The Delaware Law Series


Termination of Merger Agreement and Material Adverse Effect

Jason Halper, William Mills, and Joshua Apfelroth are partners at Cadwalader, Wickersham & Taft LLP. This post is based on a Cadwalader memorandum by Messrs. Halper, Mills, Apfelroth, and Sara Bussiere, 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 Allocating Risk Through Contract: Evidence from M&A and Policy Implications (discussed on the Forum here); and M&A Contracts: Purposes, Types, Regulation, and Patterns of Practice, both by John C. Coates, IV.

In Channel Medsystems, Inc. v. Boston Scientific Corporation, the Delaware Court of Chancery rejected an attempt by Boston Scientific to terminate and thus avoid consummating a merger agreement with Channel on the grounds that a material adverse effect as defined in the parties’ agreement had occurred. In so holding, Chancellor Andre Bouchard signaled that last year’s Court of Chancery decision in Akorn, Inc. v. Fresenius Kabi AG, in which the Court of Chancery for the first time found the existence of a material adverse effect permitting merger agreement termination, was not necessarily a watershed moment that would make such findings more common. The decision also provides important guidance on merger agreement drafting and litigation strategy and pitfalls.

Background

Channel was a privately held medical technology company and developer of a single product, Cerene. Boston Scientific, a publicly traded medical technology company, agreed to acquire Channel pursuant to the merger agreement, dated November 1, 2017 (“Agreement”). Prior to that time, in 2013, Boston Scientific had acquired approximately 15% of Channel’s equity and had an “observer” on Channel’s board of directors. Upon executing the Agreement, this observer (Christopher Kaster, Boston Scientific’s Vice President of Business Development and Venture Capital), became a “full board member.” In this pre-merger agreement period, Boston Scientific received periodic updates about Channel from Kaster and from Channel itself.

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Delaware Appraisal Decisions

Gilbert E. Matthews is Chairman Emeritus and Senior Managing Director at Sutter Securities, Inc. This post is based on his recent Sutter Securities memorandum. Related research from the Program on Corporate Governance includes Using the Deal Price for Determining “Fair Value” in Appraisal Proceedings (discussed on the Forum here) and Appraisal After Dell, both by Guhan Subramanian. This post is part of the Delaware law series; links to other posts in the series are available here.

The year 2019 was been another active period for Delaware valuation cases, not only in the Court of Chancery but also in the Supreme Court. In arm’s-length transactions, Delaware continues to rely primarily on the transaction price as a measure of appraisal value. Adjustments to eliminate the amount paid for synergies are highly dependent on expert testimony. DCF remains the principal valuation method in related party transactions. The Court of Chancery has been critical of experts on either side whose opinion it deems to be overreaching.

Introduction

The year 2019 was been another active period for valuation cases in the Delaware courts. The Supreme Court reversed one 2018 Court of Chancery decision and affirmed another, and four valuation cases were decided by the Court of Chancery; the decisions are discussed below, focusing on the point of view of expert witnesses. The predominant theme is that Delaware is that, in arm’s-length transactions, appraisal value continues to be based primarily on the transaction price rather than on discounted cash flow.

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New Considerations for Special Litigation Committees

Roger Cooper, Jared Gerber and Victor Hou are partners at Cleary Gottlieb Steen & Hamilton LLP. This post is based on a Cleary memorandum by Messrs. Cooper, Gerber, Hou, Rahul Mukhi, Rishi Zutshi, and Mark McDonald, 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 Independent Directors and Controlling Shareholders by Lucian Bebchuk and Assaf Hamdani (discussed on the Forum here).

On December 4, 2019, Vice Chancellor Sam Glassock III issued a memorandum opinion in In re Oracle Corporation Derivative Litigation finding that the Lead Plaintiff in a shareholder derivative suit against Oracle’s board of directors had the right to subpoena documents relied upon by the corporation’s Special Litigation Committee (SLC) in making its determination as to whether litigation against Oracle should be allowed to proceed, including privileged documents Oracle had produced to the SLC. While the procedural posture of this case was unusual—the SLC had decided 1) that claims against its founder and chairman should proceed, and 2) that the Lead Plaintiff should be the one to prosecute those claims—the Court’s decision has potential ramifications for SLCs in the future. SLCs should, therefore, be cognizant of these potential ramifications when they collect and prepare documents in connection with an investigation.

Background:

In July 2016, Oracle announced that it would be acquiring Netsuite, a cloud computing company. Lawrence J. Ellison, the co-founder and chairman of Oracle and a 35% shareholder in it, was also the co-founder and a 39% shareholder of Netsuite. The transaction closed in November of that year.

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On Inference When Using State Corporate Laws for Identification

Holger Spamann is Professor of Law at Harvard Law School. This post is based on his recent paper. Related research from the Program on Corporate Governance includes Firms’ Decisions Where to Incorporate by Lucian Bebchuk and Alma Cohen; Does the Evidence Favor State Competition in Corporate Law? by Lucian Bebchuk, Alma Cohen, and Allen Ferrell; How Do Staggered Boards Affect Shareholder Value? Evidence from a Natural Experiment by Alma Cohen and Charles C. Y. Wang; and Reexamining Staggered Boards and Shareholder Value by Alma Cohen and Charles C.Y. Wang (discussed on the Forum here).

