CLIENT ALERT. December 1, 1999

Transcription

1 CLIENT ALERT December 1, 1999 On October 25, 1999, the Delaware Chancery Court issued an opinion relating to notalk provisions in merger agreements, further shaping Delaware case law regarding such provisions (ACE Ltd. v. Capital Re Corp., Del.Ch., Civil Action No , 10/25/99). When Vice Chancellor Leo Strine Jr. declined to interpret a no-talk provision to bar the selling company from considering a competing offer, he marked the second time in a month that the court has looked critically at such provisions. This decision follows Chancellor William Chandler s September 27 th pronouncement that no-talk provisions are troubling because they prevent a board from meeting its duty to make an informed judgment with respect to even considering whether to negotiate with a third party (Phelps Dodge Corp. v. Cyprus Amax Minerals Co., 31 SRLR 1336, 10/8/99). However, the Delaware Chancery Court has also indicated that such provisions are common in merger agreements and has declined to halt a shareholder vote on a merger agreement containing a no-talk provision (In re IXC Communications, Inc., Del.Ch., Civil Action No , 10/27/99). This client alert examines no-talk provisions in the wake of the court s recent decisions. A Brief Summary of No-Talk Provisions No-talk (or no-shop ) provisions serve to protect a deal once the merger agreement has been signed, prohibiting the target company from soliciting or engaging in negotiations with third parties until the meeting of stockholders to vote on the deal has been held or until the deal has closed. No-talk provisions typically are among the most highly negotiated terms in a public company merger agreement, primarily because the parties involved in the negotiations have bi-polar objectives -- the potential buyer s goal is to achieve stability while the seller s goal is to maintain flexibility. The typical no-talk provision contains limitations on (1) the solicitation of competing bids, (2) the furnishing of information to inquiring parties and (3) negotiations with third parties. In essence, a no-talk provision limits the target company s right to change its mind about the deal. No-talk provisions are not as restrictive as they may sound, however, because they often contain what is known as a fiduciary out. A fiduciary out allows the board of directors of the target company to acknowledge competitive inquiries when not doing so would constitute a breach of the board s obligations to the target company and its stockholders. As examination of Phelps Dodge and ACE Ltd. v. Capital Re will show, the Delaware courts have been careful to protect stockholders interests in the context of negotiated no-talk provisions. Phelps Dodge Corp. v. Cyprus Amax Minerals Co. In Phelps Dodge, Chancellor William B. Chandler, III declined to issue a preliminary injunction and found that there was a reasonable probability that a court would uphold the no- 191 PEACHTREE STREET ATLANTA, GA / PENNSYLVANIA AVENUE, N.W. WASHINGTON, DC / AVENUE OF THE AMERICAS NEW YORK, NY / LOUISIANA, SUITE 3300 HOUSTON, TX /

2 talk provision in question. However, the Chancellor called no-talk provisions troubling... because they prevent a board from meeting its duty to make an informed judgment with respect to even considering whether to negotiate with a third party. The Chancellor expressed concern over no-talk provisions that, in essence, ex ante bargain away a target company s right to even become informed about a potential third-party bid. In the opinion of the court, such a stringent provision would be the legal equivalent of willful blindness, a blindness that may constitute a breach of a board s duty of care. The Chancellor expressed his distaste for no-talk provisions, but chose not to rule that the no-talk provision was invalid, in part, because he found that the stockholders could protect themselves from losing out on a premium bid by voting against the merger agreement. The court pointed out that, [w]hen such self-help measures are clearly available and when the arsenals of all parties have been unleashed so as to fully and completely educate the stockholders of their choices, it is not for this Court to ride to their rescue. The Capital Re No-Talk Provision The Capital Re no-talk provision is a fairly standard one, prohibiting Capital Re and its officers, directors, agents, representatives, advisors or other intermediaries from solicit[ing], initiat[ing], encourag[ing],... or tak[ing] any action knowingly to facilitate the submission of any inquiries, proposals, or offers... from any person. The Vice Chancellor identified the most important aspect of the no-talk provision as being the prohibition of Captial Re s participation in discussions (even merely in the way of informational communications) with a third party in connection with an unsolicited bona fide Transaction Proposal (generally defined as an unsolicited proposal to acquire a certain percentage of the target company) unless four conditions are met: (1) Capital Re s board of directors concludes in good faith, based on the advice of its outside financial advisors, that such Transaction Proposal is reasonably likely to be or to result in a Superior Proposal (generally defined as a proposal that the board determines, taking into account all aspects of the deal, is more favorable to stockholders and is reasonably certain to be completed); (2) Capital Re s board concludes in good faith... based on the written advice of its outside legal counsel, that participating in such negotiations or discussions or furnishing such information is required in order to prevent the Board of Directors of the Company from breaching its fiduciary duties to its stockholders under the [Delaware General Corporation Law] ; 2

