Thursday, March 01, 2012

Delaware Chancellor Refuses to Enjoin Merger Vote Despite Disloyalty Taint Since No Rival Bid Existed

The Delaware Chancellor refused to enjoin a merger of two companies even though there was a reasonable likelihood of proving that the merger was tainted by disloyalty since there was no other bid on the table and the target company shareholders have a choice of whether to turn down the merger at the ballot box. Unlike a situation when the court will enjoin a transaction whose tainted terms are precluding another available option promising higher value, no rival bid for the target existed. The court concluded that the target company shareholders should not be deprived of the chance to decide for themselves about the merger despite the disturbing nature of some of the behavior leading to its terms. In re El Paso Corporation Shareholder Litigation, Del. Chan Ct, Feb 29, 2012, Civil Action No. 6949

The Merger resulted from a non-public overture that the acquiring company made in the wake of the target’s public announcement that it would spin off its E&P business. Although a reasonable mind might debate the tactical choice made by the target board, these choices would provide little basis for enjoining a third-party merger approved by a board overwhelmingly composed of independent directors, many with substantial industry experience.

The Revlon doctrine is not a license for courts to second guess reasonable but arguable questions of business judgment in the change of control context, but to ensure that the directors act reasonably to obtain the highest value reasonably attainable and that their actions are not compromised by impermissible considerations of self interest. So long as the directors made reasonable decisions for a proper purpose, they meet their duty under Revlom and the court must defer.

By contrast, when there is a reason to conclude that debatable tactical decisions were motivated not by a principled evaluation of the risks and benefits to the shareholders, but by a fiduciary’s consideration of his or her own financial or personal self interest, then the core animating principle of Revlon is implicated.

Revlon made clear that the potential sale of a company has enormous implications for company managers and advisors and a range of human emotions, can cause fiduciaries and their advisors to be less than faithful to their duty to pursue he best value for their shareholders.

Although it was true that measures were taken to cabin an investment bank’s conflict, such as by an internal “Chinese wall” between the the bank’s advisors to the target company and bank representatives responsible for the firm’s investments in the acquiring company, those efforts were not effective. The investment bank still played an important role in advising the target board by suggesting that the board should avoid causing the acquiror to go hostile and by presenting information about the value of pursuing the spin-off instead of the merger. Indeed, the investment bank’s advice to placate the acquiring company by entering into due diligence raised management’s concerns that the investment bank team was receiving pressure from other parts of the firm to avoid a strategy that might result in the acquiror going public and making a hostile approach on the target

Also, the fact that the investment bank continued to have its hands in the dough of the spin off was important since the board was assessing the attractiveness of the merger relative to the spin off. That was critical because the board decided not to risk the acuqiring company going hostile and not do any test of the market with other possible buyers of the whole company or one a separate business. Thus, the board was down to two strategic options, the spin off or a sale. Because the investment bank stayed involved as the lead advisoe on the spin off it was in a position to exert influence over the merger.

The record suggests questionable aspects for the bank’ evaluation of the spin off and its continued revision downward that could be seen as suspicious in light of the firm’s hugh financial interest in the acquiring company. Heightening these suspicions was the fact that the firm’s lead banker did not disclose his ownership of approx. $340,000 in the acquiror’s stock.

All that said, the Chancellor noted that the price being offered by the acquiror is one that reasonable target company stockholders might find very attractive. But it bothered the Chancellor that it is not all that it might have been had things been done the way they should have been. The absence of a pre-signing market check also grated on the court, when the decision not to explore the market and instead do a safe, friendly deal rather than stretch for value or push the bidder into a public hostile fight might have been influenced by selfish considerations rather than the desire to strike the best risk-reward balance for target shareholders.