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M&A 2017 Delaware Update: Standard of Deal Review, Appraisal Rights, D&O Fiduciary Duties

Implications of Important Rulings for Planning, Negotiating and Drafting Deal Documents

Today’s faculty features:

1pm Eastern | 12pm Central | 11am Mountain | 10am Pacific THURSDAY, SEPTEMBER 28, 2017

Michael D. Allen, Director, Richards Layton & Finger, Wilmington, Del. Samuel T . Hirzel, Partner, Heyman Enerio Gattuso & Hirzel, Wilmington, Del. Patricia O. Vella, Partner, Morris Nichols Arsht & Tunnell, Wilmington, Del.

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M&A Key Delaware Law Updates for 2017

Public Company Developments

September 28, 2017

Michael D. Allen

6

• Corwin v. KKR Financial Holdings LLC, 125 A.3d 304 (Del. 2015) – absent a

controlling stockholder, the business judgment rule applies following informed stockholder approval of a transaction.

• Singh v. Attenborough, 137 A.3d 151 (Del. 2016) – informed stockholder approval

in transactions that do not include a controlling stockholder “irrebuttably” invokes the business judgment rule and precludes judicial review absent extreme allegations sufficient to state a claim for waste.

• Subsequent Court of Chancery decisions have characterized the standard of

review under Singh as the “irrebuttable business judgment rule.” See, e.g., City of Miami Gen. Emps.’ v. Comstock, 2016 WL 4464156 (Del. Ch. Aug. 24, 2016).

Standard of Review

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• In In re Volcano Corp. S’holder Litig., 143 A.3d 727 (Del. Ch. 2016), the Court of

Chancery held, and the Delaware Supreme Court affirmed, that the irrebutable business judgment rule also applies when a majority of uncoerced, disinterested and fully informed stockholders tender their shares in a two-step merger consummated under Section 251(h) of the DGCL.

• The Court dismissed fiduciary duty claims challenging the merger:

“[t]he acceptance of a first-step tender offer by a fully informed, disinterested, uncoerced stockholders representing a majority of a corporation’s outstanding shares in a two-step merger under Section 251(h) has the same cleansing effect under Corwin as a vote in favor of a merger by a fully informed, disinterested, uncoerced stockholder majority.” See also Larkin v. Shah, 2016 WL 4485447 (Del. Ch. Aug. 25, 2016).

Standard of Review

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• In In re Solera Holdings, Inc. S’holder Litig., 2017 WL 57839 (Del. Ch. Jan. 5, 2017),

the Court of Chancery held that before determining whether a stockholder vote was uncoerced, disinterested and fully informed, the plaintiff bears the burden of identifying a deficiency in the operative disclosure document. ‐ The Court stated that allocating the burden of pleading disclosure deficiencies to defendants would “create an unworkable standard, putting a litigant in the proverbially impossible position of proving a negative.”

• If the plaintiff satisfies its burden, then the burden falls to the defendant to

establish that the alleged deficiency fails as a matter of law in order to secure the cleansing effect of the stockholder vote under Corwin.

Standard of Review

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• In The Huff Energy Fund, L.P. v. Gershen, 2016 WL 5462958 (Del. Ch. Sept. 29,

2016), the Court rejected a claim that the implementation and adoption of a plan

• f dissolution was subject to enhanced scrutiny under Revlon and Unocal. Instead,

the Court held that because the plan of dissolution had been approved by a fully informed, non-coerced vote of the stockholders, the irrebutable business judgment rule under Corwin applied.

• The Court held that it was immaterial to a fully-informed stockholder vote that:

‐ (a) one director abstained from voting on the dissolution due to “the insufficiency of information and the rushed nature of the process”; and ‐ (b) the director’s abstention and the reasons for such abstention were not disclosed to the stockholders.

• The Court reached this conclusion because (1) under Delaware law, a director

need not state the grounds of his or her judgment for or against a proposed stockholder action and (2) adoption of the plan of dissolution did not require unanimous approval.

Standard of Review

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• The Court held that Revlon did not apply because the underlying policy concern of

Revlon, to protect and maximize value to stockholders of a company that agrees to a “final stage” transaction, is absent in a dissolution context because during dissolution a company continues its existence for a period of at least three years to wind up its affairs.

• Similarly, the Court noted that Revlon did not apply in a dissolution context

because there is no change in control.

• Unocal did not apply because unlike other defensive measures, the adoption and

implementation of a plan of dissolution avoids any specter of entrenchment due to the fact that following dissolution, the company is required to wind up its affairs.

Standard of Review

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• In In re Saba Software, Inc. Stockholder Litigation, the Court of Chancery declined

to apply business judgment review under Corwin to a merger for purposes of a motion to dismiss because the Court concluded that the complaint had plead facts allowing a reasonable inference that the stockholder vote approving the transaction was neither fully informed nor uncoerced.

• In determining that the vote was not fully informed, the Court focused on several

material omissions from Saba’s proxy statement, including: ‐ The failure to describe the circumstances surrounding Saba’s failure to complete a financial restatement by the deadline to regain registered status with the SEC. ‐ The failure to disclose information regarding the likelihood that Saba could ever complete the financial restatement (which impacted stockholders’ ability to “meaningfully assess” the credibility of the management projections, which assumed the financial restatement would be completed). ‐ The failure to disclose information regarding Saba’s post-deregistration

• ptions Saba had other than the proposed merger.

