The Post-Agreement Market Check Revisited
Introduction
In considering a transaction involving a change of control, directors of Delaware corporations are charged with obtaining the best transaction reasonably available for the corporation and its stockholders.[2] During the late 1980s, Delaware courts frequently were called upon to consider whether target directors who had forsaken an open auction process in favor of negotiating with a single bidder had satisfied their heightened duties in a sale of control when they agreed to a transaction with a post-agreement market check.[3] In fact, as recently as four years ago, the Court of Chancery approved a transaction that closely resembled the post-agreement market checks at issue in its earlier decisions.[4]
More recently, however, the Court of Chancery has rendered two decisions, In re Pennaco Energy Inc.[5] and In re MONY Group Inc.,[6] approving post-agreement market checks that differ in certain important respects from the post-agreement market checks previously approved by the Court of Chancery. First, in both Pennaco and MONY, the target board agreed to termination fees that, by the standards generally applied in similar circumstances in the past, were significantly higher than might have been expected in the context of a sale of control to a single bidder in the absence of a market canvass.[7] Second, the press releases issued by the Pennaco and MONY boards both failed to explicitly invite competing proposals.[8] Finally, in both Pennaco and MONY, the single bidder obtained matching rights in the event of a post-agreement superior proposal from a competing bidder.
Given these differences, one is tempted to read the recent decisions as a signal for single bidders to demand larger termination fees and more restrictive lock up provisions than has been customary in the past for transactions involving a post-agreement market check. However, a closer reading of the Pennaco and MONY decisions suggests that their unique facts, including the fact that both cases involved unaffiliated single bidders (as opposed to management-led bidders), warrant the more restrictive post-agreement market check provisions used in each case. For that reason, when advising clients in single bidder transactions that involve a post-agreement market check, prudent counsel will have to consider whether the unique facts of the specific transaction in fact provide a basis for a more (or less) restrictive post-agreement market check.
The Market Check
In the context of a sale of control transaction, a board of directors of a target corporation generally may satisfy its fiduciary duties to obtain the best transaction reasonably available under the circumstances for the corporation and its stockholders by engaging in one of several general types of transactions: (i) a transaction with the highest bidder after a full public auction of the target corporation, i.e. a pre-agreement market check, (ii) a transaction with the highest bidder after a more limited pre-agreement market check in which multiple potential bidders are contacted and participate in the bidding, (iii) a transaction with a single bidder where the target board has reliable evidence demonstrating that the board has obtained the best transaction reasonably available, or (iv) a transaction with a single bidder where the target board, due to the absence of reliable evidence that the board has obtained the best transaction reasonably available, bargains for a post-agreement market check. A transaction that follows a full auction or involves multiple bidders may warrant more restrictive deal protections, such as a higher termination fee, a matching right and a more limited no shop provision, because the market has been canvassed for potential bidders. By contrast, when a target board lacks sufficiently reliable evidence to permit it to conclude that a transaction with a single bidder is the best transaction reasonably available, the use of a post-agreement market check (coupled with modest deal protection provisions) will permit interested competing bidders to emerge, thus ensuring that the target corporation obtains the best transaction reasonably available under the circumstances.[9]
A post-agreement market check is effective because it establishes a "floor" for the transaction and, by providing for a limited period of time after the announcement of the transaction for a competing bidder to emerge, allows the reasonableness of the transaction to be tested.[10] A post-agreement market check typically includes the following components: (i) a period of time, longer than the time period legally required, following the announcement of the deal for competing bidders to emerge,[11] (ii) a "window shop" prohibiting a target company from actively soliciting bids, but allowing a target company to negotiate with bidders who make superior proposals, (iii) a "fiduciary termination right" that allows the target company to terminate the deal in favor of a superior proposal, (iv) the use of limited deal protection devices (such as termination fees that fall significantly below the normal threshold for acceptable termination fees), and (v) a press release announcing the deal and inviting competing bids.[12]
In re Fort Howard Corp. S'holders Litig.
