In re Synthes, Inc. S’holder Litig., C.A. No. 6452 (Del. Ch. Aug. 17, 2012) (Strine, C.)
In this opinion, Chancellor Strine analyzed whether a controlling stockholder, who received the same merger consideration as all other stockholders, had breached his fiduciary duties by refusing to consider an alternate offer that would have cashed out other stockholders but required the controlling stockholder to remain as an investor in the privately-held surviving company. The board of directors (the “Board”) of Synthes, Inc. (“Synthes” or the “Company”) engaged in a process to solicit bids from potential strategic and financial buyers, which lasted for two years and produced two premium offers, one of which resulted in an executed merger agreement providing for a merger in which all of the stockholders of Synthes would be entitled to receive a mix of consideration consisting of 65% stock and 35% cash. Because the controlling stockholder received the same treatment as other stockholders and the Board engaged in extended negotiations that resulted in a substantial premium, the Chancellor granted the defendant directors’ motion to dismiss with prejudice plaintiff-stockholders’ claims that they breached their fiduciary duties.
The Board was composed of ten directors, including chairman, founder, and former CEO Hansjoerg Wyss, five directors who Wyss allegedly controlled by familial and business relationships, and four independent directors, all of whom are named defendants in this litigation. Wyss owned 38.5% of the Company’s stock, and purportedly controlled approximately 52% of the Company’s stock through his control of shares owned by family and trusts. The plaintiffs alleged that Wyss was well-past retirement age and was interested in liquidity. Because of Synthes’ thin public float and the fact that a piecemeal sale of shares would result in a drop in the stock price, Wyss would need to sell his holdings to a single buyer. As part of an ongoing review of strategic alternatives, Synthes decided to explore the idea of finding a potential buyer in 2010 and engaged Credit Suisse Securities (USA) LLC (“Credit Suisse”) as its financial advisor. Although Wyss supported the decision to explore a sale transaction, the plaintiffs did not allege that it was his idea in the first instance.
In September 2010, the Board contacted nine logical strategic buyers with the capacity to acquire Synthes, which then had a market capitalization of greater than $15 billion. Four of these potential buyers expressed preliminary interest, of which one declined to proceed and three entered into confidentiality agreements. Of these three parties, only Johnson & Johnson (“J&J”) expressed interest in pursuing a deal after reviewing preliminary due diligence material. In November 2010, while continuing negotiations with J&J, the Board authorized Credit Suisse to contact potential financial buyers. Of the six private equity firms that Credit Suisse contacted, four entered into confidentiality agreements and three submitted non-binding proposals to acquire the Company. When these three firms indicated that none could independently acquire Synthes, the Board permitted them to form a consortium (the “PE Club”) for bidding purposes.
In December 2010, J&J submitted a non-binding offer of 145-150 Swiss Francs (“CHF”) per share, to be paid in cash and J&J stock. In February 2011, the PE Club submitted a bid for CHF 151 per share in cash that would also require Wyss to convert a substantial portion of his shares into equity of the post-merger company. The PE Club indicated that it could not increase its proposal above CHF 151 per share. The Board then met to compare the proposals, determining that the PE Club’s bid entailed greater value certainty because it was in all cash and greater closing risk because it depended on the health of the financing markets. Wyss opposed the PE Club’s bid, which the Board then declined to pursue, because he wanted to cash out his shares along with the other stockholders. After the Board told J&J that it would not consider any offer below CHF 160 per share, J&J increased its offer to CHF 155 but stated that it could further increase its offer pending the outcome of additional due diligence.
