What you need to know:
The Delaware Court of Chancery has put companies on notice that sale processes that involve a single bidder, while permissible, must be designed to ensure that the board satisfies its Revlon duty to secure the best value reasonably attainable for stockholders.
What you need to do:
The decision offers helpful guidance to companies seeking to establish single-bidder sale processes that will withstand attack. In particular, it makes clear that when boards choose not to conduct a market check before or after signing a merger agreement, they must take steps to ensure that the transaction is the result of a fully-informed process. That means, among other things, that boards should remove material obstacles to other bidders coming forward, such as “don’t-ask, don’t waive” provisions in standstill agreements, and that boards should ensure that fairness opinions are robust and defensible.
In Koehler v. NetSpend Holdings, Inc., Vice Chancellor Glasscock was especially critical of NetSpend’s undertaking in its merger agreement not to waive don’t-ask, don’t-waive provisions in standstill agreements with other potential acquirers. The court also concluded that NetSpend’s investment bankers had rendered a “weak” fairness opinion to its board. Among other things, these factors led the Court of Chancery to conclude that the NetSpend board was not fully informed and did not act reasonably in meeting its obligations under Revlon to secure the best value attainable for the stockholders. Nonetheless, the Court of Chancery did not enjoin the transaction. Instead, Vice Chancellor Glasscock concluded that the risk that NetSpend stockholders would lose their only opportunity to sell if he stopped the pending transaction was too great to justify an injunction.
The plaintiff stockholder in NetSpend sought to enjoin the acquisition of NetSpend, a provider of reloadable prepaid debit cards and financial services to consumers who do not have traditional bank accounts or who rely on alternative financial services, by Total System Services, Inc., which the parties had scheduled to close on May 31, 2013. NetSpend went public in October 2010 with an IPO price of $11.00 per share.
Throughout 2011 and 2012, NetSpend was contacted by multiple entities that wanted to gauge NetSpend’s potential interest in an M&A transaction. None of those transactions came to fruition.
In early 2012, the board authorized NetSpend’s CEO to provide financial projections to two private equity firms that had expressed an interest in acquiring a stake in NetSpend from an existing stockholder. In granting this authorization to its CEO, the board gave the express instruction that the entire company was not for sale. The private equity firms executed confidentiality agreements with NetSpend containing standstill provisions that prevented them from seeking to acquire or merge with NetSpend for a one- or two-year period. The agreements also contained don’t-ask, don’t-waive clauses which prevented the private equity firms from directly or indirectly requesting that NetSpend amend or waive any provision of the agreements. Neither standstill agreement terminated upon the announcement of another transaction.
In late September or early October 2012, TSYS contacted NetSpend to indicate an interest in acquiring the company. On October 30, 2012, the board decided that, although no decision to seek a sale of the company had been made, it might be productive for NetSpend stockholders if the company entered negotiations with TSYS. On December 3, 2012, NetSpend received a letter from TSYS indicating that TSYS was interested in conducting an all-cash tender offer for 100% of NetSpend for $14.50 per share. NetSpend’s stock closed at $11.65 on the last trading day prior to NetSpend’s receipt of the letter.
Given that the offer on the table for the whole company materially exceeded the then-current trading price, the stockholder whose stake was the subject of the offers by the private equity firms decided that its stake was no longer for sale and NetSpend terminated its discussions with the private equity firms.
The board declined to grant exclusivity to TSYS; however, the board also declined to contact any other potential acquirers of the company because of the risk of leaks and rumors regarding a potential sale.
The board counteroffered to TSYS at $16.75, but did not conduct any analysis of whether that price was fair to the stockholders before making the offer. (The board had received advice from its investment banker that a financial bidder was unlikely to match the TSYS offer.)
On January 18, 2013, TSYS submitted a revised written proposal to NetSpend, increasing the offer price to $15.40 per share in cash, subject to several conditions. In particular, TSYS reiterated that it would not enter into any merger agreement with a “go-shop” clause authorizing NetSpend to test the market for a superior offer for a period after the merger agreement was signed.
The NetSpend board responded that it was unwilling to proceed with a transaction at $15.40 and strongly preferred to avoid seeking an extension of a key contract, as sought by TSYS. TSYS responded by indicating that:
It was willing to proceed only if there were a five-year extension of the key contract;
It did not believe that a further increase in price was warranted;
A go-shop provision was unacceptable; and
The timing of a binding merger agreement was likely to be early February 2013.