3 (3) the competing party enters into a confidentiality agreement no less favorable to Capital Re than the confidentiality agreement between Capital Re and ACE (and a copy of such agreement is provided to ACE); and (4) Capital Re s board provides ACE with contemporaneous notice of its intent to negotiate with or furnish information to the competing offeror. The Vice Chancellor characterized the foregoing provisions as the logical gateway through which the Capital Re board must pass before it is in a position where it may terminate the merger agreement in accordance with its terms, which require that (1) Capital Re not be in breach of the terms of the merger agreement, (2) the board authorize Capital Re to enter into a binding written agreement regarding a Superior Proposal and so notify ACE in writing of its intention and (3) ACE has not made an equally favorable counter offer within five business days. Furthermore, prior to such termination, Capital Re must pay ACE a $25 million termination fee. Background of the Case Capital Re, a Delaware specialty reinsurance corporation, and ACE, a Cayman Islands holding company involved in insurance and reinsurance, entered into a definitive Agreement and Plan of Merger on June 11, The following circumstances and events led up to the execution of the merger agreement: Early 1999: Capital Re was reportedly experiencing financial difficulties and began talks with ACE regarding possible business combinations; February 1999: ACE paid Capital Re $75 million for new shares of Capital Re stock, which resulted in ACE owning 12.3% of Capital Re s outstanding common shares; March 1999: Moody s downgraded Capital Re s financial rating from AAA to AA2; May 1999: Capital Re contacted ACE to discuss alternatives, including a possible business combination with ACE; June 11, 1999: Capital Re and ACE entered into the merger agreement, whereby Capital Re stockholders would receive 0.6 of a share of ACE stock for each share of Capital Re stock (valued at that time in excess of $17.00 per share). ACE, owning 12.3% of the Capital Re stock, was party to voting agreements with stockholders holding another 33.5% of the voting stock. These agreements obligated the 33.5% holders to support the merger if the Capital Re board did not terminate the merger agreement in accordance with its provisions. As a result, ACE was positioned to control almost 46% of the stockholder vote and therefore needed very few of the remaining votes to prevail. According to the court, this gave ACE, as a virtual certainty, the votes to consummate the merger even if a 3

4 materially more valuable transaction became available. Under these circumstances, ACE entered into negotiations with the goal of executing the strongest, legally binding commitment from Capital Re, consistent with the Capital Re board s fiduciary duties, while Capital Re felt that a fiduciary out was essential if it were to protect its stockholders rights. After the execution of the merger agreement, the following events occurred: October 6, 1999: the value of the ACE shares to be received by Capital Re dropped to $10.00 per share; October 6, 1999: the Capital Re board received an offer from XL Capital for $12.50 per share in cash for each share of Capital Re stock, and the board called an emergency meeting; October 6, 1999: the board received written advice from counsel that entering into discussions with XL Capital was consistent with its fiduciary duties and verbal advice that such discussions were required; October 10, 1999: the board indicated to XL Capital that it would discuss its bid, whereby XL Capital raised its offer to $13.00 per share; Capital Re met with its legal and financial advisors and determined that XL Capital s offer was more advantageous; Capital Re sent written notice to ACE of its intention to terminate the merger agreement; October 14, 1999: ACE increased its bid to $13.00 per share (in cash and stock); October 18, 1999: XL Capital increased its offer to $14.00 per share, and Capital Re sent another termination notice to ACE; October 21, 1999: ACE filed the motion in question in the case for the issuance of a temporary restraining order to enjoin Capital Re from terminating the merger agreement. The Court s Analysis ACE argued to the court that Capital Re, in negotiating with XL Capital, violated the plain language of the merger agreement because Capital Re was forbidden to engage in discussions with XL Capital unless it received written legal advice from outside counsel opining that the board s fiduciary duties mandated such discussions. Capital Re responded that, although the merger agreement required that Capital Re consult its legal advisors before entering into discussions with a third party, the ultimate decision on whether its fiduciary duties mandated such discussions rested on the board s own good faith judgment. The court refused to issue the temporary restraining order, and broke down its analysis of the parties contentions into two parts. First, the Vice Chancellor held that the best interpretation of the merger agreement left the ultimate good faith judgment about whether the board s fiduciary duties required it to enter discussions with XL Capital to the board itself. The Vice 4