Standard of Review

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• The Court also found that the stockholder vote on the transaction was inequitably coerced.
• The Court noted that the coercion inquiry under Corwin in the deal context focuses on

whether the stockholders have enough information to give them a free choice between maintaining their current status or taking advantage of the new status offered by the proposed deal.

• The Court concluded that the vote was coercive under the circumstances because, among
• ther things:

‐ Saba repeatedly failed to restate its financials and rushed a sales process while the company was in turmoil. ‐ Saba failed to provide information in its proxy statement regarding the circumstances surrounding the restatement, leaving stockholders unable to meaningfully assess Saba’s value on a standalone basis. ‐ That, as consequence of the board’s allegedly wrongful action and inaction, the board forced stockholders to choose between a no-premium sale or holding potentially worthless stock.

• Because Corwin did not apply, the Court reviewed the transaction under Revlon’s enhanced

scrutiny standard and ultimately denied the defendants’ motion to dismiss.

Standard of Review

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• In In re Massey Energy Co. Deriv. and Class Action Litig., 160 A.3d 484 (Del. Ch.

2017), the Court of Chancery held that Corwin did not provide a basis for dismissing director oversight claims that were based on events occurring across several years prior to the company’s merger, notwithstanding the fact that (a) such events may have necessitated the sale of the company and (b) a majority of the company’s disinterested stockholders approved the merger.

• The Court clarified that in order to invoke Corwin, there must be a proximate

relationship between the transaction or issue for which stockholder approval is sought and the nature of the claims to be cleansed as a result of a fully-informed vote. “The policy underlying Corwin, to my mind, was never intended to serve as a massive eraser, exonerating corporate fiduciaries for any and all of their actions

• r inactions preceding their decision to undertake a transaction for which

stockholder approval is obtained.”

Standard of Review – Massey Energy

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• In Sciabacucchi v. Liberty Broadband Corp., 2017 WL 2352152 (Del. Ch. May 31, 2017),

the Delaware Court of Chancery held that the Defendants were not entitled to dismissal under the Corwin doctrine due to structural coercion.

• Although the Court held that the transactions did not involve a controller so inherent

coercion was not applicable, the Court nevertheless found structural coercion because the transaction was structured to include an equity issuance to the company’s largest stockholder.

• This issuance was purportedly to finance the acquisition, but the Plaintiff argued that

these issuances were not necessary to finance the acquisition and stockholders were forced to accept to equity issuance in order to approve the overall transaction.

• The Court explained that the word “‘[c]oercion’ is a loaded term, but a vote so

structured… to accept one (allegedly self-interested) transaction (i.e. the Liberty Share Issuances and Voting Proxy Agreement) so as not to lose the benefit of another independent transaction (the acquisition), cannot to my mind be considered

• uncoerced. . . . If they (the stockholders) voted one way, they could forgo two lucrative
• deals. If they voted another way, they would transfer value to an insider (and, should

Corwin apply, release a potentially valuable fiduciary duty claim).”

Standard of Review – Liberty Broadband

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• The entire fairness test is the default standard of review for challenges to

conflicted controlling stockholder transactions.

• In MFW (Kahn v. M&F Worldwide Corp., 88 A.3d 65 (Del. 2014)), the Delaware

Supreme Court held that the business judgment standard of review applies to a two-sided controlling stockholder merger when it is conditioned, ab initio, on:

• Negotiation and approval by an independent, fully functioning and duly

empowered special committee that fulfills its duty of care; and

• The uncoerced, fully informed vote of a majority of the minority

stockholders.

Standard of Review – Controlling Stockholder Transactions

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• Thus, under the MFW framework, in controlling stockholder buyouts, the business

judgment standard of review will be applied if and only if:

• the controlling stockholder conditions the transaction on the approval of

both a special committee and a majority of the minority stockholders from the outset;

• the special committee is independent;
• the special committee is empowered to freely select its own advisors and to

say no definitively;

• the special committee meets its duty of care in negotiating;
• the vote of the minority is fully informed; and
• there is no coercion of the minority.

Standard of Review – Controlling Stockholder Transactions

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• In In re Martha Stewart Living Omnimedia, Inc. S’holder Litig., 2017 WL 3568089

(Del. Ch. Aug. 18, 2017), the Court dismissed claims made against Martha Stewart, the former controlling stockholder of Martha Stewart Living Omnimedia, Inc. (“MSLO”), for alleged breaches of her fiduciary duties in connection with the 2015 sale of MSLO.

• Plaintiffs alleged that Stewart leveraged her position as a controlling stockholder

to secure greater consideration for herself through side deals with the buyer. Plaintiffs argued that entire fairness was the appropriate standard of review because Stewart was conflicted.

• The Court held that Stewart was not conflicted because even though she secured

side deals with the buyer, her side deals were not “meaningfully different” than her pre-merger arrangements with MSLO.

Standard of Review – Extension of MFW

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• In determining whether a controlling stockholder’s side deals rendered the

controlling stockholder conflicted, the Court looked at whether the side deals with the controller diverted merger consideration from the minority stockholders.

• Because, inter alia, the merger consideration was increased following negotiations

with Stewart and because the side deals Stewart received were essentially the same as deals Stewart had with MSLO, the Court held that Stewart was not a conflicted controller and was entitled to business judgment review deference.

