In In re 3Com Shareholders Litigation, C.A. No. 5067-CC (Dec. 18, 2009), read letter decision here, the Court of Chancery denied a motion to expedite discovery in connection with a preliminary injunction seeking to enjoin the consummation of a merger between 3Com Corporation and a wholly-owned subsidiary of Hewlett Packard Company.
Kevin Brady, a highly regarded Delaware litigator, provided this synopsis.
Plaintiffs sought expedited discovery in order to collect facts to support their request to enjoin the Merger. The Court denied the motion to expedite because plaintiffs failed to state colorable disclosure claims or claims for breach of fiduciary duty, and because an adequate remedy (appraisal) existed for any purported fiduciary breach.
To succeed a motion for expedited discovery, plaintiffs must establish: (i) a sufficiently colorable claim; and (ii) a sufficient possibility of threatened irreparable injury, as would justify imposing the extra costs of an expedited preliminary injunction proceeding. Plaintiffs here asserted two reasons: (a) 3Com’s management failed to make adequate disclosures in the December 4, 2009 proxy statement; and (b) the directors breached their fiduciary duties by approving the Merger because by its terms, the merger was structured to discourage or preclude competitive bids.
I. PLAINTIFFS’ FIVE DISCLOSURE CLAIMS
The Court noted at the outset that “[t]he most appropriate time to seek relief to remedy proxy disclosure violations is before the shareholder action related to the proxy occurs.” In this case, the stockholders’ meeting is scheduled for January 10, 2010 so the plaintiffs brought their challenge in a timely fashion. With respect to the requirement of irreparable injury, the Court stated that “[u]nder Delaware law, a material disclosure violation typically creates a per se irreparable harm because the approval of a transaction by uninformed or misinformed shareholders, and the resulting consummation of that transaction, cannot be adequately remedied by an award of damages.” As a result, the Court needed to address whether the plaintiff has demonstrated a sufficiently colorable claim with respect to the five alleged disclosure violations in the Proxy.
Management’s and Goldman’s projections
Plaintiffs alleged that: (a) the Proxy did not disclose cash flow measures, EBIT estimates, or EBITDA estimates from which cash flows could be derived, (b) the limited management projections that were disclosed in the Proxy differed from Goldman’s discounted cash flow analysis (“DCF Analysis”) in that management excluded stock-based compensation expense from its projections but Goldman included it in its DCF analysis, and (c) there was no disclosure of whether the management plan or the revised management plan incorporated the value of VAT refunds that 3Com expects to receive from the Chinese government.
The Court found that those challenges did not state a colorable claim because in the Proxy, 3Com management gave a complete description regarding the process they went through to obtain the Merger price, why management believed the Merger was fair and shareholders should vote in favor of it, as well as summarizing the work done by Goldman in rendering its fairness opinion. The Court stated that “[a] disclosure that does not include all financial data needed to make an independent determination of fair value is not . . . per se misleading or omitting a material fact. The fact that the financial advisors may have considered certain non-disclosed information does not alter this analysis.” The Court stated that the plaintiffs failed to show that the information that they did not receive would have altered the total mix of available information and may have even undermined the clarity of the summaries. In short, while there was a disagreement with Goldman’s methodology the Court found no disclosure violations.
The Revised Management Plan
Plaintiffs next claimed that management failed to explain why a Revised Management Plan was created and used by the Board and Goldman in evaluating the merger. The Court rejected that claim stating:
I am not convinced that failing to describe the reasons for the development and use of the Revised Management Plan was a material omission. In the Proxy, 3Com explains that both the Management Plan and the Revised Management Plan were provided to Goldman for purposes of its fairness review and that both were discussed by the Board in connection with its consideration of the Merger…. I am aware of no rule that precludes management or its financial advisor from using alternative sets of financial projections in evaluating the advisability and fairness of a merger.
Value of 3Com’s operating units
Plaintiffs claimed a disclosure violation by failing to do a “sum-of-the-parts” analysis and provide information as to the value of 3Com’s three operating segments. Under Delaware law, divisional information is material and must be disclosed where the purchaser utilizes such information in formulating its bid. However, the Court found no evidence that HP used such information in formulating its bid. Moreover, as to Goldman’s purported failure to conduct such an analysis, the Court stated that it was not aware of any requirement that Goldman had to perform such an analysis in preparing its fairness opinion. “Whether such an analysis is appropriate is best left to the discretion of investment bankers and company management. Declining to perform such an analysis does not create an obligation on the part of management to disclose divisional information.” The Court stated that the plaintiffs’ disagreement with the fairness opinion can be adequately addressed by an appraisal action.
3Com’s other strategic alternatives
Plaintiffs claimed that 3Com’s management failed to inform stockholders of the other strategic initiatives under consideration at the time it considered HP’s proposal. However, the Court rejected this claim because, “Delaware law does not require management ‘to discuss the panoply of possible alternatives to the course of action it is proposing . . . .’”
Goldman’s alleged deviations from accepted valuation practices
Plaintiffs also claimed that the analyses in Goldman’s fairness opinion deviated
from conventional practice without explaining why. In particular, they claimed that in Goldman’s DCF Analysis, Goldman: (a) treated stock-based compensation as a cash expense in its DCF Analysis even though it is normally not treated as such, (b) selected a weighted average cost of capital that was higher than 3Com’s cost of equity, and (c) increased the discount rates it used in valuing 3Com for the Merger over the discount rates it used when valuing 3Com for the 2008 Attempted Buyout even though 3Com had substantially strengthened its balance sheet in the interim period.
In rejecting this claim, the Court focused not on what Goldman did but rather on whether it was accurately described and appropriately qualified. Finding that it was, the Court said that as long as the work was disclosed, there is no need under Delaware law “to disclose any discrepancy between the financial advisor’s methodology and the Delaware fair value standard under Section 262 (or any other standard for that matter).”
Inconsistencies with the 2008 Attempted Buyout Proxy
Plaintiffs also argued that there were inconsistencies (with no explanation) in the Goldman valuation methodologies between the proxy issued by 3Com for the 2008 buyout and the current Proxy issued for the Merger. The Court rejected this claim stating that “[t]here is no rule that requires a financial advisor to follow the same protocol every time it renders a fairness opinion. There may be valid reasons that Goldman used a different approach when valuing 3Com in connection with the Merger.” Any problem with the fairness opinion can be adequately addressed in an appraisal action.
II. BREACH OF FIDUCIARY DUTY CLAIMS
Plaintiffs alleged that the 3Com directors breached their fiduciary duties in connection with the merger by: (a) including a no-solicitation and matching rights provision in the merger agreement, (b) including a $99 million termination fee that, along with a $10 million expense reimbursement fee, represents over 4% of the equity value of the merger, and (c) failing to make an effort to solicit other buyers before entering the merger agreement. The Court rejected those challenges noting that the Court of Chancery has repeatedly held that such provisions are standard merger terms and “are not per se unreasonable.”