Risks to Overbidders Under Delaware Law

A recent Delaware Court of Chancery decision refusing to dismiss damages claims by NACCO Industries arising out of its failed attempt to acquire Applica Inc. provides important guidance for parties contemplating an overbid and highlights the risks that remain even after a topping deal is successfully closed. NACCO Indus., Inc. v. Applica Inc., C.A. No. 2541-VCL (Dec. 22, 2009).

The complaint alleged that while NACCO and Applica were negotiating a merger agreement in 2006, Applica insiders provided information to principals at the Harbinger hedge funds, which were then considering their own bid for Applica. During this period, Harbinger amassed a substantial stake in Applica (which ultimately reached 40 percent) but reported only an “investment” purpose on its Schedule 13D filings, disclaiming any intent to control the company. After NACCO signed up the merger, the complaint alleged, communications between Harbinger and Applica management about a topping bid continued. Eventually, Harbinger amended its Schedule 13D disclosures and made a topping bid for Applica, which then terminated the NACCO merger agreement. After a bidding contest with NACCO, Harbinger succeeded in acquiring the company.

NACCO brought claims against Applica for breach of the merger agreement’s “noshop” and “prompt notice” provisions and against Harbinger for common law fraud and tortious interference with contract. Vice Chancellor Laster largely denied defendants’ motion to dismiss. As to the contract claims, the Court reaffirmed the utility of “no-shop” and other deal protection provisions, holding that “[i]t is critical to [Delaware] law that those bargained-for rights be enforced,” including by a post-closing damages remedy in an appropriate case. Good faith compliance with such provisions may require a party to “regularly pick[] up the phone” to communicate with a merger partner about a potential overbid, particularly because “in the context of a topping bid, days matter.” Noting that the no-shop clause was not limited to merely soliciting a competing bid, and that the “prompt notice” clause required Applica to use “commercially reasonable efforts” to inform NACCO of any alternative bids and negotiations, the Court had “no difficulty inferring” that Applica’s alleged “radio silen[ce]” about the Harbinger initiative may have failed to meet the contractual standard.

The Vice Chancellor also upheld NACCO’s common law fraud claims based on the alleged inaccuracy of Harbinger’s Schedule 13D disclosures. After a careful review of jurisdictional precedent, the Vice Chancellor dismissed Harbinger’s contention that all claims related to Schedule 13D filings belong in federal court, finding instead that when a “Delaware entity engages in fraud”— even if in an SEC filing required by the Exchange Act—it “should expect that it can be held to account in the Delaware courts.” The Court then ruled that NACCO had adequately pleaded that Harbinger’s disclosure of a mere “investment” intent was false or misleading, squarely rejecting the argument that “one need not disclose any intent other than an investment intent until one actually makes a bid.”

While the Court emphasized that NACCO was a fact-specific, pleadings-stage decision, the ruling underscores the risks inherent in an overbidding situation. Parties to merger agreements must respect no-shop and notification provisions in good faith or risk after-the-fact litigation, with uncertain damages exposure, from a jilted partner. And contrary to what is sometimes believed, Schedule 13D violations are not always curable with mere corrective disclosure, but may also give rise to damages under state law. Potential topping bidders must carefully consider all the public disclosures they make. Litigation risk remains even after the deal has closed.