A large empirical literature studies the effects of state corporate law statutes on corporate actions and performance at the firm level. Interest is in the laws for their own sake or as exogenous variation in determinants of firm behavior. For example, well over a hundred papers investigate the effects of state anti-takeover statutes or of state universal demand laws. How much should we trust the estimates of these papers? The short answer is: not much. A brief non-technical explanation follows. The full technical explanation is available on SSRN. (Quick technical summary: the conventional clustered standard errors are much too small due to the extreme cluster size imbalance.)

Like any empirical study, studies of state corporate laws have to address two potential problems: bias and noise. Bias refers to a systematic deviation of the effect estimate from the true causal effect. For example, a particular type of state might be more likely to adopt a particular type of statute and attract a particular type of firm, such that any statistical association between statute and firm outcome might be driven by selection of firms into states rather than any causal effect of the statute. Avoiding this potential bias is one reason why the vast majority of empirical studies estimate changes in firm outcomes as a function of staggered changes in state laws in a so-called difference-in-difference design. This design holds fixed individual firm’s average outcomes with so-called firm fixed effects, and usually controls for year-to-year changes common to all firms or to all firms in an industry etc. with year fixed effects or year-industry fixed effects etc. (other controls are recommended as well). Another reason to control for firm and year effects is to absorb the noise that results from firm-to-firm and year-to-year variation. Noise is random variation that is not systematically related to the variables of interest but that can obscure their relationship. The less noise, the easier the detection of true effects.

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Corporate Oversight and Disobedience

Elizabeth Pollman is Professor of Law at Loyola Law School. This post is based on a paper by Professor Pollman, forthcoming in the Vanderbilt Law Review. This post is part of the Delaware law series; links to other posts in the series are available here.

Over a decade has passed since landmark Delaware decisions on corporate oversight obligations and with virtually no cases going to trial and resulting in liability, scholars have puzzled over what it means to have the potential for corporate accountability in the fiduciary duty of good faith. Recent decisions in Marchand v. Barnhill and In re Clovis Oncology have raised this question anew, adding to the small number of Delaware cases that have survived motions to dismiss with Caremark claims. In Vanderbilt Law Review’s forthcoming symposium, I offer a two-fold answer to this question—a descriptive theory of the purpose of the obedience and oversight duties in corporate law, and a functional account of how they are applied in practice.

First, state corporate law expresses fidelity to legal compliance through dual requirements of obedience and oversight that are lodged within the duty of good faith and cannot be exculpated. Each can be traced through statutory and doctrinal developments. The obligation of obedience concerns the corporation itself, which under the Delaware General Corporation Law section 101(b) must serve a “lawful purpose,” and its directors, who have fiduciary duties that prohibit them from acting with the intention of violating the law, per the Delaware Supreme Court’s Disney opinion. The obligation of oversight concerns the monitoring function of the board of directors to ensure the legal compliance of actors within the corporation, as the Court of Chancery suggested in Caremark and the Delaware Supreme Court validated in Stone v. Ritter.

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Approval of Conflicted Transactions in Publicly Traded Limited Partnerships

Gail Weinstein is senior counsel and Warren S. de Wied and Steven Epstein are partners at Fried, Frank, Harris, Shriver & Jacobson LLP. This post is based on a Fried Frank memorandum by Ms. Weinstein, Mr. de Wied, Mr. Epstein, Andrea Gede-Lange, Brian T. Mangino, and Philip Richter, and is part of the Delaware law series; links to other posts in the series are available here.

Dieckman v. Regency (Nov. 3, 2019) reflects the potential for general partners of master limited partnerships (i.e., publicly traded limited partnerships) to be subject to scrutiny and possible liability in connection with approving conflicted transactions. More broadly, the decision underscores the critical importance of clarity in drafting and compliance with the precise terms of agreements.

The decision is the latest issued in long-standing litigation challenging the 2015 acquisition of Regency Energy Partners LP, a master limited partnership (“Regency”), by Energy Transfer Partners L.P. (“ETP”), in an $11 billion unit-for-unit merger (representing a 13.2% premium to the unaffected unit price) (the “Merger”). Both Regency’s general partner (the “General Partner”) and the general partner of ETP were indirectly owned and controlled by Energy Transfer Equity, L.P. (“ETE”). Given ETE’s control of both Regency and ETP, it was undisputed that the Merger presented a potential conflict of interest between, on the one hand, the General Partner, and, on the other hand, the common unitholders of Regency, who had no connections to ETE.

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Delaware Dismissal of Excessive Director Pay Case

Edward B. Micheletti and Regina Olshan are partners and Michael R. Bergmann is counsel at Skadden, Arps, Slate, Meagher & Flom LLP. This post is based on a Skadden memorandum by Mr. Micheletti, Ms. Olshan, Mr. Bergmann, Joseph M. Penko, Erica Schohn, and Joseph M. Yaffe. This post is part of the Delaware law series; links to other posts in the series are available here.

