Bloomberg BNA Seminar

MAKING SENSE OF THE WORLD OF DELAWARE CORPORATE LITIGATION June 3, 2014 New York, NY

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BLOOMBERG BNA SEMINAR*

Making Sense of the World

of Delaware Corporate Litigation

Bloomberg Headquarters

731 Lexington Avenue

New York, New York June 3, 2014

Presented by:

The Honorable J. Travis Laster

Vice Chancellor, Delaware Court of Chancery

Wilmington, Delaware

John L. Reed

Partner, DLA Piper LLP (US)

Wilmington, Delaware

Joseph S. Allerhand

Partner, Weil Gotshal & Manges LLP

New York, New York

Minor Myers

Associate Professor, Brooklyn Law School

Brooklyn, New York

* These materials do not constitute and should not be relied upon as legal advice, nor do these materials reflect

the positions of the panelists, their organizations or clients. In fact, not every panelist agrees with (and in

several instances, disagrees with) the thoughts and views expressed herein.

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TABLE OF CONTENTS

PAGE

DELAWARE’S LEADING ROLE IN BUSINESS AND BUSINESS LITIGATION ....................1

THE ROLE OF BANKERS AND CONFLICTS ............................................................................2

CONTROLLING-STOCKHOLDER TRANSACTIONS: EVOLVING STANDARDS

OF REVIEW ......................................................................................................................12

THE MULTI-JURISDICTIONAL STOCKHOLDER LITIGATION EPIDEMIC .......................18

APPRAISAL ARBITRAGE ..........................................................................................................22

VENTURE CAPITAL CONCERNS: PREFERRED VERSUS COMMON

STOCKHOLDERS ............................................................................................................25

EXCLUSIVE FORUM AND FEE-SHIFTING PROVISIONS FOR STOCKHOLDER

LITIGATION .....................................................................................................................29

SALE TRANSACTIONS AND THE REVLON STANDARD .....................................................33

STANDING TO BRING DERIVATIVE SUITS...........................................................................36

PRECLUSIVE EFFECT OF DISMISSAL OF DERIVATIVE CLAIMS .....................................38

CONCLUSION ..............................................................................................................................39

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DELAWARE’S LEADING ROLE IN BUSINESS AND BUSINESS LITIGATION

Delaware has long been known as the corporate capital of the world. It is the state of

incorporation for 64 percent of the Fortune 500 and more than half of all companies whose securities

trade on the NYSE, Nasdaq and other exchanges. Its preeminence in business law started with its

corporate code − the Delaware General Corporation Law − and has been enhanced by business law

innovations that have led to the creation of many new business entities designed to meet the

expanding needs of corporate and financial America.

The Delaware Court of Chancery and the Delaware Supreme Court have maintained a

balance in the application of these laws between entrepreneurship by management and the rights of

investors. Jurisdiction over a company and its management can be obtained based on the state of

incorporation, and Delaware’s courts are not just popular venues for resolving business disputes but

are now the preeminent courts in the United States for resolving challenges to actions by boards of

directors, such as breach of fiduciary duty claims, merger and acquisition litigation and virtually any

issue implicating corporate governance and compliance with Delaware’s business laws. In fact, for

more than ten years an annual assessment conducted by the United States Chamber of Commerce has

ranked Delaware first among the court systems in all 50 states, noting the Delaware courts’ fairness

and reasonableness, competence, impartiality and timeliness in resolving disputes.

Each year, the Delaware courts issue a number of significant opinions demonstrating that the

Delaware courts are neither stockholder nor management biased. Some of the more recent and

important cases are discussed herein, but the list is by no means exhaustive.

Delaware’s guiding principles remain strict adherence to fiduciary duties; prompt

enforcement of articles of incorporation, bylaws and merger agreements; and the maximization of

stockholder value. The business judgment rule remains alive and well in Delaware for directors who

reasonably inform themselves of important information and are free of economic or other disabling

conflicts of interest, and whose only agenda is that of advancing the best interests of the corporation.

While the facts and legal analyses confronting directors are usually complex, the cases often boil

down to the smell test. So long as independent directors can articulate why, in their best judgment,

they acted as they did and why they believed those actions were in the best interests of the

corporation, the Delaware courts will respect their decisions.

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THE ROLE OF BANKERS AND CONFLICTS

The Beginning

Plaintiffs’ attorneys are now focusing on the roles of bankers in an effort to enjoin otherwise

independent third-party transactions. This new tactic gained traction in 2011 in In re Del Monte

Foods Company Shareholders Litigation, 25 A.3d 813 (Del. Ch. 2011), where the Delaware Court of

Chancery temporarily enjoined a premium merger transaction, finding a reasonable probability that

the board of directors of Del Monte Foods Company breached its fiduciary duties in the course of

selling Del Monte. The court’s decision was driven, in large part, by conflicts of interest suffered by

Del Monte’s financial advisor.

Del Monte’s long-time financial advisor approached its private equity clients to stir up

interest in acquiring Del Monte. Del Monte then engaged this financial advisor to advise it in

conjunction with the offers. The financial advisor never disclosed to Del Monte that it stirred up the

interest and that it planned to provide buy-side financing. The bidders all signed a “no teaming”

provision, but Del Monte did not accept any bids. Later, the financial advisor approached KKR and

Vestar, and advocated a joint effort to acquire Del Monte, which violated the “no teaming”

provision. KKR made an offer, but did not disclose Vestar’s involvement, and Del Monte’s board of

directors approved going forward with the sale process. KKR and the financial advisor then

approached the Del Monte board and requested that Vestar be permitted to participate and that the

financial advisor be permitted to provide buy-side financing. Del Monte’s board agreed to both

requests, even though there was not yet an agreement on price. KKR increased its offer and the Del

Monte board accepted. The financial advisor was then put in charge of running a 45-day “go-shop”

period.

The Court found that the board’s decision to allow KKR to team with Vestar was

“unreasonable” because it eliminated Del Monte’s “best prospect for price competition.” The Court

also found that it was “unreasonable” for the board to permit its financial advisor to provide buy-side

financing at a time when no price had been agreed to and there was a “go-shop” process to run. The

Court enjoined the deal for 20 days and suspended the deal protection measures during that period to

avoid depriving the Del Monte stockholders “of the opportunity to receive a pre-vote topping bid in a

process free of taint from [the financial advisor’s] improper activities.” The case settled for US$89.4

million, and the court approved the settlement in December 2011, with Del Monte paying US$65.7

million and the financial advisor paying US$23.7 million. The Court awarded the amount of

attorney’s fees agreed upon in the settlement, US$23.3 million.

This plaintiff tactic continued into 2012 with In re El Paso Corporation Shareholder

Litigation, 41 A.3d 432 (Del. Ch. 2012), where the Delaware Court of Chancery denied a motion to

enjoin a merger between El Paso Corporation and Kinder Morgan, Inc. The Court’s opinion severely

criticized the actions of management and El Paso’s financial advisor, Goldman Sachs & Co., but the

Court decided to give the shareholders of El Paso the opportunity to vote on whether they liked the

deal price.

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El Paso had the options of selling or spinning off and selling its business segments, but

ultimately agreed to sell to Kinder Morgan. Goldman Sachs was El Paso’s financial advisor.

Goldman Sachs owned approximately 19 percent of Kinder Morgan (valued at US$4 billion) and

controlled two board seats, and the lead Goldman banker advising El Paso personally owned

US$340,000 worth of Kinder Morgan stock. The conflicts were fully disclosed and Morgan Stanley

was brought in to advise El Paso on the sale. Nonetheless, Goldman Sachs continued as the lead

advisor on the spinoff option and helped El Paso craft the Morgan Stanley engagement letter in a

way that provided for a fee only if the company was sold as a whole.

The Court ultimately concluded that the El Paso shareholders should have had the

opportunity to decide whether or not they like the price being offered, notwithstanding the conflicts.

The Court went on to state that “[a]lthough an after-the-fact monetary damages claim against the

defendants is not a perfect tool, it has some value as a remedial instrument, and the likely prospect of

a damages trial is no doubt unpleasant to Foshee, other El Paso managers who might be added as

defendants, and to Goldman.” The case settled for US$110 million.

The next case was In re Micromet, Inc. Shareholders Litigation, 2012 WL 681785 (Del. Ch.

Feb. 29, 2012), where the Delaware Court of Chancery denied a shareholder motion seeking to

enjoin an all-cash negotiated tender offer from Amgen, Inc. for the shares of Micromet, Inc., a

biopharmaceutical company. In denying the injunction, the court found that the directors acted

reasonably in limiting the number of buyers contacted in a post-signing market check. The court also

rejected a challenge based on alleged omissions of material information from the proxy statement.

Amgen made an all-cash negotiated tender offer for Micromet. Micromet was advised by

Goldman Sachs. Goldman Sachs held Amgen stock valued at US$336 million, which was disclosed

to Micromet. The Court’s treatment and analysis of Goldman’s interest in the buyer was different,

for good reasons, than the treatment of Goldman in the Court’s El Paso decision. The Court found

that Goldman’s US$336 million holdings in the buyer’s stock, which represented 16 percent of its

overall investment holdings and 3.8 percent of its health care sector investments, was not “material”

and did not have to be disclosed in proxy materials recommending the deal. The Court noted that the

company’s disclosure did state that Goldman “may at any time make or hold long or short positions

and investments, as well as actively trade or effect transactions, in the equity, debt and other

securities” of both the target and the buyer, and stated that any investor who wanted to know the

actual size of Goldman’s investments could find the information in Goldman’s Form 13F. The Court

also noted that the plaintiffs did not present any detailed evidence from which the court could infer

that the size and nature of Goldman’s holdings in the buyer would be likely to impede its ability to

perform its assignment for the target effectively and loyally.

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2013 Cases

The trend continued in 2013, but this time the Court of Chancery’s opinion in In re Morton’s

Restaurant Group Shareholders Litigation, 74 A.3d 656 (Del. Ch. 2013), demonstrates that a second

financial adviser, when properly engaged and actively involved, can help to overcome a merger

challenge based upon a primary financial adviser’s alleged lack of independence.

In the Morton’s case, the Court of Chancery granted a motion to dismiss a complaint

challenging the sale of Morton’s Restaurant Group, Inc. (“Morton’s”). The complaint alleged that

the Board breached their fiduciary duty by acting in favor of a private equity firm, Harlan Castle,

which owned 28% of Morton’s and allegedly instigated the sale in order to satisfy its own

‘immediate’ need for liquidity. The Court dismissed this claim; a 28% stockholder is not a

controlling stockholder, and no other facts showed control, so the actions of the Board were subject

only to business judgment review. On that level of review, a 9-month process that involved

shopping the company to about 100 potential buyers was not a breach of fiduciary duty.

The Court also dismissed a claim against Morton’s Board of Directors premised on their

willingness to allow the investment bank that ran the sales process (Jefferies) to provide financing

for the buyer, after learning that the high bidder could not otherwise secure financing. The complaint

alleged that the board breached its duties by acting in bad faith with regard to decisions it made about

its investment bank. The Court found this process did not create an inference of bad faith: “The

decision to let Jefferies finance [the high bidder’s] deal while hiring KeyBanc to provide

unconflicting advice, rather than risk losing a bid at a high premium to market, does not create an

inference of bad faith.”

The following two cases are also worth mentioning: Miramar Firefighters Pension Fund v.

AboveNet, Inc., 2013 WL 3995257 (July 31, 2013) (granting defendants’ motion to dismiss where

the plaintiff failed to allege facts supporting an inference that the board knew of alleged deficiencies

in the financial advisor’s analysis and where the board refused to allow the financial advisor to

provide staple financing to a potential acquiror); and SEPTA v. Volgenau, 2013 WL 4009193 (Del.

