintiffs were also required to prove at trial that they did not breach their duty of loyalty and were entitled to exculpation.

Finally, the Court of Chancery denied defendants’ argument that rescissory damages and quasi-appraisal damages were unavailable, finding that both measurements were possible given the failure to fully inform the stockholder electorate. (Rescissory damages is the monetary equivalent of rescission; quasi-appraisal damages is essentially monetary damages tied to the difference in equity value resulting from the non-disclosure.) The Court also rejected the defendants’ argument that In re Transkaryotic Therapies, Inc., 954 A.2d 346 (Del. Ch. 2008) barred any post-closing claim for money damages for a disclosure violation, finding that a money damages claim is possible where the disclosure violation implicates the duty of loyalty, or where plaintiffs can otherwise prove reliance, causation, and calculable damages.

 

Implications for our Clients

 

·         To obtain business judgment review of a transaction with a controlling stockholder, it is critically important that procedural safeguards be established before substantive negotiations begin.

o    The controlling stockholder must agree at the outset to condition any transaction on approval by an independent special committee and the affirmative vote of a majority-of-the-minority of stockholders (these cannot be “deal points” to be negotiated).

o    Unless both of these procedural safeguards are implemented at the outset (even if both are implemented ultimately), the most the parties can obtain is entire fairness review with a shift in the burden of persuasion to the plaintiffs (business judgment review will not be available).

·         Where entire fairness review applies, if there is “evidence of procedural and substantive unfairness,” the exculpatory provision in a company’s charter does not automatically protect even facially independent and disinterested special committee directors from potential liability for breach of the duty of loyalty; rather, each director must establish at trial that he or she is entitled to exculpation.

·         Evidence that the special committee chairman was not independent and acted in self-interest may require other facially independent and disinterested special committee members to defend their own conduct.

o    Special committee membership must be vetted carefully for potential conflicts of interest and lack of independence; if warranted, the special committee should be re-constituted.

o    Directors considering special committee service should pay careful attention to the conflicts and independence of other possible committee members when considering whether to accept the committee appointment.

·         Under entire fairness review, post-closing damages may be awarded if disclosures to stockholders in the solicitation of majority-of-the-minority approval contain material inaccuracies.

o    Further, even in arms-length third-party merger cases, post-closing damages may be available for materially misleading disclosures, subject to plaintiff’s proof of reliance, causation and quantifiable damages.

o    This may lead to a reduction in pre-closing settlement of merger cases based on disclosures, or an increase in the cost of those settlements.

·         The decision may be appealed eventually, and it is possible that certain of the holdings, particularly those concerning the availability of exculpation for facially conflict-free and independent directors and of money damages for disclosure claims post-closing, may be considered further.

 

Discussion

Delaware Court of Chancery precedent has established that the business judgment rule can apply to squeeze-out mergers by controlling stockholders where certain procedural safeguards are adopted. In re CNX Gas Corporation Shareholders Litigation, 4 A.3d 397 (Del. Ch. 2010), established that a transaction with a controlling stockholder may be subject to deferential business judgment review if the transaction is conditioned on approval by an independent special committee and by a majority of the minority stockholder vote. In re MFW Shareholders Litigation, 67 A.3d 496, 502 (Del. Ch. 2013), clarified that, to obtain business judgment review, the special committee must have authorization to negotiate and the controlling stockholder must agree to the dual independent approval process up front, before beginning negotiations.

 

In re Orchard reiterates this timing requirement when attempting to secure business judgment protection for a transaction with a controlling stockholder. Although the transaction ultimately was approved by a special committee vested with the authority to negotiate, and by a majority–of-the-minority stockholder vote, the Court of Chancery declined to apply the business judgment rule because the controller did not agree up-front to both of those protections (and, indeed, used the majority–of-the-minority approval as a deal point to reduce the purchase price). In re Orchard confirms (resolving a question left open by CNX Gas and In re MFW), however, that the burden of persuasion may be shifted from the defendants to the plaintiff under the entire fairness standard if a controller agrees to one but not both protections. While a shift in the burden of persuasion is commonly viewed as an inferior procedural benefit because it does not obviate a potentially costly and time-consuming post-closing trial on the merits, a shift in the burden still may be valuable to defendants by incentivizing plaintiffs to settle before trial.

