The Court of Chancery in In Re Del Monte Foods Company Shareholders Litigation, Consol. C.A. No. 6027-VCL (Del. Ch. Feb. 14, 2011), read opinion here, on a preliminary record, enjoined for twenty days the Del Monte Board and the acquiring entities from proceeding with a stockholder vote on the proposed $5.3 billion leveraged buyout of Del Monte. In addition, the Court ordered that, pending the vote on the merger, the parties to the merger agreement were enjoined from enforcing the no-solicitation and match-right provisions as well as the termination fee provision relating to topping bids and changes of recommendation.
Kevin F. Brady of Connolly Bove Lodge & Hutz LLP prepared this summary.
Barclays Capital was the financial advisor to Del Monte. In 2009, Barclays met with Kohlberg, Kravis, Roberts & Co. (“KKR”) to discuss an acquisition of Del Monte. Barclays was interested in advising Del Monte and it also intended to provide buy-side financing. Vestar Capital Partners (“Vestar”) contacted Barclays and expressed an interest in Del Monte as well, but Vestar would only commit to half of the equity required in the transaction. In September 2010, Barclays paired up Vestar with KKR which eventually made a bid for Del Monte. However, the KKR offer letter did not mention Vestar. Moreover, Barclays worked with KKR to conceal Vestar’s participation from Del Monte. The Del Monte Board decided to pursue price negotiations with KKR, and while it considered a pre-signing market check, it decided that one was not needed for various reasons.
In November 2010, KKR “formally approached Barclays Capital to request that the Company allow KKR/Centerview to include Vestar in the deal as an additional member of the sponsor group.” Also at this time, Barclays finally asked Del Monte if Barclays could provide buy-side financing and Del Monte agreed.
The Merger Agreement and the Deal Protection Provisions
Section 6.5(a) of Merger Agreement provided for a 45-day post-signing go-shop period during which Del Monte had the right to “initiate, solicit and encourage any inquiry or the making of any proposal or offers that could constitute an Acquisition Proposal” which was defined as:
any bona fide inquiry, proposal or offer … involving an acquisition of the Company (or any subsidiary or subsidiaries of the Company whose business constitutes 15% or more of the net revenues, net income or assets of the Company and its subsidiaries, taken as a whole) or (B) the acquisition in any manner, directly or indirectly, of over 15% of the equity securities or consolidated total assets of the Company and its subsidiaries, in each case other than the Merger.
Once the go-shop period was over, there was a no-solicitation provision that prohibited Del Monte from, among other things, “initiat[ing], solicit[ing], or knowingly encourage[ing] any inquiries or the making of any proposal or offer that constitutes or reasonably could be expected to lead to an Acquisition Proposal.” The no-solicitation clause permitted Del Monte to respond to a Superior Proposal, defined generally as an Acquisition Proposal (but with the references to 15% changed to 50%) that the Board determined was “more favorable to the Company’s stockholders from a financial point of view” than the Merger and “is reasonably likely to be consummated.”
During the go-shop period, Del Monte was also authorized to waive or release any party from any pre-existing standstill agreements with the Company “at its sole discretion.” Section 8.3(a) of the Merger Agreement permitted Del Monte to terminate its deal with KKR to accept a Superior Proposal prior to the stockholder vote on the merger if certain conditions were met. Prior to exercising the termination right, Del Monte had to have given KKR written notice describing the material terms and conditions of the Superior Proposal, and had to have negotiated with KKR in good faith for three business days to enable KKR to match the Superior Proposal. The Del Monte Board decided to let Barclays run the go-shop which set up a direct financial conflict for Barclays. As the sell-side financial advisor, Barclays had earned $2.5 million for its fairness opinion and would earn another $21 million if the deal closed. Because Barclays was going to provide buy-side financing for KKR, Barclays stood to earn another $21 to $24 million.
The Proxy Supplement
On January 12, 2011, Del Monte issued its proxy statement but many of the disclosures about the background of the transaction were false and misleading. Late on Friday, February 4, 2011, after the completion of discovery in connection with the preliminary injunction application, Del Monte amended its 100-plus page proxy statement with significant changes in an attempt to correct the disclosure problems and “moot the plaintiffs’ claims.” The stockholders had until February 15, 2011 to “digest it, determine how to vote, and either submit proxies or revocations or appear and vote at the special meeting.”