Standard of Review – Extension of MFW

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• Further, the Court opined that even if the side deals had rendered Stewart conflicted,

the procedural protections provided to the minority stockholders lowered the standard

• f review to business judgment under MFW.
• The Court, in dicta, opined that conflicted one-sided controller transactions are entitled

to pleadings-stage business judgment rule deference if the MFW protective framework is put into place before the controller and third party begin to negotiate any special arrangement for the controller. ‐ The Court defined a conflicted one-sided controlling stockholder transaction as

• ne in which “the controlling stockholder does not stand on both sides of the

transaction but exploits its position of leverage on the sell-side to extract ‘different consideration or derive some unique benefit from the transaction not shared with the common stockholders.’” ‐ This one-sided controller transaction ab initio requirement is different from MFW because MFW requires conflicted two-sided controller transactions to have the MFW-prescribed protective measures in place before merger negotiations commence between the buyer and target company.

Standard of Review – Extension of MFW

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Proxy Statement Disclosure

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• In Vento v. Currey, 2017 WL 1076725 (Del. Ch. Mar. 22, 2017) the Court enjoined a

stockholder meeting for 5 days so that disclosures could be made regarding fees that the acquiring company’s financial advisor would receive for participating in the acquisition financing.

• Under NASDAQ rules, the acquiring company was required to obtain stockholder

approval of the proposed acquisition given that it would be issuing more than 20%

• f its outstanding stock to the target’s stockholders.
• The acquiror’s registration statement disclosed that in addition to advisory fees

(which were fully disclosed), the financial advisor would receive certain “additional fees” payable in connection with the financing of the merger.

• Plaintiff moved to enjoin the meeting arguing that the registration statement

failed to adequately disclose the financial advisor’s compensation in connection with the financing of the merger.

Proxy Statement Disclosure – Vento

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• Defendants countered that an estimate of the advisor’s financing-related fees

could be calculated from publically available information: ‐ Registration statement disclosed total merger financing fees ‐ A 248-page 8-K, disclosed that the financial advisor would supply 40% of the merger financing

• The Court granted the motion to enjoin the meeting, holding that such disclosures

were inadequate. ‐ All material and quantifiable fees should be fully disclosed in one place so that stockholders do not have to “go on a scavenger hunt to try to obtain a complete and accurate picture of the financial advisor’s interests in a transaction.”

• Compare to In re Columbia Pipeline Group, Inc. S’holder Litig., C.A. No. 12152-VCL

(Del. Ch. Mar. 7, 2017) (holding that disclosures of a sell-side financial advisor’s investments in the target and the acquirer need not be disclosed in a proxy statement if such information is already reported in a Form 13F).

Proxy Statement Disclosure – Vento

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• On April 27, 2017, a stockholder plaintiff filed a complaint captioned Patel v. Galena

BioPharma, Inc., against Galena BioPharma, Inc., for allegedly: ‐ making inconsistent disclosures in its proxy statement with respect to how broker non-votes would be counted at its annual and special meetings on various items; and ‐ tallying votes incorrectly at the annual and special meetings on items submitted to stockholders for approval.

• Disclosure claims like those made in Vento and Galena are becoming more common

as litigation in the M&A space declines following Corwin and Trulia.

Proxy Statement Disclosure – Galena BioPharma

For Additional Information

Michael D. Allen Director 302.651.7760 allen@rlf.com

This presentation and the material contained herein are provided as general information and should not be construed as legal advice on any specific matter or as creating an attorney-client relationship. Before relying on general legal information or deciding on legal action, request a consultation or information from a Richards, Layton & Finger attorney on specific legal needs.

M&A 2017 Delaware Update: Recent Developments in M&A Contract Cases

September 28, 2017 Patricia O. Vella Morris, Nichols, Arsht & Tunnell LLP pvella@mnat.com

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M&A Contract Cases Reasonable Best Efforts/Commercially Reasonable Efforts Post-Closing Adjustments Fraud Exception

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REASONABLE BEST EFFORTS / COMMERCIALLY REASONABLE EFFORTS

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 Structure of the Transaction:  Step One:

• ETE created a new entity, ETC, a Delaware limited partnership.
• Williams would merge into ETC.
• ETE would transfer $6 billion to ETC in exchange for 19% of ETC’s

stock.

• $6 billion and 81% of ETC’s stock would be distributed to the Williams

stockholders in exchange for their Williams stock.

 Step Two:

• ETC would then transfer the Williams assets to ETE in exchange for

newly issued ETE Class E partnership units.

 End result: Williams stockholders would receive $6 billion plus 81% of

ETC’s stock, ETE would receive the Williams assets and 19% of ETC’s stock, and ETC would own ETE Class E partnership units equal in number to the shares issued by ETC.

 Consummation of the transaction was conditioned on ETE’s counsel being able to deliver a “should” 721 tax opinion.

Williams Cos., Inc. v. Energy Transfer Equity, L.P., (Del. Mar. 23, 2017)

30

 Closing Conditions

 SECTION 6.01(h). Contribution Opinion. TopCo and the Company shall have received a written opinion from Latham & Watkins LLP, dated as of the Closing Date, and based on facts, representations, assumptions and exclusions set forth or referred to in such opinion (including an exclusion to the effect that the opinion may not apply to the extent TopCo receives money or other consideration) … to the effect that the Contribution and the Parent Class E Issuance should qualify as an exchange to which Section 721(a) of the Code applies.