Ch. Aug. 5, 2013), aff’d, 2014 WL 1912537 (Del. May 13, 2014) (dismissing a claim of advisor

conflict based upon the allegation that a $8.4 million fee paid only upon the completion of the deal).

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2014: Investment Bank Found Liable For Manipulating

The Sale Of A Corporation For Its Own Benefit

On March 7, 2014, the Delaware Court of Chancery issued an important decision in the

evolving area of banker conflicts in In re Rural Metro Corporation Stockholders Litigation, 2014

WL 971718 (Del. Ch. Mar. 7, 2014), holding RBC Capital Markets, LLC (“RBC”) liable for aiding

and abetting breaches of fiduciary duty by the board of directors of Rural/Metro Corporation

(“Rural”) in connection with Warburg Pincus LLC’s acquisition of Rural. The case proceeded to

trial against RBC even though Rural’s directors, as well as Moelis & Company LLC, which had

served as financial advisor in a secondary role, had settled before trial. The Court’s 91-page opinion

makes clear that when financial advisors step outside their roles as gatekeepers, and take active steps

to manipulate a Company’s sale for their own self-interests, they risk incurring liability for aiding

and abetting a breach of fiduciary duty.

Factual Background

Rural was a public corporation that provided ambulance and fire protection services. Rural

had one national competitor, American Medical Response (“AMR”), a subsidiary of Emergency

Medical Services Corporation (“EMS”). During the summer of 2010, Rural began looking at

potential strategic alternatives and formed a Special Committee in August 2010, which considered

three potential options: (1) continue to pursue the standalone business plan; (2) pursue a sale of the

Company; or (3) pursue a business combination to take advantage of synergies available.

In early December 2010, rumors circulated that EMS was pursuing strategic alternatives.

RBC gave certain directors of Rural an overview of the EMS process and suggested Rural as a

potential partner in the process. At the same time, RBC recognized that if Rural engaged in a sales

process led by RBC, then RBC could use its position as sell-side advisor to secure buy-side roles

with private equity firms bidding for EMS, potentially getting on all of the EMS bidders’ “financing

trees.” In making its pitch to the Special Committee, however, RBC did not disclose that it planned

to use its engagement as Rural’s financial advisor to secure financing work from the bidders for

EMS. According to the minutes of the meeting, counsel advised the Special Committee of the

potential conflict and, if RBC was selected, to be particularly vigilant about the integrity of the

process and to consider appointing a second independent firm.

RBC was selected as financial advisor and commenced a process that the Court found

favored its own interest in gaining financing work by prioritizing bidders involved in the EMS

process over those who were not. In addition to an M&A advisory fee of $5.1 million, RBC hoped

for staple financing fees of $14-20 million for the Rural deal and $14-35 million by financing a

portion of any EMS deal.

When RBC began soliciting bids, it discovered that most larger firms were conflicted out of

Rural’s process due to non-disclosure agreements signed during the EMS process. Nevertheless,

RBC pressed on, and received six indications of interest. The Special Committee, but not the full

Board, met to discuss these results in February 2011. RBC gave a presentation that included no

valuation metrics. One director asked for and was given an analysis of potential LBO returns,

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showing that at $18 per share, an LBO would result in five-year internal rates of return exceeding

20%. This information was not shared with the other directors.

It was not until March 15, 2011 that Rural held another meeting of its full Board. RBC’s

presentation again included no valuation metrics. The Board adopted a resolution granting the

Special Committee authority to seek a purchase of RBC. At the same time, RBC internally worked

on securing a $590 million staple financing package for Warburg, anticipating $8-16 million in fees

from this work.

Only Warburg offered a formal bid for Rural, at $17.00 per share on March 22, 2011. After

some negotiation, Warburg offered $17.25 on March 25, saying that it was Warburg’s “best and final

offer,” and that it expired on March 28. RBC spent March 26 attempting to get a piece of the

financing for Warburg’s bid. RBC then submitted valuation materials to its internal fairness

committee, but later tweaked the valuations in ways that made the offer more appealing.

On March 27, 2011, the Board accepted Warburg’s $17.25 offer. At 9:42 pm, the Board

received Warburg’s valuation information -- the first valuation information the Board ever received

during this process. At 11:00 pm, the meeting began, and the Board approved the merger after

midnight.

The Court’s Analysis

In proving a claim that RBC aided and abetted breaches of fiduciary duty by the Rural Board,

Plaintiff had to demonstrate: (i) the existence of a fiduciary relationship; (ii) a breach of the

fiduciary’s duty; (iii) knowing participation in the breach by the non-fiduciary defendants; and (iv)

damages proximately caused by the breach. Plaintiff alleged that RBC aided and abetted breaches of

duty both during the sales process and by inducing disclosure violations.

With a fiduciary relationship between Rural’s Board and its stockholders readily established,

the Court turned to breach of fiduciary duty. In evaluating the directors’ conduct in this case, the

Court noted the Revlon standard of review applied, whereby directors must have “act[ed] reasonably

to seek the transaction offering best value reasonably available to stockholders.” The Court therefore

asked “whether the defendant directors employed a reasonable decision-making process and reached

a reasonable result,” in pursuit of the required goal that they secure the transaction offering the best

value reasonably available to the stockholders. As this case involved an aiding and abetting claim

(and the directors’ settled before trial), Plaintiff bore the burden of proof.

Before turning to the merits of the sale process, the Court considered whether a Section

102(b)(7) provision, which exculpates directors from liability for breaches of the fiduciary duty of

care, precludes liability for aiding and abetting a breach of fiduciary duty. Citing to the text of

Section 102(b)(7) and prior case-law, the Court held that this only covers directors, not aiders and

abettors. The DGCL encourages members of a board to rely on advice from experts, and so the

Court held there are “sound reasons” why the legislature might wish to exculpate board members but

not experts.

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The Court then considered whether several decisions of the Board fell outside the range of

reasonableness.

First, the Court held that the decision to run the sales process in parallel with the EMS

auction fell outside the range of reasonableness because RBC did not disclose that a parallel process

advanced RBC’s self-interest in gaining a role on the financing trees of bidders for EMC. RBC

favored those bidders over others. The Court also held that RBC and one of the Special Committee

members unilaterally put Rural into play without Board authorization. The Court concluded that a

well-informed Board could at that time have decided to initiate a sales process, but these two

problems were severe enough that the initiation of a sale process fell outside the range of

reasonableness.

Second, the Court held that the decision to continue the sales process despite feedback that it

was not working fell within the range of reasonableness. While multiple private equity sources

recommended deferring any sale until after Rural developed a track record with its acquisition

strategy, the Special Committee received six indications of interests at substantial premiums.

Third, the Court held that Board decision to accept Warburg’s bid of $17.25 per share fell

outside the range of reasonableness. The Court determined that the Board failed to provide active

and direct oversight of RBC. “When it approved the merger, the Board was unaware of RBC’s last

minute efforts to solicit a buy-side financing role from Warburg, had not received any valuation

information until three hours before the meeting to approve the deal, and did not know about RBC’s

manipulation of its valuation metrics.”

Having established that certain decisions of the board fell outside the range of reasonableness

thereby giving rise to a breach of fiduciary duty under enhanced scrutiny, the Court then determined

that RBC knowingly participated when it, for improper motives of its own, misled the directors into

breaching their duty of care. The Court noted that “RBC created the unreasonable process and

informational gaps that led to the Board’s breach of duty.” These acts were actionable because they

affected the process, even though RBC did not succeed in providing either staple financing or the

buy-side financing for EMS.

The Court gave short shrift to RBC’s argument that its engagement letter with Rural

somehow insulated RBC from liability. The letter contained a generalized acknowledgment that the

financial advisors might extend acquisition financing to other firms. To secure a waiver of this

conflict of interest, RBC should have disclosed the conflict and its significance.

Finally, the Court held that the plaintiffs proved that RBC proximately caused the breach of

fiduciary duty and harm to Rural “by causing the Company to be sold at a price below its fair value.”

“RBC’s self-interested manipulations caused the Rural process to unfold differently than it

otherwise would have.” “The near-term sales process that RBC and Shackelton drove prevented

Rural from generating the higher values that could be achieved by allowing DiMino to develop

Rural’s business strategy with the opportunity for a later, better timed sale to a strategic buyer.”

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For similar reasons, the Court held that RBC aided and abetted the Board’s breach of its

fiduciary duty of disclosure by causing the Board to include inaccurate valuation materials in its

Proxy Statement, and causing the Board to provide false and misleading statements about RBC’s

incentives in the Proxy Statement.

The Court declined to determine the measure of the damages award at this juncture, instead

requesting revised expert evaluations that the Court would use to determine damages. The Court

also requested briefing on the issue of contribution, which could greatly affect RBC’s exposure.

Finally, the Court invited plaintiffs to formally move for fees based on the bad faith exception to the

American Rule based on multiple representations made before trial by RBC that contrasted with the

evidence presented at trial.

Thoughts/Takeaways

Whether “reasonableness” is the appropriate standard for determining that an underlying

breach of fiduciary duty occurred is a significant issue. Traditionally, the standard for determining

liability for a breach of the fiduciary duty of care has been “gross negligence,” not mere negligence

or unreasonable conduct. Until that issue gets resolved, this opinion serves as the latest example of

the Delaware Court of Chancery’s willingness to impose liability when an advisor manipulates a

sales process for its own self-interest. Regardless, the opinion suggests ways for advisors to avoid

incurring this kind of liability.

First, an advisor who serves in the traditional role of a gatekeeper faces little risk of liability.

The Court discussed academic literature concerning “gatekeepers” at great length. The Court

defined a “gatekeeper” as “a reputational intermediary … [that] receives only a limited payoff from

any involvement in misconduct ….” If a firm takes a fee for advice and its total financial interest in

the transaction stems only from that fee, it should in most circumstances be on safe ground.

Second, boards should actively inform themselves of potential conflicts of their advisors prior

to structuring a sales process and monitor any conflicts that exist throughout the entire process.

Third, advisors must disclose and monitor potential conflicts of interest, and receive clear

direction from the board. The Court of Chancery has taken a zero tolerance approach to undisclosed

conflicts of interest.

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Discussion Issues

All of this raises multiple issues as to what is a conflict, what diligence needs to be done to

identify it, how to deal with it, how it should be disclosed, and whether there is any room for a

middle ground. The following are some questions that need to be confronted:

1. As to existing relationships between the target’s financial advisor and potential bidders, what

should be disclosed?

Past or current advisory work for potential bidders:

o Past fees received – How much is too much?

o Proximity in time of work performed for bidder – Presumptively safe gap?

o Nature of ongoing relationship – What services are irrelevant?

Financial advisor (or affiliate) as existing lender to potential bidder:

o Lead bank?

o Syndicate member?

o Secondary market purchase of debt?

Financial advisor (or affiliate) as stockholder in potential bidder:

o Size and nature of investment by bank as principal?

o Board representation?

o Investments by individual bankers on transaction?

o Other relationships?

2. What is the relevance of informational firewalls, separate compensation pools and full

disclosure?

“These things are not per se disqualifications, but the conflict is not cleansed if they

are disclosed.” Vice Chancellor Laster, 2012 Annual Tulane Corporate Law

Institute.

3. Is the value brought by past relationships being ignored?

4. When do contingent fees amount to a conflict?

Alignment on the “value” issue?

The conflict on the “sell” or “don’t sell” issue should be obvious?

In In re Atheros Communications, Inc. Shareholder Litig., 2011 WL 864928 (Del. Ch. Mar.