The NetSpend board determined it would be willing to proceed with a transaction at a price of $16.00 per share with a no-shop clause and 3% termination fee and communicated those proposals to TSYS.
The final package of terms included:
A price of $16.00 per share in cash;
A no-shop provision;
A 3.9% termination fee; and
A targeted announcement date in early February 2013.
The price of $16.00 per share represented a 45% premium over NetSpend’s stock price one week before the deal. The total value of the transaction was approximately $1.4 billion.
The parties executed the merger agreement and related agreements on February 19, 2013 and issued a joint press release announcing the merger agreement on that date. The merger agreement provided that NetSpend could not waive don’t-ask, don’t-waive terms in standstill agreements, but it did include a “fiduciary out” for a superior offer. NetSpend did not receive any indications of interest after the sale was announced.
NetSpend’s investment bank prepared a fairness opinion for NetSpend’s board based on several analyses, including a discounted cash flow analysis, a comparable companies analysis and a comparable transactions analysis. The $16.00 price was below the DCF valuation, which set out a range of prices of $19.22 to $25.52.
The deal-protection devices consisted of the termination fee, a no-shop clause, matching rights, and voting agreements which locked up approximately 40% of the stock. As indicated above, the no-shop clause had a fiduciary out for a superior offer. The voting agreements would not terminate if the board withdrew its recommendation in favor of the merger agreement or if the board endorsed a competing offer. Instead, the voting agreements would only terminate if the board terminated the merger agreement. Finally, the merger agreement prevented NetSpend from waiving any standstill agreement to which NetSpend was a party without TSYS’ consent, including the standstill agreements (and the don’t-ask, don’t-waive clauses therein) entered into with the private equity firms.
The Revlon Duty
Under Revlon v. MacAndrews & Forbes Hldgs., Inc., and subject to certain exceptions, when a board decides to enter into a transaction that involves the sale of the company in a change of control transaction, the directors of the target have a duty to secure the best value reasonably attainable for the stockholders. In such a situation, directors have a duty to act in a fully informed manner, and in good faith, to obtain the best deal available. Directors need not follow a particular path to maximize stockholder value, but the directors’ path must be a reasonable exercise toward accomplishing that end.
Courts applying the Revlon analysis therefore look to determine the reasonableness of the process. Reasonableness requires that the board be informed and that it construct a sales process designed to maximize value in light of that information. Revlon’s enhanced scrutiny is a “middle ground” between the deference provided to boards under the business judgment rule and skepticism under entire fairness review. Under this middle-ground review, the directors have the burden of proving that they were fully informed and acted reasonably. Still, Revlon requires only a reasonable decision, not a perfect decision.
Under Revlon, if a board is considering selling the company and there is only one offer, the general rule is that the board must canvass the market to determine if higher bids may be elicited. However, a board may dispense with a market check where “the directors possess a body of reliable evidence with which to evaluate the fairness of a transaction.”
The Vice Chancellor’s Analysis
Vice Chancellor Glasscock concluded that under Revlon and related authority, the NetSpend board, having foregone a market check before signing the merger agreement, and relying on a fairness opinion which the court determined was “ambiguous” and “weak,” “had to be particularly scrupulous in ensuring a process to adequately inform itself that it had achieved the best price.” Instead, the board agreed to the no-shop clause and continuing the don’t-ask, don’t-waive provisions, preventing the board from learning whether the private equity firms were interested in bidding. As a result, Vice Chancellor Glasscock indicated he could not find that the board was sufficiently informed.
Where a board decides to skip a market check and focus on a single bidder, that decision must inform its actions regarding the sale going forward and those actions must produce a process reasonably designed to maximize price. In that regard, Vice Chancellor Glasscock noted that the fairness opinion was “weak” and, thus, a poor substitute for a market check.
The fairness opinion reviewed several valuation methods for the company. Two of the valuations were based on the trading price of NetSpend’s stock, but the NetSpend board had already expressed its own belief that the market undervalued NetSpend considerably. In addition, the fairness opinion relied on analysis of “comparable” companies and transactions. However, the court concluded that the comparable companies were dissimilar to NetSpend.
Finally, according to Vice Chancellor Glasscock, the DCF analysis indicated that the TSYS offer was grossly inadequate and based on financial projections that were outside the range of management’s customary projections. Indeed, the $16.00-per-share merger price was 20% below the bottom range of values implied by the DCF.
