Practice Points in Response to Activision

In Ap-Fonden v. Activision (Feb. 29, 2024)—a decision that came as a surprise to practitioners, and has far-reaching consequences—the Delaware Court of Chancery held that common practices the board of Activision Blizzard, Inc. (the “Company”) followed in approving its October 2023 merger with Microsoft Corporation may not have complied with technical requirements in the Delaware General Corporation Law relating to mergers, and therefore the merger may have been invalid. On that basis, the court, at the pleading stage of litigation, let survive the plaintiff’s claim for unlawful conversion of his shares in the merger (i.e., an unlawful taking—essentially, a tort of theft).

Notably, the court followed the approach taken in the Moelis decision, issued just days before Activision, which also upended longstanding common corporate practice based on a literal reading of DGCL requirements. In Moelis, the court, after trial, held that the grant of extensive governance and control rights in a stockholders agreement violated the DGCL’s requirement that the business and affairs of a corporation be managed by the board unless provided otherwise in the statute or the company’s charter.

Key Points

A new frontier for challenging mergers. Activision opens a new arena for challenging a board’s process in approving mergers. In addition to the range of fiduciary duty claims that still can be made, we can now expect that claims may be made relating to compliance with statutory requirements. Further, we note that the court’s emphasis on literal interpretation of the DGCL and strict compliance with its requirements may affect other areas of corporate practice as well.

Change to board practices going forward. Based on Activision, pending any further developments (such as an appeal of the decision or possibly legislative amendment of the DGCL), boards should change their standard practices when approving merger agreements. Such changes should be relatively easy to implement going forward. As discussed below, first, generally, a board that has approved a not-fully-final draft of the merger agreement now should, in most cases, ratify approval of the agreement after it is finalized and executed, with the disclosure schedules and the charter of the surviving corporation of the merger attached; second, generally, a board should include a brief description of the merger agreement in the proxy notice itself, rather than referencing in the notice the copy of the merger agreement attached to the proxy statement; and third, generally, if a board delegates resolution of an open merger agreement issue to a committee, the board should ratify the committee’s resolution.

Some uncertainty as to the validity of past mergers. As some of the practices the court found problematic reflect longstanding common board practice, the decision, at least as a technical matter, raises some uncertainty as to whether past mergers were valid and conversion claims can be asserted with respect to them. We note that it is not clear that the court intends in Activision to suggest that past mergers may be invalid; the decision may be appealed; the decision may be interpreted and applied narrowly in future cases; and the Delaware legislature may amend the DGCL in response to the decision. Moreover, there are significant issues as to the practicability of litigating conversion claims with respect to past mergers—including, for example, with respect to the statute of limitations, laches, damages, who the proper parties would be, and so on. And there are significant defenses that could be raised, including, for example, laches, waiver, and actual or effective ratification.

Background

Microsoft approached Activision about a potential strategic combination in November 2021. The Board, with independent financial and legal advisors, met to consider the outreach. The Board then received unsolicited overtures from other companies and authorized management to contact other potential acquirors. In late December 2021, Activision and Microsoft agreed on a purchase price and entered into an exclusivity agreement, and over the ensuing weeks negotiated key points. The Board, with its advisors, met many times over that period and received briefings on key terms and the status of negotiations. On January 17, 2022, the Board met and approved a then-current draft of the merger agreement (the “Draft Merger Agreement”), which it had received for review prior to the meeting.

At that time, one still outstanding issue between the parties was what dividends Activision could declare during the period between signing and closing. At the January 17 meeting, the Board delegated resolution of this issue to an ad hoc committee of the Board comprised of three of the directors. Activision’s CEO and the ad hoc committee reached an agreement with Microsoft that limited Activision, while the deal was pending, to one regular cash dividend not to exceed a certain amount per share (the “Dividend Provision”).

On January 18, 2022, the parties executed the final Merger Agreement. On March 21, 2022, Activision filed a proxy statement (the “Proxy Statement”) seeking stockholder approval of the merger. The stockholders approved the merger at a stockholder meeting on April 28, 2022, with more than 98% of the shares present voting in favor. In November 2022, while the merger faced antitrust scrutiny, the plaintiff filed suit against the Board, as well as Microsoft and its board of directors, claiming that the defendants violated Sections 251 and 141 of the DGCL, and asserting claims for conversion. When the antitrust hurdles were cleared in October 2023, the merger closed. Following briefing and oral argument, Chancellor Kathaleen St. J. McCormick rejected the defendants’ motion to dismiss the plaintiff’s claims. (This decision does not address the plaintiff’s claims for breach of fiduciary duties and aiding and abetting.)