The post-agreement market check was first tested in the Delaware courts in the case of In re Fort Howard Corp. S'holders Litig.[13] In Fort Howard, plaintiffs, shareholders of Fort Howard Corporation ("Fort Howard"), sought a preliminary injunction against the closing of a public tender offer for up to all of the outstanding shares of Fort Howard. The tender offer was the first step of a two-step leveraged buyout transaction. The plaintiffs alleged, among other things, that the Fort Howard directors favored the management-led buyers and did not seek the best transaction reasonably available under the circumstances.
The transaction at issue in Fort Howard included a number of features that have since become known as a post-agreement market check. In particular, the Fort Howard board approved a transaction with a single bidder, but provided a mechanism by which competing bidders could later emerge. The transaction contained the following features: (i) a four day period between the announcement of the transaction and the commencement of the tender offer; (ii) a 26 business day period between the commencement of the tender offer and the anticipated closing of the tender offer; (iii) a window shop allowing Fort Howard to receive and consider alternative proposals, but not to actively solicit such proposals, (iv) a termination fee amounting to 1.9% of the equity value of the transaction; and (v) a press release stating that Fort Howard had the right to entertain alternative proposals, would entertain alternative proposals and would cooperate with anyone submitting a competing bid.[14]
The Court of Chancery concluded that the rationale for adopting this approach - "for permitting the negotiations with the management affiliated buyout group to be completed before turning to the market in any respect" - made sense. The Court of Chancery noted that "[t]o start a bidding contest before it was known that an all cash bid for all shares, could and would be made, would increase the risk of a possible takeover attempt at less than a 'fair' price or for less than all shares."[15] The Court of Chancery also determined that the "alternative 'market check' that was achieved was not so hobbled by lock-ups, termination fees or topping fees; so constrained in time or so administered (with respect to access to pertinent information or manner of announcing 'window shopping' rights) as to permit the inference that this alternative was a sham designed from the outset to be ineffective or minimally effective."[16] The Court of Chancery was "particularly impressed with the announcement in the financial press and with the rapid and full-hearted response to the eight inquiries received." Thus, having reached the conclusion that the Fort Howard board acted in good faith by structuring the transaction in this manner, the Court of Chancery concluded that the Fort Howard board did not violate its Revlon duties in agreeing to a transaction with a management-led single bidder followed by a post-agreement market check.
For more than a decade after the Fort Howard decision, the Court of Chancery consistently reiterated both the rationale and factors relied upon by the court in that decision.[17] However, in a case decided in 2001, the Court of Chancery revisited post-agreement market checks and for the first time condoned a transaction that utilized a form of post-agreement market check that differed in significant respects from the Fort Howard model.[18]
In re Pennaco Energy, Inc.
Plaintiffs, shareholders of Pennaco Energy, Inc. ("Pennaco"), sought a preliminary injunction against the closing of a tender offer by Marathon Oil ("Marathon") for the acquisition of all the shares of Pennaco. The plaintiffs alleged, among other things, that the Pennaco directors did not undertake efforts that were reasonably calculated to secure the best value for Pennaco. The Court of Chancery, applying the traditional test for a preliminary injunction, denied the motion.
