The Delaware Law Series


Drafting Considerations from the MAC Decision

Gail Weinstein is senior counsel, and Steven Epstein and Matthew V. Soran are partners at Fried, Frank, Harris, Shriver & Jacobson LLP. This post is based on a Fried Frank memorandum by Ms. Weinstein, Mr. Epstein, Mr. Soran, Robert C. SchwenkelDavid L. Shaw, and Andrew J. Colosimoand is part of the Delaware law series; links to other posts in the series are available hereRelated 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 Akorn v. Fresenius (Oct. 1, 2018), the Delaware Court of Chancery found for the first time ever that a target company had suffered a “material adverse effect” (MAC) between the signing and closing of a merger agreement, which entitled the acquiror to terminate the agreement. The 246-page opinion by Vice Chancellor Laster also serves essentially as a primer on how the court may interpret certain standard provisions in merger agreements and in corporate contracts generally.

Below, we provide (i) a summary of Key Points relating to the decision; (ii) a summary of the factual background and the court’s holdings; and (iii) a review of the court’s discussion of various agreement provisions. We also offer practice points, including specific drafting considerations, that arise from the opinion. We note that the decision is being appealed, thus further explication of these issues may follow.

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MFW’s “Ab Initio” Requirements for Business Judgement Rule Review

Joshua Apfelroth, Jason Halper, and William Mills are partners at Cadwalader, Wickersham & Taft LLP. This post is based on a Cadwalader memorandum by Mr. Apfelroth, Mr. Halper, Mr. Mills, and Chelsea Donafeld. 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); Adverse Selection and Gains to Controllers in Corporate Freezeouts by Lucian Bebchuk and Marcel Kahan; and The Effect of Delaware Doctrine on Freezeout Structure and Outcomes: Evidence on the Unified Approach by Fernan Restrepo and Guhan Subramanian (discussed on the Forum here).

In Flood v. Synutra Int’l Inc., the Delaware Supreme Court clarified its holding in Kahn v. M&F Worldwide Corp. (“MFW”). In MFW, the Court held that the business judgment rule—rather than the entire fairness standard—applies to a controlling stockholder transaction if such transaction is conditioned “ab initio,” or at the beginning, upon approval of both an independent special committee of directors and the informed vote of a majority of the minority stockholders (the “MFW Conditions”). At issue in Flood was whether the Court of Chancery properly applied the business judgment rule to a controlling stockholder acquisition of Synutra International even though the controlling stockholder did not include the MFW Conditions in its initial proposal to acquire Synutra, but instead included such conditions in a follow-up letter sent two weeks later. Chief Justice Strine, writing for the majority, affirmed the Delaware Court of Chancery’s decision, which held that the MFW Conditions need not be included in the controlling stockholder’s initial expression of interest for the transaction to be afforded business judgment protection; instead, business judgment protection will be afforded so long as the MFW Conditions are in place before any substantive economic negotiations occur between the special committee, the board of directors and the controlling stockholder.

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Lessons Learned from the CBS-NAI Dispute, Part VI: Board Access to Privileged Communications with Company Counsel

Victor L. Hou is partner, Rahul Mukhi is counsel, and Jessica Thompson is an associate at Cleary Gottlieb Steen & Hamilton LLP. This post is based on their Cleary Gottlieb memorandum, and is part of the Delaware law series; links to other posts in the series are available here.

As described in a prior post, on May 14, 2018, certain members of the CBS board filed suit in Delaware seeking authorization to issue a special dividend intended to dilute the voting control of NAI, CBS’s controlling stockholder. [1] The majority of the CBS board (other than three directors with ties to NAI) subsequently considered and purported to approve a dividend of a fraction of a Class A (voting) share to be paid to holders of both CBS’s Class A (voting) common stock and Class B (nonvoting) common stock for the express purpose of diluting NAI’s voting interest in CBS, with the payment of such dividend conditioned on Delaware court approval.