 Other Agreements / Covenants

 SECTION 5.03. Reasonable Best Efforts. (a) Upon the terms and subject to the conditions set forth in this Agreement, each of the parties hereto shall use its reasonable best efforts to, and shall cause their respective Affiliates to use reasonable best efforts to, take, or cause to be taken, all actions, and to do, or cause to be done, and to assist and cooperate with the other parties in doing, all things necessary, proper

• r advisable to consummate and make effective, in the most expeditious manner

practicable, the Transactions…  SECTION 5.07. Certain Tax Matters. (a) The Company, TopCo and Parent shall cooperate and each use its commercially reasonable efforts to cause (i) the Merger to qualify for the Intended Tax Treatment, and (ii) the Contribution and the Parent Class E Issuance to qualify as an exchange to which Section 721(a) of the Code applies, in each case, including by not taking or failing to take any action which action or failure to act such party knows is reasonably likely to prevent such qualification

Important Contractual Terms

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SECTION 8.10. Specific Enforcement; Consent to Jurisdiction. (a) The parties hereto agree that irreparable damage would occur and that the parties would not have any adequate remedy at law in the event that any provision of this Agreement were not performed in accordance with its specific terms or were otherwise breached and that monetary damages, even if available, would not be an adequate remedy therefor and that the right of specific enforcement is an integral part of the Transactions and without that right, neither the Company nor Parent would have entered into this Agreement. It is accordingly agreed that, the Company and Parent shall be entitled to an injunction or injunctions to prevent breaches of this Agreement and to enforce specifically the performance

• f the terms and provisions of this Agreement without proof of actual

damages.

Important Contractual Terms

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 After signing, the energy market suffered a severe decline and this caused the transaction to become financially undesirable to ETE. It also led to ETE raising an issue as to whether the IRS might view a portion

• f the $6 billion not as payment only for the ETC stock, but as payment

in part for the Williams assets, thus rendering the second step of the merger taxable.  Latham informed ETE and Williams’ counsel, Cravath, that it would be unwilling to give the 721 opinion. Cravath disagreed with Latham’s conclusion and offered two proposals to fix the issue with the 721

• pinion. ETE amended its proxy and disclosed that Latham as of that

time would not be able to deliver a 721 opinion. Williams sued for breach of contract.

Between Signing and Closing

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 The Court of Chancery made two primary findings upon which it determined that ETE had not breached the contract and thus Williams was not entitled to injunctive relief forcing ETE to consummate the transaction.  First, the Court determined that Latham’s determination that it could not give the 721 tax opinion was made in good faith.  Second, the Court noted that by agreeing to use “commercially reasonable efforts,” ETE submitted itself to an objective standard. The Court also noted that Williams did not point to any direct evidence that ETE instructed Latham, directly or indirectly, to fail to satisfy the condition precedent. Therefore, Williams was not able to establish a breach of the agreement.

The Court of Chancery’s Decision

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 While affirming the Court of Chancery’s decision, the Supreme Court noted that the Court of Chancery erred by focusing on the absence of any evidence to show that ETE caused Latham to withhold the 721 opinion. The Supreme Court noted that there was in fact evidence from which the Court of Chancery could have concluded that ETE had breached its covenants, including:  ETE “did not direct Latham to engage earlier or more fully with Williams’ counsel, failed itself to negotiate the issue directly with Williams, failed to coordinate a response among the various players, went public with the information that Latham had declined to issue the 721 Opinion, and generally did not act like an enthusiastic partner in pursuit of consummation of the [Merger Agreement].”  Nonetheless, the Supreme Court determined that even if ETE breached its

• bligation to use commercially reasonable efforts, and thus bore the

burden of proof, ETE could still prevail if the breach did not materially contribute to the failure of the closing condition. The Supreme Court relied on a footnote in the Court of Chancery’s opinion indicating that regardless of who bore the burden of proof, ETE’s actions did not cause the failure of the condition.

The Supreme Court Decision

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 Increase tax diligence before signing to get comfortable the tax opinion can be given.  Don’t have a condition requiring seller’s counsel to opine that the deal would be tax free to seller.  Deliver tax opinion concurrently with signing rather than at closing, with bring-down to closing that can change based only on changes in law.  Attach form of tax opinion and representation letters at signing, and have parties covenant not to take action that might cause the merger to be taxable.  Allow alternate counsel to deliver tax opinion if seller’s or buyer’s counsel will not.  Require acceptance of tax opinion from counterparty’s counsel if the party’s counsel does not deliver tax opinion.  Parties agree not to take any action that would be reasonably likely to prevent tax-free treatment and agree to work in good faith to amend the merger agreement in order to make the combination tax free if an amendment is required.

Possible Resolutions

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POST-CLOSING DISPUTE RESOLUTION MECHANISMS

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Background  Chicago Bridge appealed the Court of Chancery’s grant of a judgment on the pleadings to Westinghouse.  Here, parties had originally agreed to collaborate on the construction of two new nuclear power plants, through a subsidiary of Chicago Bridge, but due to cost overruns and a breakdown in the relationship between the two parties, they sought to separate by having Chicago Bridge sell the subsidiary to Westinghouse.  Under the Agreement:  Westinghouse paid $0 for the subsidiary;  Westinghouse assumed all current and potential liabilities;  After the closing of the transaction, the parties would follow the post- closing adjustment provisions to determine whether either party was

• bligated to pay the other based on the net working capital amount at

closing and possible earnout payments.

