The Duty of Activist Investors in Negotiating Mergers

Meredith E. Kotler, Roger A. Cooper, and Mark E. McDonald are partners at Cleary Gottlieb Steen & Hamilton LLP. This post is based on a Cleary memorandum by Ms. Kotler, Mr. Cooper, Mr. McDonald, and Kal Blassberger, and is part of the Delaware law series; links to other posts in the series are available here. Related research from the Program on Corporate Governance includes The Long-Term Effects of Hedge Fund Activism by Lucian Bebchuk, Alon Brav, and Wei Jiang (discussed on the Forum here); Dancing with Activists by Lucian Bebchuk, Alon Brav, Wei Jiang, and Thomas Keusch (discussed on the Forum here); and Who Bleeds When the Wolves Bite? A Flesh-and-Blood Perspective on Hedge Fund Activism and Our Strange Corporate Governance System by Leo E. Strine, Jr. (discussed on the Forum here).

On October 16, the Delaware Court of Chancery found an activist investor aided and abetted a target board’s breaches of fiduciary duty, most significantly by concealing from the target board (and from the stockholders who were asked to tender into the transaction) material facts bearing on a potential conflict of interest between the activist investor and the target’s remaining stockholders. See In re PLX Technology Inc. S’holders Litig., C.A. No. 9880-VCL (Del. Ch. Oct. 16, 2018). This decision serves as a reminder of the importance of full disclosure of material facts in cases involving potential conflicts (and not just of the potential conflicts themselves, but also of the ways in which such potential conflicts manifest themselves)—both at the board level and at the stockholder level. As this decision also demonstrates, in addition to the more familiar allegations of financial advisor conflicts, the court may find potential conflicts exist where an activist investor in the target with short-term interests that could be perceived to diverge from the interests of other stockholders is involved in merger negotiations.

At the same time, this decision expands on the Delaware Supreme Court’s recent appraisal jurisprudence favoring deal price as persuasive evidence of fair value in arm’s-length (and particularly in synergistic) transactions (see our prior posts here and here), by applying the reasoning of those decisions in this fiduciary duty case to find that, notwithstanding the target board’s failure to conduct a reasonable sale process, the plaintiffs had failed to prove any damages.

Background

PLX Technology Inc. (“PLX”) was a publicly-traded company that developed and sold “specialized integrated circuits used in connectivity applications.” In February 2013, Avago Technologies Wireless (U.S.A.) Manufacturing Inc. (“Avago”) expressed interest in acquiring PLX for $6 per share. PLX’s board told Avago that its offer would need to be at least $7 per share in order for PLX to consider it. Avago declined to raise its bid and talks fell through.

Shortly afterwards, Potomac Capital Partners II, L.P. (“Potomac”), an activist investor, acquired a stake in PLX for the express purpose of inducing PLX to sell itself to Avago. Following its investment in PLX, Potomac initiated a proxy contest, ultimately succeeding in installing its co-managing member, Singer, and two other nominees on PLX’s board.

After joining the board, Singer learned from Deutsche Bank, PLX’s financial advisor, that it had been informed by Avago that once Avago completed a separate acquisition, it would be open to a potential acquisition of PLX for $300 million, equivalent to approximately $6.53 per share. Deutsche Bank was at that time also advising Avago on its other pending acquisition. Singer did not report this “tip” to the other members of the PLX board.

In the meantime, Singer was appointed chair of a special committee formed by the PLX board to “run an affirmative process to consider the sale of the Company,” a position which would effectively allow him to run the sale process with Avago. Several months later, after closing its separate transaction, Avago submitted a proposal to acquire PLX at a price of $6.25 per share, which PLX countered at $6.75 per share. Just nine days later, PLX agreed in principle to Avago’s “best and final proposal” of $6.50 per share, almost the exact amount Singer and Deutsche Bank had been told months earlier Avago was then prepared to pay (and notwithstanding the PLX board’s previous refusal to entertain an offer from Avago under $7 per share).

The Decision

After a 3-day trial, Vice Chancellor Laster found that the board’s failure to disclose Deutsche Bank’s “tip” to Singer in the Schedule 14D-9 was a material omission that amounted to a breach of the directors’ duty of disclosure, and that Potomac had aided and abetted such breach through Singer’s (its agent’s) actions. [1] Key to this analysis was the court’s finding that both Potomac/Singer and Deutsche Bank faced potential conflicts—the former because they were interested in short-term gains, not necessarily achieving the highest long-term value for the corporation, and the latter because the acquiror was a significant client. Importantly, the court did not find that either of these potential conflicts were themselves undisclosed. Rather, the court found that, in light of those conflicts, a reasonable investor would have found Singer’s and Deutsche Bank’s undisclosed actions, including Singer’s involvement in the negotiations with Avago while concealing Deutsche Bank’s tip from the rest of the board, to be material.