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Lessons from the CBS-NAI Dispute, Part V: “Independent” Directors at Controlled Corporations

Victor Lewkow, Christopher E. Austin, and Paul M. Tiger are partners at Cleary Gottlieb Steen & Hamilton LLP. This post is based on a Cleary Gottlieb memorandum by Mr. Lewkow, Mr. Austin, Mr. Tiger, and Max A. Wade, 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).

Stock exchange rules and state corporate law often rely on the “independence” of a company’s board of directors as a mechanism for policing potential conflicts of interest that might arise between and among the company’s various constituencies. While stock exchange rules tend to focus on the ongoing independence of directors from management to prevent management from behaving opportunistically at the expense of stockholders, state corporate law also focuses on the independence of directors from a particular stockholder in the context of a transaction with that stockholder and from other directors in the context of derivative actions against such other directors.

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Investment Bank Liability for M&A Services

Arthur H. Rosenbloom is Managing Director of Consilium ADR LLC, and Gilbert E. Matthews is Senior Managing Director and Chairman of the Board of Sutter Securities, Inc. This post is based on their recent paper and is part of the Delaware law series; links to other posts in the series are available here.

Introduction

To err is human but there is often no divine or other forgiveness for investment banks in Delaware litigation when their misconduct rises to the level of aiding and abetting the board’s breach of fiduciary duty to its shareholders. In this article, we consider recent Delaware case law on investment banker liability that has resulted in judgments against bankers and has caused them to make contributions to shareholders when some of these matters settle even when they deny liability.

Delaware has ruled that investment banks are not in privity with the shareholders, their obligations being limited solely to those who engage them. In the 1990 Shoe-Town decision, the Court of Chancery ruled that the investment bank hired by management “owed no fiduciary duty to the shareholders.” [1] The Court distinguished this case from the Wells decision in New York (which had ruled that the investment banks liable to shareholders) “because the investment advisor in that case was hired by a special committee charged solely with determining the fairness of the transaction for the shareholders.” [2] In 1996, the Delaware Superior Court ruled similarly in Stuchen v. Duty Free Int’l, Inc. [1996 WL 33167249 (Del. Super. Apr. 22, 1996) at *12.]

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Synutra—A Practical Application of MFW or a Free Look for Controlling Stockholders?

William Lawlor is partner and Michael Darby is an associate at Dechert LLP. This post is based on their Dechert 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 Independent Directors and Controlling Shareholders by Lucian Bebchuk and Assaf Hamdani (discussed on the Forum here); Adverse Selection and Gains to Controllers in Corporate Freezeouts by Lucian Bebchuk and Marcel Kahan; and The Effect of Delaware Doctrine on Freezeout Structure and Outcomes: Evidence on the Unified Approach by Fernan Restrepo and Guhan Subramanian (discussed on the Forum here).

In the recent decision of Flood v. Synutra International, Inc., a divided Delaware Supreme Court affirmed the Court of Chancery’s dismissal of a challenge to a controlling stockholder’s take-private transaction. The Court in an opinion by Chief Justice Strine held, among other things, [1] that the deferential business judgment review applied to the merger because the controlling stockholder had timely satisfied the dual requirements of Kahn v. M&F Worldwide Corp. [2] (“MFW”) in proposing those requirements in the initial stages of the process but after submitting its initial proposal letter.

The plaintiff challenged the application of MFW on the grounds that the controlling stockholder had failed to satisfy MFW’s “ab initio” requirement that the merger be conditioned on MFW’s dual requirements upfront. The controlling stockholder had submitted an initial written proposal to the target board and attached the proposal as an exhibit to its Schedule 13D filing. That initial proposal did not condition the merger on MFW’s dual requirements, but a follow-up proposal two weeks later did. Nevertheless, in rejecting the plaintiff’s argument for the “brightest of lines”—the initial offer—the Court held that the follow-up proposal was sufficient because the MFW conditions were in place before any “economic horse trading” had begun.

