On December 19, 2014, the Delaware Supreme Court, in C&J Energy Services, Inc. v. City of Miami General Employees' & Sanitation Employees' Retirement Trust,1 issued a strongly worded decision refusing to enjoin a change of control transaction. The court, sitting en banc and in an opinion written by recently elevated Chief Justice Leo E. Strine, Jr., reversed a November 25, 2014 decision by the Delaware Court of Chancery, in which the court (1) found a sufficient probability of success that the board of directors of C&J Energy Services (C&J) breached its duties under the "Revlon" standard of review and (2) issued an unusual mandatory injunction compelling the C&J board to shop C&J to other possible buyers, despite a non-solicitation provision in the merger agreement.
Only hours later, the recently appointed Chancellor Andre G. Bouchard of the Delaware Court of Chancery issued a similar decision in the litigation over the sale of Family Dollar Stores. There, Chancellor Bouchard refused to enjoin a vote of the Family Dollar stockholders scheduled for December 23 on the basis that the members of the majority-independent Family Dollar board had allegedly breached their duties by pursuing a sale to Dollar Tree and not to Dollar General.
Both of these decisions, written by the recently appointed Chief Justice and Chancellor, send important messages that the decisions of independent, properly motivated, appropriately informed boards, and the deals they negotiate, should not be easily disturbed.
The Court of Chancery Decision in C&J
On November 25, 2014, in litigation challenging the multi-billion dollar combination of C&J with Nabors Industries, Vice Chancellor John W. Noble issued an oral bench ruling enjoining the C&J stockholder vote for 30 days and compelling the C&J board to conduct a "go-shop" of the company, even though C&J's merger agreement with Nabors prevented C&J from actively soliciting additional offers. C&J and Nabors had announced the transaction on June 25, 2014, exactly five months prior to the ruling, and no topping bidder had emerged since. Nonetheless, the court was troubled by several of plaintiffs' allegations, including that the C&J board allegedly did not appreciate that the deal involved a sale of control for the C&J public stockholders.
This allegation was based upon the structure of the deal, which involved a tax-friendly "inversion" in which C&J would be merged with a Bermuda-based Nabors entity, the C&J stockholders would receive stock in the surviving company (which would continue to be traded under C&J's ticker), and Nabors would contribute significant assets into the surviving company. As a result of this structure, while the surviving company would in many respects have C&J's pre-acquisition management team, a Nabors entity would hold a majority equity stake in the surviving company—resulting in a sale of control subject to the intermediate "Revlon" standard of review, which under Delaware law requires that directors act reasonably to achieve the highest value immediately attainable for stockholders.
Among the other allegations that the Court of Chancery identified as significant were the following: (1) the C&J board allegedly never conducted an active market check for other buyers; (2) the C&J CEO allegedly led the sale process while knowing that he and the management team would have lucrative post-acquisition employment arrangements with Nabors; (3) C&J's financial advisor had originally pitched the idea of the deal, had worked with Nabors in the past, was suggested by Nabors because Nabors wanted to use C&J's usual investment bank, and ultimately provided financing for the transaction at the request of the C&J board (albeit with the C&J board hiring a second financial advisor for a fairness opinion); and (4) even though some questions allegedly emerged late in the negotiation process regarding Nabors' financial performance, C&J agreed to more favorable projections and a higher valuation for Nabors.