 

The decision also concludes that, in a controlling stockholder transaction subject to entire fairness review, an exculpatory clause in the company’s charter under DGCL § 102(b)(7) does not automatically shield even facially independent and disinterested directors from potential liability where there is evidence of procedural and substantive unfairness indicating a breach of the duty of loyalty. A trial is required to determine whether the transaction was entirely fair, and, if it was not, then an analysis on a director-by-director basis at trial is required to determine whether they committed any breach of loyalty. In re Orchard thus diminishes the opportunity for dismissal of facially independent and disinterested directors at an early stage in merger litigation (and increases the potential cost and hassle of service on a special committee). While DGCL § 102(b)(7) remains a strong substantive protection for directors who can reap the benefits of its protection at trial—even when the transaction was not entirely fair — In re Orchard meaningfully increases the risk that otherwise “clean” Special Committee members may need to bear the burden of preparation for and participation in a trial, as well as the associated reputational risks.

 

Finally, the Court held that monetary damages for alleged disclosure deficiencies in soliciting stockholder approval may continue to be available even after a merger closes. Although injunctive relief to correct disclosure deficiencies may be granted before a merger vote in order to prevent “irreparable harm” the Court rejected defendants’ inference that there can be no post-closing “remedy” in the form of monetary damages. However, plaintiffs who assert post-closing disclosure-based claims must still prove reliance, causation and quantifiable damages.

 

If you have any questions about this M&A Client Alert, please contact one of the authors listed below
or the Latham attorney with whom you normally consult:

 

Stephen B. Amdur

Mark G. Gerstein

Rachel J. Rodriguez

Blair Connelly

Pamela S. Palmer

Bradley C. Faris

Sarah M. Lightdale

 

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Recent Revlon Ruling Reaffirms Rules

In a recent New York Superior Court decision applying Delaware Law, the court held that what are known as the “Revlon Duties” do not apply in a stock for stock merger where there is no true change of control.

In the specific case, the stock merger resulted in a combined corporation in which there was no controlling shareholder, only a larger group of non-controlling shareholders.  This was key to the decision as the language of the court decision makes clear:

“In the context of a stock-for-stock merger, a change of control for Revlon purposes can be triggered if the target’s shareholders are relegated to a minority in the resulting entity, and the resulting entity has a controlling stockholder or stockholder group. Where, however, ownership of the merged company will remain in “a large, fluid, changeable and changing market,” Revlon is not implicated.”(1)

Rather than holding the corporation’s board’s decision to approve the merger to the standards in “Revlon”, the board’s decision was held to the standards of the business judgement rule which defers to the judgement of the board if it acts in an informed basis, in good faith, and in the honest belief that its actions are in the best interests of the company.

Click here to read ReedSmith, the law firm’s, post on this decision.

(1) Badowski, at *7 (citing, inter alia, Arnold v. Society for Savings Bancorp. Inc., 650 A.2d 1270, 1290 (Del 2009); Smurfit-Stone Container Corp. S’holder Litig., No. 6164-VCP, 2011 WL 2028076, *12 n. 92 (Del Ch. May 24, 2011)).

New Tender Offer Rules Working

Companies are taking advantage of the new tender offer rules to avoid a time-consuming and costly second step merger.  As Brad Farris, attorney with Latham & Watkins, described on a panel reviewing tender offers done since the new rules were permitted.

For background on the issue, please click here to review my prior post.

For a summary of the recent panel including Brad Farris’ remarks, click here.

 

 

M&A Trends In 2013

By Dennis McCarthy – (213) 222-8260 – dennis@mbsecurities.com – 

Stats now confirm what many of us in the M&A business have recognized for some time (link).  Middle market M&A activity has gotten stronger over the last several quarters.

The stats that I mention are courtesy of Mergermarket, the well-regarded source for M&A data.  Mergermarket reports that middle market M&A value is up 40% so far in 2013 vs  the same period last year as reported in its “Q1-Q3 M&A Trend Report”.

Stats like these are valuable but they’re a lagging indicator of deal activity because M&A projects typically take months from initiation to completion.   This report captures M&A deals that closed during this last three quarters ended September 30, 2013.  Companies embarked on those projects many months before, many in 2012, for example.

