LAWYER
The M&A
ARTICLE REPRINT
November/December 2010 n Volume 14 n Issue 10
Director Latitude in
Corporate Sale Process—
Recent Cases Show the
Current State of Revlon
B y S tep h en F . A r cano and Robe r t S . S aunde r s
Stephen F. Arcano is a partner in the New York office, and Robert S. Saunders is a partner in the
Wilmington office, of Skadden, Arps, Slate, Meagher & Flom LLP. The views expressed herein are the
authors’ only, and do not necessarily reflect the views of Skadden, Arps.
Almost twenty-five years after the Delaware Supreme Court’s seminal ruling in
Revlon, Inc. v. MacAndrews & Forbes
Holdings, Inc.,1 public company directors continue to strive to understand their
obligations when engaged in a corporate
sales process. While Revlon’s basic charge
is well-known—maximize stockholder
value—its application in specific circumstances can be less than clear. Several cases
recently decided by the Delaware Court of
Chancery provide further guidance to corporate directors on their fiduciary duties in
the context of change of control transactions. Two of these opinions, In re Dollar
Thrifty Shareholder Litigation2 and In re
Cogent, Inc. Shareholder Litigation,3 build
on and reinforce the proposition, last articulated by the Delaware Supreme Court
in its 2009 decision in Lyondell Chemical
Company v. Ryan,4 that there is no checklist or blueprint that directors must follow
in pursuing a sale of the Company. However, a transcript ruling in Forgo v. Health
Grades, Inc., serves as a reminder that,
when Revlon applies, directors’ discretion
is not unfettered, and a board will bear the
burden of establishing the reasonableness
of its decisions. In combination, these cases
demonstrate that the Delaware courts continue to allow properly motivated directors
significant flexibility to craft a sale process
based on their judgment of the best path
to maximize the outcome for stockholders,
though directors should expect that they
will be called upon to explain the basis for
their decisions.
A Brief Prologue
Numerous Delaware Supreme Court and
Court of Chancery decisions since Revlon
have examined directors’ compliance with
their fiduciary duties in connection with
change-of-control transactions, and have
CONTINUED ON PAGE 3
Article REPRINT
Reprinted from The M&A Lawyer. Copyright
© 2011 Thomson Reuters. For more
information about this publication please
visit www.west.thomson.com
November|December 2010
n
Volume 14
n
Issue 10 The M&A Lawyer Newsletter ad 2.8772 x 4.5.qxp
2/1/2010
1:38 PM
West LegalEdcenter
© 2011 Thomson Reuters. This publication was
created to provide you with accurate and authoritative
information concerning the subject matter covered,
however it may not necessarily have been prepared
by persons licensed to practice law in a particular
jurisdiction. The publisher is not engaged in rendering
legal or other professional advice, and this publication
is not a substitute for the advice of an attorney. If you
require legal or other expert advice, you should seek the
services of a competent attorney or other professional.
For authorization to photocopy, please contact the
Copyright Clearance Center at 222 Rosewood Drive,
Danvers, MA 01923, USA (978) 750-8400; fax (978)
646-8600 or West’s Copyright Services at 610 Opperman
Drive, Eagan, MN 55123, fax (651)687-7551. Please
outline the specific material involved, the number of
copies you wish to distribute and the purpose or format
of the use.
LOG ON.
LOOK UP.
LEARN.