Discussion

The court emphasized a need for strict statutory compliance in connection with mergers. The court wrote: “Delaware courts require ‘strict compliance’ with statutory requirements governing fundamental transactions like mergers.” The Chancellor cited several times the principle that Vice Chancellor Laster recently articulated and stressed in Moelis, that DGCL requirements will be interpreted literally and must be complied with strictly, even when that “does not square with norms of market practice.” Where market practice conflicts with the strict requirements of the DGCL, “then market practice needs to check itself,” the Chancellor wrote. Interestingly, in Moelis (noted above), where the court required strict compliance with the mandate in DGCL Section 141(a) that governance rights granted to key stockholders be set forth in the charter rather than in stockholder agreements, the policy rationale was evident in that stockholders are better protected when governance rights are set forth in a charter that requires stockholder approval and is publicly available. By contrast, in Activision, the DGCL requirements at issue were technical in nature and the benefit to the corporation or stockholders of compliance with such requirements is not evident other than in the sense of strict compliance with statutory requirements being a benefit in and of itself.

The court interpreted DGCL Section 251(b) as requiring that a board approve “an essentially complete version” of a merger agreement. Section 251(b) provides that a board “shall approve the agreement of merger,” which shall include certain specified items (including the charter of the surviving corporation), and that “the agreement so adopted shall be executed by an authorized person.” It is common practice that, as merger agreement negotiations approach an end, the target and buyer boards will approve the most recent draft of the merger agreement. Typically, management and the board’s legal advisors will inform the board of certain details (such as the name of the target company and the merger price) that have not been stated in the draft due to concerns about the potential for leaks prior to board approval and public announcement of the merger, and also will identify any open issues to be resolved in the final hours of negotiations prior to execution. The Activision Board followed this procedure. While the court “assume[d] for the sake of analysis” that a board is not required under Section 251(b) to approve an execution version of the merger agreement, the court held that, “at bare minimum” what Section 251(b) requires is that a board approve an “essentially complete version” of the merger agreement. This requirement, the court stated, reflects “just the basic exercise of fiduciary duties, not to mention good corporate hygiene.”

The court found that the Draft Merger Agreement likely was not an “essentially complete version” of the merger agreement. “There was a lot of important stuff missing from the Draft Merger Agreement,” the court stated. The court noted that the draft: did not contain the name of the target (using instead the transaction code name for the company); left a blank for the merger consideration; did not contain the disclosure letter, the disclosure schedules, or the charter of the surviving company; and did not contain the Dividend Provision (which was a “key” issue, the court stated, because the parties expected that the period between signing and closing would be lengthy due to antitrust issues). With respect to the disclosure letter and schedules, the court stated that “reasonable minds [could] differ” as to whether their inclusion was required for the Draft Merger Agreement to constitute an essentially complete version. The court stated that this issue need not be determined, however, because the other omissions were sufficient for a conclusion that the Draft Merger Agreement was not an essentially complete version.

The court interpreted DGCL Section 251(c) as requiring that a brief summary of the merger agreement be included in the proxy notice itself or that an essentially complete version of the agreement be attached. We note that it is common practice to attach the proxy statement to the proxy notice; and it is common practice to attach to the proxy statement the final, executed merger agreement but without the disclosure letter and schedules thereto (as they contain detailed business information that generally is not relevant to the stockholders when approving the merger) and without the charter of the surviving corporation. This was the procedure the Activision Board followed. The court observed that Section 251(c) provides “that a notice of the stockholder meeting set for the purpose of acting on a merger agreement must contain either the agreement required by Section 251(b) (option one) or a brief summary thereof (option two).” Accordingly, the court stated, unless a brief summary is contained in the proxy notice, an essentially complete version of the merger agreement must be attached to the notice. As the final Merger Agreement attached to the Proxy Statement omitted “at least one item mandated by Section 251(b) to be included in the merger agreement—the charter of the surviving company,” option one was not satisfied, the court held. Further, option two also was not satisfied, the court held, because the brief summary was not included in the proxy notice as required by Section 251(c). “The Proxy Statement is not the proxy notice,” the court wrote. In a footnote, the court added that Section 251 “could be amended [by the Delaware legislature] to allow a corporation to include the ‘brief summary’ in the proxy statement.”

The court interpreted DGCL Section 141(c) as not permitting a board to delegate to a board committee resolution of an open issue in a merger agreement. DGCL Section 251(b) imposes a statutory duty on a board to approve the terms of a merger agreement. The court wrote: “Where a board has a specific statutory duty, it may not delegate that duty to a committee unless Section 141(c) permits it to do so.” The court noted that, under Section 141(c)(2), “a committee does not have any power with respect to” approving an agreement of merger or its terms. “The Dividend Provision was a term of the merger…[and it appeared] that the committee alone, and not the Board, approved the Dividend Provision, which did not appear in the Draft Merger Agreement.” The court made clear that it viewed the Dividend Provision as a “key open issue” given the lengthy period expected between singing and closing—but it is uncertain whether the court’s analysis applies only to key open issues or instead to any open issues.