Now, another point to consider.  The fourth quarter of last year was a very strong quarter for M&A deals because deals  closed in 2012 qualified for favorable tax treatment. So the full year 2013 results may not show such a dramatic increase because last year’s fourth quarter was such a big M&A quarter.

I think the trend of increasing middle market M&A activity will continue; the conditions driving the trend remain favorable.

I’ve attached a link to the Mergermarket report below.

Please contact me to help your company to successfully complete an M&A deal or any capital market project.

Click here to go to the Mergermarket Q1-Q3 M&A Trend Report

CoverImage
  Google

In M&A, Is Flat the New Up?

By Dennis McCarthy – (213) 222-8260 – dennis@mbsecurities.com – 

In my experience with M&A deals, everything increases; it goes up.

All projections show increases in revenues and profits.  If you buy a company today, you’ll sell it for more money later.  Deals get bigger. Debt leverage goes up.  M&A multiples go up.  The M&A business, itself, goes up.  But what if…?

That’s the sobering message from  a study of middle market M&A published by Deloitte, the international accounting firm, looking back over 2011 and 2012.

Deloitte reports that between 2011 and 2012, middle market M&A was flat.  Deal volume was flat. Average deal value was flat.  Purchase price multiples were flat. Senior debt multiples were flat.  You get the idea.

But look on the bright side.  At least those metrics were flat.

International acquisitions of US middle market companies declined.

Purchase price multiples of LBOs declined.

All things considered, flat may not be so bad.  Maybe flat is the new up.

Supposedly, statistics don’t lie.  But 2012 certainly seemed to me to be a better, more active year than 2011.

Company executives I know seemed to be more confident that the economy was stable.  Not big growth but no big problems either.

Maybe we won’t see the impact of the improved environments until this year, 2013, given how long it takes to close an M&A deal,

I know I’m looking forward to an active 2013.  In any event, I’ll take flat over down every time.

I’ve attached a link to the Deloitte report below.

Please contact me to help your company with M&A or any capital market project. 

Deloitte US Middle Market M&A Stats 2012

 

Google

M&A Technique Upheld

Dennis McCarthy – (213) 222-8260 – dennis@monarchbayassociates.com

At the end of 2012, The Delaware Chancery Court upheld the use of a valuable technique in the auction of public companies, referred to as the “don’t ask, don’t waive” provision.

This provision prevents the bidders who lose in an auction from making a topping bid once the winning bid is determined.  It is designed to encourage bidders to make their best offer knowing that they won’t be forced into additional rounds of bidding.

It is a technique used to get sellers the highest price and to bring closure to an auction.

This provision, usually inserted into the standstill provisions of a non-disclosure agreement, is agreed upon at the very beginning of the auction process, often without much attention, when potential bidders are cooperative and eager to get started on their evaluation. 

It comes into play, however, at the very end of the auction process after the potential bidders’ evaluation is over and final bids have been submitted.

So, what’s the issue?

Under Delaware law, Board’s of companies have the duty to maximize value on a sale and to be fully informed of the potential for higher bids.

So, does the “don’t ask, don’t waive” provision prevent the Board of a selling company from entertaining potentially topping bids from losing bidders?

This was the question addressed by the Delaware Court. In a ruling Mid-December, the court determined that a selling company can use the “don’t ask, don’t waive” provision as a tool to maximize value as long as the Board, its advisers and  shareholders are aware of its use and understand its impact.

The “don’t ask, don’t waive” provision, therefore, remains an available technique for use by selling companies.

I think that this will be a very active M&A year. 

Companies and their advisers need to be informed about the latest developments in M&A.

Please subscribe to my blog to get current updates on key trends in the capital markets.  Also, please contact me to help your company to get the best M&A deal or to successfully complete whatever capital markets project you pursue.

Background article on the topic:

http://www.corporatesecuritieslawblog.com/367371-print.html

 

 

M&A Boom

Dennis McCarthy – (213) 222-8260 – dennis@monarchbayassociates.com

The Wall Street Journal recently ran a story entitled “Buyout Boom, But Not Like ‘07”.  The article quoted M&A and buyout professionals citing the reasons for the increase in deal activity including (i) availability of low cost debt, (ii) a reasonably stable and predictable economic environment, and (Iii) pent up supply by sellers who took businesses off the market during the recent economic downturn.

