In two recent cases, the Delaware Court of Chancery denied plaintiffs’ requests to enjoin shareholder votes on proposed mergers that the court found likely to have been tainted by breaches of fiduciary duties. Noting the absence of any competing suitors and the availability of monetary damages, the court found it preferable to allow the shareholders to decide rather than deprive them of the opportunity to receive a premium to market for their shares.
In re Delphi Financial Group Shareholder Litigation (V.C. Glasscock March 6, 2012) involved the proposed takeover of Delphi Financial Group, Inc., by Tokio Marine Holdings, Inc. ("TMH") Delphi's Founder and CEO (the "Founder") created two classes of stock upon taking the company public: Class A shares, primarily owned by the public and entitled to one vote per share, and Class B shares, beneficially owned by the Founder and entitled to 10 votes per share. As part of the IPO, Delphi’s Charter was amended to prohibit disparate consideration between the classes of stock in the event of a merger. Although he owned less than 13 percent of the total outstanding shares, the Founder controlled 49.9 percent of Delphi’s voting power, but he could not benefit financially from his control position. In 2011, TMH contacted the Founder about purchasing Delphi at a significant premium. The Founder notified Delphi’s board of directors of his unwillingness to approve the merger as a shareholder if he did not receive a special control premium for his Class B shares above the price to be paid for his Class A shares.
The Board, while reluctant to agree to disparate consideration, recognized that TMH was willing to pay a substantial premium that stockholders might find attractive and created a Special Committee of independent directors charged with representing the Class A shareholders and responding to the Founder's demand for a control premium consideration. The conflicted Founder, with the approval of the Committee, continued to lead negotiations with TMH. He successfully convinced TMH to agree to pay a hefty premium. The Committee negotiated with the Founder to reduce the amount of his “control” premium. Recognizing the significant market premium to be received by all stockholders, the Committee and Board agreed to the merger contingent upon a majority vote of the disinterested stockholders and the approval of a charter amendment allowing for different merger consideration to be paid to Class A and Class B stockholders.
Although a controlling stockholder is allowed, with limited exceptions under Delaware law, to negotiate a control premium for his shares, the plaintiff stockholders claimed that the Founder relinquished his right to such a premium due to the IPO charter provision mandating equal merger consideration. Plaintiffs argued that the proposed amendment to the IPO charter provision was coercive because in order to realize the benefits of the merger, the stockholders were required to obtain his consent by repealing a charter provision that existed to protect them from that exact situation.
The court agreed with the plaintiffs and on a preliminary record opined that Class A stockholders purchased Delphi’s stock under the assumption that Delphi’s charter denied the Founder a control premium in the event of a merger, “and that as a result, he effectively extracted a control premium from the initial sale of the Class A shares. . . .” The court found that the plaintiffs were reasonably likely to demonstrate that his negotiation for disparate consideration and conditional support of the merger violated his duties, either fiduciary or good faith and fair dealings, to the stockholders. However, because damages were available as a remedy and no other potential purchaser existed, the balance of the equities favored letting the stockholders vote on the merger because if the merger was enjoined, the deal would be lost, and the substantial premium over market price would evaporate.
One week before its In re Delphi decision, Delaware’s Court of Chancery delivered an opinion in In re El Paso Shareholder Litigation (Chancellor Strine) in which stockholder plaintiffs sought a preliminary injunction to enjoin a merger between publicly traded energy companies, El Paso Corporation and Kinder Morgan, Inc. Kinder’s offer to purchase El Paso was made soon after El Paso’s public announcement of its intention to spin-off its exploration and production (“E&P”) business. Kinder wanted to purchase El Paso prior to the spin-off so it could sell the E&P business to help finance the merger. Unbeknownst to El Paso’s board of directors, its CEO intended to make an offer to Kinder to purchase the E&P business in a management buyout after the merger. This presented a potential conflict, as El Paso's CEO had an incentive to keep the merger consideration paid by Kinder low, so as to minimize the potential purchase price he would have to pay for the E&P business.
El Paso looked to its longtime financial adviser for advice on whether to proceed with the spin-off or simply merge with Kinder. However, that financial adviser was conflicted: it owned 19 percent (a $4 billion investment) of Kinder, held two board seats and its lead banker advising El Paso personally owned roughly $340,000 in Kinder stock, which he did not report to El Paso. In an attempt to cleanse the conflict, the Board engaged a second financial adviser for the proposed merger. Nevertheless, the court on a preliminary record found that the longtime adviser was able to use its allies within El Paso’s management to make the new banker's fee contingent upon the signing of the merger agreement, thereby incentivizing the banker to pursue a merger and thereby increasing the longtime adviser's chance to benefit from the merger. After the new banker advised El Paso that a merger with Kinder was more attractive than spinning off the E&P business, El Paso and Kinder negotiated the merger agreement.
Plaintiffs claimed that the merger was tainted by the self interested motivations of El Paso's CEO and the longtime adviser. They claimed the Board breached its fiduciary duties when it failed to shop for a better offer allowed its CEO, despite his conflicts, to singlehandedly negotiate with Kinder allowed Kinder to renege on an agreement in principle for a higher price and signed on to extreme deal protection measures that effectively precluded a post-signing market check.
The court found that plaintiffs had established a reasonable probability of success on a claim that the merger was tainted by the above conflicts and breaches of fiduciary duties. Although noting that monetary damages may not serve as a perfect remediation tool, the court declined to enjoin the shareholder vote, finding that no rival bid existed, and an injunction could kill the deal.
The Delaware Chancery Court in In re Delphi and El Paso displayed its unwillingness to interrupt proposed mergers, despite indications of significant breaches of fiduciary duties and conflicts of interests, where the acquirer offers a significant premium over market and there are no other bidders. The court has also noted that although monetary damages are not a perfect tool to make shareholders whole in such a situation, they are adequate enough to prevent the granting of a preliminary injunction. This makes it all the more important for Boards and Special Committees to thoroughly vet directors, officers, financial advisers and other parties for conflicts of interests and when a conflict exists to effectively wall-off or limit the role of the conflicted party.
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This article was originally published by Bingham McCutchen LLP.