The court held that the plaintiff adequately pled a conversion claim. The court wrote: “Through the merger, Defendants took Plaintiff’s shares and replaced them with something else, in disregard of his rights as a stockholder under Section 251. Conversion by merger satisfies the tort of conversion. Plaintiff has adequately alleged that the merger was invalid under Section 251, and so has pled a conversion claim.”

The court suggested that the defendants act to remedy their possible statutory noncompliance. The court noted that, with respect to the Board’s noncompliance with DGCL Section 251, “Delaware law offers solutions for missteps.” Without further discussion, the court cited, in a footnote, DGCL Sections 204 and 205. These Sections provide for validation of defective corporate acts where the defect was the result of a failure of proper authorization of the act. Section 204 provides that a board can ratify its prior defective corporate acts by adopting resolutions to that effect—which must be approved by the stockholders if a stockholder vote was required at the time of the defective corporate act. Section 205 provides that a corporation may request that the court validate prior defective corporate acts. As discussed in “Practice Points” below, it is uncertain whether utilizing Section 204 or 205 would be practicable in the context of past mergers.

Practice Points

• M&A practitioners should keep in mind the court’s recent emphasis on strict compliance with statutory requirements. For example, practitioners should:
  • keep up-to-date with respect to the result of any appeals of Activision or Moelis, and any DGCL amendments, that may change the practical impact of these decisions;
  • put renewed emphasis on preparing and adhering to detailed checklists and timetables in connection with a merger process, including with respect to compliance with statutory requirements based on the court’s interpretations in Activision; and
  • consider carefully whether there are any other areas in which common corporate practice may not be consistent with the technical requirements of the DGCL under a strict reading of the statutory provisions.

• Boards should review and ratify the final, executed version of a merger agreement, with the disclosure schedules and charter of the surviving corporation. Given the practicalities of M&A transactions, including the need for confidentiality until execution of the final merger agreement, announcement immediately after execution, and negotiation of schedules and open points until just before execution and announcement, boards may wish to continue the practice of approving a most-recent draft of the merger agreement, so that the final agreement can be executed and announced without delay caused by waiting for board approval. Based on Activision, however, a board should also review and ratify the final, executed merger agreement, including the final disclosure letter and schedules and the charter for the surviving corporation. To facilitate such ratification, a board could consider amending the company’s bylaws to provide a lower quorum requirement (for example, the minimum permissible one-third of the board) for any such ratification.
• A brief summary of the merger agreement should be included in the proxy notice. The court suggested in Activision (although it did not decide) that a merger agreement attached to the proxy notice may have to include disclosure schedules and the disclosure letter (and, less problematically, the court held that the charter of the surviving corporation must be included). A board may wish to provide a brief summary of the merger agreement in the proxy notice itself, and then attach a merger agreement without the disclosure schedules to the proxy statement.
• Boards should not delegate resolution of merger agreement issues to committees, or should approve any such resolution of issues by committees. A board should consider not delegating to a committee the negotiation and resolution of (of at least key) terms of a merger agreement. Alternatively, if such a delegation is made, the board should review and approve the committee’s resolution. (Again, this may be accomplished through ratification of the committee’s resolution, after execution and announcement of the merger agreement; and, again, a bylaw amendment to lower the quorum for such ratification, as noted above, may be advisable to facilitate such ratification.) Private companies and companies going public should consider providing in their charter for broader delegation of authority to committees. Already-public companies could consider whether to seek such approval at a regular annual meeting as part of general corporate housekeeping.
• Boards should consider whether to remedy possible statutory noncompliance with respect to their approval of mergers in the past. We note that the court discussed the conversion claim in Activision only very briefly. We discuss above the many issues that would arise in connection with asserting such claims with respect to past mergers. Nonetheless, companies should be prepared for the potential that the plaintiffs’ bar will seek opportunities to make such claims. A board could proceed now, under DGCL Sections 204 or 205, to try to remedy noncompliance with respect to any past mergers; could wait to see how market practice, or future court decisions, evolve with respect to the conversion issue; or could proceed under Sections 204 or 205 after being sued for conversion (in which case a mootness fee of some amount may be payable to the plaintiff’s attorney). We note that case law involving Sections 204 and 205 (which were enacted in 2014) is still evolving and has mostly involved cases relating to defects in authorizing or issuing shares of stock. There may possibly be practical difficulties in addressing defective authorization under Section 204 in the merger context, especially with respect to mergers not recently completed. For example, through the merger, the target company, target stockholders and target board may no longer exist. However, as the court cited Sections 204 and 205 as routes to remedying the Activision board’s “missteps,” the court may interpret and apply them so that they can be used in the merger context.
• Possible action by practitioners. We suggest that practitioners advocate for legislative amendment of the DGCL to validate the practices the court found problematic in Activision (and Moelis), as the court itself suggested in both opinions. In addition, practitioners could consider the feasibility of some kind of joint request under DGCL 205 to cover all past authorizations of mergers by Delaware corporations that may be invalid based on the statutory noncompliance issues identified in Activision.