Although noting in the bench ruling that the matter was a "very close call," the Court of Chancery found that the plaintiffs had sufficiently alleged that the C&J directors had acted unreasonably under Revlon and granted the preliminary injunction, which affirmatively required the board to conduct a "go-shop" over the next 30 days.2
The Delaware Supreme Court Decision in C&J
In a 38-page decision following an expedited appeal, the Delaware Supreme Court issued a strong reversal of the Court of Chancery's decision. Explaining the roots of the original Revlon decision from 1986, the court stated that "it is too often forgotten that Revlon . . . and later cases . . . primarily involved board resistance to a competing bid after the board had agreed to a change of control, which threatened to impede the emergence of another high-priced deal. No hint of such a defensive, entrenching motive emerges from this record."3 The court noted that the Court of Chancery's "ruling rested on an erroneous understanding of what Revlon requires" and the court cited various precedents as reminders that a board need not conduct a full-blown "auction" or follow a "single blueprint" to maximize value.4 Rather, boards must make a "reasonable decision, not a perfect decision," and a board is permitted to "pursue the transaction it reasonably views as most valuable to stockholders, so long as the transaction is subject to an effective market check"—including a passive post-signing market check—"under circumstances in which the bidder interested in paying more has a reasonable opportunity to do so."5
The court also rebuked the "unusual injunction" that the Court of Chancery issued. The court remarked that mandatory, affirmative injunctions of the kind issued "should only issue with the confidence of findings made after a trial or on undisputed facts," that "[s]uch an injunction cannot strip an innocent third party of its contractual rights while simultaneously binding that party to consummate the transaction, and that "[t]o blue pencil a contract as the Court of Chancery did here is not an appropriate exercise of equitable authority in a preliminary injunction order"—particularly given the Court of Chancery's own concerns about the force of the facts and its conclusion that Nabors had not aided and abetted any breach of fiduciary duty.6 The court emphasized that courts should be disinclined to grant injunctions where stockholders, as here, will vote on the transaction and no topping bidder has emerged.
Looking back at the facts, the court noted that "the record before us reveals a board process that sometimes fell short of ideal," but did not allow the court to conclude that the plaintiffs had shown that the C&J directors had acted unreasonably in light of the board's "overall course of action."7 A majority of the C&J board was independent, including one director employed by a fund that owned 10 percent of C&J's stock and who was therefore incentivized to pursue an optimal sale.8 The transaction with Nabors was subject to a "lengthy" passive post-signing market check, during which time "a potential competing bidder faced only modest deal protection barriers"—and the board had been advised that other would-be acquirors likely had little interest in an acquisition.9 The C&J board had secured for the C&J stockholders various governance rights in the post-acquisition entity relating to the election of the board, subsequent acquisitions (e.g., the stockholders would be required to receive their pro rata portion of the total consideration in a future sale), and various other actions. Although the CEO had obtained "generous" post-acquisition arrangements, those arrangements were reached after the parties had agreed to the terms of the transaction, he himself had a 10 percent stake in C&J, and the board—which the court determined was aware of the "Revlon" implications of the transaction—was engaged and oversaw the CEO's activities in the sale process. As for the valuation questions about Nabors, the court stated that the record "could be read to suggest" that C&J had endeavored to pursue "a positive value" for C&J stockholders while believing that C&J stockholders would benefit from ownership in the post-acquisition entity and assets.10
The Court of Chancery Decision in Family Dollar
Sounding similar themes, in In re Family Dollar Stores, Inc. Stockholder Litigation,11 Chancellor Bouchard refused to enjoin the stockholder vote on the sale of Family Dollar to Dollar Tree on the grounds that the Family Dollar board had allegedly unreasonably favored Dollar Tree over Dollar General.
For several months before signing up a deal, the Family Dollar board pursued discussions with both potential bidders, considered various alternatives, and received advice from its financial advisor that other parties, financial or strategic, were unlikely to be interested in an acquisition. Dollar General ultimately declined to make a bid on the ground that it was prepared to offer only a "modest premium." Dollar Tree, however, made an offer at a price of $74.50 per share—compared to the then-current stock price of $68.14—and involving significant antitrust concessions that made antitrust review a "formality." Family Dollar signed and announced the deal. Thereafter, Dollar General made offers of $78.50 and then $80 per share—more than the deal with Dollar Tree in hand—but with antitrust provisions that, on the advice of Family Dollar's counsel, made Dollar General's competing bid only 40% likely to survive antitrust review. Under the terms of Family Dollar's merger agreement with Dollar Tree, the Family Dollar board had customary fiduciary outs, and the definition of "superior proposal" that triggered them required a competing bid to be more financially favorable to stockholders and "reasonably likely to be completed on the terms proposed." The Family Dollar board determined that Dollar General's proposal did not so qualify. On the advice of its counsel, the Family Dollar board did not ask Dollar General to submit an improved offer, determining instead that Dollar General's proffered divestiture provisions were so insufficient that Family Dollar did not want to suggest they were even in the right "zip code." Of course, stockholder litigation over that decision—and Family Dollar's process and disclosures—ensued.
