Monday, December 22, 2014

Revlon and the ‘Unusual’ Oil and Gas Deal that May Yet Thrive as Equally ‘Unusual’ Injunction Dies

[This story previously appeared in Securities Regulation Daily.]

By Mark S. Nelson, J.D.

The Delaware Supreme Court on Friday reversed the chancery court’s preliminary injunction of the merger between C&J Energy Services, Inc. (C&J) and a division of Nabors Industries, Ltd. (Nabors). Chief Justice Leo E. Strine, Jr. said the high court was puzzled by the chancery court’s ruling because the record showed no apparent Revlon breach, despite the “unusual” deal terms, and the possibly mixed motives of Joshua Comstock, C&J's CEO, chairman, and founder (and 10 percent shareholder), who could have been led to pay too much for the deal because he yearned for a new pay package. The reversal of the injunction came just two days after the court heard a speedy interlocutory appeal in the case (C&J Energy Services, Inc. v. City of Miami General Employees’ And Sanitation Employees’ Retirement Trust, December 19, 2014, Strine, L.).

Late Friday afternoon, C&J issued a press release praising the Supreme Court’s opinion. The company said it is now free to close the deal it had reached with Nabors, once shareholders give their approval. C&J had expressed its doubts about the preliminary injunction in a press release within days of the chancery court’s November ruling, but later said it had engaged Morgan Stanley to help it solicit new bids. The company said it will now end its solicitation for other bids.

 “C&J has been and will continue to be dedicated to upholding the highest governance standards, and we believe that our Board, management, and legal teams negotiated a precedent setting transaction in accordance with Delaware law and at all times acting in the best interest of our stockholders,” said Comstock.

A statement on the Supreme Court’s opinion was not immediately available from the website of plaintiff City of Miami General Employees’ And Sanitation Employees’ Retirement Trust (Miami General Employees).

Unusual deal and ruling. Miami General Employees had asked the chancery court to stop C&J from merging with a subsidiary of Bermuda-domiciled Nabors. Under the deal, U.S-based C&J would acquire the subsidiary, but Nabors would get a majority of the voting shares in the surviving entity, C&J Energy Services, Ltd. One aim of the deal was to leverage tax benefits of a domicile change to Bermuda.

Chief Justice Strine said the deal was “unusual” because of the resulting control arrangement. But the court explained that several built-in terms would ease the blow to C&J, including the right to get a pro rata share of any future control premium from the sale of the surviving entity, and a “fiduciary out” provision (with only mild deal protection features) that could be invoked if a better deal arose during an extended post-signing passive market check.

But just as “unusual” as the deal, the court said, was the chancery court’s granting of a 30-day mandatory, affirmative, preliminary injunction stopping the merger. The chancery court also ordered C&J to shop itself in the face of merger terms that barred C&J from taking more bids.

According to two late November orders, Vice Chancellor John W. Noble issued the preliminary injunction based on a “plausible” Revlon breach, even though the C&J board was not conflicted and had enough deal information; the vice chancellor also certified the case for interlocutory appeal to the state supreme court.

Particularly strong. The Supreme Court said the record offered a degree of support for both Miami General Employees and C&J, despite the C&J board’s imperfect deal process. The court also assumed the power structure that would result from Nabors’ taking control of the surviving entity was enough to invoke Revlon’s enhanced scrutiny. That case requires a board faced with C&J’s situation to act reasonably in the circumstances as a good faith try to get the best price for the company reasonably possible.

For starters, the court said the chancery court applied the right preliminary injunction standard, but misfired when it found Miami General Employees made a “plausible” argument that it was likely to win on the merits. Delaware law, said the Supreme Court, requires (among other things) that a plaintiff have a reasonable probability of winning on the merits. This showing must be “particularly strong” in cases like the one against C&J due to the lack of bidders and the light deal protections.

As for Revlon, the court favorably cited a batch of former Chancellor Allen’s opinions for the view that a board can still pursue its vision for the company by taking a particular deal if it also gives potential suitors a reasonable chance to buy the company for a higher price than was offered in the board’s preferred deal. The court said the needed market check might even be a passive solicitation if the board is free to take the better deal.

The chancery court here understood Revlon to require “impeccable knowledge” of the deal, which it said the C&J board lacked, so it ordered C&J to conduct a pre-signing, active solicitation. But the Supreme Court said there is “no single blueprint” for boards to meet Revlon, and the chancery court’s ruling went against that court’s own prior rulings and the Supreme Court’s 2009 Lyondell opinion.

By contrast, the court said Comstock’s possibly mixed motives are less ominous because his 10 percent C&J stake and the purpose of the deal (C&J can better manage Nabors’ underutilized assets) imply a motive to seek deal protections so he can be involved in the resulting entity. Comstock also could have obtained equally lucrative pay packages in other deals C&J mulled.

C&J’s board also understood that Nabors would need to gain control of the surviving entity in order to bring about a tax-driven domicile change to Bermuda. Other deal protections for C&J include an advisory vote on executive pay, a binding vote on the merger, approval of Comstock’s pay package by the surviving entity, a pro rata share of any premium paid if the resulting entity is sold (all shareholders must approve a repeal of this bylaw), and a “fiduciary out” if a better deal comes along during the post-signing market check.

But perhaps this opinion will be remembered most for what it teaches about Revlon. In a telling passage, the Supreme Court reminded Delaware practitioners that Revlon is at heart about a board taking steps to thwart a specific bidder. This type of effort can make it difficult for a bidder offering a higher price to emerge. Still, Revlon does not mandate an auction just because control will change hands, nor does it always require an active market check.

In the context of the C&J-Nabors deal, the Supreme Court imagined the deal protections to be cogent, and yet it could not say for sure they were enough to avoid Revlon. Specifically, a new bidder could emerge under the low barriers erected by the deal, even if the chancery court was properly skeptical that would happen.

Mandatory injunction lifted. The Supreme Court reiterated that in Delaware a mandatory injunction requires the chancery court to first hold a trial or to grant the injunction on based on undisputed facts. More generally, said the court, the purpose of a preliminary injunction is to preserve the status quo.

Here, the chancery court erred by ruling on a paper record that contained factual disputes. The court said the lack of a rival bidder and the presence of seemingly well-informed shareholders ought to have led the chancery court to hold-off granting the injunction. The terms of the C&J-Nabors deal also should have led the chancery court to a different conclusion because a breach of the no solicitation clause could undermine the deal. The court said it is especially important for judges to carefully use their injunctive powers in unusual cases where shareholders may lose out on a deal once the injunction is lifted.

The case is No. 655/657, 2014.