Quality legal training and
CLE - online, anytime
westlegaledcenter.com
1.800.241.0214
Part of Thomson Reuters
For subscription information, please contact the publisher
at: west.legalworkspublications@thomson.com
Editorial Board
CHAIRMAN:
Paul T. Schnell,
Skadden, Arps, Slate, Meagher & Flom LLP
New York, NY
MANAGING EDITOR:
Chris O’Leary
H. Rodgin Cohen
Sullivan & Cromwell
New York, NY
Phillip A. Proger
Jones, Day
Washington, DC
Robert E. Spatt
Simpson Thacher & Bartlett
New York, NY
Stephen I. Glover
Gibson, Dunn & Crutcher LLP
Washington, DC
Philip Richter
Fried Frank Harris Shriver & Jacobsen
New York, NY
Eckart Wilcke
Hogan Lovells
Frankfurt, Germany
Herbert Henryson II
MICHAEL S. RINGLER
Wilson Sonsini Goodrich & Rosati
San Francisco, CA
Gregory P. Williams
Richards, Layton & Finger
Wilmington, DE
Paul S. Rykowski
Ernst & Young
New York, NY
William F. Wynne, Jr
White & Case
New York, NY
BOARD OF EDITORS:
Edward D. Herlihy
Wachtell, Lipton, Rosen & Katz
New York, NY
Bernard S. Black
University of Texas Law School
Austin, TX
Victor I. Lewkow
Cleary Gottlieb Steen & Hamilton LLP
New York, NY
Franci J. Blassberg
Debevoise & Plimpton
New York, NY
Peter D. Lyons
Shearman & Sterling
New York, NY
Dennis J. Block
Cadwalader, Wickersham & Taft
New York, NY
Didier Martin
Bredin Prat
Paris, France
Andrew E. Bogen
Gibson, Dunn & Crutcher LLP
Los Angeles, CA
Francisco Antunes
Maciel Mussnich
Barbosa, Mussnich & Aragão
Advogados, Rio de Janeiro, Brasil
The M&A Lawyer
West LegalEdcenter
610 Opperman Drive
Eagan, MN 55123
For authorization to photocopy, please contact the Copyright Clearance Center at 222 Rosewood Drive, Danvers, MA 01923, USA (978) 750-8400; fax (978) 646-8600
or West’s Copyright Services at 610 Opperman Drive, Eagan, MN 55123, fax (651) 687-7551. Please outline the specific material involved, the number of copies you
wish to distribute and the purpose or format of the use.
Faiza J. Saeed
Cravath, Swaine & Moore LLP
New York, NY
Carole Schiffman
Davis Polk & Wardwell
New York, NY
This publication was created to provide you with accurate and authoritative information concerning the subject matter covered. However, this publication was not necessarily
prepared by persons licensed to practice law in a particular jurisdication. The publisher is not engaged in rendering legal or other professional advice, and this publication
is not a substitute for the advice of an attorney. If you require legal or other expert advice, you should seek the services of a competent attorney or other professional.
© 2011 Thomson Reuters
Copyright is not claimed as to any part of the original work prepared by a United States Government officer or employee as part of the person’s official duties.
One Year Subscription
(ISSN#: 1093-3255)
2
n
10 Issues
n
$586.12
© 2 0 1 1 T h o mson Reu t e rs
Page 1
The M&A Lawyer articulated the so-called “Revlon duty” to maximize stockholder value in a variety of ways. At its
essence, Revlon stands for the proposition that in
connection with a sale of control of a Delaware
corporation, directors are obligated to seek to secure the best value reasonably attainable for stockholders.5 In order to ascertain if this standard is
met, Delaware courts employ enhanced scrutiny
of director conduct, examining (i) “the adequacy
of the decision-making process employed by the
directors” and (ii) “the reasonableness of the directors’ action in light of the circumstances.”6
Revlon did not establish any particular procedural path that must be followed by directors in
selling a company, and subsequent case law has
confirmed that “there is no single blueprint that
a board must follow to fulfill its duties.”7 The
proposition that properly motivated directors
are free to design a sales process that they believe
will result in the best outcome for stockholders was recently reinforced by the Delaware Supreme Court in Lyondell. In reversing the Court
of Chancery’s decision to allow to proceed claims
that a target’s board of directors failed to act in
good faith because it had not engaged in adequate
pre-signing market test, the Supreme Court rejected the Court of Chancery’s conclusion that
Lyondell’s board might have violated a “known
set” of Revlon duties because it “did not conduct
an auction or a market check” and otherwise
lacked “impeccable” market knowledge. In doing
so, the Supreme Court emphasized the flexibility
that directors have in attempting to satisfy their
duty under Revlon. The court confirmed that
Revlon does not create any specific fiduciary requirements separate from directors’ duties of care
and loyalty, but rather, stands for the proposition
that the “board must perform its fiduciary duties
in the service of a specific objective: maximizing
the sale price of the enterprise.”8 In other words,
although directors’ duty under Revlon is to “[get]
the best price for the stockholders at a sale of the
company… . No court can tell directors exactly
how to accomplish that goal, because they will
be facing a unique combination of circumstances,
many of which will be outside their control.”9
© 2011 thomson re ut e rs November|December 2010
n
Volume 14
n
Issue 10
Dollar Thrifty
In In re Dollar Thrifty, the Court of Chancery
denied the plaintiffs’ request to enjoin the consummation of a two-step (tender offer followed
by a merger) transaction in which Hertz would
acquire Dollar Thrifty for a mix of cash and stock
having a value of approximately $41 per share.