4, 2011), the Court held that a 50 to 1 ratio contingent to non-contingent fee “can readily be seen as

providing an extraordinary incentive” to support the transaction, and “raise[s] doubts about the

independence and objectivity,” and thus, should be “disclosed.” See also In re Smurfit-Stone

Container Corp. Shareholder Litig., 2011 WL 2028076 (Del. Ch. May 24, 2011) (finding

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“[c]ontingent fees for financial advisors in a merger context are somewhat ‘routine’” and any conflict

is mitigated by “continuous and diligent oversight” of a special committee); In re Alloy, Ins.

Shareholder Litig., 2011 WL 4863716 (Del. Ch. Oct. 13, 2011) (“Although this Court has held that

stockbrokers may have sufficient concerns about contingent fee arrangements to warrant disclosure

of such arrangements, that need to disclose does not imply that contingent fees necessarily produce

specious fairness opinions.”); Frank v. Elgamal, 2014 WL 957550 (Del. Ch. Mar. 10, 2014)

contingent fee did not give rise to conflict).

5. How do you deal with late bidders that have the same banker?

6. What issues should be raised during the engagement process and as things proceed?

The role of the board, management, and counsel?

How much detail must be disclosed by a financial advisor with regard to relationships

with potential bidders?

What about the banker’s confidentiality obligations?

Disclosure of ownership interest in potential bidders?

What should be in the engagement letters?

o Identify known conflicts?

o Require updates as potential conflicts emerge?

o Where potential conflict is identified, require information barriers?

o Any restrictions survive the life of the transaction/engagement?

7. What about the independent directors’ relationships with the bankers?

8. What are the issues and potential benefits of staple financing to targets / stockholders?

Can ensure the availability of financing for every bidder, which may create a more

competitive auction process?

Bank might be more likely to perform its lending obligations in uncertain

circumstances in view of its role as sell-side advisor?

Establish implied floor price?

May help preserve confidentiality?

In In re Toys “R” Us, Inc. Shareholder Litigation, 877 A.2d 975 (Del. Ch. June 24, 2005),

the Court states the following, “In general . . . it is advisable that investment banks representing

sellers not create the appearance that they desire buy-side work, especially when it may be that they

are more likely to be selected by some buyers for that lucrative role than by others.” However, the

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Court also noted that sell/advisor buy-side financing might be permissible when it is offered to all

potential bidders “in order to induce more bidders to take the risk of an acquisition.” During the oral

argument on plaintiffs’ request for a preliminary injunction in In re El Paso Corporation

Shareholder Litigation, the Court joked: “Of course, we all know about staple financing. They’re

available in financing markets where you don’t need staple financing and they’re unavailable in

markets which it would be useful.”

9. Is staple financing ever possible since Del Monte?

10. When is a second financial advisor necessary or appropriate?

Staple financing?

Other conflicts?

When retained, what is the scope of the assignment?

Is there a continuing role of first bank?

What should be the fee stricture of fees for the second investment bank?

What should happen to the first advisor’s financial opinion?

In In re Transatlantic Holdings, Inc. Shareholders Litigation, 2013 WL 1191738 (Del. Ch.

Mar. 8, 2013), the Court stated: “I don’t understand the idea of a banker running a process, doing all

the cool and important stuff, and not having to back it up with a fairness opinion. It in no way

addresses the conflict for the person who plays the operative role to not actually have to put the

fairness opinion on the line.”

11. With the fast moving nature of the process, are we asking too much from everyone involved?

12. Are we turning third-party deals into interested transactions akin to “entire fairness” cases

simply because of banker conflicts?

“Acknowledge the problem, don’t deny it or downplay it.” Vice Chancellor Laster,

2012 Annual Tulane corporate Law Institute.

“When all the discretionary decisions flow in the direction of the self-interest, its

going to raise issues.” Vice Chancellor Laster, 2012 Annual Tulane corporate Law

Institute.

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CONTROLLING-STOCKHOLDER TRANSACTIONS:

EVOLVING STANDARDS OF REVIEW

Why The Standard Of Review Is So Important

The standard of review applicable to a transaction has enormous implications for any

litigation -- which inevitably follows from the announcement of a large public-company deal.

Regardless of the merits of such suits, the standard of review affects the timing within which

unmeritorious actions can be dismissed, and this affects litigation costs, people costs due to time

devoted to discovery, etc., and it creates business uncertainty as well as uncertainty about personal

liability for the directors involved.

In carrying out the business of the corporation, management is protected by the business

judgment rule, which is the standard by which courts review most, but not all, board decisions. The

business judgment rule reflects the legal premise that decisions made by directors who are fully

informed and free from conflicts of interest should not, and will not, be second-guessed by a court,

even if the business decision under review turns out to have been “poor.” To receive a favorable

presumption of the business judgment rule, a director must be disinterested and independent (i.e.,

satisfy the fiduciary duty of loyalty), review and consider all pertinent information reasonably

available (i.e., satisfy the fiduciary duty of care), and not act in a manner or with a motive prohibited

by statute or otherwise improper, and at all times act in good faith when discharging his or her

fiduciary duties. This is a process inquiry. If the directors are not conflicted and are fully informed,

the action will be dismissed and the substance of the transaction will not be reviewed.

If the business judgment rule cannot be asserted, the transaction is not void but voidable;

however, the heightened “entire fairness” standard will be applied and, under such circumstances, the

burden is on the directors to prove that the decision or transaction at issue is fair to both the company

and its stockholders. Even if the transaction is approved by an independent special committee or a

vote of a majority of the minority stockholders, such procedural safeguards only shift the burden

back to a stockholder-plaintiff to prove that the transaction was unfair, which means the substance of

the transaction will be evaluated by a court. This is very different from transactions that are eligible

for business judgment rule protection where the court merely evaluates whether a board was fully

informed (duty of care) and whether a majority of the board was disinterested and independent (duty

of loyalty). Satisfying the entire fairness standard is extremely difficult because the board must

demonstrate fair process and fair price. Failure to establish the entire fairness of the decision or

transaction can render it void and lead to personal liability for directors. Endeavoring to satisfy the

entire fairness standard means lots of discovery, a trial on the merits, a time-table that can now be a

year instead of a few months, and a legal budget in the millions of dollars instead of a few hundred

thousand.

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Negotiated Mergers

On March 14, 2014, the Delaware Supreme Court issued an en banc opinion in Kahn v. M&F

Worldwide Corp., 88 A.3d 635 (Del. 2014) , affirming then-Chancellor (now Chief Justice) Leo E.

Strine, Jr.’s ruling in In re MFW S’holders Litig., 67 A.3d 496 (Del. Ch. 2013) that a controlling

stockholder may secure business judgment review of its purchase of the corporation through a going

private merger by conditioning consummation ab initio upon the approval of (i) a special committee

of independent directors and (ii) a majority of the minority stockholders.

Nearly two decades ago, in Kahn v. Lynch Commc’n Sys., 638 A.2d 1110 (Del. 1994), the

Delaware Supreme Court held that entire fairness review applies to controlling-stockholder

transactions, and that approval by a special committee or a majority of the minority stockholders

would mean that the plaintiff, not the defendant, would bear the burden of persuasion on entire

fairness at trial. Until this opinion, no case presented the opportunity for the Delaware Supreme

Court to rule on the effect of using both procedural protections together.

MacAndrews & Forbes owned 43% of M&F Worldwide (“MFW”). MacAndrews & Forbes

announced its interest in buying the rest of MFW’s equity in a going private merger at $24 per share.

MacAndrews & Forbes simultaneously announced it would not proceed with the merger absent the

approval of a special committee of independent directors and the approval of a majority of the

minority stockholders. MFW’s Board of Directors established a Special Committee to consider the

proposed transaction, which met eight times over three months, negotiated a $1 increase in merger

consideration, and approved the deal. A substantial majority of MFW’s minority stockholders --

65% -- voted in favor of the merger. Plaintiff stockholders commenced an action in the Delaware

Court of Chancery, first seeking injunctive relief based on alleged disclosure issues, but they later

abandoned those claims in favor of a post-closing damages action alleging the Board of Directors

breached its fiduciary duties. The defendant Directors moved for summary judgment on the breach

of fiduciary duty claim, which was the Court of Chancery granted and was the subject of the appeal.

In its opinion, the Delaware Supreme Court summarized the new standard applicable to

buyouts by controlling stockholders as follows:

The business judgment standard of review will be applied if and only

if: (i) the controller conditions the procession of the transaction on the

approval of both a Special Committee and a majority of the minority

stockholders; (ii) the Special Committee is independent; (iii) the

Special Committee is empowered to freely select its own advisors and

to say no definitively; (iv) the Special Committee meets its duty of

care in negotiating a fair price; (v) the vote of the minority is

informed; and (vi) there is no coercion of the minority.

The Supreme Court reasoned that this new standard is appropriate because: (i) the

undermining influence of a controlling stockholder does not exist in every controlled merger setting;

(ii) the “dual procedural protection merger structure optimally protects the minority stockholders in

controlling buyouts,” (iii) it is consistent with the central purpose of Delaware law to defer decisions

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to independent, fully-informed directors; and (iv) the dual protection merger structures ensures a fair

price.

While the Court of Chancery’s opinion suggested that a plaintiff’s failure to plead factual

allegations that a controlling stockholder transaction lacked the specified requirements for business

judgment protection could lead to dismissal of complaints at the pleading stage, the Delaware

Supreme Court indicated that obtaining early dismissal could be much more difficult. In footnote 14

of its opinion, the Delaware Supreme Court explained that the Plaintiff’s complaint would have

likely survived a motion to dismiss under this new framework, reasoning that Plaintiff’s “allegations

about the sufficiency of the price call into question the adequacy of the Special Committee’s

negotiations, thereby necessitating discovery on all of the new prerequisites to the application of the

business judgment rule.” As nearly all plaintiffs’ lawsuits involving similar transactions challenge

the adequacy of the price, it appears that early dismissal will be extremely difficult until greater

clarity on this area of the law is developed.

The Supreme Court emphasized that defendants must establish that the challenged

transaction qualifies for business judgment protection prior to trial in order to avoid entire fairness

review: “If, after discovery, triable issues of fact remain about whether either or both of the dual

procedural protections were established, or if established were effective, the case will proceed to a

trial in which the court will conduct an entire fairness review.”

Having articulated the new standard for establishing business judgment protection of a

controlled merger, the Court then analyzes whether those requirements have been established in this

case. The Supreme Court affirmed the Court of Chancery’s finding that no factual disputes stood in

the way of the conclusion that the Special Committee was sufficiently empowered and informed, was

independent, and fulfilled its duty of care. Plaintiffs argued that a factual dispute existed concerning

the independence of three members of the special committee. The Court disagreed, noting that

Plaintiffs failed to offer evidence of the economic circumstances of any of the directors. “Bare

allegations that directors are friendly with, travel in the same social circles as, or have past business

relationships with the proponent of a transaction or the person they are investigating are not enough

to rebut the presumption of independence.”

Thoughts/Takeaways

The level or standard of review applied to special committees will impact the future of MFW.

Nothing in the MFW opinion alters what the Delaware Supreme Court held in Americas Mining

Corp. v. Theriault, 51 A.3d 1213 (Del. 2012), when it affirmed the Court of Chancery’s 105-page

post-trial opinion in In re Southern Peru Copper Corporation Shareholder Derivative Litigation, 52

A.3d 761 (Del. Ch. 2011). The trial court concluded that there is “no way” to determine whether a

special committee is “well-functioning” without “taking into consideration the substantive decisions

of the special committee, a fact intensive exercise that overlaps with the examination of fairness

itself.” The Court acknowledged that there are “several problems with this approach,” the most

obvious being that it reduces the incentive to use a special committee if all of its decisions can be

second-guessed and weakens its utility as a “reliable pre-trial guide to the burden of persuasion.”