Refusing to enjoin the vote by Family Dollar stockholders on the deal, and citing C&J, Chancellor Bouchard similarly suggested that this was not the set of facts that originally gave life to Revlon. The court noted that ten of the eleven members of the Family Dollar board were independent, that one of those ten was appointed by a financial fund with significant holdings and incentive to pursue a value-maximizing sale, and that the only inside executive on the board was also a large stockholder with similar incentives. The court determined that "the record here demonstrates that the Board was properly motivated to maximize value for Family's stockholders" and that "[t]hese actions do not suggest any favoritism of [Dollar] Tree over [Dollar] General based on an improper motivation."12 Rather, the board was entitled to pursue the transaction "it reasonably views as most valuable to stockholders," which may mean that antitrust concerns make the nominally higher bid less favorable.13 The Court also rejected the other process and disclosure claims the plaintiffs had assembled.14
The Takeaways
The Delaware Supreme Court's decision in C&J sends a strong message that the decisions of independent, properly motivated, and appropriately informed boards should be respected and the deals they strike with third parties should not be easily undone. This decision is also a powerful reminder that Revlon was intended as a check on board action that discriminates against bidders and prevents stockholders from receiving the best value reasonably attainable, not as a mechanism for rewriting the deals negotiated by boards or as a requirement for 20/20 hindsight perfection. Revlon was not intended or designed to permit shareholders or courts to "second-guess" the good faith judgments of independent directors, made with due care and following careful deliberation, about how to conduct an appropriate sales process. Chancellor Bouchard's decision in Family Dollar, issued only a few hours after C&J, suggests a similar viewpoint. Public company deal litigation is nearly ubiquitous, and the plaintiffs' bar and some stockholders likely will not cease filing such litigation any time soon. These decisions, however, should provide comfort for independent boards of directors and their advisors, and they should provide very helpful guideposts in responding to frivolous litigation.
1 No. 655/657 (Del. Dec. 19, 2014).
2 The order accompanying the bench ruling also provided that "[t]he solicitation of proposals consistent with this Order and any subsequent negotiations of any alternative proposal that emerges will not constitute a breach of the Merger Agreement in any respect," essentially meaning that Nabors could not terminate the merger agreement in light of C&J's court-sanctioned violations of the no solicitation provision of the merger agreement. Order Granting Preliminary Injunction, Certifying Interlocutory Appeal, and Staying the Injunction Pending Appeal, C.A. No. 9980-VCN, at pgh. 2 (Del. Ch. Nov. 26, 2014).
3 Id. at 3-4.
4 Id. at 27.
5 Id. at 27-28 (internal citations omitted).
6 Id. at 4.
7 Id. at 25.
8 This decision accords with another statement recently made by the Delaware Supreme Court in Iroquois Master Fund Ltd. v. Answers Corp., No. 109, 2014 (Del. Dec. 4, 2014) ("When a large stockholder supports a sales process and receives the same per share consideration as every other stockholder, that is ordinarily evidence of fairness, not of the opposite, especially because the support of a large stockholder for the sale helps assure buyers that it can get the support needed to close the deal.").
9 Id. at 1, 17.
10 Id. at 15.
11 C.A. No. 9985-CB (Del. Ch. Dec. 19, 2014).
12 Id. at 30, 32.
13 Id. at 44 (internal citations omitted). For similar issues addressing antitrust risk as compared to price, see In re Dollar Thrifty S'holder Litig., 14 A.3d 573 (Del. Ch. 2010).
14 Interestingly for transaction planners, and addressing an issue that has only occasionally come up in the case law, Chancellor Bouchard was not troubled by, and held that the Family Dollar board did not act unreasonably in agreeing to, a "naked no-vote" fee of 1.05% of the equity value of the deal, payable in the event that the Family Dollar stockholders rejected the deal. Id. at 27-28 n.80.