5 Chancellor explained that, [t]hough the board must base its judgment on the written advice of outside counsel, the language of the contract does not preclude the board from concluding, even if its outside counsel equivocates (as lawyers sometimes tend to do) that such negotiations are fiduciarily mandated. Second, and perhaps more significantly, the court held that, if the no-talk provision in fact prohibited the Capital Re board from even discussing another offer absent a written opinion of counsel stating that such discussions were required, and ACE had demanded such a provision, the no-talk provision would be invalid. According to the court: For the superior proposal out... of the [m]erger [a]greement to mean anything, the board must be free to explore such a proposal in good faith. A ban on considering such a proposal, even one with an exception where legal counsel opines in writing that such consideration is required, comes close to selfdisablement by the board. Our case law takes a rather dim view of restrictions that tend to produce such a result. Applying the precepts involved in traditional contract interpretation, the Vice Chancellor explained that, if ACE, a business-savvy party, negotiated a term in the merger agreement that required Capital Re to ignore its fiduciary duty, such a term would be invalid. Quoting the Restatement (Second) of Contracts 193, the Vice Chancellor went on to say that a promise by a fiduciary to violate his fiduciary duty or a promise that tends to induce such a violation is unenforceable on public policy grounds. A More Liberal Approach to No-talk Provisions In re IXC Communications, Inc., Vice Chancellor Steele declined to intervene and enjoin a shareholder vote on a merger agreement containing a no-talk provision, holding that an informed vote on the agreement would provide adequate protection to shareholders. The Vice Chancellor noted that to intervene to frustrate the exercise of the shareholder franchise in law or equity, a showing must be made that the shareholders are either inadequately informed or are misinformed about either the terms of the merger or the process by which it came about. Vice Chancellor Steele noted that the IXC merger agreement was heavily negotiated and subject to substantial disagreement over allowing discussions with other potential suitors. Furthermore, the original no-talk provision prohibited discussions of any kind with a third party, but was subsequently revised to incorporate a fiduciary out, whereby the board could investigate other proposals without shopping the company under perceived adverse circumstances. Based on the extent of the negotiations, specifically those relating to the notalk provision itself, the Vice Chancellor dismissed plaintiffs contention that the no-talk provision amounted to willful blindness. The Vice Chancellor emphasized freedom-of- 5

6 contract and relied on the business judgment rule, upholding the IXC board s actions absent a showing of disloyalty. In the judgment of the court, event those no-talk provisions without a fiduciary out are common in merger agreements and do not imply some automatic breach of fiduciary duty. Negotiating No-Talk Provisions Going Forward The holding in Capital Re provides some guidance for shaping no-talk provisions in the future. Following the court s analysis, a provision prohibiting a board from play[ing] footsie with other potential bidders or [stirring] up an auction is not only understandable, but quite possibly necessary if good faith business transactions are to be encouraged. On the other hand, a provision prohibiting the board from considering another offer when such a refusal would virtually guarantee consummation of the original transaction, however less valuable the original transaction may have become, absent a written opinion that the board must consider that offer, may be viewed critically. The challenge in negotiating a public company deal lies in formulating language that effectively protects the terms of the original deal without conflicting with the board s obligations to its stockholders. It is somewhat significant to note that, in the context of the ACE/Capital Re transaction, the stockholders would not have had the benefit of protecting themselves through a stockholder vote because, in light of the ACE ownership and stockholder voting agreements, the merger was virtually certain to be approved. Perhaps the court would not have been so careful to preserve the fiduciary out if the stockholders had a meaningful opportunity to vote against the transaction. Chancellor Chandler indicated as much in Phelps Dodge, pointing out that he need not rescue shareholders because they could free themselves from the transaction by voting against the merger agreement. Most importantly, in light of the Phelps Dodge and Capital Re cases, it is critical that no talk provisions in a merger agreement be carefully structured and negotiated. If you would like more information regarding these cases, please contact Bill Bates in King & Spalding s New York office (telephone: 212/ ; wbates@kslaw.com) or Bill Baxley in King & Spalding s Atlanta office (telephone: 404/ ; bbaxley@kslaw.com), co-heads of King & Spalding s M&A Practice Group. King & Spalding s M&A Practice Group consists of over 70 lawyers within the Corporate practice area in Atlanta, D.C., Houston and New York who have a principal focus on merger and acquisition activity. The lawyers in the M&A Practice Group have extensive experience in representing bidders, target companies, special committees, dealer managers and financial advisors in a wide variety of transactions, including the acquisition and divestiture of public and private companies; going-private transactions, the structuring and formation of strategic joint ventures; advising financial intermediaries in evaluating and facilitating transactions; antitrust strategies; advising proxy contestants; and structuring acquisition offers and arranging public and private financing. 6