For several years, Dollar Thrifty had discussed the
possibility of a transaction with both Hertz and
Avis. In 2009, Dollar Thrifty received an acquisition proposal from Hertz and decided to engage
in discussions with Hertz, which lasted a number
of months. At several points during the pendency
of discussions with Hertz, Dollar Thrifty’s board
considered whether to contact Avis, but determined not to do so based on considerations including Avis’ financial position, the state of credit
markets, the board’s belief as to antitrust risk associated with an Avis transaction, the history of
failed negotiations with Avis and a concern that
Hertz would go away if there were an auction.
Late in the process, Avis made indirect contact
with Dollar Thrifty’s CEO but did not clearly express an interest in bidding, and Dollar Thrifty
did not pursue discussions with Avis prior to executing the merger agreement with Hertz.
The merger agreement contained deal protection mechanisms, including a termination fee and
expense reimbursement totaling 3.9% of the consideration payable to stockholders, a “no shop”
provision with a fiduciary out to permit the board
to entertain superior proposals, and matching
rights. Importantly, the contract also placed divestiture obligations on Hertz if necessary to obtain
antitrust approval, as well as a requirement for
Hertz to pay a reverse termination fee if antitrust
approval was not obtained.
After the announcement of the merger agreement, Avis advised Dollar Thrifty that it intended
to make a substantially higher offer, and Dollar
Thrifty permitted Avis to perform due diligence.
Three months later, Avis offered to acquire Dollar Thrifty for $46.50 per share in a combination
of cash and stock, with no termination fee and
no matching rights, but no reverse termination
fee in the event antitrust approval could not be
attained. In light of the antitrust concerns, Dol-
3
November|December 2010
n
Volume 14
n
Issue 10 lar Thrifty’s board concluded that Avis’ proposal
was not reasonably expected to be consummated
on a timely basis and declined to accept it. Plaintiffs then sought to enjoin the Hertz deal, alleging,
among other things, that “by failing to take affirmative steps to draw Avis into a bidding contest
with Hertz before signing up a definitive merger
agreement with Hertz, the Dollar Thrifty directors breached their duty to take a reasonable approach to immediate value maximization, as required by Revlon.”
The court began its analysis by discussing the
nature of review under Revlon, stating that “although the level of judicial scrutiny under Revlon
is more exacting than the deferential rationality
standard applicable to run-of-the-mill decisions
governed by the business judgment rule, at bottom Revlon is a test of reasonableness; directors are generally free to select the path to value
maximization, so long as they choose a reasonable route to get there.”10 The court wrote that its
review to assess whether this test has been satisfied focuses on the board’s motivations, taking a
“nuanced and realistic look at the possibility that
personal interests short of pure self-dealing have
influenced the board to block a bid or to steer a
deal with one bidder rather than another.” The
court identified the question that it ultimately
must address as “whether the directors made a
reasonable decision, not a perfect decision” and
stated that when well-motivated directors diligently involved in a transaction process choose a
course of action, “this court should be reluctant
to second-guess their actions as unreasonable.”11
In a detailed analysis of the particular facts and
circumstances, the court focused on the independence of a majority of the Dollar Thrifty board,
the lack of any personal interests divergent from
stockholder interests, and the long history of interaction with Hertz and Avis, and concluded that
the Dollar Thrifty board “was closely engaged
at all relevant times in making a decision about
how to handle the negotiations with Hertz and
whether to try to bring Avis into the process.”12
The court found that the Dollar Thrifty board
had acted appropriately in taking into account
factors such as deal certainty and the history of
discussions, and that the board’s decision to lock
4
The M&A Lawyer in a value at or near its view of the high-end of
the company’s stand-alone value, while allowing
itself the ability to respond to a superior Avis proposal, was a reasonable approach to value maximization. In addressing the deal-protection terms
of the merger agreement, the court found the termination fee and expense reimbursement of 3.9%
to be “robust” but an insubstantial barrier to a
topping bid, and that the “relatively lenient” noshop and matching rights, collectively were reasonable and neither preclusive nor coercive.