Chicago Bridge & Iron Company N.V. v. Westinghouse Electric Company LLC (Del. June 28, 2017)

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 Key facts: Seller represented that the company’s financial statements were GAAP compliant. Parties agreed that the reps and warranties would not survive closing. The purchase price adjustment formula contemplated GAAP compliance.  Arguments: Seller claimed that Buyer’s calculation of the closing date adjustment breached the express provisions of the purchase agreement and argued that Buyer was attempting to circumvent the non-survival provision and bring a breach of rep claim through the purchase price adjustment even though Buyer knew prior to closing that certain matters were not accounted for in the subsidiary’s financial statements and chose to close anyway. Seller argued that the agreement prevented the Buyer from making adjustments to items that appeared on the subsidiary’s financial statements. Buyer, claiming it was owed $2 billion under the adjustment provisions, argued that regardless of merits, an independent expert must decide.  The Court of Chancery determined that the purchase price dispute must be decided by an independent expert chosen in the manner set forth in the contract—not by the Court.  See also Alliant Techsystems, Inc. v. MidOcean Bushnell Holdings, L.P. (Del. Ch. Apr. 24, 2015) (holding that issues of GAAP compliance in connection with purchase price adjustment should be resolved by independent accountant). Compare OSI Systems, Inc. v. Instrumentarioum Corp. (Del. Ch. 2006) (holding that independent accountant’s authority did not extend to determination of GAAP compliance in purchase price adjustment and treating issue of GAAP compliance as within the scope of a claim for breach of reps).

Court of Chancery Decision

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 The Supreme Court reversed the Court of Chancery’s decision on the pleadings for Buyer and instead ruled that the contract unambiguously precluded submitting the issue of GAAP compliance to the independent accountant. The Supreme Court focused on (1) the transaction’s structure and purpose, and (2) the choice of an expert rather an arbitrator.  Structure and Purpose: Here, Buyer had the right to not close, without any financial repercussions, if it believed that the financials were not GAAP

• compliant. The purpose of the agreement was to adjust payment based on the
• peration of the subsidiary between signing and closing, and the uncapped

financial burden that could accrue from the expert determining the accounting principles were not GAAP compliant was significant.  Experts vs. Arbitrators: “The reason parties can hazard having an expert decide disputes in this blinkered, rapid manner is because when considering claims under the True Up, the expert is addressing a confined period of time between signing and closing using the same accounting principles that were the subject of due diligence and contractual representations and warranties, and thus formed the foundation for the parties’ agreement to sign up and close the transaction.”

Supreme Court Decision

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FRAUD EXCEPTION

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 In Abry, the Court of Chancery considered fraud claims by a buyer against the seller of a portfolio company. In the Stock Purchase Agreement (SPA) that served as the focal point of the dispute, the parties “carefully delineated the representations and warranties” of the portfolio company and the seller. Further, the SPA purported to limit the liability

• f the seller for any misrepresentation of fact contained in the agreement

to $20 million in a contractually established indemnity fund.  After the consummation of the agreement, the buyer discovered that the portfolio company’s financial statements had been manipulated to inflate the company’s EBITDA and that a number of facts that had been represented and warranted in the SPA were false. The buyer then filed suit, seeking to hold the seller accountable for the serious financial discrepancies, and the seller filed a motion to dismiss, claiming the SPA precluded the claim.  The Court of Chancery granted in part and denied in part the motion, balancing contractual freedom with Delaware’s policy against fraud.

The Abry Framework

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 Extra-Contractual Fraud: The Court made quick work of the buyer’s claims based on material provided by the seller that the buyer had explicitly disclaimed reliance upon in the contract. To allow such claims to proceed would be tantamount to forgiving the buyer’s “lie” that it had not relied on facts outside the contract. Thus, where a contract has a clear non-reliance provision, a buyer cannot proceed with extra- contractual claims.  Contractual Fraud: By contrast, the Court found that public policy prevented a party from contractually insulating itself from fraud claims for lies within the agreement.  In the subsequent cases building off Abry, disputes focus on two questions: (1) what is the scope of the non-reliance provision, and (2) is the claim permissibly covered by the non-reliance clause.

The Abry Framework

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Background  Defendants (including members of management and several institutional stockholders) sold company to private equity fund pursuant to SPA.  Company’s financial performance dramatically declined after closing and Buyer conducted an investigation which revealed months of financial manipulation, acceleration of revenue, and recognition of sham revenue and earnings. Buyer alleged in complaint that company’s employees knowingly engaged in a scheme to manipulate earnings.  Buyer then brought suit against the Sellers, claiming that the SPA did not preclude the Buyer from pursuing fraud claims against either of the Company or the Sellers.  Sellers move to dismiss the complaint, claiming that Buyer was limited to funds set aside in an escrow account which had already been depleted.