Preliminary Injunction Analysis
To obtain a preliminary injunction, the Court noted that the plaintiffs had to demonstrate (i) a reasonable probability of success on the merits on their breach of fiduciary duty and aiding and abetting claims; (ii) irreparable injury if an injunction was not granted; and (iii) that the balance of the equities favored the issuance of an injunction. Because of the conflicts facing the directors, the Court applied the enhanced scrutiny test where the directors bore the initial burden to “show that their motivations were proper and not selfish.” In other words, “the directors must show that they sought ‘to secure the transaction offering the best value reasonably available for the stockholders.’” Then the directors had to show that they (i) followed a reasonable decision-making process and based their decisions on a reasonable body of information, and (ii) acted reasonably in light of the circumstances then existing.
In evaluating the adequacy of the directors’ decision-making and the information available to them, the focus turned to the extent to which the board had relied on expert advisors. The Court discussed the facts surrounding the Toys “R” Us decision, where Vice Chancellor Strine considered whether an investment banker’s role in providing sell-side financing created a conflict of interest that merited injunctive relief when the banker asked about possibly providing buyer-side financing as well. Vice Chancellor Strine concluded “upon close scrutiny” that First Boston’s appearance of conflict did not have “a causal influence” on the board’s process. He cautioned that “[i]n general, however, it is advisable that investment banks representing sellers not create the appearance that they desire buy-side work, especially when it might be that they are more likely to be selected by some buyers for that lucrative role than by others.” In applying the Toys “R” Us analysis to this case, the Court found that Barclays’ activities went too far:
Barclays set out to provide acquisition financing, and as established by the internal screening memos from January and March 2010, Barclays’ Del Monte coverage officer pitched a Del Monte LBO to KKR, Apollo, and other private equity firms that would be likely to use Barclays for acquisition financing. Once it secured the sell-side role, Barclays structured a small, private process that maximized the likelihood that it could provide acquisition financing. Barclays never disclosed to the Board its interactions with the private equity shops or its desire to provide acquisition financing. [Later] Barclays paired up Vestar and KKR in violation of their confidentiality agreements with Del Monte. Barclays then assisted Vestar and KKR in preparing an indication of interest. After being re-engaged by Del Monte, Barclays again did not disclose its interactions with the banks or its plan to secure a buy-side role, and it actively concealed the fact that Vestar and KKR were working together. When KKR “formally requested” permission to make a joint bid with Vestar, Barclays did not come clean, and Del Monte agreed without seeking to extract any pro-stockholder concession or other advantage. Before the Merger Agreement was signed and with price negotiations still on¬going, Barclays sought and obtained a buy-side role and worked with KKR to develop financing. As a result, at the same time Barclays ostensibly was negotiating to get KKR to pay more, Barclays had an incentive as a well-compensated lender to ensure that a deal was reached and that KKR did not overpay.
[W]hat indisputably crossed the line was the surreptitious and unauthorized pairing of Vestar with KKR. In doing so, Barclays materially reduced the prospect of price competition for Del Monte. Vestar had been the high bidder in the early 2010 process, and although Vestar needed a partner, a non-conflicted financial advisor could have teamed Vestar with a different sponsor. It was to address precisely this risk of competition-limiting behavior that Del Monte secured the No Teaming Provision. Barclays’ efforts caused Vestar and KKR to violate the No Teaming Provision. Most egregiously, Barclays actively concealed the pairing from the Del Monte Board…Barclays continued to hide its involvement and recommended that the pairing be permitted.
Barclays similarly crossed the line with its late-stage request for permission to be one of KKR’s lead banks. There was no deal-related reason for the request, just Barclays’ desire for more fees. Del Monte did not benefit. The immediate consequence was to force Del Monte to spend $3 million to hire a second bank. The more serious consequence was to taint the final negotiations. At the time Barclays made its request, the Merger Agreement was not yet signed, and Barclays and KKR were still negotiating over price. Barclays’ internal documents from January and March 2010 had stated that ‘Barclays will look to participate in the acquisition financing once the Company has reached a definitive agreement with a buyer.’ But Barclays could not wait. In considering Barclays’ request, the Board again failed to act reasonably. The Board did not ask whether KKR could fund the deal without Barclays’ involvement, and Del Monte did not learn until this litigation that Barclays was not needed on the buy-side…Without some justification reasonably related to advancing stockholder interests, it was unreasonable for the Board to permit Barclays to take on a direct conflict when still negotiating price. It is impossible to know how the negotiations would have turned out if handled by a representative that did not have a direct conflict. The burden of that uncertainty must rest with the fiduciaries who created it.