Cogent
In the Cogent decision, issued shortly after Dollar Thrifty, the Court of Chancery addressed the
propriety of a board signing up a merger agreement with one party even though another party
had indicated interest in pursuing a transaction at
a higher price. After having explored its strategic
options for more than two years, Cogent entered
into a merger agreement with 3M. The agreement provided for 3M to make a tender offer for
all shares of Cogent stock at $10.50 per share,
to be followed by a short-form merger at the
same price, a termination fee equal to 3% of equity value, a “no shop” coupled with a fiduciary
out, matching rights and a top-up option giving
3M the right to purchase from Cogent sufficient
shares to increase its ownership to 90% and effect a short-form merger. 3M also obtained a voting and tender agreement from Cogent’s founder
and CEO, who owned approximately 39% of the
outstanding shares, terminable upon a change in
recommendation by Cogent’s board.
Shortly before it entered into the merger agreement with 3M, Cogent had received a non-binding indication of interest from a third party to acquire Cogent for a price between $11 and $12 per
share, subject to conditions including the completion of due diligence. The Cogent board considered the merits and risks of the third party’s offer
and concluded that the execution risks associated
with this offer were greater than the risks associated with 3M’s proposal.
Plaintiff stockholders sued, alleging, among
other things, that Cogent’s board had breached
its fiduciary duties by engaging in an unfair sales
© 2 0 1 1 T h o mson Reu t e rs
The M&A Lawyer process that impermissibly favored 3M and by
agreeing to the 3M transaction notwithstanding
a nonbinding expression of interest from another
party indicating a price range in excess of the 3M
offer. The plaintiffs sought a preliminary injunction of 3M’s tender offer and also challenged the
deal protection provisions agreed to by Cogent’s
board.
The Court of Chancery found that the Cogent board acted reasonably when it effectively
discounted the third party’s nonbinding expression of interest based on the risk that it would
not make a firm offer. The court noted that the
board had considered the period of time Cogent
was perceived as being for sale without having
received another offer, the perception of foot
dragging by the third party following a history of
start-stop negotiations, the risk the third party’s
non-binding offer could be withdrawn, and the
risk of losing 3M’s bid. The court found that “after being fully informed as to the benefits and risks
associated with each of its two potential suitors,
Cogent’s board reasonably could conclude that
the greater certainty associated with 3M’s bid
outweighed the risk of waiting for a potentially
higher offer from the third party that might never
materialize.”13
The court wrote that “[i]n considering whether
to accept a bid from a purchaser, a seller’s board
is entitled to take into consideration factors other
than just the price offered”14 and, citing the consideration given by the board stated that “after
being fully informed as to the benefits and risks
associated with each of its two potential suitors,
Cogent’s board could reasonably conclude that
the greater certainly of 3M’s bid outweighed the
risk of waiting for a potentially higher offer from
[the third party] that might never materialize.”15
The court also found that the deal protection
terms, including the termination fee of 3% of the
equity value of Cogent (though 6.6% of its enterprise value because Cogent held a large amount
of cash), the no-shop and matching rights were
reasonable and not preclusive. The court also
rejected the plaintiffs’ challenge to the top-up
option, finding that the provision of the merger
agreement which stated that the fair value of
shares in an appraisal would be determined with-
© 2011 thomson re ut e rs November|December 2010
n
Volume 14
n
Issue 10
out regard to the top-up option was sufficient to
overcome any concerns about the potential dilutive effect of the top-up option.
Health Grades
Just a few days before issuing its opinion in
Dollar Thrifty, the Court of Chancery delivered
a bench ruling in Forgo v. Health Grades, Inc.
addressing plaintiffs’ request to enjoin a twostep transaction in which Vestar Capital Partners
would acquire Health Grades, Inc. for $8.20
per share in cash. Although the court refused to
enjoin the transaction because it did not find a
threat of irreparable harm, the court held that the
plaintiffs had demonstrated a reasonable probability of success on the merits of their claim that
the Health Grades directors had breached their
duty under Revlon.
Vestar, a private equity firm, approached Health
Grades with an acquisition proposal in late 2009.
Health Grades entered into negotiations with Vestar but did not conduct any active solicitation
of other potential bidders and told parties with
which it had contact that it was not for sale. After
several months of negotiations with Vestar, the
Health Grades board approved the transaction
which included a no-shop (coupled with a fiduciary out) and a termination fee equal to 3.25%
of the deal consideration.
At the outset, the court noted that the Revlon
standard is not a “business judgment standard”
and that the directors would have the burden of
proof under Revlon to show that their decisions
were reasonable. The court found that the board
had not contacted any other potential bidders,
and had failed to “sift through possible strategic and private equity buyers and make a judgment about whether there might be someone who
would be interested.”16 The court reviewed the
potential differing interest that a founder/CEO
might have from stockholders generally, and
expressed concern that because there was a substantial likelihood that the company’s CEO “will
remain as an executive and retain the ability to
share in the upside of the company,”17 the CEO
“and his top managers have a totally different incentive system than everybody else.”18 The court
5
November|December 2010
n
Volume 14
n
Issue 10 criticized the lack of engagement by the board in
light of these different incentives.