Although the Pennaco board did not canvas the market to determine if any other buyers might exist, the Pennaco board made an effort to negotiate for minimum deal protections in the merger agreement in order to create an effective post-agreement market check. The result of these negotiations was a merger agreement containing, among other things, the following components: (i) a non-restrictive no shop clause that allowed Pennaco "to talk and provide information to any party that could reasonably be expected to make a superior offer that could be consummated without undue delay";[19] (ii) a broad fiduciary out permitting Pennaco to terminate the merger agreement in the event such a superior proposal emerged; (iii) a three day window for Marathon to match any superior proposal; and (iv) a termination fee amounting to 3% of the equity value of the deal.[20] Marathon also agreed that it would not commence its tender offer until 9 business days, or 17 calendar days, after announcement of the transaction. Significantly, while Pennaco did announce the transaction in a press release (and filed a form 8-K attaching the merger agreement and press release as exhibits), Pennaco did not explicitly solicit competing bids in the press release.[21]
In determining the merits of plaintiff's allegations, the Court of Chancery concluded that the plaintiffs were unlikely to prove that the Pennaco board failed to satisfy its Revlon duties when the board did not actively shop for any potential buyers and dealt solely with Marathon. The Court of Chancery reasoned as follows:
- The board's actions must be evaluated in the context of Pennaco's market posture. Even the plaintiffs concede that Pennaco was a source of industry interest. The company was followed by reputable analysts. The company communicated with the market in a bullish manner and freely communicated with interested parties. The company had done an extensive search for a joint venture partner in 1998, which brought it to the attention of twenty to thirty industry players. Not only that, the company had reincorporated in Delaware to facilitate its participation in the mergers and acquisitions market.[22]
The Court of Chancery noted that had the merger agreement contained "onerous deal protection measures that presented a formidable barrier to the emergence of a superior offer, the Pennaco board's failure to canvass the market earlier might tilt its actions toward the unreasonable.[23] The Court found, however, that the Pennaco board was "careful to balance its single buyer negotiation strategy by ensuring that an effective post-agreement market check would occur."[24] Turning to the key provisions of the merger agreement, the Court of Chancery determined that the agreement "le[ft] Marathon exposed to competition from rival bidders, with only modest and reasonable advantages of a 3% termination fee and matching rights."[25] The Court of Chancery, citing cases decided in the context of a stock-for-stock merger, found that the plaintiffs' "attack on the termination fee's level is make-weight and at odds with precedent upholding the validity of fees at this level."[26]
In re MONY Group Inc.
Plaintiffs, stockholders of MONY Group Inc. ("MONY"), filed suit in the Court of Chancery seeking a preliminary injunction against a stockholder vote on cash-out merger between MONY and AXA Financial, Inc. ("AXA"). Among other things, the plaintiffs alleged that the MONY board violated its Revlon duties by not seeking the best transaction available. In particular, the plaintiffs alleged that the MONY board breached its fiduciary duties by refusing to hold a pre-agreement auction and instead choosing a process involving a single bidder negotiation followed by a post-agreement market check.[27]
As in Pennaco, the MONY board made an effort to negotiate a merger agreement that would provide for an effective post-agreement market check. The merger agreement that resulted from the negotiations contained: (i) a window shop provision that prohibited MONY from actively soliciting bidders, but permitted MONY to furnish information to and participate in discussions and negotiations with any person that makes a bona fide written "inquiry, proposal or offer … relating to, or that could be reasonably expected to lead to" a business combination with MONY that the MONY board "determines in good faith by resolution duly adopted, after consultation with outside legal counsel and a financial advisor of nationally recognized reputation, constitutes or is reasonably likely to constitute a Superior Proposal….";[28] (ii) a fiduciary out permitting MONY to terminate the merger agreement in the event of a superior proposal; (iii) a five day window for AXA to match any competing proposal; and (iv) a termination fee amounting to 3.3% of the equity value of the deal.[29] The press release announcing the deal on September 17, 2003 did not contain an explicit invitation for competing proposals. The transaction was announced on September 17, 2003 and a stockholder vote on the transaction ultimately was set for February 24, 2004.[30]
In responding to plaintiffs' arguments, the Court noted that "[s]ingle-bidder approaches offer the benefits of protecting against the risk that an auction will be a failed one, and avoiding a premature disclosure to the detriment of the company's then on-going business."[31] The Court noted that MONY took into consideration a number of factors in deciding not to engage in a public auction, including "a concern that an earlier attempt by Allmerica Financial to conduct a public auction in the life insurance industry resulted in no buyer emerging and very harsh consequences thereafter to that company's business and the market performance of its stock; that an auction or active solicitation would jeopardize MONY's career agency force; that competitors might use the process to obtain due diligence from MONY and gain access to MONY's career agents; and the knowledge of the possibility of a post-agreement market check."[32] The Court of Chancery concluded that "[g]iven the nature of MONY's business, specifically its career agency force, the Board's judgment was reasonable that the risks of a pre-agreement auction, as opposed to a post-agreement market check, outweighed the benefits."[33]
The plaintiffs also challenged the adequacy of the post-agreement market check, arguing that: (i) hostile bids in the insurance industry are rare and therefore any post-agreement market check is suspect; (ii) the complexity of the insurance industry requires that any competing bidders conduct extensive due diligence that could not be done before the scheduled stockholder vote; and (iii) the additional costs of the termination fee, which amounted to 3.3% of the equity value of the deal, and certain change of control agreements ("CICs") prevented an adequate market check.