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On appeal, the Delaware Supreme Court, although given the opportunity to hold otherwise,

reaffirmed the status of the law on review of special committee decisions. The law could have been

clarified, if not changed, here. Though the case law applying the business judgment rule to a

conflict-free and well-informed board does not use the phrase “well functioning,” it is a functionally

equivalent determination. Likewise, once a court determines that a special committee is conflict

free, informed and well-qualified, burden shifting should be automatic, without substantive inquiry.

The court can then take “into consideration the substantive decision of the special committee” --

because it has to under the “entire fairness” standard -- but with the burden of proof on the plaintiffs,

not defendants. Unfortunately, the Delaware Supreme Court continues to feel otherwise, and parties

must deal with it. A 1997 Delaware Supreme Court case, Kahn v. Tremont Corp., 694 A.2d 422

(Del. 1997), required the Chancellor to determine whether the committee was well-functioning by, as

he put it, taking “a look back at the substance, and efficacy, of the special committee’s negotiations,

rather than just a look at the composition and mandate of the special committee.” The Supreme

Court quoted this passage with approval in its affirmance.

Tender Offers

In In re CNX Gas Corporation Shareholders Litigation, 4 A.2d 397 (Del. Ch. 2010) the

Delaware Court of Chancery developed a “unified standard” for reviewing controlling

stockholder going-private transactions. The unified standard provides business judgment rule

review, but only if the transaction is: (1) negotiated and recommended by a special committee; and

(2) approved by a majority of the minority shareholders. Historically, Delaware courts have applied

different standards of review for negotiated mergers and transactions accomplished via a unilateral

tender offer. Negotiated mergers have been reviewed under the “entire fairness” doctrine and

unilateral tender offers (assuming no disclosure issues) have left the cashed-out stockholders with

appraisal rights and no fiduciary review. If the Delaware Supreme Court were to affirm the unified

standard enunciated in CNX, it would eliminate the dichotomy between controlling-stockholder

tender offers and negotiated cash-out deals.

The Facts

This case arose from the acquisition of CNX Gas Corporation (CNX) by CONSOL Energy,

Inc. (CONSOL). Prior to the acquisition, CONSOL owned 83.5% of CNX’s common stock and its

representatives controlled the CNX board. In September 2009, CONSOL initially approached T.

Rowe Price, which managed funds that owned 6.3% of CNX’s common stock, about acquiring the

CNX shares held by the T. Rowe Price funds. In March 2010, T. Rowe Price reached an agreement

to tender its CNX shares in a proposed CONSOL tender offer for all publicly held shares at $38.25

per share in cash.

After the announcement of T. Rowe Price’s agreement, the CNX board approved the

formation of a special committee consisting of the only independent director on CNX’s board, John

Pipski. The board granted him authority to prepare a Schedule 14D-9, hire independent legal and

financial advisors, and make a recommendation as to the fairness of the transaction. However, Pipski

was not given authority to negotiate the terms of the tender offer, adopt a rights plan or consider

alternative deals.

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CONSOL commenced its tender offer for all publicly held shares of CNX in April 2010. The

tender offer was subject to a non-waivable condition that a majority of CNX’s outstanding minority

shares be tendered, excluding shares owned by the officers and directors of CONSOL or CNX.

Shares held by T. Rowe Price were not excluded. Because T. Rowe Price had previously agreed to

tender its shares (which represented approximately 37% of the minority shares), only 13% of the

remaining minority was needed to satisfy the minimum condition.

Approximately a month after creating the special committee of one, and just a day before the

filing of its 14D-9, the CNX board “retroactively” authorized Pipski to negotiate with CONSOL.

The special committee’s financial advisor opined that $38.25 per share transaction price was fair, but

both Pipski and the financial advisors believed CONSOL may have been willing to offer more.

Thereafter, Pipski tried to negotiate a higher price, but was unsuccessful.

The special committee decided not to make any recommendation and to remain neutral

because (i) CONSOL had set the offer price while negotiating with T. Rowe Price, not the special

committee, and (ii) CONSOL had been unwilling to negotiate despite statements from CONSOL

suggesting CNX was worth more than $38.25 per share. The Schedule 14D-9 also identified the

CNX board’s refusal to give the special committee the full power of the board as an additional

reason for remaining neutral.

The Court’s Ruling

The Court of Chancery applied its two-prong unified standard -- i.e., negotiation and approval

by a special committee and approval by a majority of the minority -- and held that neither

requirement had been met. Because the special committee did not affirmatively recommend the deal,

the Court found the first prong of the standard was not met. The Court also noted that the special

committee was not initially empowered to negotiate with the controlling stockholder and did not

have full board authority such as the ability to adopt a poison pill or pursue alternatives. The Court

further explained that even if some of these options would have been exercises in futility, that

judgment should have been left to the special committee, rather than the CNX board. With regard to

the second prong, the Court found that the majority of the minority condition was ineffective because

T. Rowe Price’s shares were counted as part of the minority for purposes of satisfying the condition.

The Court viewed the T. Rowe Price funds to be “interested” because they had an economic interest

on both sides of the transaction due to their significant ownership in both CONSOL and CNX.

The Defendant petitioned the Court to certify an interlocutory appeal of its refusal to dismiss

the action. The Court granted the request and provided additional analysis in its opinion certifying

the question for review. See In re CNX Gas Corporation Shareholders Litigation, 2010 WL

2705147 (Del. Ch. July 5, 2010). Unfortunately, the Delaware Supreme Court exercised its

discretion and refused to accept the appeal, stating that it would prefer to wait until the factual record

is developed. See In re CNX Gas Corporation Shareholders Litigation, 30 A.3d 782 (Del. 2010).

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Thoughts/Takeaways

Sophisticated parties understand the standard of review dynamics in structuring transactions

involving controlling stockholders. So, the question here is this: Should the dichotomy between

controlling-stockholder tender offers and negotiated cash-out deals be eliminated? There are strong

views on both sides.

Those that oppose unification emphasize that for negotiated mergers, the DGCL requires a

board to first approve a merger agreement and adopt a resolution recommending its advisability to

the stockholders. The stockholders cannot unilaterally propose and vote on a merger because the

board, by express statutory mandate, is a gatekeeper. There is no such requirement for tender offers.

“Entire fairness” applies to negotiated controlling-stockholder transactions because the controlling

stockholder has the ability to exercise control over some or all of the directors and therefore dictate

the terms, often to the detriment of the minority who can be cashed-out against their will due to the

voting power of the controlling stockholder. However, if the controlling stockholder is merely going

to the market with a tender offer, the minority gets to decide whether or not to tender -- if the price is

right they will and vice versa. Requiring a controlling stockholder to get the company to appoint a

special committee to play a role can cause delay, cause litigation over the make-up of the committee,

etc., and it defeats the right to go directly to the stockholders and bypass the board altogether.

The argument for unification is grounded on the basis for imposing entire fairness review to

controlling-stockholder transactions in the first place. Regardless of whether a transaction is friendly

or hostile, Delaware has always recognized that the board has a role and can do many things to

protect the interests of the company and its stockholders (from a mere recommendation to not tender

to the adoption of a pill). A controlling stockholder has the ability to exploit information and

relationships, and exert influence over what a board does or does not do, to the detriment of the

minority. Imposition of a unified standard would eliminate any doubt about the fairness of the

process and price, and would therefore promote the maximization of stockholder value. Without it,

the same rationale for differential treatment of tender offers could be used to extend business

judgment protection to deals conditioned only on a vote of a majority of the minority -- and that is

clearly not Delaware law.

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THE MULTI-JURISDICTIONAL STOCKHOLDER LITIGATION EPIDEMIC

(This section is based on Professor Myers’ article,

Fixing Multi-Forum Shareholder Litigation, 2014 U. ILL. L. REV. 467)

Serious intra-corporate disputes at public companies now attract stockholder lawsuits in

multiple fora. This phenomenon has attracted the most attention in the context of merger class

actions at Delaware firms, but it is as prevalent among non-Delaware firms and non-merger disputes.

Many firms have responded to the threat of multi-forum stockholder litigation by adopting forum

selection bylaws. Cost-shifting bylaws might offer an additional potential avenue for dealing with

the multi-forum issue.

What Is Happening?

In a recent law review article, I investigated the incidence of multi-forum litigation in two

types of stockholder suits: derivative litigation over options backdating and fiduciary class actions

challenging the 250 largest mergers between 2009 and 2011. For each firm implicated, I determined

where the firm was sued and whether it was sued in more than one forum. I broke the firms into

three types: those incorporated in Delaware, non-Delaware firms that are incorporated outside of

their headquarters state, and non-Delaware firms that are incorporated in-state. The following table

shows the percentage of firms in each kind of litigation (backdating and mergers) that experienced

multi-forum litigation by the type of firm incorporation.

Percentage of firms with multi-forum litigation in backdating and merger cases, by firm incorporation type

Number of fora where each firm was sued

Backdating litigation Merger litigation

One forum Multi-forum One forum Multi-forum

Delaware inc. 36% 64% 32% 68%

Other, hq ≠ inc. state 33 67 20 80

Other, hq = inc. state 39 61 45 52

This table reveals that the multi-forum pattern in stockholder litigation is pervasive, not unique to

merger litigation, nor to Delaware firms. In the backdating litigation, more than 60% of firms,

regardless of incorporation type, experienced multi-forum backdating litigation. In the merger class

actions, the pattern was also common across all types of firms, affecting more than a majority even

of those firms that are incorporated and headquartered in the same state. Multi-forum litigation is not

of course limited to these two categories of claims. Allegations of phone hacking at News

Corporation, bribery at Wal-Mart’s Mexico subsidiary, and FCPA violations at Alcoa’s Bahrain

operation have all drawn multi-forum filings. The most reasonable assumption is that multi-forum

litigation can arise in any type of stockholder claims outside of the PSLRA and SLUSA regime that

are sufficiently attractive to plaintiffs’ attorneys.

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I collected data on the attributes of the underlying mergers in my data, which permitted

additional analysis through regression. The size of the merger premium had no effect on the

incidence of multi-forum litigation, but the strongest predictor of the multi-forum pattern was the

raw number of suits filed. In other words, whatever features of a merger drive plaintiffs’ attorneys to

file multiple suits also drive the litigation to fragment across multiple fora.

The most basic explanation for multi-forum litigation is competition among plaintiffs’

counsel for control of cases and a share of any settlement fee. Merger cases are highly likely to settle

for some fee, as were backdating derivative suits. When multiple suits are filed in the same

jurisdiction, there are straightforward rules for consolidating the cases and appointing a lead plaintiff

and lead counsel. For a counsel who stands little chance of securing a leadership position in a

consolidated case, the best option is to file in a separate forum. If that attorney can secure control of

the case in some other forum, that attorney can win a seat at the settlement table. He has leverage

with the defendants because he could press ahead with litigation in that forum. And he has leverage

with the plaintiffs’ attorneys in other fora because he could potentially settle the claims with the

defendants. Multi-forum shareholder litigation is thus the natural result of an environment where

plaintiffs’ attorneys compete for fees, multiple courts are willing to proceed with cases, and no

mechanism exists to coordinate cases in different courts.

What Are the Consequences?

In my view, the multi-forum character of shareholder litigation comes with substantial costs

and offers shareholders no benefits. At first glance this looks like a market in the enforcement of

fiduciary duties. But this is not inter-jurisdictional competition that in other situations can be

attractive. If courts are competing to attract filings, the terms of the competition are to entice the

attorneys, whose incentives diverge from those of shareholders. The attributes of a forum that appeal

to a plaintiffs’ attorney—uncritical review of settlements, for example—are not those that would

necessarily appeal to shareholders. And neither judges nor actual plaintiffs are in a position impose

sufficient discipline on the process. There are thus no apparent benefits for shareholders from multi-

forum litigation.