The Court also found that Barclays’ conflict tainted the go-shop process, noting that the Strategic Committee which had delegated the task of running the go-shop to Barclays had no direct insight into how Barclays interacted with the parties it contacted. The Court also found that Barclays deceived the Del Monte Board by withholding information “about its buy-side intentions, its involvement with KKR, and its pairing of KKR and Vestar.” As a result, the Court found that “the plaintiffs have established a reasonable likelihood of success on the merits of their claim that the director defendants failed to act reasonably in connection with the sale process.”
With respect to the plaintiffs’ claim that KKR aided and abetted the directors’ breaches of fiduciary duty, the plaintiffs had to show: (1) the existence of a fiduciary relationship; (2) a breach of the fiduciary’s duty; (3) knowing participation in that breach by the defendants; and (4) damages proximately caused by the breach. The Court found that the plaintiffs had met their burden by showing that KKR knowingly participated in Barclays’ self-interested activities.
When Barclays secretly paired Vestar with KKR in September 2010, KKR knew it was bound by the No Teaming Provision and was barred from discussing a Del Monte bid with anyone absent prior written permission from Del Monte. KKR nevertheless worked with Barclays and Vestar on a joint bid and agreed to keep Vestar’s involvement hidden from the Board. KKR also knowingly participated in the creation of Barclays’ buy-side conflict. Before the Board had cleared Barclays to provide financing to KKR, Barclays and KKR had agreed that Barclays would be one of the lead banks. KKR necessarily knew that Barclays would not push as hard in the price negotiations when it stood to earn substantial fees from both sides of a successful deal. KKR later ensured that a conflicted Barclays would run the go-shop when KKR ‘squared things away’ with Goldman for 5% of the syndication, ending Goldman’s interest in running the go-shop process.
The Court found that “[a]bsent an injunction, the Del Monte stockholders will be deprived forever of the opportunity to receive a pre-vote topping bid in a process free of taint from Barclays’ improper activities” and absent an injunction, the stockholders could seek monetary damages, and there are obvious difficulties (for example exculpation under Section 102(b)(7)) in going that route. The Court concluded that “[t]he unique nature of a sale opportunity and the difficulty of crafting an accurate post-closing damages award counsel heavily in favor of equitable relief. The plaintiffs have shown the necessary threat of irreparable harm.”
Balancing of Hardships
The Court noted that:
[o]n the one hand, without an injunction, Del Monte’s stockholders will lose forever the chance for a competitive process that could lead to a higher sale price for their company. On the other hand, granting an injunction jeopardizes the stockholders’ ability to receive a premium for their shares. No one disputes, and the evidence establishes, that $19 is an attractive price. Any delay subjects the Merger to market risk. All else equal, a longer delay means greater risk. There is also the difficult question of the parties’ contract rights, which Delaware courts strive to respect.
The plaintiffs had asked for an injunction with respect to the merger vote for 30 to 45 days and that the parties be enjoined from enforcing the deal protections in the merger agreement during that period. The Court did not believe that
[a] 30 to 45 day delay is warranted. A postponement of this length might be appropriate if Del Monte never had been exposed to the market. The reality is that although a conflicted banker conducted the go-shop process, the Del Monte transaction was shopped actively for 45 days. Since the go-shop process ended on January 10, 2011, the Company has been subject to an additional passive market check. A further delay of 30 to 45 days ignores the fact that many potential bidders have already evaluated this opportunity. I will therefore enjoin the merger vote for a period of only 20 days, which should provide ample time for a serious and motivated bidder to emerge.
The Court also ordered that during the pre-vote period, the parties to the merger agreement would be enjoined from enforcing the deal protection measures because they were the product of a fiduciary breach that could not be remedied post-closing after a full trial. The Court conditioned the injunction on the plaintiffs posting bond in the amount of $1.2 million.