With respect to the first argument, the Court of Chancery noted that it presupposes a hostile bid when a friendly bid could be generated by the market check. The Court of Chancery likewise rejected the second argument, finding that the five month period, which exceeded the typical market check periods of one to two months approved by the Court of Chancery in the tender offer context, was a sufficient amount of time to allow for competing bids, even in the regulated insurance industry. Finally, the Court of Chancery rejected the third argument noting that the termination fee was "well within the range of reasonableness" and the CICs were bidder neutral.[34]
Analyzing Pennaco and MONY
The Pennaco and MONY decisions differ in certain material respects from prior post-agreement market check cases. In prior decisions, the Court of Chancery approved post-agreement market checks containing termination fees ranging from 1.9% to 2.2% of the equity value of the deal.[35] Only when the market has been canvassed prior to the deal has the Court of Chancery approved termination fees in the context of post-agreement market checks exceeding this minimal percentage.[36] Citing precedent decided in the context of stock-for-stock mergers or liquidated damages provisions, the Court of Chancery approved the higher termination fees in Pennaco and MONY without any analysis as to whether a higher termination fee of this size was reasonable in comparison to the fees previously approved by the Court of Chancery in earlier decisions involving single bidders and post-agreement market checks.[37] The Court of Chancery avoided any analytical discussion of the termination fee appropriate for the type of deal before it and merely decided that the termination fees in each of Pennaco and MONY was in the range of reasonableness previously approved by the Court of Chancery.[38] The Court of Chancery also avoided any analytical discussion in these cases as to why the Court was not troubled by the absence of a press release explicitly inviting competing proposals or by the presence of a matching right for the single bidder.
The Court of Chancery's approval of these higher termination fees and cursory discussion thereof, as well as the approval of the transaction despite the absence of an explicit press release and the presence of a matching right, invites one to consider whether more restrictive deal protections are now acceptable in post-agreement market checks, regardless of the context. Following the Court of Chancery's decisions in the late 1980s, practitioners were of the view that a target, even when it had not engaged in a prior canvass of the market, could negotiate with a single bidder and agree to be acquired by that bidder, provided that the transaction included a post-agreement market check and a modest (approximately 2% of the equity value or less) termination fee. Practitioners also understood that competing bids should be solicited in a press release and other deal protections, such as a matching right, should be kept to a minimum. These recent decisions cast that view in some doubt and raise the question as to whether the facts of these new decisions differ in some material respect from the prior decisions of the Court of Chancery, thus accounting for the anomaly.
Upon closer review of the precedent, a distinction may be drawn between the prior market check cases, in which the single bidder was a management-led group, and the Pennaco and MONY decisions, in which the single bidder was an unaffiliated third party. A higher termination fee may be warranted in the context of a third party single bidder transaction because a third party will invariably incur greater costs, and thus is at risk of greater opportunity lost, in conducting the due diligence and otherwise evaluating a transaction. Moreover, a higher termination fee may be necessary in the third party context to lure a third party bidder to make a competitive offer while ensuring that the single bidder will be compensated for its costs if a competing proposal emerges. This greater cost is in marked contrast with a management-led group who, due to its access to the inner working of the target company, necessarily will have greater insight into the value of the target company. As such, the costs that a management-led group must bear in conducting due diligence and otherwise evaluating a transaction may be significantly less than a third party's costs. Because of this lower cost, it seems appropriate to require a lower termination fee in post-agreement market check transactions that involve a management-led buyout.
As with termination fees, the analytical justification for not requiring an explicit press release inviting competing proposals and allowing a matching right may lie in the fact that a third party single bidder was involved, and not a management-led group. In the context of a management-led buyout, an inherent chilling effect may be present in light of the perception that management would be less than cooperative in providing information to a competing bidder. A competing proposal may, therefore, be less likely to arise given the fact that potential bidders would be uncertain as to whether their competing proposals would be welcome and seriously considered. An explicit press release addresses this uncertainty.