The Vice Chancellor then addressed the plaintiff’s criticisms of the various deal protections, focusing on the no-shop and the standstill agreements. The Vice Chancellor noted that NetSpend repeatedly asked for a go-shop, but TSYS refused. Faced with the knowledge that NetSpend could either allow TSYS to walk, or it could attempt to use the lack of a go-shop as a bargaining chip, the board chose to bargain, only agreeing to the no-shop once it had gotten a higher price and a lower termination fee. While it is not per se unreasonable for a board to forgo a go-shop, because the NetSpend board anticipated a short period before the deal’s consummation, the board cannot have intended that a leisurely post-agreement, pre-closing period with a customary fiduciary out would provide an adequate alternative to a market check, according to Vice Chancellor Glasscock.
As noted above, the merger agreement also forbade NetSpend from waiving the don’t-ask, don’t-waive provisions that prevented the private equity firms from expressing any interest in bidding for the company. The Vice Chancellor was concerned that it did not appear that the board considered whether the standstill agreements should remain in place once it began negotiating with TSYS, even though that would have been the ideal time to waive the don’t-ask, don’t-waive clauses, a step the board could have taken until it imported the provisions into the merger agreement. (Shortly after oral argument, TSYS consented to NetSpend’s waiver of the don’t-ask, don’t-waive clauses in the standstill agreements.) Nonetheless, neither private equity firm indicated to NetSpend that it had any interest in submitting an offer. The Vice Chancellor said that while the withdrawal of the don’t-ask, don’t-waive clauses after oral argument did not affect the reasonableness of the process (in other words, it did not remedy an otherwise unreasonable process), it did inform his decision on relief.
Faced with the lack of a market check at any stage in the process, the board’s reliance on a weak fairness opinion, the deal protections, including incorporating the don’t-ask, don’t-waive clauses into the merger agreement, and the lack of an anticipated post-agreement process which would allow other potential acquirers to assert themselves, the Vice Chancellor concluded that the Defendants would fail to meet their burden of proving at trial that they acted reasonably to maximize share price. In particular, the board acted unreasonably in failing to waive the don’t-ask, don’t-waive provisions prior to entering the merger agreement, and in agreeing to forgo the right to waive them in the merger agreement, without considering or understanding the effect this would have on its duty to act in an informed manner. The sale process, reviewed as a whole, was unreasonable.
However, while the Vice Chancellor determined that plaintiff had adequately shown the threat of irreparable harm, a necessary precondition to issuance of an injunction is that the magnitude of the harm absent an injunction must exceed the potential harm if an injunction is issued. In a merger case such as this one, Vice Chancellor Glasscock noted, the Court of Chancery hesitates to enjoin a transaction that affords stockholders a premium in the absence of a competing offer. An injunction may issue only where the court is confident that the plaintiff’s claims are strong, and the risks to the stockholders’ financial interests are small.
Here, in light of the failure of any entity—during what turns out to have been a lengthy period between the merger agreement and the closing—to express an interest in NetSpend, or any other indication that another offer (at least comparable) was going to emerge, the irreparable harm threatened was small, and the possibility of a benefit from delaying the closing and requiring NetSpend to go-shop was low. The merger agreement allowed the Court of Chancery to postpone the closing date without affecting the parties’ other bargained-for contractual rights. Because NetSpend could still seek contractual remedies, including specific performance, if TSYS refused to close the merger after a go-shop imposed by injunction, the risk of harm to stockholders was low. The relevant risk was only that further delay would cause the deal to fall through because of a material adverse change or security breach, events that would release TSYS from its obligations under the contract.
In the Vice Chancellor’s view, if a material change did occur, causing the deal to fail, the harm resulting from the imposition of injunctive relief could be quite large. Stockholders would lose the opportunity to receive a substantial premium over the market value of their shares, an opportunity that might never reappear. Thus, he declined to issue the injunction.
For boards considering transactions like the one at issue in NetSpend, the Court of Chancery’s opinion is instructive. Single-bidder processes are not per se unreasonable. So long as boards take steps to ensure that they are reasonably informed for purposes of evaluating price, NetSpend is no obstacle. However, relying on “weak” or “ambiguous” fairness opinions and importing don’t-ask, don’t-waive provisions into merger agreements such that potential alternative transactions are unlikely to come to the fore are at least two ways in which boards risk a finding that their process for dealing with a single bidder was unreasonable.