It caught my eye that the average deal size so far in 2012 is smaller, averaging $156 million and less than half the average deal size in 2007 according to Dealogic’s tally reported in the article.  Now, this year’s deal size is in the sweet spot for my colleagues and me at Monarch Bay and AgriCapital.

It’s true, my colleagues and I are seeing a rebound in M&A activity from the depressed levels of ’08 and ’09.  We see much more M&A activity, however, involving corporate buyers than private equity groups. 

Don’t get me wrong. I’m not disputing the Wall Street Journal article.  I’m just suggesting that the bigger story is the M&A boom involving corporate buyers.

Corporate buyers need to show growth and are finding organic growth is hard to come by.  Cash rich corporate buyers have turned to the M&A market to buy growth.

So, if you own a company and have been considering a sale, now may be the time to go to market whether the buyer is corporate or a private equity group.

Here are some additional observations on the M&A environment today.

In general, companies are running lean and mean now.  This goes for sellers and buyers.

This means that sellers, who need to keep their eye on the ball to maintain their business, should hire experienced investment bankers to manage the sale process.  That is the best way to stretch your company’s resources.

Because the buyers are also running lean and mean, the seller’s offering materials need to be crystal clear and compelling to get buyer attention and top dollar. Having an experienced advisor help prepare your offering materials makes a big difference.

To get the best price in the sale of a business, it helps to create competition among the buyers.  Many times it takes reaching out to a large number of potential buyers to create that competitive environment. Knowing the buyers to contact, as we do, speeds this process.

For sellers who are wary of disclosing too much to competitors, we can limit what’s made available to potential buyers. That remains under the seller’s control.

Am I getting the best price?   Every seller asks this question.  The answer is that if the economic environment is favorable and you’ve run a professional auction, you can feel good that you’ve gotten the best price.

Today, the environment is right.  We can run a professional auction to help you get that best price.  Please contact me or any of my colleagues to discuss your company and your goals.

M&A Boom

M&A Boom

Zombie Shares

Dennis McCarthy – (213) 222-8260 – dennis@monarchbayassociates.com

Well, “zombie shares” caught my eye.  I clicked on the article in the online magazine “Growth Capitalist” to find out just what are “zombie shares”.

Zombies, as I understand it, are the dead reanimated and controlled by someone through witchcraft.  Zombies move and react to their surroundings like they are alive but, in reality, they are not.

So, I presume that, “zombie shares” are shares of stock that look like normal shares but, in reality, are different.  In the example that follows, you’ll see that “zombie shares” may look like they’re still outstanding and held by the shareholder of record but, in reality, they are not.

In the “Growth Capitalist” article, the “zombie shares” are shares that have effectively been repurchased by and now voted by the issuing company but are left outstanding in the hands of the prior owner to permit the shares to be counted in shareholder votes. So, they’re “zombie shares”.

I mentioned something like this in prior posts on M&A defense such as “M&A Defense Checklist”.  In that context, however, a hostile investor would obtain effective voting control or effective ownership without tripping the definition of ownership to trigger a “poison pill” or 13(d) disclosure.  A hostile party, therefore, could control many more shares than its visible ownership would indicate.

At the time I posted, “M&A Defense Checklist”, I didn’t have a cool name like “zombie shares”.

The link to the article at “Growth Capitalist” is below.  Thanks to them for adding this colorful name.

As always, please contact me to assist your company to raise equity or debt or to complete M&A projects.

Article: http://www.growthcapitalist.com/2012/07/zombie-shares-race-to-bottom-at-issue-in-emmis-take-private-plan/

Corporate Proxy Videos

Dennis McCarthy – (213) 222-8260 – dennis@monarchbayassociates.com

As a follow-up to my recent posts on the 2012 proxy season entitled, “Silent Majority Speaks” and “Just a Small Leak“, I’d like to pass along to you a website that provides valuable information about corporate proxies.

This website, I’m pleased to report, will not likely cause your eyes to glaze over with boredom.

Created by Equilar, the compensation consulting company that I’ve mentioned in prior posts, this website presents short and informative videos on corporate proxy issues.

I’ve listed the website below for your review.  Let me know what you think.

As always, please call me to help your company with raising equity or debt or to complete M&A projects.

Equilar website:  http://www.equilar.com/knowledge-network/episode-8.php

Corporate Proxy Video

Corporate Proxy Video