The transcript in Health Grades shows that although Revlon permits directors broad latitude to
choose the right path in a sale of the company,
Delaware courts will expect those directors to be
able to explain their reasons for the path chosen:
[D]efendants in this context rightly asked this
Court to examine the decisions that a board
makes in light of the particular circumstances that that board faces. That is absolutely a
fair expectation. What comes with that, then,
is the duty of the board to actually do that itself and not come in to court without having
done so...If boards want to have the benefits,
as they should, of credit for the contextual
risks that they face, they also need to create
a record that they’ve thought about them in
a reasonable way.19
The State of Play
Dollar Thrifty, Cogent, and Health Grades
provide helpful guidance regarding judicial review of director conduct under Revlon. Dollar
Thrifty and Cogent reinforce the continued vitality of the principle that there is no single blueprint
that a board must follow to fulfill its duties under
Revlon, and confirm that independent and disinterested directors have the latitude to conduct
a sale process in the manner they reasonably believe will maximize stockholder value. In particular, directors can reasonably consider factors that
impact value, such as risk of non-consummation
and risk of loss of an existing proposal, in discounting a nominally higher proposal. However,
as demonstrated in Health Grades, directors must
stay engaged in oversight of the process, ensure
that their decisions are informed, and be prepared
to explain the basis for their decisions.
In any corporate sale process it is important
for the board to make an informed decision as
to what process to pursue based on the company’s individual circumstances. In order to address
post-hoc questions as to why a particular process
was followed in connection with a sale of corporate control, directors are well-advised to identify
6
The M&A Lawyer and record the rationale for board decisions, so
that the court is not subsequently left to guess as
to the directors motivations. This is particularly
the case where a board comes to an informed belief that stockholder interests are best served in a
particular situation by pursuing exclusive negotiations or by refraining from negotiation with an
interested person.
NOTES
1. 506 A.2d 173 (Del. 1986).
2. Consol. C.A. No. 5458-VCS (Del. Ch. Sept. 8, 2010).
3. Consol. C.A. No. 5780-VCP (Del. Ch. Oct. 5, 2010).
4. 970 A.2d 235 (Del. 2009).
5. While the articulation of this standard in Revlon
itself was that directors are “charged with
the duty of selling the company at the highest
price attainable for the stockholders benefit,”
subsequent cases have refined this description.
Compare Revlon, 506 A.2d at 184, note 16, with
e.g., Paramount Commc’ns, Inc. v. QVC Network
Inc., 637 A.2d 34, 37 (Del. 1994) (“secure the best
value reasonably available to the stockholders”).
6. Paramount Commc’ns, 637 A.2d at 45.
7. Barkan v. Amsted Industries, Inc., 567 A.2d 1279,
1286 (Del. 1989).
8. Lyondell, 970 A.2d at 239 (quoting Malpiede v.
Townson, 780 A.2d 1075, 1083 (Del. 2001)).
9. Lyondell, 970 A.2d at 242.
10.In re Dollar Thrifty, mem. op. at 41. This point
was also made in another recent Court of
Chancery decision, Lonergan v. EPE Holdings LLC,
C.A. No. 5856-VCL (Del. Ch. Oct. 11, 2010), where
Vice-Chancellor Laster wrote: “Rather than
establishing conduct requirements… Revlon and
its progeny identify a recurring situation in which
Delaware courts apply a heightened standard of
review.” Slip op. at 17.
11.In re Dollar Thrifty, mem. op. at 5-6.
12.In re Dollar Thrifty, mem. op. at 52-53.
13.In re Cogent, Consol. C.A. No. 5780-VCP, mem.
op. at 20.
14.In re Cogent, mem. op. at 19. The court cited In re
Lear Corporation Shareholder Litigation where
Vice-Chancellor Strine held that a board could
reasonably consider the risk that conducting a
formal auction could result in the loss of an the
existing bid. Id. at 19-20.
15.In re Cogent, mem. op. at 20.
16.Health Grades, transcript at 14.
17.Health Grades, transcript at 6-7.
18.Health Grades, transcript at 21-22.
19.Health Grades, transcript at 19-20.
© 2 0 1 1 T h o mson Reu t e rs