Having found the stockholder vote was not fully informed on the basis of this omission, [2] the court then applied Revlon’s enhanced scrutiny to plaintiffs’ sale process claims rather than business judgment review under Corwin[3] Here again the court focused on Singer’s failure to disclose Deutsche Bank’s tip regarding Avago’s interest to his fellow directors. The court noted that ordinarily the facts in this case (where the board conducted pre-signing outreach to potential buyers, and the merger agreement contained a no-shop clause subject to fiduciary out and standard termination fees) “would not be grounds to debate whether the Board fulfilled” its Revlon duties. But the court found that the undisclosed tip in particular supported a finding that “Potomac and Singer succeeded in influencing the directors to favor a sale when they otherwise would have decided to remain independent,” thereby inducing the board to breach its fiduciary duties.

Notwithstanding these findings, Vice Chancellor Laster concluded that plaintiffs failed to prove any damages. Because plaintiffs’ theory was that the company should not have been sold at all—not that there was an alternative transaction at a higher price reasonably available—the measure of damages was the difference, if any, between the merger consideration and the company’s “fair” or “intrinsic” value (which the court described as a “quasi-appraisal” remedy). The court applied the Delaware Supreme Court’s recent Dell and DFC decisions [4] to find that, because PLX’s sale was negotiated in an arm’s length transaction involving multiple potential bidders, the deal price should be afforded “heavy, if not overriding, probative value.” Although the court found the sale process was “flawed” for the reasons discussed above, it was “sufficiently reliable” to “exclude” plaintiffs’ contention that the fair or intrinsic value of PLX exceeded the merger consideration, particularly in light of the fact that the merger consideration reflected anticipated synergies resulting from the transaction.

Key Takeaways

  • First, this case underscores again the importance of directors making full disclosure of all material facts, both to their fellow directors and to stockholders being asked to approve a merger involving potential conflicts of interest (including those of activist investors who may have different aims than the rest of the company’s stockholder base). As noted above, such disclosure is not limited to the potential conflicts themselves, but also should include any facts that may be found to be material in light of the potential conflicts, such as price discussions between potentially conflicted parties for the target and a potential acquiror. Had such disclosures been made in the 14D-9 in this case, Corwin likely would have led to a different outcome (since Corwin has been held to extinguish both sale process claims against directors and aiding and abetting claims, as we discussed in a prior post). In addition, disclosure by Singer of the “tip” to the full board also would have led the court to find the directors fulfilled their fiduciary duties in connection with the sale process; instead, the court found the board breached its duties and Potomac was liable for aiding and abetting such breach.
  • Second, on the flipside, this decision expands the protections of DFC and Dell (previously limited to the statutory appraisal context) to cases involving fiduciary duty and aiding and abetting claims when plaintiffs seek “quasi-appraisal” damages. Of particular note, Vice Chancellor Laster gave significant, if not dispositive, weight to the deal price even though he found that the sale process was flawed and was negotiated and approved by a board that breached its fiduciary duties (albeit not in bad faith).

Endnotes

1Because Deutsche Bank settled before trial, the court did not analyze whether it too aided and abetted the board’s breaches of fiduciary duties.(go back)

2The court also found other disclosure violations, including a misleading description in the 14D-9 of different sets of projections used by Deutsche Bank in rendering financial advice to the board.(go back)

3See Revlon Inc. v. MacAndrews & Forbes Hldgs., 506 A.2d 173, 182 (Del. 1986) (heightened standard of review applies to change of control transactions); Corwin v. KKR Financial Holdings, LLC, 125 A.3d 304, 309 (Del. 2015) (business judgment rule, not enhanced scrutiny, applies where majority of fully informed and uncoerced stockholders approve merger).(go back)

4See Dell, Inc. v. Magnetar Glob. Event Driven Master Fund Ltd., 177 A.3d 1, 605 (Del. 2017) (deal price should be afforded “heavy, if not overriding, probative value” in statutory appraisal actions involving arms’ length and competitive mergers); DFC Glob. Corp. v. Muirfield Value P’rs., 172 A.3d 346, 366 (Del. 2017) (in open and arm’s length mergers, “the best evidence of fair value [i]s the deal price”).(go back)

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