At the same time, multi-forum litigation has two broad consequences that are distinctly

negative for shareholders. First, it weakens shareholder litigation as a governance tool by diverting

attorneys’ fees away from the lawyers who actually prosecute the claims and also by allowing

defendants to obtain weaker settlements through competition among plaintiffs’ attorneys. Fees go up

because there are more mouths to feed. The price of peace in multi-forum litigation is often

attorneys’ fees for the lead counsel in each forum, whether or not the litigation is active in that

forum. Splitting fees with inactive attorneys diminishes the ex ante incentive for the prosecuting

attorney to invest in pursuing the claims. Multi-forum litigation also can inhibit the ability of each

plaintiffs’ attorney to press for a tough bargain in settlement. The plaintiffs in each forum are in

competition with each other to achieve a settlement. Each offers the same thing – a general release

for the defendants. This creates what John Coffee has called the reverse auction. Defendants will

settle with the plaintiff who offers the most attractive settlement offer. Each plaintiff will limit its

settlement demands because it knows that other plaintiffs are making competing offers. In sum,

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however feeble shareholder litigation might be as a tool of corporate governance, its multi-forum

character aggravates its ineffectiveness.

The second major negative consequence of multi-forum shareholder litigation is that it

undermines the U.S. system of producing corporate law. There are strong reasons to think that some

of these multi-forum disputes involve important transactions and novel legal questions. When cases

proceed in alternative fora, incorporation states often lose out on the opportunity to update their

corporate law and apply it to new scenarios. This is, of course, a problem for Delaware. But it is

problematic for any state that wishes to provide authoritative guidance on the content of its corporate

law to firms incorporated there. Thus, multi-forum litigation has negative systemic consequences for

the production of corporate law in the United States.

What are the Responses?

I have argued that the federal government should adopt a regime that coordinates stockholder

litigation across court systems. By allowing cases filed in non-incorporation states to be removed to

federal court and by staying federal cases in favor of incorporation state cases, such an approach

could directly solve the multi-forum problem.

The most prominent existing approach to dealing with multi-forum shareholder litigation is

for companies to adopt forum selection clauses in their organizational documents. For a time, there

was some question about the validity of such clauses, especially when adopted exclusively by board

action. In 2013, then-Chancellor Strine provided some clarity on that question by holding that board-

adopted forum selection bylaws are facially valid and enforceable under Delaware law. That

opinion, however, left open the possibility of a future as-applied challenge that such a bylaw might

operate unreasonably.

A chief risk is nevertheless that a foreign court might fail to enforce a forum selection bylaw.

One potential solution on this front is an anti-suit injunction issued by a Delaware court. The

Delaware courts have thus far declined to issue anti-suit injunctions in connection with enforcing a

forum selection clause, preferring instead to have the foreign courts deal first with the enforceability

of the clause.

A recent case from the Delaware Supreme Court also suggests one additional tool that might

be useful in addressing multi-forum litigation. In ATP Tour, Inc. v. Deutscher Tennis Bund, --- A.3d

---, 2014 WL 1847446 (Del. May 8, 2014), the Delaware Supreme Court upheld the validity of a

board-adopted bylaw that would require a plaintiff in an intra-corporate to bear the litigation

expenses of the corporation and related defendants if it was wholly unsuccessful or even just partly

successful. The court noted that a goal of deterring litigation might be a proper purpose for adopting

such a by-law. The threat of such cost-shifting, particularly if combined with a forum selection

bylaw, might be sufficient to deter most multi-forum situations.

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NOTE: A recent study prepared by Matthew D. Cain (University of Notre Dame,

Department of Finance) and Steve M. Davidoff (Ohio State University, Michael E. Moritz College of

Law) on M&A deals in 2013 showed:

97.5 percent of all transactions resulted in litigation

Each transaction resulted in an average of 7 lawsuits (an all time high)

41.6 percent of all transactions experienced multijurisdictional litigation (down

from 51.8 percent in 2012)

Median attorneys’ fee awards per settlement remained steady at US$485,000

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APPRAISAL ARBITRAGE

(This section is based on a forthcoming article in the Washington University Law Review by

Professor Myers and Professor Charles Korsmo, Assistant Professor at Case Western Reserve

University School of Law, titled, Appraisal Arbitrage and the Future of Public Company M&A)

Stockholder appraisal has been thrust into the spotlight by two high-profile and very large

appraisal actions in Delaware involving the Dell and Dole going-private transactions. As we have

shown in our academic work, these two cases are part of a larger trend of explosive growth in

appraisal. Furthermore, the parties driving this growth are a new group of sophisticated investors

who specialize in pursuing appraisal claims. In short, we are in the midst of the rise of appraisal

arbitrage. We argue in our article that this is, on balance, a beneficial development and one that

Delaware should encourage. We propose two reforms designed to improve the operation of

stockholder appraisal. First, we argue that Delaware should expand the remedy so that it does not

depend on the form of consideration that target shareholders receive. Second, we argue that

Delaware should provide a narrow but complete safe harbor when the target has been subjected to a

genuine market test.

What is Happening?

Appraisal allows a dissenting stockholder to forego the merger consideration and instead file

a judicial proceeding to determine the “fair value” of the shares. In our forthcoming article we offer

the first comprehensive look at appraisal litigation in Delaware. Across various measures of appraisal

activity, we document sharp increases in the last three years. From 2004 through 2010, stockholders

filed an average of approximately 10 appraisal petitions per year, but an average of more than 20

petitions were filed each year from 2011 through 2013. In 2013, there were with nearly 30 petitions

filed in 2013 alone. This surge in appraisal filings does not reflect an increase in merger activity.

Approximately 5% of appraisal-eligible transactions attracted appraisal litigation from 2004 through

2010. The appraisal rate more than doubled in 2011 and has continued to increase since then. By

2013, nearly 20% of appraisal-eligible transactions attracted an appraisal petition. The value of

claims in appraisal in 2013 was nearly $1.5 billion, a tenfold increase from 2004 and nearly 1% of

the equity value of all merger activity in 2013.

In addition to the increasing volume of appraisal activity—measured both in the number of

petitions and the dollar values at stake—the profile of the public company appraisal petitioner has

changed sharply since 2010. Petitioners have become increasingly specialized and sophisticated, with

repeat petitioners dominating appraisal activity. Before 2010, resort to appraisal was almost

exclusively a one-off exercise for aggrieved minority stockholders. But since 2010 repeat petitioners

dominate, with more than 80% of appraisal proceedings involving at least one repeat petitioner.

These repeat petitioners typically make the decision to invest after a merger deal has already

been announced, with the express purpose of seeking appraisal—a practice described as “appraisal

arbitrage.” Among this new breed of appraisal arbitrageurs are large, sophisticated hedge funds

including Magnetar Capital and Verition Fund, a Greenwich-based fund managed by former

principals at Amaranth Advisors. The largest repeat petitioner is Merion Capital, with over $700

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million invested in appraisal claims. The fund is headed by a successful plaintiffs’ attorney from

Philadelphia and has reportedly sought to raise $1 billion for a dedicated appraisal fund.

The causes of this rise in appraisal are unclear, but we can confidently dismiss two potential

explanations. The first points to the method of calculating interest on appraisal claims. Delaware

offers a statutory rate of interest equal to the federal funds rate plus 5%, high enough to be unusually

attractive in an era of historically low interest rates. Given, however, the risks an appraisal petitioner

must assume—an extended period of illiquidity with an unsecured claim against a surviving

company that may be highly leveraged, plus the risk of the legal claim itself—the idea that interest

rates are driving sophisticated parties to target appraisal is implausible. While the interest rate surely

may offset some of the risk faced by an appraisal petitioner (which is of course the goal of awarding

interest in the first place), it is unlikely to be driving the surge in appraisal

The second explanation ties the increase in appraisal to In re Transkaryotic, a 2007 Chancery

Court decision. Transkaryotic expanded the time frame for purchasing appraisal-eligible stock in

advance of a stockholder vote to approve a merger. But the judicial ruling itself likely contributed

little, if at all, to the rise in appraisal arbitrage. Transkaryotic only marginally expanded the time

available to arbitrageurs for evaluating appraisal claims and, more importantly, only affected a subset

of merger transactions triggering appraisal—those requiring shareholder votes. The surge in activity

has, however, been stronger in mergers involving two-step mergers, where Transkaryotic can have

had had no effect, than in deals calling for a stockholder vote. Thus, the larger trend is unlikely to be

the result of the Transkaryotic holding. Indeed, the economic result in the Transkaryotic litigation,

rather than the consequences of the court ruling, is more likely to have played a role in the increased

interest in appraisal. The parties ultimately settled the claims for a 35% premium over the merger

consideration.

What are the Consequences?

Given the increasing incidence of appraisal litigation and the escalating dollar amounts at

stake, examining the policy implications of appraisal becomes a matter of some urgency. At least

superficially, there is some reason to fear that appraisal—as a species of shareholder litigation—will

share some of the well-known pathologies of other types of shareholder litigation. In particular, most

forms of shareholder litigation generate a serious agency problem between the stockholders, as

nominal plaintiffs, and the plaintiffs’ attorneys. The structure of appraisal litigation, however, is such

that serious agency problems are unlikely. There are no class claims in appraisal. Each petitioner

must affirmatively opt in by dissenting and seeking appraisal. Further, the sole issue at stake in an

appraisal action is the fair value of the plaintiff’s shares. The single-issue nature of the claim

precludes collusive “disclosure only” settlement and reduces the nuisance value of a claim by

narrowing the scope of the issues subject to discovery and resolution at trial. In addition, the fact that

an appraisal petitioner must forego the merger consideration and the risk that the court may

ultimately declare fair value to be less than the merger consideration equalizes the risk faced by the

parties. This further reduces the in terrorem value of litigation.

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Indeed, our analysis reveals that appraisal suits—in contrast to fiduciary suits challenging the

same universe of transactions—bear multiple indicia of litigation merit. Appraisal petitions target

transactions with substantially lower deal premia. They also target going-private transactions, where

minority shareholders are most likely to face expropriation. Appraisal petitioners, in other words, are

focusing on the right deals.

In light of these empirical findings, we argue that the rise of appraisal arbitrage is, on balance,

a beneficial development. Much as the market for corporate control generates a disciplining effect

on management, a robust market for appraisal arbitrage could serve as an effective back-end check

on expropriation from stockholders in merger transactions. Appraisal can protect minority holders

against opportunism at the hands of controlling stockholders, and in third-party transactions appraisal

can serve as a bulwark against sloth, negligence, or unconscious bias in the sales process. For

appraisal to perform such a role, however, a deep and active appraisal arbitrage market is necessary.

By buying up large positions after the announcement of a transaction, arbitrageurs can overcome the

collective action problems that would otherwise render appraisal ineffective. A highly-developed

appraisal arbitrage market would aid minority shareholders—even those not equipped to pursue

appraisal themselves—by deterring abusive mergers and by causing shares traded post-

announcement to be bid up toward the expected value of an appraisal claim.

What are the Responses?

We propose that Delaware reform section 262 of the DGCL to improve the functioning of

appraisal in two ways. First, the basic premise of appraisal—that a judicial proceeding can provide a

more reliable valuation of stock than some market process—fails in predicable circumstances. In our

view, a genuine market test of the target company will necessarily provide a superior valuation of the

stockholders’ interest, and in such circumstances an appraisal proceeding can only cause mischief.

