In the recent case of Orman v. Cullman, the Court of Chancery on October 20, 2004 denied a claim that the Board of Directors of General Cigar Holdings impermissibly coerced the shareholders to vote for a merger because of a lock-up provision required by the acquiring party. The Court reasoned that the public shareholders had retained full authority to veto the transaction; the Board had negotiated an effective fiduciary out, and any interested third-party was free to purchase the publicly held shares. The issues in this case could easily lend themselves to a law review article, but this is intended as a short summary limited to the Court’s decision in this case only.

The transaction at issue involved the purchase by a company called Swedish Match AB, of 64% of General Cigar Holdings, Inc., although Edgar Cullman, Sr. and Edgar Cullman, Jr. would remain in control of the company. Part of the deal was that the Cullmans enter into a voting agreement that required them not to sell their shares and not to vote their shares against any alternative acquisition proposal for 18 months following the termination of the merger agreement between Swedish Match and General Cigar. The voting agreement also required the Cullmans to vote their shares, which constituted a majority of the voting power of the company, in favor of the merger only in their capacity as shareholders. Nothing in the voting agreement limited their actions as officers or directors of General Cigar. Importantly, the merger agreement also permitted General Cigar’s Board to entertain unsolicited acquisition proposals from potential acquirers if the Board, upon recommendation by the special committee, concluded that such a proposal was a bona fide one, and would be more favorable to the public shareholders than the proposed merger with Swedish Match. The merger agreement also permitted the Board to withdraw its recommendation of the merger with Swedish Match if the Board concluded, upon consultation with outside counsel, that its fiduciary duties so required. The public shareholders were a minority in terms of voting power, and the majority of that minority was required to approve the merger in order for it to proceed. That approval was overwhelmingly given. In a prior decision several years ago, the Court of Chancery determined that the transaction did not involve a sale of control. Orman v. Cullman, 794 A.2d 5 (Del. Ch. 2002).
After the Court’s decision in 2002 in this case, the only issue that remained at that time was whether the public shareholders’ approval of the merger was legally sufficient to dispose of the plaintiff’s fiduciary duty claims, but subsequently the issue presented to the Court was whether the deal protection devices described above were unreasonably coercive of the shareholder vote, and therefore, whether the vote could extinguish the fiduciary duties of the Board. In addition to the coercion issue the plaintiff also argued that the Board breached their fiduciary duties by entering into a voting agreement. The Court viewed those arguments as both without merit and based on a misapplication of the Delaware Supreme Court decisions in Paramount Communications, Inc. v. QVC Network, Inc. and OmniCare, Inc. v. NCS Healthcare, Inc. The Court distinguished Paramount and OmniCare because in the present case, the agreement was made by the parties in their capacity as shareholders and not directors. The Court relied on established Delaware law that allows a majority shareholder to decide when and to whom to sell his shares. The Court reviewed the claims in light of the decision of the Board to recommend to the public shareholders that they approve the merger and whether that ensuing vote of the shareholders was improperly coerced.
In OmniCare, the Board of Directors approved a merger with a three-part deal protection mechanism that did not have any effective fiduciary out clause and which made the merger a fait accompli. The Orman case described the OmniCare decision as one by a “bare majority of the Supreme Court” which held that the tripartite deal protection mechanism was invalid and that those deal protection devices to protect a proposed merger did still require enhanced scrutiny even though not involving a change in control. In a footnote, Orman noted the dissent in OmniCare that would not have applied the enhanced scrutiny standard from the Unocal decision, but rather would have applied the business judgment rule. Nonetheless, in Orman, the Court found that the first stage of Unocal was satisfied because the Board of General Cigar had reasonable grounds for believing a danger to corporate policy and effectiveness existed in light of the risk that they may have lost the Swedish Match transaction with no comparable alternatives if the Board had not approved the deal protection devices. The second stage of Unocal was also satisfied. Relying on prior Delaware decisions for determining the standard for measuring the coerciveness of deal protection devices, the Court found that the public shareholders of General Cigar were not encouraged to vote in favor of the Swedish Match transaction for reasons unrelated to the transaction’s merits. Instead the “lock-up” negotiated was similar to the termination fee found permissible by the Supreme Court in Brazen v. Bell Atlantic Corp. Finally, the Court observed that unlike in OmniCare, the deal protection mechanisms at issue in Orman were not tantamount to a fait accompli. Moreover, the fiduciary out negotiated by General Cigar’s Board was meaningful and effective, and enabled the shareholders to be fully empowered to reject the merger.
The Court concluded its reasoning under Unocal by noting that the deal protection devices were within a range of reasonable responses in relation to the danger to corporate policy and effectiveness. Without the deal protection mechanisms, there would have been no merger and the shareholders could have lost the significant premium that Swedish Match’s offer carried, especially in light of the uncertain future of the tobacco industry.
In sum, the Court found that in addition to the fiduciary out allowing the Board to consider superior proposals, a majority of the disinterested shareholders could have rejected the deal on its merits. They were fully informed about the offer and with no other suitor waiting in the wings, an 18 month delay as a deal protection measure was not a realistic coercion. In the absence of any allegations of gift or waste, the fully informed, ratifying vote of the disinterested shareholders allowed the Court to grant summary judgment against the plaintiff’s fiduciary duty claims.