Moreover, a more explicit press release may be warranted in a management-led buyout context in light of the fact that the market may not have been aware of the potential for an extraordinary transaction involving the target company. In fact, the Court of Chancery makes it clear in Pennaco that the market was aware of the potential for an extraordinary transaction.[39] In the context of a management-led buyout, however, information that a company is ripe for an extraordinary transaction may not be present in the market and may merely be available to management given their status as insiders. It follows, therefore, that a transaction involving a management-led buyout should include a press release specifically inviting competing proposals. Likewise, a matching right may be more tolerable in the context of a third party single bidder transaction as such a deal protection device may be required to entice the third party single bidder to engage in the transaction, and arguably is less-chilling to competing bidders than a matching right in the hands of a management-led group.
Conclusion
In providing advice with respect to transactions involving post-agreement market checks, practitioners must be mindful of the context in which the transaction arises. Practitioners should be cautious in providing advice that deal protection measures similar to those approved in Pennaco and MONY always will be acceptable. In a situation in which the single bidder is management-led or otherwise has an advantage in the bidding process that may cause a chilling effect on competing bids, practitioners should advise clients that the post-agreement market checks approved in the late 1980s, and more recently in Kohls v. Duthie, may provide a better model for structuring such transactions.
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Notes
1 Michael K. Reilly is an associate in the Wilmington, Delaware law firm of Potter Anderson & Corroon LLP. The views expressed are solely those of the author and do not necessarily represent the views of the firm or its clients.
2 Revlon Inc. v. MacAndrews & Forbes Holdings, Inc., 506 A.2d 173, 182 (Del. 1986) (finding that once directors have decided to sell control of the company "[t]he directors' role changed from defenders of the corporate bastion to auctioneers charged with getting the best price for the stockholders at a sale of the company").
3 A post-agreement market check is a transaction in which the target corporation agrees with a single bidder to a transaction having limited deal protections, sets a "floor" for a transaction and then announces in a press release that for an extended period of time post-signing the target may talk with any competing bidders that may emerge. See, e.g., In re Fort Howard Corp. S'holders Litig., Consol. C.A. No. 99991 (Del. Ch. Aug. 8, 1988); Braunschweiger v. American Home Shield Corp., C.A. No. 10755 (Del. Ch. Oct. 26, 1989); Roberts v. General Instr. Corp., Consol. C.A. No. 11639 (Del. Ch. Aug. 13, 1990).
4 Kohls v. Duthie, 765 A.2d 1274 (Del. Ch. 2000).
5 787 A.2d 691 (Del. Ch. 2001).
6 C.A. No. 20554, Lamb, V.C. (Del. Ch. Feb. 18, 2004).
7 Compare Pennaco, 787 A.2d at 707 (approving a termination fee amounting to 3% of the equity value in the context of a transaction involving a third party single bidder and a post-agreement market check); and MONY, slip op. at 19-20 (approving a termination fee amounting to 3.3% of the equity value in the context of a transaction involving a third party single bidder and a post-agreement market check); with Kohls, 765 A.2d at 1285 (refusing to enjoin a transaction involving a termination fee amounting to 2.2% of the equity value of the transaction); and Fort Howard, slip op. at 17, 32 (refusing to enjoin a transaction involving a termination fee amounting to 1.9% of the equity value of the transaction); and Braunschweiger, slip op. at 12, 19 (refusing to enjoin a transaction involving a termination fee amounting to 1.9% of the equity value of the transaction); and General Instr., slip op. at 21 (refusing to enjoin a transaction involving a termination fee amounting to 2% of the equity value of the transaction).
8 Pennaco, 787 A.2d at 703 (noting that the target company filed a form 8-K and attached the merger agreement which "gave the marketplace knowledge of Pennaco's ability to speak with rival bidders and the standard nature of the termination fee"); MONY, slip op. at 7 (noting that the transaction was announced on September 17, 2003).
9 Barkan v. Amsted Indus., Inc., 567 A.2d 1279, 1286 (Del. 1989).
10 Evelyn Sroufe, A Bird in the hand or Pie in the Sky: The Market Checks in the '90's, 5 No. 10 Insights 12, 12 (Oct. 1991).
