Court Rejects Challenge to “Sign and Consent” Merger with Majority Shareholder Despite Omnicare
In re OPENLANE, Inc. Shareholders Litigation, Cons. C.A. No. 6849-VCN (Del. Ch. Sept. 30, 2011), read opinion here.
Issue Addressed: Did the majority shareholders and the board of directors in this closely-held company breach their fiduciary duties by approving a merger in which they had sufficient control to provide the statutorily required consent and did not follow customary procedures, such as failing to obtain a fairness opinion and failing to include a “fiduciary-out”? Short answer: No.
The Paul Weiss firm provides an overview of the case here, referring to the deal structure as “sign and consent”, which was upheld under the Revlon standard and notwithstanding the Omnicare decision. Wachtell Lipton provides an analysis of the case here. Comparisons with other Delaware disclosure decisions is available here.
This action arises out of the proposed merger of OPENLANE, Inc. with a wholly owned subsidiary. Plaintiff brought a class action on behalf of the public shareholders of OPENLANE and moved to preliminarily enjoin the merger. This 46-page decision denied that motion. OPENLANE was in the business of selling leased vehicles that were turned in by lessees. In April 2010, they anticipated a decline in the number of vehicles coming off lease in 2011 and 2012, and signed an engagement agreement with a financial advisor to undertake a market outreach to a limited number of strategic acquirers. In May 2011, OPENLANE entered into a second agreement with its financial advisor which provided for a market outreach to a limited number of strategic acquirers including one that had already expressed an indication of interest.
On August 11, 2011, the board unanimously approved the merger and on August 15, 2011 entered into an agreement and plan of merger. The next day OPENLANE received consents from a majority of the preferred and common shareholders sufficient under Delaware law and the charter of OPENLANE to approve the merger agreement. The merger agreement with KAR provided that as a condition to closing, the holders of at least 75% of the outstanding shares of stock shall have executed and delivered written consents approving the merger, although that condition could have been waived by KAR. That condition was, however, satisfied on September 12, 2011. The merger agreement also included a no-solicitation provision and provided that $36 million would be held in escrow for at least 18 months to cover numerous contingencies, including indemnification obligations, and appraisal proceedings by shareholders.
On September 9, 2011, the plaintiff filed the complaint and a motion for a preliminary injunction requesting that the Court enjoin the merger.
Plaintiffs argued that the sales process undertaken by the board was flawed, and in violation of both Revlon and Omnicare.
The plaintiffs argued that the sales process was flawed because the board only contacted three potential buyers, failed to perform an adequate market check, failed to receive a fairness opinion and relied on scant financial information which led to a transaction that failed to maximize shareholder value. The plaintiffs also argued that the members of the board breached their fiduciary duty by agreeing to improper deal protection devices such as the no-solicitation clause and because the management owned a majority of the shares which made shareholder approval almost certain – – and there was also the absence of a fiduciary-out provision. The complaint also alleged that the board was motivated by improper reasons such as by an offer of employment in the surviving company and the acceleration of stock options.
After reciting the familiar standard for preliminary injunctions, see footnote 14, the Court parsed each of the allegations.
For example, the Court reviewed the Revlon claims and observed that there is no single path for the board to follow in order to maximize stockholder value but the directors must follow a path of reasonableness which leads to that goal. The Court observed that “if a board fails to employ any traditional value maximization tool, such as an auction, a broad market check, or a go-shop provision, that board must possess an impeccable knowledge of the company’s business for the Court to determine that it acted reasonably.” See footnote 22.
The Court described the two-part analysis for the enhanced scrutiny involved in a change of control transaction: (a) a judicial determination regarding the adequacy of the decision making process employed by the directors, including the information that the directors based their decision; and (b) a judicial examination of the reasonableness of the directors’ action in light of the circumstances then existing. The Court focused on the gist of the review under the enhanced scrutiny standard in this context as requiring that the board demonstrate that “they were adequately informed and acted reasonably.”
