No Fair in Delaware
A recent Delaware Court of Chancery decision raises two interesting points concerning the obligations of corporations that undertake mergers with subsidiaries
From The Daily Deal, Vol.2, No.100, June 30, 2000
Copyright ©2000 The Deal LLC
Reprinted with permission. All rights reserved.
The case, In re Unocal Exploration Corp. Shareholders Litigation, was brought by minority shareholders of Unocal Exploration Corp. in connection with the 1992 short-form merger of UXC into Unocal Corp., which owned 96% of UXC's stock.
The plaintiffs argued that they did not receive a fair price for their shares and challenged the independence of the UXC special committee that negotiated the merger. The exchange ratio for the deal was determined by the committee based on a February 1992 fairness opinion by PaineWebber and an April 1992 presentation. However, the plaintiffs asserted that the merger price was unfair because it not properly reflect the increase in gas prices during the first quarter of 1992, which should have caused UXC's market value (as a "pure play" company) to grow at a greater rate than its diversified parent.
In a June 13 decision, Vice Chancellor Stephen Lamb ruled in favor of the defendants, concluding that appraisal was the minority shareholders' only remedy.
The first question raised is whether the standard of review depends on the form of the merger. Unocal had structured the deal as a short-form merger under Sec. 253 of the Delaware General Corporation Law, which allows a parent to merge out a 90%-owned subsidiary without any process whatsoever at the subsidiary level.
In this case, however, Unocal caused UXC to set up a special committee (which was comprised solely of UXC directors who also served as directors of the parent). The court seemed surprised by the use of a committee in a Sec. 253 merger, but attributed the use of the committee to the confusion in Delaware law over whether the "entire fairness" standard of review applies to all parent-subsidiary mergers or only long-form parent-subsidiary mergers.
After reviewing the relevant decisions, Lamb concluded that there is no "process requirement" in a Sec. 253 merger - neither a board recommendation nor approval of the board of the subsidiary is necessary - and therefore there's no reason to evaluate such a transaction under the entire fairness standard. (Indeed, in his words, doing so would "gut the short-form merger statute of its meaning.") Rather, Lamb concluded, the stockholders' sole remedy in such a merger, absent fraud or some other illegality, is appraisal.
The second issue raised by the UXC decision is whether there's an obligation to obtain a bring-down opinion from an investment banker when it is alleged that the deal's fixed exchange ratio is no longer fair because of market changes after delivery of the formal fairness opinion.
As Lamb noted: "The evidence at trial made clear that full bring-down opinions are the exception, not the rule. Naturally, changes between the date of a fairness opinion and the date of the merger completion can be so great as to render an earlier fairness opinion unreliable." Quoting Chancellor William Allen's decision in Behrens v. United Investors Management Co., Lamb wrote: "Perhaps some set of intervening changes in public markets would be such as to require diligent directors to, in effect, say 'How could it be that the deal we earlier negotiated is still fair to the minority?'"
In this case, however, the court found that there was "no proof that the Special Committee or Unocal affirmatively closed its eyes to relevant information. "
While both the Unocal and Behrens decisions involved a short-form merger (cashing out the minority), the discussion on this point appears to be equally apt for long-form mergers, which are governed by Sec. 251.
Now that Delaware law permits parties to a merger to include a "force the vote" provision, the state courts appear poised to pay much closer attention to whether a board's decision to recommend a transaction - or later change its recommendation - results from an informed process. In reaching an informed decision, the board's ability to rely upon a current fairness opinion often may be critical. One can easily posit a number of circumstances (for example, a dramatic decrease in the market price of an acquirer's stock in a transaction that involves a fixed exchange ratio) where a court might conclude that a board's decision to maintain its recommendation was not informed, absent a bring-down opinion.
Lamb's analysis is consistent with our advice that, where circumstances change between the initial delivery of the fairness opinion and the stockholders meeting, the board must: (i) investigate what impact, if any, such changes have on the deal; (ii) decide whether, in light of such changes, the board should seek a bring-down opinion from its investment banker; and (iii) then decide, if whether it is appropriate for the board to maintain, change or withdraw its recommendation. If the board takes these steps, then a Delaware court should defer to its decision to maintain or change its recommendation.