The first half of 2019 saw several decisions from the Delaware courts that will affect M&A dealmaking
Aruba: Supreme Court awards "deal price less synergies" in closely watched appraisal case
Rejecting the Chancery Court's use of unaffected market price, the Delaware Supreme Court awarded stockholders seeking appraisal in connection with Hewlett-Packard Company’s 2015 acquisition of Aruba Networks, Inc. US$19.10 per share—a price based on the 2015 deal price minus synergies arising from the transaction. The Supreme Court’s decision confirms the continuing importance of deal price in appraisal proceedings.
The Chancery Court had previously determined the fair value of Aruba’s stock to be its 30-day average unaffected market price of US$17.13 per share—a significant discount from the US$24.67 per-share deal price paid in the 2015 transaction. The Chancery Court held that recent appraisal decisions by the Supreme Court in connection with the acquisitions of computer maker Dell Inc. and payday lender DFC Global Corp. endorsed using market price as an indicator of fair value when shares of the subject company trade in an efficient market.
In reversing the Chancery Court's decision, the Supreme Court emphasized that, for purposes of appraisal, the subject company should be valued "as an operating entity…but without regard to post-merger events or other possible business combinations." As a result, any appraisal award must exclude any value the selling company’s stockholders would receive because a buyer intends to operate the subject company as part of a larger enterprise. Applying this going-concern standard, the Supreme Court found that the Chancery Court incorrectly dismissed deal value less synergies as an indication of fair value because the Chancery Court believed it needed to make additional deductions from the deal price for unspecified "reduced agency costs." According to the Supreme Court, the Chancery Court's view had no basis in the record. In particular, the Supreme Court noted that, unlike a private equity transaction, the HP/Aruba acquisition would not replace Aruba’s public stockholders with a concentrated group of owners but simply swap out one set of public stockholders for another. According to the Supreme Court, "HP's synergies case likely already priced any agency cost reductions it may have expected."
The Supreme Court also made clear that the recent appraisal decisions in Dell and DFC do not compel reliance on unaffected market price in determining fair value. While the price a stock trades at in an efficient market is an important factor, a market price further informed by the due diligence efforts of arm’s-length buyers, with access to confidential non-public information, to learn more about the company they are buying "is even more likely to be indicative of so-called fundamental value." Going forward, parties should expect deal price less synergies to receive considerable weight in appraisal proceedings absent deficiencies in the deal process.
Olenik: Further guidance for controller transactions
The Supreme Court provided further guidance on how to obtain the benefit of business judgment rule treatment (and avoid the more stringent "entire fairness" standard) in connection with controlling stockholder transactions. The Supreme Court had previously held that the deferential business judgment rule applies to a controlling stockholder transaction if such transaction is conditioned "ab initio" upon the approval of the informed vote of a majority of the minority stockholders and upon the approval of an independent committee of directors (Kahn v. M&F Worldwide Corp. (MFW)). In late 2018, the Supreme Court clarified that MFW's "ab initio" requirement would be satisfied if the required conditions were in place prior to any "substantive economic negotiations" (Flood v. Synutra).
In the April 2019 case of Olenik v. Lodzinski, the Supreme Court provided further guidance on when substantive economic negotiations begin. The Chancery Court had previously dismissed a challenge by Olenik, a stockholder of Earthstone Energy, Inc., to a business combination between Earthstone Energy and Bold Energy III LLC on the basis that MFW’s protections applied and the transaction was subject to the business judgment rule. The Supreme Court reversed, finding that the plaintiff had pled facts supporting a reasonable inference that the MFW requirements were not in place before substantive economic negotiation took place. While some early interactions between the parties could be fairly described as preliminary, the Supreme Court found that, for purposes of dismissal at the pleadings stage, the preliminary discussions transitioned to substantive economic negotiations “when the parties engaged in a joint exercise to value Earthstone and Bold.” According to the Supreme Court, these valuations “set the field of play for the economic negotiations to come.” Since the MFW conditions were not in place prior to these substantive economic discussions, the Supreme Court held that the complaint should not have been dismissed. Based on this most recent case, controlling stockholders hoping to obtain business judgment treatment should carefully monitor the nature of any discussions held prior to imposing the protective MFW conditions.
RSI: Protecting attorney-client privilege
In 2013, the Chancery Court held that, following a merger, all assets of a target company, including privileges over pre-merger attorney-client communications, transfer to the surviving company unless the seller takes affirmative action to prevent such transfer (Great Hill Equity Partners IV, LP v. SIG Growth Equity Fund I, LLLP). In Great Hill, the sellers neither included language in their merger agreement preserving their privilege nor prevented the surviving company from taking actual possession of the communications. As a result, the Chancery Court held that the sellers had waived their ability to assert privilege.
The Great Hill decision encouraged sellers to use their contractual freedom in order to avoid waiving attorney-client privilege in connection with a merger transaction. In the recent case of Shareholder Representative Services LLC v. RSI Holdco, LLC, the sellers did just that in connection with the sale of Radixx Solutions International, Inc. The applicable merger agreement contained an express provision that 1) preserved any privilege attaching to pre-merger communications, 2) assigned to the sellers' representative control over those privileges, 3) required all parties to take steps necessary to ensure that the privileges remained in effect, and 4) prevented the buyer from using or relying on any privileged communications in post-closing disputes against the sellers.
Despite this provision, the buyer, in a post-closing dispute with the sellers, sought to use approximately 1,200 pre-merger emails between Radixx and its counsel contained on computers and email servers acquired in the merger. Because the sellers did not excise or segregate the privileged communications from the computers and email servers transferred to the surviving company, the buyer argued that the sellers waived the privilege. The Chancery Court rejected the buyer’s argument. Importantly, the Chancery Court noted that the merger agreement provision covered any privileged communication prior to the Closing Date. Thus, even if the sellers waived privilege post-closing, the merger agreement still prohibited the buyer from using the communications against the sellers. The Chancery Court also noted that requiring the sellers to take action to preserve privilege would undermine the guidance of Great Hill, which had encouraged parties to negotiate for contractual protections. By enforcing such a provision, the Chancery Court reminds parties of the importance of clearly stating how pre-merger communications will be treated following a transaction.