CHANGE YOUR EXPERIENCE OF FINANCIAL PRINTING Moving On... A retreat from post-financial scrutiny of M&A deals
CHANGE YOUR EXPERIENCE OF FINANCIAL PRINTING MOVING ON: A RETREAT FROM POST-FINANCIAL CRISIS SCRUTINY OF M&A DEALS By Andrew M. Levine and Adam S. Namoury 1 Shareholder lawsuits have long been a staple of M&A transactions, but the number of lawsuits challenging M&A transactions has exploded in the aftermath of the Financial Crisis. Commonly cited studies show that shareholder lawsuits have more than doubled since 2007, 2 the year before the fjnancial markets essentially crumbled. At this point, well over 90% of announced $100+ million transactions in the U.S. result in litigation. In the past, we have been critical of the courts’ willingness to engage in after-the-fact nitpicking of isolated and sometimes seemingly insignifjcant aspects of M&A processes. Among other things, this approach has contributed to the nearly automatic fjling of shareholder suits following public company M&A announcements and the incredible waste of time, resources and expense that inevitably arise from their defense. But it is time to give credit where credit is due, as recent decisions in a number of high-profjle deals appear to indicate that courts are retreating from the trend of post-Financial Crisis scrutiny of M&A deals and instead recognizing that good faith business judgments of independent directors should not be second-guessed. Post-Financial Crisis Judicial Scrutiny There are plenty of examples of the courts’ Monday morning quarterbacking of M&A processes following the Financial Crisis. For the most part, the highest profjle cases have focused on directors’ fjduciary duties in the context of management involvement in negotiations or highly debatable confmicts of interests involving their fjnancial advisors ( e.g. , the Del Monte , 3 Rural Metro 4 and El Paso 5 cases). To make matters worse, the astonishing size of some of the damage awards handed down in recent years have only emboldened shareholder plaintifgs in their quest to extract additional disclosures, legal fees and price increases. While these decisions can be frustrating for M&A practitioners given that they become new fuel for the shareholder lawsuit fjre within minutes of their publication, they really should not have come as a surprise. Following any major market break, Washington inevitably intervenes through legislation (for example, Sarbanes-Oxley after the accounting scandals in the early 2000s and Dodd- Frank after the Financial Crisis) and the courts – most notably in Delaware – also have a natural tendency to retrench in respect of transaction-related matters and to increase their after-the-fact scrutiny of corporate behavior. 1 Mr. Levine is an M&A partner, and Mr. Namoury is an M&A associate, in the New York offjce of Jones Day. The views expressed here are solely those of the authors and do not necessarily refmect those of Jones Day or any of its cli- ents. 2 Olga Koumrian, Shareholder Litigation Involving Mergers and Acquisitions: Review of 2013 Litigation Cornerstone Research, Cornerstone Research (March 2014). 3 In re Del Monte Foods Co. S’holder Litig., Consol. C.A. No. 6027-VCL (Del. Ch. Feb. 14, 2011). 4 In re Rural Metro Corp. S’holder Litig., C.A. No. 6350-VCL (Del. Ch. Mar. 7, 2014). 5 In re El Paso Corp. S’holder Litig., C.A. No. 6949-CS (Del. Ch. Feb. 29, 2012).