The parties negotiated the terms of a merger agreement until April 2011, and J&J increased its offer to CHF 159 per share to be paid in 65% stock (subject to a collar) and 35% cash. The Chancellor noted that the plaintiffs did not allege that Wyss attempted to negotiate for a higher price for his shares. In the merger agreement, J&J obtained five deal protections: (1) a voting agreement with Wyss, his daughter who was a director, and two family trusts with respect to 37% of the Company’s stock (with such percentage reduced to 33% if the Board changed its recommendation in response to a superior proposal), (2) a no-solicitation with a fiduciary out to consider a superior proposal, (3) agreement to hold a stockholder vote regardless of whether the Board exercised its fiduciary out or changed its recommendation, (4) matching rights in the event of a superior proposal, and (5) a $650 million termination fee which represented approximately 3.05% of equity value and approximately 2.9% of enterprise value (which the Court noted was the more relevant measure for assessing the preclusive effect of a termination fee on a materially better topping bid). During this time neither the PE Club, nor any other bidder, expressed interest in submitting a better bid for Synthes. Credit Suisse then opined that the merger was fair to the Synthes stockholders, the Board approved the merger agreement and recommended that the stockholders vote in favor of it, the parties executed the merger agreement with an implied value of $21.3 billion (26% premium to the average trading price during the preceding month), the Synthes stockholders voted to approve the merger, and in June 2012 the merger closed. No other party emerged to make a better offer before closing.
The plaintiffs alleged, in their second amended complaint, that (1) entire fairness should apply because the merger was a conflicted transaction given the financial motives of Wyss, as the purported controlling stockholder, to seek liquidity, (2) the merger was subject to Revlon enhanced scrutiny because the merger was an “end stage” transaction representing the last opportunity for the Synthes stockholders to receive a control premium for their shares, and (3) the directors breached their fiduciary duties by agreeing to unreasonable deal protections that precluded more attractive bids. The defendants moved to dismiss the complaint, arguing that Wyss received the same consideration as other stockholders and was ideally suited to bargain on behalf of all stockholders, Revlon did not apply because there was no change of control, and the Board engaged in lengthy, open negotiations that resulted in greater value and standard deal protections.
The Chancellor disagreed with the plaintiffs’ first argument, which claimed that Wyss had cost other stockholders a better deal because he was in a rush to liquidate his investment. The Chancellor found that the Board had initiated a process to patiently solicit and evaluate offers, Wyss was not in any particular rush to attain liquidity, and that Wyss’s decision to accept pro rata treatment should afford him safe harbor protection. If the Chancellor did not apply business judgment, the Chancellor inferred that controlling stockholders would have no incentive to align their interests with other stockholders. Although recognizing that there may be very narrow circumstances in which a controlling stockholder’s immediate need for liquidity could constitute a disabling conflict of interest, the Court found that the complaint was devoid of those allegations. The Chancellor further observed that plaintiffs had the same interest as Wyss in seeking liquidity. As for the plaintiffs’ argument that Wyss and the Board had a duty to pursue the PE Club’s all-cash offer because it provided better terms for the other stockholders, the Chancellor noted that Delaware law prevents a controlling stockholder from gaining unfair advantage at the expense of the minority, but does not impose a duty of self-sacrifice for the benefit of those other stockholders. Finally, the plaintiffs argued that Wyss and the Board foreclosed the PE Club from submitting a better offer. The Chancellor found that no facts supported the inference that the PE Club, despite having indicated that it could not increase its bid, would have made an offer involving terms equally favorable to Wyss and the other stockholders. The Chancellor also rejected the related argument that the Board should not have ceased to communicate with the PE Club because it could have either elicited a better bid or prompted J&J to increase its bid. For all of these reasons, the Chancellor held that the entire fairness standard of review did not apply to these actions.
The Chancellor also rejected the plaintiffs’ assertions that Revlon and Unocal required application of enhanced scrutiny. As an initial matter, the Court noted that the stockholders were moving from a company controlled by Wyss to a company without a controlling stockholder. In addition, the Court found that the transaction does not qualify as a change of control under the Supreme Court’s decision in Santa Fe because of the mix of consideration and the fact that the 65% stock component of the consideration will be held in a large, fluid market. The Chancellor further noted that, even if Revlon were applicable, the plaintiffs had not pleaded facts to support a viable claim.
Similarly, the Chancellor held that the plaintiffs had not pleaded facts supporting an inference that the deal protections unreasonably precluded a topping bidder.