EMSI Acquisition, Inc. v. Contrarian Funds, LLC (Del. Ch. May 3, 2017)

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Relevant Contractual Provisions:

 Selling stockholders made limited reps but target company made more expansive reps.  Buyer represented that it was only relying on reps in the agreement in a straight forward nonreliance provision.  Agreement contained typical indemnification scheme with basket and cap and limited Seller’s indemnification liability to the amount of the escrow fund:  Agreement also made clear that indemnification is exclusive remedy for a Seller’s breach:  Another provision appeared to carve out from this limitation “any” claim “based upon fraud”: Notwithstanding anything to the contrary in this Agreement, the Buyer Indemnified Parties shall only be entitled to indemnification (i) with respect to Losses in respect of the representations and warranties (other than the Excluded Representations and the Specific Indemnity Items) to the extent of, and exclusively from, any then-remaining Escrow Funds . . . From and after Closing (except . . . in the case of claims for fraud or willful or intentional misrepresentation), the sole and exclusive remedy of the Seller Indemnified Parties and the Buyer Indemnified Parties for any breach or inaccuracy, or alleged breach or inaccuracy, of any representation, warranty or covenant under, or for any other claims arising in connection with, any of the Transaction Documents, other than specific performance, shall be indemnification in accordance with this Article X, subject to the limitations set forth herein . . . Notwithstanding anything in this Agreement to the contrary (including . . . any limitations on remedies or recoveries . . .) nothing in this Agreement (or elsewhere) shall limit or restrict (i) any Indemnified Party’s rights or ability to maintain or recover any amounts in connection with any action or claim based upon fraud in connection with the transactions contemplated hereby . . .

45

Competing Contractual Provisions  “Notwithstanding anything in this Agreement to the contrary (including . . . any limitations on remedies or recoveries . . .) nothing in this Agreement . . . shall limit or restrict . . . any Indemnified Party’s rights

• r ability to recover any amounts in connection with any action or

claim based upon fraud in connection with the transactions contemplated hereby . . .”  “Notwithstanding anything to the contrary in this Agreement . . . [t]he Buyer Indemnified Parties shall not be entitled to indemnification under 10.2(a) for any and all Losses . . . in excess of . . . and exclusively from, any then remaining Escrow Funds.”

46

Parties’ Arguments

 Sellers argued that they took pains to honor Abry by preserving the parties’ rights to bring a non-contractual claim based on fraud outside of the strictures that apply to contractual indemnification claims. Specifically, they preserved claims for fraud by the Sellers within and subject to the indemnification framework and also made clear that extra-contractual claims “based upon fraud” against the Sellers are not subject to the bargained-for limits on remedies for contractual

• indemnification. According to Sellers, this scheme provided two paths to

recovery for a purchaser alleging misrepresentations in connection with a stock purchase agreement: (1) suing contractually and going through the indemnification provisions or (2) suing for fraud, based on the Sellers’ own fraudulent actions.  Buyer disagreed, arguing that the parties took a step beyond Abry by allowing the Buyer, without limitation or restriction, “to recover any amounts in connection with any action or claim ‘based upon fraud’ in connection with the contemplated transaction.” Buyer contended that the SPA deliberately allocated to Sellers the risk that the Company was knowingly misrepresenting itself when it entered into the SPA. Therefore, since Buyer’s indemnification claim is “based upon” the allegedly fraudulent misrepresentations by the Company, as opposed to innocent breaches of the SPA, Buyer argued that its claim is not subject to limitations on recovery.

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 Court denied defendant’s motion to dismiss and noted that it required extrinsic evidence to construe the ambiguous indemnification provisions before determining which of the competing interpretations reflect the parties’ intent with respect to indemnification for claims of fraud against the Sellers arising from misrepresentations by the Company.

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Patricia O. Vella

PARTNER Delaware Corporate Counseling Group (302) 351-9349 T pvella@mnat.com Patricia is a partner with the firm’s Delaware Corporate Counseling Group. She regularly provides advice on corporate governance matters and a variety of corporate transactions for publicly traded and privately held corporations. Patricia is often called upon to advise on mergers and acquisitions, financings, asset sales and other significant transactions. Her work includes structuring complex transactions and often involves counseling boards of directors and board committees on their fiduciary duties and the technical aspects of Delaware corporate law. She also provides formal legal opinions on issues involving Delaware corporate law. Patricia is actively involved with the American Bar Association’s Mergers & Acquisitions Committee and Corporate Laws Committee, and is Vice-Chair of the Subcommittee on Acquisitions of Public Companies and Co-Chair of the Joint Task Force on Governance Issues in Business Combinations. Patricia is a member of the Council of the Corporation Law Section of the Delaware State Bar Association and, in that capacity, participates in the annual review of, and preparation of amendments to, the Delaware General Corporation Law. She was appointed in 2012 by the Delaware Supreme Court to serve as a member of the court’s Board on Professional

• Responsibility. Patricia also frequently speaks on Delaware corporate law issues at corporate

law seminars and symposia around the country, including the University of Texas Mergers & Acquisitions Institute, the Ray Garrett Jr. Corporate and Securities Law Institute, the Northwestern Law Securities Regulation Institute and The Harvard School of Law. She has been named by Chambers USA as a leading Delaware Corporate/M&A practitioner since 2014 and as one of the leading M&A lawyers by The International Who’s Who of Merger & Acquisition Lawyers 2014 and Who’s Who Legal: M&A and Governance 2015 and

• 2016. She also was selected for inclusion in The Best Lawyers in America and Best Lawyers

Business Edition’s Women in the Law for Corporate Governance Law in 2016.

Speaker

Samuel T. Hirzel, Esq. Heyman Enerio Gattuso & Hirzel LLP Shirzel@HEGH.law (302) 472-7315 www.HEGH.law

8 Del. C. Section 262 provides the statutory process for a judicial determination of the fair value of the shares of a Delaware corporation that is a party to certain types of M&A transactions. 8 Del. C. Section 262 has two main components: (1) Perfection

• f Appraisal Rights, and (2) Valuation.

