Mergers & Acquisitions

• M&A Practice May Be Impacted By California Case On Transferring Liability Insurance

• Delaware’s Willingness To Invalidate Deal Protection Clauses Reveals Troubling Bias

Securities Enforcement & Fraud

• Redundant Criminal Sanctions For Fraud In Sarbanes-Oxley Seem Unnecessary

Investment Banking

• Investment Bankers Should Take Defensive Steps To Guard Against Even Indirect Liability

Securities Regulation & Disclosure

• Reminder On How Sarbanes-Oxley’s Whistleblower Protection Works

Corporate Governance & Directors' Duties

• When Officers Can Be Charged With Criminal Responsibility

• Solve The Family (Corporate) Feud Through A Provisional Director

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Overview: Considers the Delaware law of fiduciary responsibility in mergers through the lens of a common merger-agreement provision. Notes that Delaware courts do not categorically reject no-shop and no-talk clauses but rather treat them warily and often disallow them (or permit their breach). Questions whether an invariable preference for target shareholders’ rights over the acquiror’s contract rights strikes the proper balance of legitimate interests.

No-stop shopping. Having expended effort and money to identify and negotiate with a target, an acquiror wants to preserve its position against freebooting poachers by having the target agree, at a minimum, not to seek other merger partners and, if possible, not to deal with unsolicited competing bidders. Attorney Karl Balz, a German practitioner with an LL.M from University of Michigan Law School, explains that these no-shop/no-talk clauses seem problematic to target directors, who fear liability if a competing bidder offers a higher price. Sometimes parties negotiate a fiduciary-out clause, which allows the board to end the deal if the directors believe (generally based on a legal opinion) that ignoring a better offer would violate their fiduciary duties. Delaware treats no-shop clauses as a species of antitakeover defense. The courts review them under a standard somewhere between business-judgment deference and entire-fairness strictness, as either a Unocal/Unitrin reasonable response or a Revlon auction rubric. If the parties know of a third-party offer that would jeopardize the strategic values advanced by the potential merger, the deal-protection clause generally survives—unless it is coercive to the shareholders or disproportionate to the reality of the threat. When the target is up for grabs in the market and the Revlon auction duty is triggered, much stricter scrutiny applies; on the other hand, when two publicly held companies participate on a relatively equal basis, Revlon seldom applies because of the continuity of public ownership pre- and post-transaction.

Weakness in the armor. The author warns of analytical problems under the Unocal/Unitrin view of deal protection, noting that under the coercion-preclusion standard, no no-shop clause could ever fail the test, since they are by nature noncoercive of shareholders (as opposed to directors). Under the Revlon approach, Delaware courts have gradually moved from nearly per se rejection of deal protection clauses to a much more benign attitude, exemplified by a 1994 chancery court case affirmed by the Delaware Supreme Court in 1995. In Rand v. Western Airlines, despite Western’s Revlon status, its directors cleared judicial review of a stringent no-talk agreement without a fiduciary out, because the board had thoroughly canvassed the market before closing a deal with Delta and had traded the no-talk clause for better pricing protection for Western. Delaware courts have also upheld less drastic clauses, either plain ones or those with fiduciary outs, in a wider range of circumstances. The critical element in upholding such clauses appears to be how well-informed the target’s board was at the time it struck the deal with the acquiror.

Not a slam dunk. Notwithstanding the relaxing trend in cases under the Revlon rule, even strategic mergers that would normally fall under the business judgment rule can find their no-shop or no-talk clauses invalid. The author points to several recent cases that appear to present chancellors’ conflicting views. In the 1999 Phelps Dodge Corp. v. McAllister decision, Chancellor Chandler appeared to question categorically whether no-talk clauses offend the requirement for a fully informed board, calling the clause a form of "willful negligence." In a different context in the same year, Vice Chancellor Strine in ACE Ltd. v. Capital Re Corp. frustrated the acquiror. The court decided that the target directors could interpret a somewhat ambiguous legal opinion on the fiduciary-out clause as permitting them to deal with third parties. On the other side of the ledger, Vice Chancellor Steele, in In Re IXC Communications Shareholder Litigation (1999) and the following year in State of Wisconsin Investment Board v. Bartlett, upheld no-talk clauses by saying that they were common devices and that the directors who adopted them had fully informed themselves before signing on and had sought other possible transactions before agreeing to the ones under litigation. The common thread in these cases, the author maintains, is the question of whether the board was fully informed.

Corporate law trumps contract rights. The willingness of Delaware and other state courts to invalidate no-shop and no-talk clauses, the author contends, reveals a bias in favor of corporate law principles over contract principles. The latter would enforce the contracts regardless of whether the target directors violated their fiduciary duties, as long as the directors had general authority to conclude the deal. The author considers the strongest doctrinal support for contract law values to be the doctrine of the good-faith purchaser, but he concedes that this is also its greatest weakness. A large corporation with sophisticated legal advice is seldom unaware of the fiduciary problems that may beset the target’s directors, so the acquiror is more likely to find itself in the position of one who knows or should know of the target directors’ breach of trust. The same result obtains under agency law when the agent exceeds its authority. Nevertheless, in the end, Delaware’s preference for corporate law resolution, more often exposing the acquiror to loss rather than the target, may yield better results than the contract law resolution.

Abstracted from Delaware Journal of Corporate Law, published by Widener University School of Law, 4601 Concord Pike, PO Box 7286, Wilmington, DE 19803. To subscribe, call (302) 477-2145; or visit www.law.widener.edu/CURRENT/STUDENTSERVICES/STUDENT_ORGS/
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