Moreover, the Court reiterated the standard in the context of a preliminary injunction which requires a plaintiff to “establish a reasonable likelihood that at trial the members of the board would not be able to show that they had satisfied their fiduciary duties.” (citing Optima Int’l of Miami, Inc. v. WCI Steel, Inc., C.A. No. 3833-VCL, at 130 (Del. Ch. June 27, 2008) (transcript)). The Court explained in great detail why the plaintiff failed to present a compelling argument for injunctive relief and the Court also described in detail the satisfactory efforts that the board followed including the expertise by at least two members of the board who were very active in the industry.
The Court found that although rare in deals with public companies, and common in deals for private companies, there is no inherent unfairness to shareholders of an escrow agreement, which is often incentive for buyers to pay more.
Defensive Devices Under Delaware Law to Lock up a Merger
Defensive devices which lock up a merger require special scrutiny under the two-part test in Unocal Corp. v. Mesa Petroleum Co., 493 A.2d 946 (Del. 1985). The first part of the Unocal test requires that the board demonstrate that it had reasonable grounds for believing a danger to corporate policy and effectiveness existed which is basically a process-based review. They demonstrate the first part of the Unocal test by demonstrating good faith and reasonable investigation but the process must lead to the finding of a threat. The second part of the Unocal test requires the board to demonstrate that its defensive response was reasonable in relation to the threat posed.
This inquiry also involves a two-step analysis. The board must first establish that the merger deal protection device is adopted in response to the threat and was not coercive or preclusive; and then demonstrate that their response was within a range of reasonable responses to the threat perceived.
To satisfy this burden the plaintiff must establish a reasonable likelihood that at trial the members of the board would not be able to show that they had reasonable grounds for believing a danger to corporate policy and effectiveness existed and that the response they adopted to combat the threat was reasonable in relation to the threat posed.
In a change of control transaction where a majority of the board has no interest in the surviving entity, the board does not have the entrenchment goal which the Supreme Court was worried may have motivated the directors in Unocal.
The Court explained those situations that the Supreme Court in Unocal regarded as either coercive or preclusive.
The Court also reviewed the Delaware Supreme Court decision in Omnicare in which the Supreme Court determined that shareholder voting agreements negotiated as part of a merger agreement, which guaranteed shareholder approval of the merger if put to a vote, coupled with the merger agreement that both lacked the fiduciary-out, and contained a Section 251(c) provision requiring the board to submit the merger to a shareholder vote, constituted a coercive and preclusive defensive device. See Omnicare, 818 A.2d at 935.
The Court distinguished the Omnicare decision because in that case the merger was a fait accompli. Instead, the merger before the Court in the instant case was not a fait accompli, in part because there was no evidence of a stockholders agreement to lock up statutory approval of the merger. Rather, the merger was approved through the solicitation of shareholder consents under 8 Del. C. Section 228. See footnote 48.
Under the DGCL, a majority of a corporation’s outstanding stock must support a merger based on Section 251(c) and stockholders are allowed to demonstrate their approval through written consents under Section 228(a). See Optima, C.A. No. 3833-VCL at 127 (noting that nothing in the DGCL requires any particular period of time between the authorization by a board of a merger agreement and the necessary stockholder vote). See also footnote 53 (noting that there is no clear authority under Delaware law that would require a Court to automatically enjoin a merger agreement that did not contain a “fiduciary out” when no superior offer has emerged).
The facts of this case were that the majority consent was obtained one day after the board approved the merger, but the supermajority consent – – which was not needed to approve the merger but was a waivable condition to closing by KAR, came several weeks later.
The Court spent a substantial number of pages discussing the disclosure claims which it rejected.
The Court concluded the last few pages of the opinion with a review of the elements for the prerequisites for injunctive relief and found the absence of irreparable harm in addition to the failure to demonstrate a reasonable probability with success on the merits. As for the balancing of the equities, although the lack of an auction, the lack of a fairness opinion, the lack of a fiduciary-out or any post-agreement market check, did raise concerns, there were no better offers that came forward, and sophisticated buyers should understand that if a materially better offer were to be made, that judicial relief quite likely would have been available. In sum, the balancing of the equities did not favor enjoining the transaction and the motion for injunctive relief was therefore denied.
Final practical observation: It should be noted in closing that this hefty opinion was drafted, and all the briefing and a hearing occurred all in the space of approximately 3 weeks.