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Shareholder does not vote in favor of the merger and demands appraisal. See In re Appraisal of Dell Inc., 2016 WL 3030909 (May 11, 2016) (finding that 83% of shares that pursued appraisal through trial were not entitled to appraisal based on inadvertent failures in the “Byzantine” system of “daisy chain” authorizations in connection with voting beneficially owned shares). Shareholder may withdraw demand and receive the merger consideration for 60 days after the effective date of the merger if they have not commenced or joined an appraisal action. Shareholder does not need to separately file a petition to become part of a quasi-class. Typical course of litigation with fact discovery and expert discovery culminating in a “battle of the experts” (and their foundations) trial. Claims of breach of fiduciary duty in connection with the transaction giving rise to the appraisal may be pursued together with the appraisal. Entire fairness turns on fair process and fair price, and therefore there is significant overlap on the price component.

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The appraisal petitioner is entitled to a proportionate share of the “fair value in the going concern on the date of the merger” but is not entitled to elements of value “arising from the accomplishment or expectation of the merger,” e.g., synergies. The DGCL grants the Court significant discretion to determine the “fair value” of the shares and “take into account all relevant factors.”

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Historical preference for discounted cash flow analysis (“DCF”) based valuations using contemporaneous management projections used in the

• rdinary course of business, but comparable transactions and comparable

company analyses are also accepted approaches. The Delaware Supreme Court has repeatedly and specifically rejected any presumption in favor of the merger consideration as evidence of “fair value” in an appraisal action even if it was the result of an arms’-length negotiation. Golden Telecom, Inc. v. Global FT Ltd., 11 A.3d 214 (Del. 2010). A number of recent cases, however, have given the deal price weight as data point absent evidence of a tainted process.

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Costs—appraisals are expensive. Fees—fee shifting is rarely granted. Time—it could take years for resolution. Security – Petitioner is an unsecured creditor and bears the company’s credit risk. Uncertainty—the appraised value could be higher or lower than the merger consideration.

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Trends

Observed trend of “event driven” funds buying into and filing appraisal

• actions. See Charles R. Korsmo &

Minor Myers, Appraisal Arbitrage and the Future of Public Company M&A, 92 Wash U. L. Rev. 1551 at Figures 1 & 3 (2014-15) (see next two slides). Observed increase in the number of appraisal petitions filed since 2012. Possible slow down in 2017.

Transkaryotic decision

In re Appraisal of Transkaryotic Therapies, Inc., 2007 WL 1378345 (Del. Ch. May 2, 2007) (opening the door for investors to buy into an appraisal action by upholding appraisal rights for shareholders who acquired shares after the record date, so long as the number of shares for which appraisal is sought does not exceed the total number of ‘street name’ shares held by the record holder that were not voted in favor of the transaction). Reaffirmed in Merion Capital LP v. BMC Software, Inc. and In re Appraisal of Ancestry.com, Inc.

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Characterizing buying into an appraisal action shortly after announcement of a merger as “unseemly.” Describing appraisal arbitrage as a ploy to obtain statutory interest rate in a low interest rate environment. Noting appraisal arbitrage threatens deal certainty and creates risk for buyers.

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The Council of the Corporation Law Section of the Delaware State Bar Association formed a Subcommittee in February 2014 to study appraisal arbitrage and the desirability of amending Section 262—including whether to eliminate or modify the statute to address appraisal arbitrage. March 2015 explanatory paper provided an explanation for the Council’s decision not to recommend amendments to limit appraisal arbitrage. The Council found that appraisal arbitrage does not upset the balance between corporations’ ability to engage in value-enhancing transactions and stockholders’ rights to dissent and seek appraisal and does not encourage frivolous litigation.

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Section 262(g) (de minimus exception): “If immediately before the merger or consolidation the shares of the class or series of stock of the constituent corporation as to which appraisal rights are available were listed on a national securities exchange, the Court shall dismiss the proceedings as to all holders

• f such shares who are otherwise

entitled to appraisal rights unless (1) the total number of shares entitled to appraisal exceeds 1% of the outstanding shares of the class or series eligible for appraisal, (2) the value of the consideration provided in the merger or consolidation for such total number of shares exceeds $1 million…” Section 262(h) (pre-payment): “At any time before the entry of judgment in the proceedings, the surviving corporation may pay to each stockholder entitled to appraisal an amount in cash, in which case interest shall accrue thereafter as provided herein only upon the sum of (1) the difference, if any, between the amount so paid and the fair value of the shares as determined by the Court, and (2) interest theretofore accrued, unless paid at that time.” Divergent theories on whether pre- payment will curb or encourage appraisal litigation.

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DFC Glob. Corp. v. Muirfield Value Partners, L.P., 2017 WL 3261190 (Del. Aug. 1, 2017) (Delaware Supreme Court again refused to establish a presumption in favor of tying fair value to merger price, affirming Golden Telecom decision, and concluded that the Chancery Court should continue to exercise its discretion to determine fair value, but while doing so it should also explain why it was accorded a certain weight to its indicators of value, including the deal price). In re of SWS Grp., Inc., 2017 WL 2334852 (Del. Ch. May 30, 2017)(Appraisal action following the merger of a small and struggling bank holding company with one of its substantial creditors. The Court found process deficiencies, but found that the company did not have reliable long-term projections and declined to rely on petitioner’s view of future performance. The Court relied on its

• wn DCF analysis and appraised the company at 7.8% below the merger price. But statutory interests

resulted in a recovery for the petitioners that was greater than the merger consideration). In re PetSmart, Inc., 2017 WL 2303599 (Del. Ch. May 26, 2017) (The Court recognized that its statutory

• bligation to consider “all relevant factors” did not end with its finding that the merger price was a

reliable indicator of fair value; and needed to consider the reliability of a DCF or any other valuation method it could use to reach its final determination of fair value. The Court found that a DCF valuation would not be reliable because management had not historically created long-term projections and the projections that were created for the sale process were too aggressive. The Court ultimately reverted the merger price for its determination of fair value).