For this reason, we would support the development of a safe harbor to eliminate appraisal where the

transaction has undergone a true auction. A target could affirmatively seek the protection of the safe

harbor only by subjecting itself to a genuine market test, not merely by engaging by jumping through

certain procedural hoops that happen to satisfy Revlon. Our second reform proposal focuses on

decoupling appraisal rights from the form of merger consideration. Delaware currently limits the

availability of appraisal to mergers where the consideration takes certain forms—primarily cash or

non-public shares. We argue that the form of merger consideration should be irrelevant to eligibility

for appraisal. The adequacy of the consideration paid in a merger does not, at the end of the day,

depend on the form of that consideration. Our two reform proposals together would improve the

functioning of appraisal arbitrage as a mechanism of corporate governance.

Acquiring companies no doubt regard any appraisal activity as a nuisance or worse. Some

have suggested more inchoate reforms aimed at limiting appraisal or reversing Transkaryotic.

Delaware, for example, could adopt some legislation that would limit appraisal eligibility only to

those who held stock on the record date. This would at the margin prevent some investors from

buying stock to seek appraisal because they would have a limited opportunity to review merger-

related proxy disclosures.

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VENTURE CAPITAL CONCERNS:

PREFERRED VERSUS COMMON STOCKHOLDERS

The Delaware Court of Chancery’s 114-page opinion in In re Trados Inc. S’holders Litig.,

2013 WL 4511262 (Del. Ch. Aug. 16, 2013) (Vice Chancellor J. Travis Laster) deals extensively

with a variety of issues that directors and investors should consider. While management and the

preferred stockholders of Trados, Inc. received all of the merger consideration in an end-stage

transaction and the common stockholders received nothing, the Court found that the transaction was

still “entirely fair” to the common stockholders because the common stock had no monetary value

before the merger.

Background: in US$60M sale of Trados, common stockholders received nothing

In July 2005, SDL plc acquired Trados for US$60 million. The Trados board of directors,

composed primarily of management and appointees of venture capital investors in Trados, approved

the merger and a management incentive plan that awarded incentives to management for a sale, even

if the sale netted nothing for the common stock. The US$60 million sale price left the venture

capital firms’ liquidation preferences almost fully satisfied and paid some money into the

management incentive plan, but resulted in the common stockholders receiving nothing. The

plaintiff sought both an appraisal and a fiduciary duty remedy, arguing that the board had a fiduciary

duty to continue to operate Trados so that it could recover money for the common stock, rather than

selling at a price that would get nothing for common stockholders. The Court first resolved the

fiduciary duty claim before addressing appraisal, because a finding on that claim could moot the

appraisal proceeding. Because six of the seven directors were materially interested based on their

obligations to the venture capital firms and the incentives created by the management incentive plan,

the Court applied the entire fairness standard, which places the burden of proof on the directors to

demonstrate that the transaction resulted from a fair process and produced a fair price. In this case,

notably, the board made decisions that benefited preferred stockholders, notwithstanding the board’s

duty to common stockholders. The Court therefore began by asking to whom, precisely, directors

owe fiduciary duties, among potentially competing classes of stockholders:

The standard of conduct for directors requires that they strive in good faith and on an

informed basis to maximize the value of the corporation for the benefit of its residual

claimants, the ultimate beneficiaries of the firm’s value, not for the benefit of its

contractual claimants. In light of this obligation, it is the duty of directors to pursue

the best interests of the corporation and its common stockholders, if that can be done

faithfully with the contractual promises owed to the preferred.

The Trados directors failed to demonstrate they followed a fair process

Turning to the facts, the Court first found that the Trados directors failed to demonstrate that

they had followed a fair process. Although Trados’s new CEO suggested that he might be able to

develop a new line of business rather than sell the company, the board never considered any

alternative to the sale. The Court went so far as to say: “[T]here was no contemporaneous evidence

suggesting that the directors set out to deal with the common stockholders in a procedurally fair

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manner.” The Court held: “In this case, the VC directors pursued the Merger because Trados did not

offer sufficient risk-adjusted upside to warrant either the continuing investment of their time and

energy or their funds’ ongoing exposure to the possibility of capital loss.” The Court pointed to a

number of particular procedural failings. The Court intimated that the board should have at least

considered the sale from the standpoint of the common stockholders. Instead, “[t]he VC directors

did not make this decision [to sell Trados] after evaluating Trados from the perspective of the

common stockholders, but rather as holders of preferred stock with contractual cash flow rights that

diverged materially from those of the common stock and who sought to generate returns consistent

with their VC funds’ business model.” Further evidence of unfair dealing was found in the

management incentive plan. To address a conflict of interest, the court held that directors must at the

very least understand the nature of the conflict. “Directors who cannot perceive a conflict or who

deny its existence cannot meaningfully address it.” This principle applied with great force in this

case because one director admitted, during his deposition, that the board never even discussed the

conflict of interest between the common and preferred stock until the litigation began. The Court

also held that the defendants missed chances to improve the record on the process by failing to either

secure a fairness opinion or condition the transaction on the approval of a majority of the common

stockholders.

Despite the flawed process, the court found the defendants established a fair price

With respect to the fair price analysis, the court found that the defendants had satisfied their

burden of establishing that the price was entirely fair to the common stockholders. The plaintiff

proffered an expert report suggesting that the common stockholders should have received more, but

that report included a valuation based on comparable companies that yielded an extremely wide

range of values. The Court ultimately concluded that no companies were comparable to Trados.

Instead, the Court relied on a discounted cash flow valuation prepared by the defendants’ expert,

which incorporated a variety of plaintiff-friendly assumptions but nevertheless demonstrated that

there was no realistic scenario in which the common stock would have any economic value, even if

Trados had successfully developed a new line of business rather than entering into the sale. In

making this determination, the Court emphasized that the preferred shares held an 8 percent

accumulating dividend, meaning that the preferred shares’ liquidation preferences grew by 8 percent

per year. The Court found that Trados “did not have a realistic chance of generating a sufficient

return to escape the gravitational pull of the large liquidation preference and cumulative dividend.”

Because the common stock had no value, the Court found that the directors did not breach their

fiduciary duty: “In light of this reality, the directors breached no duty to the common stock by

agreeing to a Merger in which the common stock received nothing.” On the strength of that same

factual finding, the Court held that the “fair value” of Trados’ common stock for appraisal purposes

was zero. The plaintiff also made a request for fee-shifting. Despite the defendants’ successful

defense of the claims, the Court signaled its willingness to entertain a separate fee application

because of the defendants’ bad faith conduct. The Court emphasized that the defendant directors

changed their testimony between their depositions and trial, and even explicitly disavowed “four sets

of minutes in which the Board ostensibly determined in good faith that the fair value of the common

stock was $0.10 per share and upon which this Court previously relied.” The Court also pointed to

the defendants’ decision to file three summary judgment motions, one of which the Court considered

potentially frivolous, and that the plaintiff was forced to file four separate motions to compel, all of

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which resulted in the defendants providing additional discovery material, due to conduct the court

summarized as “serial failures to produce.”

Thoughts/Takeaways

1. Non-employee status is no guarantee of independence

Directors are not guaranteed to be deemed independent simply because they do not work for a

venture capital firm directly. One of the directors had worked collaboratively with the venture

capital firm on several companies, and he had invested approximately US$300,000 in one of the

funds. This director was also CEO of another company in which the venture capital firm was an

investor and had a director designee. The Court found that these relationships “resulted in a sense of

owingness that compromised [the director’s] independence.” Accordingly, companies should

consider these types of relationships when appointing a director believed to be independent or relying

on his independence in connection with corporate action.

2. Understand the nature of directors’ fiduciary obligations to preferred shareholders

The Court also held that directors do not owe fiduciary duties to preferred stockholders when

considering an action that might violate or circumvent the preferred shares’ contractual rights. The

preferential rights of preferred stockholders, even if set forth in a company’s certificate of

incorporation, are contractual in nature. Directors must act in good faith and on an informed basis to

maximize the value of the corporation for the benefit of residual claimants (that is, common

stockholders and preferred stockholders not relying on a liquidation preference or some other

preference). The board only owes fiduciary duties to preferred stockholders when such holders are

relying on a right shared equally with common stockholders.

3. Evaluate incentives created by management change-in-control and bonus plans

Companies should revisit their change-in-control bonus plans, because this opinion criticizes

a bonus plan that functions in a common way. The Court held that the structure of the management

incentive plan (MIP) gave further evidence that the Trados board dealt unfairly with the common

stockholders. This holding shows that directors may violate their duty of loyalty if they improperly

structure a change-in-control bonus plan to favor preferred stockholders over common stockholders

or to incentivize management to take action for the benefit of the preferred stockholders. The MIP

paid a bonus to management tied to the proceeds to be received in a sale transaction. The bonus was

paid before any proceeds were paid to stockholders. These types of bonus plans are often

implemented in venture-backed companies in which the value of the companies is believed to be too

low relative to the liquidation preference to provide management with sufficient incentive value in

their common equity. The structure of the MIP was similar to a structure often seen. The MIP

provided an escalating percentage of proceeds based on deal consideration. The plan also offset

amounts payable to management by any dollars received by management by virtue of their holdings

of common stock. The Court found that the MIP skewed management’s approach to a sale

transaction in a manner adverse to common stockholders. First, the MIP’s structure resulted in the

MIP’s cost being allocated disproportionately between the preferred and common stockholders. As

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deal proceeds exceeded the liquidation preference, common stockholders increasingly bore the cost

of the MIP. The Court did not provide guidance as to what would be an appropriate allocation, other

than to say that an allocation in which 100 percent of the cost comes from the preferred stock would

raise no fairness issues and an allocation in which 100 percent of the cost comes from the common

raises serious fairness issues. Second, the offset for common proceeds caused management to focus

on maximizing their return under the MIP versus their return as common stockholders and

incentivized management to pursue a sale even at valuations at which the common stockholders

received nothing. It also caused management to favor a sale rather than remaining independent in the

hope of obtaining a higher value at a later date. The Court noted that, while the plaintiff in Trados

did not bring a claim that the directors breached their duty of loyalty by implementing the MIP as

designed, the directors would have found it difficult to prove that their doing so was fair to the

common stockholders to whom the directors owed fiduciary duties.

4. Remember that courts place great weight on contemporaneous written communications

Finally, this opinion illustrates the importance of contemporaneous written communications

of management, directors and investors (including internal reports and communications solely within

the venture firms). The Court placed particular significance on the reports made by the board

designees of the venture firms to the designees’ partners inside the firms. The opinion recites and

references these reports more than 15 times. Written materials made contemporaneously with an

event are often given more evidentiary weight than subsequent testimony or statements given by the

same persons. Rarely are these communications written with an eye towards litigation, and they are

often more candid than would otherwise be the case. When considering a sale of a company or other

corporate action that may be later challenged, involved persons should take extra care to ensure that

their written communications are accurate and consistent with their fiduciary obligations.

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EXCLUSIVE FORUM AND FEE-SHIFTING

PROVISIONS FOR STOCKHOLDER LITIGATION

Exclusive Forum Provisions

In Boilermakers Local 154 Retirement Fund v. Chevron Corp., 73 A.3d 934 (Del. Ch. 2013),

the Delaware Court of Chancery held that boards of directors of Delaware corporations may adopt

bylaws, which are binding on shareholders, requiring that lawsuits over the internal affairs of a

Delaware corporation be brought exclusively in Delaware.

The Court consolidated two actions for purposes of this opinion because the actions involved

virtually identical bylaws and complaints. Defendants filed a motion for judgment on the pleadings,

and the court granted the motion with respect to two challenges to the bylaws. The opinion

addressed the validity of the bylaws under the Delaware General Corporation Law (DGCL) as well

as the question of whether bylaws enacted by a board of directors without shareholder involvement

can be enforced, as a contractual matter, against shareholder plaintiffs.