11 In the context of a transaction involving a tender offer, the parties typically agree to announce the transaction and delay the commencement of the tender offer for some limited period of time after the announcement. See, e.g., Fort Howard, slip op. at 7-8 (delaying the commencement of the tender offer for four business days after the announcement of the transaction). Also, the length of time between the commencement of the tender offer and the anticipated closing of the tender offer is typically extended beyond the required twenty day period. See, e.g., Fort Howard, slip op. at 7-8 (delaying the closing of the tender offer for twenty-six business days after the commencement of the tender offer).
12 See Charles F. Richards and J. Travis Laster, Return of the Market Check, 15 No. 6 Insights 20, 20 (June 2001); Sroufe supra note 9, at 12.
13 Consol. C.A. No. 99991 (Del. Ch. Aug. 8, 1988)
14 Fort Howard, slip op. at 1, 18-23.
15 Id., slip op. at 32.
16 Id.
17 See In re Fort Howard Corp. S'holders Litig., Consol. C.A. No. 99991 (Del. Ch. Aug. 8, 1988); Braunschweiger v. American Home Shield Corp., C.A. No. 10755 (Del. Ch. Oct. 26, 1989); Roberts v. General Instr. Corp., Consol. C.A. No. 11639 (Del. Ch. Aug. 13, 1990); Kohls v. Duthie, 765 A.2d 1274 (Del. Ch. 2000).
18 In re Pennaco Energy Inc., 787 A.2d 691.
19 Id., 787 A.2d at 702.
20 Id., 787 A.2d at 702-3.
21 Id.
22 Id., 787 A.2d at 705.
23 Id., 787 A2.d at 708.
24 Id.
25 Id.
26 Id.
27 MONY, slip op. at 1.
28 Id., slip op. at 17 n.31.
29 Id., slip op. at 17-20.
30 Id., slip op. at 19.
31 Id., slip op. at 14.
32 Id., slip op. at 14 -15.
33 Id., slip op. at 14.
34 Id., slip op. at 19-20 (citing Kysor Indus. v. Margaux, Inc., 674 A.2d 889 (Del. Super. 1996)).
35 See supra note 7.
36 See, e.g., KDI, slip op. at 13-14 (refusing to enjoin a transaction involving a three month pre-agreement market check and a post-agreement market check and containing a termination fee amounting to 4.3% of the equity value); Formica, slip op. at 22, 35 (approving a transaction involving an active pre-agreement market check and a post-agreement market check and containing a termination fee amounting to 4.5% of the equity value).
37 Pennaco, 787 A.2d at 707 n.27 (citing McMillan v. Intercargo Corp., C.A. No. 16963, Strine, V.C. (Apr. 20, 2000); Matador Capital Management Corp. v. BRC Holdings, Inc., 729 A.2d 280 (Del. Ch. 1998); Goodwin v. Live Entertainment, Inc., C.A. No. 15765, Strine, V.C. (Jan. 25, 1999)); MONY, slip op. at 19-20 (citing Kysor Indus. v. Margaux, Inc., 674 A.2d 889 (Del. Super. 1996)).
38 See Pennaco, 787 A.2d at 707 ("The merger agreement's provisions leave Marathon exposed to competition from rival bidders, with only the modest and reasonable advantages of a 3% termination fee and matching rights. The plaintiffs' attack on the termination fee's level is make-weight and at odds with precedent upholding the validity of fees at this level."); MONY, slip op. at 19-20 ("The termination fee is well within the range of reasonableness; here representing only 3.3% of MONY's total equity value, and only 2.4% of the total transaction value.").
39 Pennaco, 787 A.2d at 705 ("Even the plaintiffs concede that Pennaco was a source of industry interest. The company was followed by reputable analysts. The company communicated with the market in a bullish manner, and freely communicated with interested parties. The company had done an extensive search for a joint venture partner in 1998, which brought it to the attention of twenty to thirty industry players. Not only that, the company had reincorporated in Delaware to facilitate its participation in the mergers and acquisition market.").