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Merion Capital L.P. v. Lender Processing Servs., Inc., 2016 WL 7324170 (Del. Ch. Dec. 16, 2016) (The Court found no reason to depart from merger price following a reliable sale process and reliable projections. The Court’s own DCF valuation came out 4% above the merger price and gave the Court comfort as to the reliability of merger price. The Court also rejected the respondent’s synergies argument as unsupported by any evidence). Dunmire v. Farmers & Merchants Bancorp of W. Pennsylvania, Inc., 2016 WL 6651411 (Del. Ch.

• Nov. 10, 2016) (The Court rejected market price absent an auction, majority of the minority

approval, and buyer and seller were controlled by the same family, rejected “wildly divergent” expert valuations, and conducted its own independent discounted net income valuation to arrive at an appraised value of 11% over the deal price in connection with the appraisal of a closely held community bank). In re ISN Software Corp. Appraisal Litig., 2016 WL 4275388 (Del. Ch. Aug. 11, 2016) (Court of Chancery awarded 2.5 x deal price using DCF in connection with the appraisal of a privately held software company following a merger approved without the benefit of a financial advisor or fairness opinion. Although the company did not have long-term management projections used in the ordinary course of business, the Court found the projections relied on by respondent’s expert, subject to corrections to certain assumptions, to be reliable given the subscription based business model, customer retention, and inelastic demand for the company’s product.)

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Merion Capital LP v. BMC Software, Inc., 2015 WL 6164771 (Del. Ch. Oct. 21, 2015) (relying on merger price generated in the market after a “vigorous” sales process as evidence of fair value after the Court conducted its own DCF analysis and lamented wildly divergent expert opinions). LongPath Capital, LLC v. Ramtron Int'l Corp., 2015 WL 4540443 (Del. Ch. June 30, 2015) (relying

• n the merger price even after finding that the projections were unreliable and concluding fair

value was below deal price due to synergies that are not available to an appraisal petitioner). Merlin Partners LP v. AutoInfo, Inc., 2015 WL 2069417 (Del. Ch. Apr. 30, 2015) (rejecting DCF based on management projections that were not used in the ordinary course of business, but that were prepared for the investment bankers in favor of the negotiated merger price) In re Appraisal of Ancestry.com, Inc., 2015 WL 399726 (Del. Ch. Jan. 30, 2015) (electing to defer to the deal price after conducting DCF analysis and finding a valuation close to the deal price). Huff Fund Investment P’ship v. CKx, Inc., 2013 WL 5878807 (Del. Ch. Nov. 1, 2013) aff’d 2015 WL 631586 (Del. Feb. 12, 2015) (affirming the Court of Chancery has discretion to use the merger consideration as an indicator of fair value).

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ACP Master, Ltd. v. Sprint Corp. (“Clearwire”), 2017 WL 3421142 (Del. Ch. July 21, 2017) (The Court of Chancery found the price paid in Sprint/Nextel’s 2013 acquisition of Clearwire to be entirely fair and that fair value was 50% below merger price because of “massive synergies” based on DCF analysis founded

• n management projections prepared in the ordinary course of business and

rejecting projections prepared by the buyer’s management in connection with competitive bidding). In re Dole Food Co., Inc. S’holder Litig., 2015 WL 5052214 (Del. Ch. Aug. 27, 2015) (The Court awarded a 20% premium based on strong findings of fraud by buyer / chairman and CEO. Court concluded that the decision likely renders the appraisal proceeding moot). Owen v. Cannon, 2015 WL 3819204 (Del. Ch. June 17, 2015) (awarding a 60% premium over deal price and rejecting post-hoc projections in favor of contemporaneous management projections).

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• Consolidation. In re Appraisal of Stillwater Mining Company, Consol. C.A. No. 2017-0385-JTL

(Del. Ch. Aug. 29, 2017 Order) (Court of Chancery granted consolidation and appointed lead counsel, but, in recognition of less than optimal cooperation between lead and non-lead counsel in prior appraisals, also granted other non-lead petitioners participation rights including: service

• f pleadings, correspondence between lead counsel and respondent’s counsel, access to the

discovery record at their own expense, notice of and the right to participate in depositions, advance copies of key briefs and expert reports, and participation rights in settlement discussions). Fee and Expense Sharing. In re Appraisal of Dell Inc., 2016 WL 6069017 (Del. Ch. Oct. 17, 2017)(Court of Chancery granted lead counsel’s fee and expense application following an appraisal award at a 28% premium to deal price, extending contingency fee structure to non- clients, rejecting offset to fee award for independent counsel, and declining to reduce expense award for post-trial disqualification of 83% of the appraisal class) (oral argument on the appeal held on September 27, 2017).

• Settlement. Mannix v. PlasmaNet, Inc., 2015 WL 4455032 (Del. Ch. July 21, 2015) (Holding that

the Court can approve a settlement between surviving company and non-appearing dissenters who did not file or join in appraisal action even if those terms are not made available to all dissenters who perfected appraisal rights).

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