The Court made two primary holdings. First, the Court found that the DGCL permits an

exclusive forum selection bylaw. Specifically, 8 Del. C. § 109(b) allows a corporation’s bylaws to

“contain any provision, not inconsistent with law or with the certificate of incorporation, relating to

the business of the corporation, the conduct of its affairs, and its rights or powers or the rights or

powers of its stockholders, directors, officers, or employees.” The Court held that forum selection

bylaws “easily meet these requirements.”

Second, the Court held that these forum selection provisions are enforceable against

shareholder plaintiffs, even though the bylaws were board-enacted. The Court criticized the

plaintiff’s contract argument as being premised on an incorrect understanding of the nature of the

relationship between shareholders and a corporation. Properly understood, bylaws are part of a

flexible contractual relationship between shareholders and a corporation. Based on the Certificate of

Incorporation, stockholders understand whether a particular board of directors has the power to enact

bylaws. If the Certificate of Incorporation grants a board the power to unilaterally amend the

corporation’s bylaws, as permitted by 8 Del. C. § 109(a), then the board may enact bylaws and

thereby unilaterally alter the flexible contract.

The Court left the door open for additional litigation over the validity of exclusive forum

selection bylaws in particular circumstances, however, by refusing to address plaintiffs’ arguments

that in certain hypothetical situations the enforcement of these bylaws might be unreasonable.

Exclusive forum selection bylaws represent a response to the phenomena of multi-forum

litigation, in which plaintiffs bring the same suit in multiple jurisdictions simultaneously. The

Court’s decision is therefore an important step toward addressing this problem.

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Fee-Shifting Provisions

In ATP Tour, Inc. et al. v. Deutscher Tennis Bund et al., --- A.3d ---, 2014 WL 1847446 (Del.

May 8, 2014), the Delaware Supreme Court, sitting en banc, held that a Delaware corporate bylaw

that requires a losing claimant to pay the legal fees and expenses of the defendants is not invalid per

se, and if otherwise enforceable can be enforced against losing claimants whether or not they were

already stockholders when the relevant bylaw provision was adopted. The Court’s ruling was in

response to four certified questions from the US District Court in Delaware, which had been

considering whether to enforce the bylaw provisions in question in a dispute between ATP Tour, Inc.

and some of its members.

In 2006, the board of directors of ATP Tour, Inc. a Delaware non-stock (also known as a

membership) corporation, adopted a bylaw providing that if any member or members brought or

supported a claim against the corporation or any other member, the claimant would then be obligated

(and if more than one claimant, jointly and severally obligated) to pay the legal fees and expenses of

those against whom the claim was brought if the claimant “does not obtain a judgment on the merits

that substantially achieves, in substance and amount, the full remedy sought…” Members of ATP

Tour, Inc. filed claims against the corporation and the board as a result of certain changes to the

importance and timing of their tournaments, and the district court, having found for the defendants

on all counts, certified the question of the fee-shifting provision to the Delaware Supreme Court.

Citing Section 109(b) of the Delaware General Corporation Law (DGCL) for the baseline

rule that the bylaws may contain any provision not inconsistent with law or the corporation’s

certificate of incorporation, the Court noted that bylaws are presumptively valid and that a bylaw that

“allocated risk among parties in intra-corporate litigation would appear to satisfy the DGCL’s

requirement that bylaws ‘must relat[e] to the business of the corporation, the conduct of its affairs,

and its rights and powers or the rights and powers of its stockholders, directors, officers or

employees.’” Although the corporation in this case was a non-stock corporation, the analysis is

applicable to stock corporations and non-stock corporations alike, with the members of non-stock

corporations being analogous to stockholders.

The Court noted that no principle of common law prohibits directors from enacting fee-

shifting bylaws and that because contracting parties may modify the “American rule” under which

litigants pay their owns costs to provide that “loser pays,” a fee-shifting bylaw (bylaws being

“contracts among a corporation’s shareholders”) would be a permissible contractual exception to the

American rule. The Court noted further that an intent to deter litigation (as a fee-shifting provision

inherently does) was not invariably an improper purpose.

Declining to rule (or even comment in dicta) on the specific bylaw provision in question, the

Court did note that the enforceability of such a bylaw provision would depend on the manner in

which it was adopted and the circumstances under which it was envoked, and that “[b]ylaws that may

otherwise be facially valid will not be enforced if adopted or used for an inequitable purpose.”

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Finally, citing generally the propositions described above, the Court affirmed the other

questions presented for certification, that:

(i) this particular bylaw, if valid and enforceable, could shift fees if the plaintiff obtained

no relief in the litigation;

(ii) the bylaw would be unenforceable if adopted for an improper purpose; and

(iii) a bylaw amendment is enforceable against members who join the corporation

before its enactment.

Because the Court did not rule on the enforceability of the specific fee-shifting provision in

question, practitioners will still need to rely on existing Delaware rulings on the enforceability of

bylaw provisions for guidance on particular provisions to be adopted and enforced under particular

circumstances. Certainly, the adoption of a fee-shifting bylaw well before the possibility of any

litigation would seem to improve its chances of enforcement. It is also notable that despite the

Court’s analysis of the fee-shifting mechanics in light of “the American rule” versus “loser pays,” the

bylaw provision in question only shifted the expense to a losing claimant, and is arguably

asymmetric in its effect to the benefit of the corporation (not to mention the directors) in its (and

their) more likely position as defendants. While this distinction does not appear to be materially

relevant to the Court’s overall analysis in ATP, practitioners should take note of this and other issues

in determining how best to craft fee-shifting bylaws that will be subject to additional scrutiny as

these types of provision gain in popularity.

Thoughts/Takeaways

Because this is the first case touching on this issue, the reaction of ISS, proxy advisory firms

and others to the extension of the ATP rationale to general corporations is yet to be known. The

Court was careful to point out that such a bylaw may be facially valid but could be rendered

unenforceable if used for an inequitable purpose.

If ATP could be extended to general corporations, the logistics are easy. If a company has an

exclusive forum provision, it could make the fee-shifting provision apply to any and all claims

covered by the exclusive forum provision, which would cover class actions, derivative claims and

claims involving the internal affairs doctrine. One could argue that certain actions expressly

permitted by the DGCL should be excluded -- e.g., 211, 220, 225 and 262 actions -- because the

DGCL authorizes them without condition, but the rationale for exempting even these actions from a

validly adopted charter (or bylaw) provision is not clear (other than making a public policy judgment

call). On the issue of fee-shifting provisions being one-sided, for class actions and derivative

actions, a court has to approve of any fee to plaintiff’s counsel (so a provision that says corporate-

loser pays plaintiff-winner may not be enforceable anyway).

All of the above considerations may become irrelevant, however, because in a “dude, not so

fast” moment, after wrangling behind closed doors, on May 29, the Corporation Law Section of the

Delaware State Bar Association voted to recommend to the Delaware Legislature a statutory

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amendment that would quash the adoption of ATP-type bylaw provisions for general corporations --

essentially making a legislative end-run around the Supreme Court’s decision. Proposed changes to

the DGCL are often given great deference -- the Delaware State Bar Association recommends a

change and the Delaware Legislature gives great weight to the advice of its experts, which has

worked quite well and has created the most widely-respected corporate legal framework in the world.

Statutory changes generally occur on an annual cycle where new changes take effect on August 1.

In the interim, rather than rushing to have their boards adopt fee-shifting bylaws provisions,

corporations will do well to step back and coolly observe the Delaware process at work.

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SALE TRANSACTIONS AND THE REVLON STANDARD

“Revlon” duties -- derived from the 1985 case of Revlon Inc. v. McAndrews & Forbes

Holdings Inc., 506 A.2d 173 (Del. 1985) -- require a board, when selling the company, to act

reasonably to obtain the best transaction reasonably available. The sale process, the merger

consideration, and the existing stockholder make-up can all implicate Revlon.

Process

In Lyondell Chem. Co. v. Ryan, 970 A.2d 235 (Del. 2009), the Delaware Supreme Court held

that “there are no legally prescribed steps that directors must follow to satisfy their Revlon duties.”

Reaffirming existing Delaware law, the Supreme Court held that:

There is only one Revlon duty -- to “[get] the best price for the

stockholders at a sale of the company.” No court can tell directors

exactly how to accomplish that goal, because they will be facing a[]

unique combination of circumstances, many of which will be

outside their control. . . . “[T]here is no single blueprint that a board

must follow to fulfill its duties.”

Mixed Consideration

In In re Smurfit-Stone Container Corp. S’holder Litig., 2011 WL 2028076 (Del. Ch. May 20,

2011), the Delaware Court of Chancery decided an issue that in its view “has not yet been squarely

addressed in Delaware law”: whether enhanced “reasonableness” scrutiny under Revlon and its

progeny -- rather than deferential review under the business judgment rule -- should govern a board’s

decision to sell a corporation for consideration consisting of a mix of 50% cash and 50% of the

acquirer’s stock. Ruling on a motion to preliminarily enjoin the sale, the Court held that, although

the question was “not free from doubt[,]” plaintiffs were “likely to prevail on their argument that

Revlon [scrutiny] applies.”

The case involved an attempt by plaintiff-stockholders of Smurfit-Stone Container

Corporation to enjoin a merger transaction involving total consideration of $35 per share, to be paid

in $17.50 cash and $17.50 in the acquirer’s stock, based on an exchange ratio set forth in the merger

agreement. Following the transaction, the former Smurfit-Stone stockholders would own

approximately 45% of the acquirer’s outstanding shares of common stock. The merger agreement

had no floor or cap on the stock component of the consideration. As a result, when the acquirer’s

stock price rose following the announcement of the merger, the stock component of the transaction

increased to approximately 56% of the total consideration. The Court reasoned, however, that in the

interest of predictability, the analysis of whether Revlon scrutiny should apply should focus on the

stock-cash mix set forth in the original merger agreement – here 50%-50%.

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The Smurfit-Stone Court reasoned that, under Delaware Supreme Court precedent, the Revlon

duty to obtain the “highest price reasonably available” in a sale transaction (and accompanying

heightened scrutiny) will apply “in at least three” circumstances: (1) a corporation initiates an active

bidding process to sell itself or otherwise “break-up” the company; (2) a corporation, in response to

an offer, “abandons its long-term strategy” and seeks a transaction involving “the break-up” of the

company; or (3) when approval of a transaction results in a “sale or change of control.” The Smurfit-

Stone plaintiffs argued that the third circumstance was present: that a 50% stock and 50% cash

transaction qualified as a “change of control.”

The Vice Chancellor summarized precedent in this area, reasoning that 100% stock-for-stock

transactions “do not necessarily trigger Revlon.” Revlon would apply to such transactions where the

resulting entity would have a new controlling stockholder such that “the target’s stockholders” would

be “relegated to minority status[.]” On the other hand, a 100% stock transaction involving a shift in

ownership from one “large unaffiliated group” of stockholders to another does not trigger Revlon,

because the stockholders’ voting power will not be diminished to minority status, and they will retain

the opportunity to obtain a control premium through a future sales transaction.

On the other hand, with respect to 100% cash transactions, Revlon would always apply

because “there is no tomorrow” for the target’s stockholders, who will “forever be shut out of from

future profits generated by the resulting entity[.]” In such circumstances, enhanced scrutiny is

justified because of the heightened risk that the target’s board, which will no longer be accountable

to stockholders, “may favor its interests” over those of the stockholders.