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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.
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Clarifying MFW’s ab initio Condition

Roger Cooper and Rishi Zutshi are partners and Vanessa Richardson is an associate at Cleary Gottlieb Steen & Hamilton LLP. This post is based on their Cleary 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 Independent Directors and Controlling Shareholders by Lucian Bebchuk and Assaf Hamdani (discussed on the Forum here); Adverse Selection and Gains to Controllers in Corporate Freezeouts by Lucian Bebchuk and Marcel Kahan; and The Effect of Delaware Doctrine on Freezeout Structure and Outcomes: Evidence on the Unified Approach by Fernan Restrepo and Guhan Subramanian (discussed on the Forum here).

The Delaware Supreme Court has clarified that controlling stockholder take-private transactions will be reviewed under the business judgment rule, rather than the less deferential entire fairness standard, if the controlling stockholder self-disables by committing to special committee and majority-of-the-minority approval before “economic negotiations” take place, even if the controlling stockholder fails to do so in its initial written offer. See Flood v. Synutra Int’l, Inc., No. 101, 2018 (Del. Oct. 9, 2018). [1]

The Delaware Supreme Court first announced in Kahn v. M&F Worldwide Corp., 88 A.3d 635 (Del. 2014) (“MFW”) that business judgment review applies to a merger proposed by a controlling stockholder conditioned “ab initio” on two procedural protections: (1) the approval of an independent, adequately empowered Special Committee that fulfills its duty of care; and (2) the uncoerced, informed vote of a majority of the minority stockholders. [2] Since then, several Delaware cases have involved questions about whether the MFW conditions were in place “ab initio.” [3] In Synutra, the Delaware Supreme Court provided further significant guidance on the meaning of the “ab initio” requirement.

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Materiality and Efforts Qualifiers—Some Distinctions, Some Without Differences

Daniel E. Wolf and Eric L. Schiele are partners at Kirkland & Ellis LLP. This post is based on a Kirkland & Ellis publication by Mr. Wolf and Mr. Schiele, 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 M&A Contracts: Purposes, Types, Regulation, and Patterns of Practice and Allocating Risk Through Contract: Evidence from M&A and Policy Implications (discussed on the Forum here), both by John C. Coates, IV.

Much deserved attention has been paid to the first finding of a “material adverse change” (MAC) by a Delaware court in the recent Akorn decision. Of perhaps equal practical importance to dealmakers is the court’s guidance on a question that has long occupied draftspersons—whether or not there is, and the extent of, any legal difference between the many shades of qualifiers used in deal agreements on two key terms: materiality modifiers and efforts covenants. Building on earlier Delaware decisions, the court reached a clear split decision on this question.

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Cracking the Corwin Conundrum and Other Mysteries Regarding Shareholder Approval of Mergers and Acquisitions

Franklin Gevurtz is Distinguished Professor of Law at the University of the Pacific McGeorge School of Law. This post is based on a recent paper authored by Professor Gevurtz, and is part of the Delaware law series; links to other posts in the series are available here.

Corporate mergers and acquisitions are big business and so is the constant stream of litigation challenging board decisions to enter such transactions. Plaintiffs cast these actions as a contest between victimized shareholders and faithless directors. Yet, merging or selling a corporation normally requires approval by the shareholders, who rarely vote down the deal. This apparent incongruity between what plaintiff shareholders assert and how most shareholders vote, in turn, raises the question of what impact shareholder approval should have on judicial scrutiny when dissenting shareholders sue.

Simple policy might suggest that shareholders okaying a corporate merger or sale should radically reduce, if not eliminate, the willingness of a court to say that directors breached their duty to the shareholders in saying yes to the deal. After all, if most of the shareholders vote in favor of a merger or sale, who is a judge to say the deal is not good enough? In Corwin v KKR Financial Holdings, the Delaware Supreme Court took a seemingly major step toward this conclusion. The Court stated that an informed and un-coerced vote by the shareholders to approve a merger or sale of a company invokes the deferential business judgment rule in litigation challenging the deal, at least when the deal does not involve a controlling shareholder on the other side.

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