CHANGE YOUR EXPERIENCE OF FINANCIAL PRINTING In reaction to the perceived missteps of corporate America, some courts placed deal processes under a microscope and second-guessed the business judgments of directors, even in situations in which the shareholders were handsomely rewarded and the directors appeared to have acted independently and in good faith. During these periods of judicial retrenchment, courts tend to go to great lengths to evaluate each step taken, and each decision made, in a particular transaction, displaying a reluctance to take a more holistic approach in determining whether there was a material failure in director oversight that in fact had an actual adverse consequence for shareholders. This focus on particular imperfections in a process becomes immediate fodder for the plaintifgs’ bar, which in turn causes a drag on the system and ultimately costs shareholders money at the end of the day — the exact opposite of what the shareholder claims purport to do. Return to the Norm The “norm,” of course, should be the recognition of one of the most basic principles of U.S. corporate law – that courts should not be substituting their own judgments for the good faith business judgments of independent directors. This principle is more defensible now than it ever has been in U.S. corporate history. The rules and guidelines for director membership have never been stricter. The once-prevalent assumption that CEOs dominate their old golf-buddy directors when it comes to corporate decision-making, including in the transactional context, is baseless today. Boards are now indeed fjlled with many of the most experienced, respected and accomplished business people in corporate America, with the benefjt of varied perspectives and substantive skill-sets. Directors are more educated about their fjduciary duties than ever before, and they take their roles seriously. With this as the backdrop, the suggestion that directors are breaching their fjduciary duties at a rate higher than 90% as the fjled lawsuits would indicate, or even at the rates in efgect before the Financial Crisis, is just silly. The good news, however, is that the courts, particularly in Delaware, appear to be hitting the reset button on merger litigation. The recovery and stabilization of the fjnancial markets have brought the courts to their pre-crisis stance that boards should be trusted in their decision-making as long as directors have not abused their positions or otherwise acted in a manner contrary to the shareholders’ interests. Within the last two years, Delaware judges have issued a number of important decisions in which they deferred to the judgment of directors and refrained from criticizing processes that had been characterized by plaintifgs as seriously fmawed. For example, in AboveNet , 1 Vice Chancellor Noble hammered home again and again that the plaintifgs had failed to allege any reasonably conceivable set of facts in support of their theories. In another example — Plains Exploration 2 — Vice Chancellor Noble denied the plaintifgs’ motion to enjoin the transaction, notwithstanding the lack of a pre-signing market check or a post-signing go-shop process. And in one of the most publicized takeover attempts in recent memory, Chancellor Strine (now Chief Justice of the Delaware Supreme Court) consistently refused to second-guess the Dell Special Committee’s decision-making process, despite constant and very public criticisms from the shareholder group and M&A pundits. 3 1 Miramar Firefjghters Pension Fund v. AboveNet, Inc., C.A. No. 7376-VCN (Del. Ch. July 31, 2013) 2 In re Plains Exploration & Production Co. S’holder Litig., Consol. C.A. No. 8090-VCN (Del. Ch. May 9, 2013). 3 High River LP et al. v. Dell Inc. et al., C.A. No. 8762 (Del. Ch. 2013).
CHANGE YOUR EXPERIENCE OF FINANCIAL PRINTING This trend continued in two cases decided on the same day at the end of 2014 — Family Dollar 1 and C&J Energy Services 2 . In each of these cases, decided under the more exacting enhanced scrutiny standard (the so-called Revlon standard) in which the board’s fjduciary duties require it to engage in a process to obtain the best value reasonably available to shareholders, the courts refused to second-guess the boards’ processes based on purported fmaws asserted by strike-suit plaintifgs. In Family Dollar , the Delaware Chancery Court deferred to the board’s decision not to engage with another bidder given its valid concerns about, among other things, the antitrust risk associated with the other bidder. The Court reemphasized that, under Revlon , while directors have an initial burden to show that they were adequately informed and acted reasonably, directors need not abide by a “single blueprint” to obtain the highest value attainable in a transaction. Similarly, in C&J Energy Services , the Delaware Supreme Court reaffjrmed its position that Revlon does not require “impeccable knowledge” of the value of the target company in the context of a transaction in which only a post-signing, passive market check was utilized. The C&J Energy Services court noted the board did not need to “set aside its own view of what is best for the corporation’s stockholders” and run an auction. Admittedly, every case is fact-specifjc and decided on its own merits, but collectively these decisions illustrate a return to the core principles of reviewing board decisions in the M&A context. This is exactly the type of thinking and policy-making that is necessary to curb the seemingly never- ending stream of shareholder litigation in M&A transactions. As the recent cases recognize, the correct standard for viewing merger cases is whether the directors actually failed to oversee the process properly and, if so, whether that failure actually had a negative impact on the price received in the transaction. In the absence of any meaningful tort reform, which is little more than a pipe dream in the current environment, this approach is the only real hope to stem the tide. 1 In re Family Dollar Stores, Inc. Stockholder Litig., C.A. No. 9985-CB (Del. Ch. Dec. 19, 2014). 2 C&J Energy Servs., Inc. v. City of Miami Gen. Emps.’ & Sanitation Emps.’ Ret. Trust, No. 655/657, 2014 (Del. Dec. 19, 2014).
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