The Court then reviewed precedent with respect to mixed stock-cash transactions. The

Delaware Supreme Court had previously held that a 33% cash deal, with the remainder to be paid in

stock, did not trigger Revlon scrutiny. (See In re Santa Fe Pac. Corp. S’holder Litig., 669 A.2d 59,

64-65 (Del. 1995)). On the other end of the spectrum, the Court of Chancery held that a sale in

which 62% of the total deal consideration -- rather than consideration payable per share -- was cash

(and in which a majority of stockholders therefore could have completely cashed out their shares)

triggered Revlon scrutiny. (See In re Lukens, Inc. S’holder Litig., 757 A.2d 720 (Del. Ch. 1999)).

The Court of Chancery reasoned in that case that Revlon should apply because there was no “long

run” for a “substantial majority of the then-current shareholders.”

The Smurfit-Stone Court ultimately held that it was likely Revlon would apply to a 50%-50%

stock-cash transaction. The Vice Chancellor found significant the fact that there would be “no

tomorrow” for 50% of each individual stockholder’s investment in Smurfit-Stone. The Court

reasoned broadly that Revlon requires enhanced scrutiny in “a transaction that constitutes an end-

game for all or a substantial part of a stockholder’s investment in a Delaware Corporation.” It

further reasoned that Revlon should apply even assuming the post-merger entity “has no controlling

stockholder” and that the Smurfit-Stone stockholders “will not be relegated to minority status,”

reasoning that what was significant is that “half of their investment will be liquidated.” In this

regard, the Court found that “the fact that control … will remain with a large pool of unaffiliated

stockholders, while important, neither addresses nor affords protection to the portion of the

stockholders’ investment that will be converted to cash and thereby deprived of its long-run

potential.”

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The Court of Chancery’s opinion in Smurfit-Stone follows on the heels of a January 24, 2011

transcript ruling by another Vice Chancellor, who ruled (similarly in the context of a preliminary

injunction proceeding) that a 50%-50% stock-cash transaction in which the target’s stockholders

would own approximately 15% of the post-merger corporation would likely be governed by Revlon.

(See Steinhardt v. Howard-Anderson, C.A. No. 5878-VCL (Del. Ch. Jan. 24, 2011) (Transcript).)

The Court reasoned in pertinent part that it was a “constructive final stage transaction” because the

stockholders would be “giving up control to a person who could then cash you out because he’s the

new controller.” The Court further reasoned that this was the stockholders’ last chance “to have their

fiduciaries bargain for a premium for their shares has the holders of equity interests in” the target.

Even though they would receive stock in the new entity, and could therefore in the future receive a

control premium in connection with a sale, this was their last chance to bargain for “how much of

that future premium” they would get. The Court also noted that “[t]his is the only chance that [the]

stockholders have to extract a premium, both in the sense of maximizing cash now, and in the sense

of maximizing their relative share of the future entity’s control premium.”). Accordingly, the

Steinhardt Court reasoned that enhanced “reasonableness” review under Revlon would likely apply.

Thoughts/Takeaways

Going forward, it appears Revlon is likely to apply more frequently, but the standard should

be easier to satisfy in light of decisions like Lyondell. The Delaware courts are becoming very

deferential to non-conflicted directors in the sale process, imposing no firm rules, and taking the

approach that “reasonableness” under Revlon means contextual reasoning -- i.e., the standard does

not impose disproportional efforts in relation to what is at stake. The area of the law in sales

transactions that continues to be murky involves disclosures. Finding a disclosure violation is the

easiest way for plaintiffs’ firms to enjoin a transaction so very careful review of the state of the law is

highly recommended prior to filing a proxy statement.

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STANDING TO BRING DERIVATIVE SUITS

In Arkansas Teacher Retirement System v. Countrywide Financial Corp. (“Countrywide”), 73

A.3d 888 (Del. 2013), the Delaware Supreme Court answered a certified question of law from the

United States Court of Appeals for the Ninth Circuit, a procedural path permitted by Article IV,

Section 11(8) of the Delaware Constitution and Supreme Court Rule 41, concerning the scope of the

fraud exception to the rule that a plaintiff shareholder must continue to own shares to pursue a

derivative claim, called the “continuous ownership rule.” The Delaware Supreme Court held that a

merger strips shareholders of standing to maintain a derivative claim, even if the alleged fraud that is

the subject of the derivative claim necessitated the merger. In so holding, the Court clarified that the

so-called “fraud exception” to the requirement of continuous ownership means only that if directors

of a corporation effectuate a merger for the sole purpose of extinguishing a derivative claim, that

action grants the shareholders a direct suit against the directors.

This opinion arose from a derivative action brought by five institutional investors in

Countrywide Financial Corporation against Countrywide’s directors, in the United States District

Court for the Central District of California. While the case was pending, Countrywide merged into a

wholly owned subsidiary of Bank of America Corporation, divesting the plaintiff shareholders of

Countrywide stock. The District Court then granted a motion to dismiss the action, holding that

Delaware’s continuous ownership rule meant the merger stripped Countrywide shareholders of

standing to bring a derivative suit, that is, a suit on behalf of Countrywide. On appeal to the Ninth

Circuit, plaintiffs argued that a recent Delaware Supreme Court opinion had broadened the fraud

exception to the continuous ownership rule. The Ninth Circuit certified the question of the breadth

of the fraud exception to the Delaware Supreme Court, asking whether shareholders may maintain a

derivative lawsuit after a merger if the alleged fraud that is the basis of the derivative claims

necessitated the merger. The Delaware Supreme Court answered the question in the negative.

The continuous ownership rule, as explained in the 1984 Delaware Supreme Court case

Lewis v. Anderson, 477 A.2d 1040 (Del. 1984), states that a shareholder must continue owning

shares for the duration of a lawsuit the shareholder brings on behalf of the corporation (that is, a

derivative lawsuit). As a consequence of this role, shareholders in a corporation that is merged into

another entity lose standing to either bring or maintain an existing derivative suit on behalf of the

corporation in which they owned shares prior to a merger. Lewis v. Anderson also made clear that

the fraud exception permits shareholders who allege that a merger occurred for the sole purpose of

extinguishing derivative claims to bring a direct claim against the directors. A direct claim alleges a

harm to the shareholders and any recovery goes to the shareholders; a derivative claim alleges harm

to the corporation and any recovery goes to the corporation.

Plaintiffs argued to the Ninth Circuit, and then to the Delaware Supreme Court, that a 2010

Delaware Supreme Court opinion, Arkansas Teacher Retirement Systems v. Caiafa, 996 A.2d 321

(Del. 2010), represented a material change in the scope of the fraud exception to the continuous

ownership rule. Caiafa also arose from litigation against the Countrywide directors.

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By way of background, after announcement of the merger between Countrywide and Bank of

America, the plaintiffs in California amended their complaint to add direct claims based on the

merger. The California District Court stayed those claims in favor of similar claims asserted on

behalf of the same putative class that were pending before the Delaware Court of Chancery. The

Delaware parties announced a settlement of the direct claims that would allow the merger to be

consummated, and the California plaintiffs challenged the settlement before the Court of Chancery.

The Court of Chancery approved the settlement, allowing the merger to proceed, and the Delaware

Supreme Court affirmed that decision in Caiafa. The Delaware Supreme Court began its opinion in

Caiafa by stating: “The Vice Chancellor denied the objection and approved the settlement, allowing

[Bank of America] to close its acquisition of Countrywide, thus extinguishing [the plaintiff’s]

standing to pursue derivative claims.”

The Delaware Supreme Court continued, in dictum in Caiafa, to discuss a claim that the

plaintiffs could have brought but had failed to present. Specifically, the Court stated in Caiafa that

plaintiffs could have plead “‘a single, inseparable fraud’ alleging that pre-merger fraudulent conduct

made the merger a ‘fait accompli.’” Noting that the plaintiffs had not presented this claim, the

Supreme Court affirmed the Court of Chancery’s decision approving the settlement, “despite facts in

the complaint suggesting that the Countrywide directors’ premerger agreement fraud severely

depressed the company’s value at the time of BOA’s acquisition, and arguably necessitated a fire sale

merger.”

After Caiafa, the plaintiffs moved in California for the District Court to reconsider its

dismissal of their derivative claims. The plaintiffs argued that although the derivative claims did not

fit within the fraud exception described by Lewis v. Anderson, the Caiafa dictum represented “a new

material change of law” that allowed derivative standing post-merger if the alleged fraud necessitated

the merger. The District Court denied that motion and dismissed the case, holding that Caiafa

confirmed that “shareholders – not the corporation via a derivative suit – would have had post-

merger standing to recover damages from a direct fraud claim, if one had been properly pleaded.” It

was this decision that the plaintiffs appealed to the Ninth Circuit, and the question of whether Caiafa

expanded the fraud exception as announced in Lewis v. Anderson then came to the Delaware

Supreme Court as a certified question of law.

After explaining this background, the Delaware Supreme Court in Countrywide provided a

relatively brief discussion of the fraud exception to the continuous ownership rule. The court rejected

the plaintiffs’ argument that the Caiafa dictum “overruled sub silentio more than twenty-five years of

precedent that consistently held the fraud exception applies only where the sole purpose of a merger

is to extinguish shareholders’ derivative standing.” Instead, the Caiafa dictum described a direct

claim that shareholders could bring. Caiafa was not intended to expand derivative standing after a

merger, and it did not do so. The Court described its opinion in Caiafa as “unambiguous,” quoting a

passage from Caiafa that stated if plaintiffs had pleaded a fraud claim, then the plaintiff shareholders

“rather than Countrywide – could recover from the former Countrywide directors.” The court

therefore answered the certified question from the Ninth Circuit in the negative.

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PRECLUSIVE EFFECT OF DISMISSAL OF DERIVATIVE CLAIMS

In Pyott v. Louisiana Municipal Police Employees’ Retirement System, 74 A.3d 612 (Del.

2013), the Delaware Supreme Court (en banc) reversed a Court of Chancery ruling that refused to

give preclusive effect to a California court’s dismissal with prejudice of similar derivative claims. In

refusing to dismiss the Delaware derivative complaint, the Court of Chancery held: (1) as a matter of

Delaware law, the stockholder plaintiffs in the two jurisdictions were not in privity with each other;

and (2) the California stockholders were not adequate representatives of the defendant corporation.

The Delaware Supreme Court found that the Court of Chancery erred in both respects.

On the first issue, the Delaware Supreme Court held that the privity issue should not have

been analyzed under Delaware law. For that reason, the Court did not even begin to analyze the

substantive issue, holding instead that California or federal common law applied to the issue and that

Full Faith and Credit mandates that the California judgment be respected.

With regard to the second issue, the Court held that the California stockholders were

adequate representatives of the defendant corporation. The Court of Chancery had found that the

California stockholders were not adequate representatives because “rather than representing the best

interests of the corporation, the California plaintiffs wanted to maximize the return for the law firms

that filed suit on their behalf.” The Court of Chancery also suggested that stockholders who do not

first obtain books and records pursuant to section 220 of the DGCL are presumptively inadequate.

The Delaware Supreme Court rejected the creation of such a presumption because there was no

factual record to support that finding.

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CONCLUSION

These cases once again demonstrate that the Delaware courts are neither stockholder nor

management biased. Delaware’s guiding principles remain strict adherence to fiduciary duties,

prompt enforcement of articles of incorporation, bylaws, and merger agreements, and the

maximization of stockholder value. The business judgment rule remains alive and well for directors

who reasonably inform themselves of important information, are free of economic or other disabling

conflicts of interest, and whose only agenda is that of advancing the best interests of the corporation.

While the facts and legal analyses confronting directors are many times complex, the cases often

boil down to the smell test. So long as independent directors can articulate why, in their best

judgment, they acted as they did and believe those actions were in the best interest of the corporation,

Delaware courts frequently will respect their decisions.