On October 30, 2019, the Delaware Court of Chancery struck a major blow against the plaintiffs’ bar’s efforts to lower the statutory hurdle to maintaining stockholder derivative claims. A stockholder of Ultragenyx Pharmaceutical Inc. claimed that the company’s board of directors had awarded its non-employee directors excessive pay. Under applicable Delaware law, a stockholder asserting such a claim has two mutually exclusive options: make a pre-suit demand on the board or plead with particularity the reason it would have been futile to do so. A stockholder who makes a pre-suit demand may not later claim demand futility, but instead must make the more difficult claim that the board wrongfully refused the demand, which is essentially a business judgment analysis. The Chancery Court previously has noted that pleading demand futility is a steep road, but that making a pre-suit demand is “steeper yet.”

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Entire Fairness Review of Tesla CEO Compensation

Robert A. ProfusekLizanne Thomas, and James P. Dougherty are partners at Jones Day. This post is based on a Jones Day memorandum by Ms. Thomas, Mr. Profusek, Mr. Dougherty, Randi C. Lesnick, and Jennifer C, Lewis. This post is based on their Jones Day memorandum 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 Paying for Long-Term Performance by Lucian Bebchuk and Jesse Fried (discussed on the Forum here), The Growth of Executive Pay by Lucian Bebchuk and Yaniv Grinstein, and Independent Directors and Controlling Shareholders by Lucian Bebchuk and Assaf Hamdani (discussed on the Forum here).

A Tesla shareholder challenged a unique and extremely lucrative equity grant to Elon Musk, claiming that the directors’ decision to approve the pay package breached their fiduciary duties. The compensation consisted of stock options that only vested upon Tesla’s achievement of extraordinary market cap and operational milestones, with a value to Musk of up to a staggering $55.8 billion.

The performance award was approved by Tesla’s independent compensation committee and its full board of directors, with Musk and his brother recusing themselves. The award, which was also conditioned on the approval of a majority of the disinterested shares, was approved by 73% of the disinterested shares voted, or 47% of the outstanding disinterested shares.

The Chancery Court acknowledged that although the ratifying shareholder vote would justify business judgment review in ordinary circumstances, it was insufficient in the case of compensation granted to a controlling shareholder, even in the situation, such as this one, where the shareholder vote is made on a fully informed basis. Accordingly, the Chancery Court denied the directors’ motion to dismiss, holding that the exacting “entire fairness” standard of review was warranted in the circumstances, in part because fewer than a majority of the disinterested shareholders voted to ratify the award.

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Judicial Deference on Executive Compensation Decisions

David Berger and Brad Sorrels are partners and Lori Will is of counsel at Wilson Sonsini Goodrich & Rosati. This post is based on a WSGR memorandum by Mr. Berger, Mr. Sorrell, Ms. Will, Katherine Henderson, Amy Simmerman, and Ryan Greecher. This post is part of the Delaware law series; links to other posts in the series are available here.

The Delaware Court of Chancery recently denied two books and records demands made by stockholders of Facebook, Inc. that sought to investigate alleged wrongdoing surrounding Facebook’s executive compensation practices at a time when its advertising revenues were declining. In Southeastern Pennsylvania Transportation Authority v. Facebook, Inc., Vice Chancellor Joseph R. Slights III found that the stockholder plaintiffs lacked a proper purpose for the demands because they could not demonstrate a “credible basis” to suspect any disloyal conduct by the board. The court also found that—even if the plaintiffs had stated a proper purpose—Facebook had already turned over all “necessary and essential” information. The decision is instructive for companies faced with books and records demands seeking to investigate potential board misconduct. The case is also a useful reminder that decisions about executive compensation are—absent a board conflict, a controlling stockholder conflict, or waste—a classic business judgment to which the courts will defer.

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A Guidebook to Boardroom Governance Issues

Katherine HendersonAmy Simmerman are partners at Wilson Sonsini Goodrich & Rosati. This post is based on a WSGR publication by Ms. Henderson, Ms. Simmerman, Brad Sorrels, Ryan Greecher, David Berger, and Lisa Stimmell.

In recent years, we have seen boards and management increasingly grapple with a recurring set of governance issues in the boardroom. This publication is intended to distill the most prevalent issues in one place and provide our clients with a useful and practical overview of the state of the law and appropriate ways to address complex governance problems. This publication is designed to be valuable both to public and private companies, and various governance issues overlap across those spaces, although certainly some of these issues will take on greater prominence depending on whether a company is public or private. There are other important adjacent topics not covered in this publication—for example, the influence of stockholder activism or the role of proxy advisory firms. Our focus here is on the most sensitive issues that arise internally within the boardroom, to help directors and management run the affairs of the corporation responsibly and limit their own exposure in the process.

The Purpose of the Corporation and the Role of Stakeholders

Corporate purpose, along with the related question of whether and how a board of directors should consider non-stockholder interests—such as environmental, social, and governance (“ESG”) issues—has become a major source of debate among policymakers, lawyers, academics, institutional investors, and even jurists in recent years. This debate challenges the dominance of stockholder primacy ideology, which has effectively constrained corporate boards since at least the mid-1980s.

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