Here we go ... the Wayne County Employees' Retirement System of Michigan and the Police and Fire Retirement System of the City of Detroit have filed an application for a TRO in the Delaware Court of Chancery. (Bloomberg) The Bear Stearns shareholders are trying to stop the sale of 95 million new voting shares to JP Morgan, which is projected to close on April 8.
We discussed this proposed sale here, and we mentioned Omnicare, Inc. v. NCS Healthcare. In that case, the Delaware Supreme Court invalidated a merger agreement and two voting agreements between an acquiring company and two shareholders of the target company. The two shareholders together controlled over 65% of the target company's votes, and the shareholders agreed to vote their shares in favor of the challenged transaction. In addition, the two companies had agreed that the target board would present the challenged transaction for a shareholder vote, even if the board received a better offer. The Delaware Supreme Court held that "the merger agreement and voting agreements, as they were combined to operate in concert in this case, are inconsistent with the NCS directors' fiduciary duties."
In doctrinal terms, the merger agreement and two voting agreements were treated as "defensive measures" under Unocal Corp. v. Mesa Petroleum Co., 493 A.2d 946 (Del.1985) and Unitrin, Inc. v. Am. Gen. Corp., 651 A.2d 1361 (Del.1995), which prohibit measures that are "preclusive" or "coercive." The Omnicare court reasoned:
Although the minority stockholders were not forced to vote for the [challenged] merger, they were required to accept it because it was a fait accompli. The record reflects that the defensive devices employed by the [target] board are preclusive and coercive in the sense that they accomplished a fait accompli. In this case, despite the fact that the [target] board has withdrawn its recommendation for the [challenged] transaction and recommended its rejection by the stockholders, the deal protection devices approved by the [target] board operated in concert to have a preclusive and coercive effect [because they] made it "mathematically impossible" and "realistically unattainable" for the [alternative] transaction or any other proposal to succeed, no matter how superior the proposal.
In the last section of the opinion, labeled "Effective Fiduciary Out Required," the Court went out of its way to provide an alternative basis for the ruling:
The defensive measures that protected the merger transaction are unenforceable not only because they are preclusive and coercive but, alternatively, they are unenforceable because they are invalid as they operate in this case. Given the specifically enforceable irrevocable voting agreements, the provision in the merger agreement requiring the board to submit the transaction for a stockholder vote and the omission of a fiduciary out clause in the merger agreement completely prevented the board from discharging its fiduciary responsibilities to the minority stockholders when Omnicare presented its superior transaction.
The NCS board could not abdicate its fiduciary duties to the minority by leaving it to the stockholders alone to approve or disapprove the merger agreement because two stockholders had already combined to establish a majority of the voting power that made the outcome of the stockholder vote a foregone conclusion.
Omnicare was a divided decision, with three justices in the majority and two in dissent. And post-decision commentary has been almost universally critical. But it serves as a nice base of comparison with the Bear Stearns-JP Morgan transaction. Which board of directors was more faithful to its obligations: the board that allowed existing majority shareholders to commit themselves to a transaction that they viewed as favorable (Omnicare), or the board that is planning to issue stock to the acquiring company to make approval of the transaction over the objections of the existing shareholders much more likely (Bear Stearns)?
That is not intended to be a difficult question. Nevertheless, the lawyers have structured the Bear Stearns-JP Morgan transaction in a manner that elides the obvious pitfalls in Omnicare. That is, it is not technically a fait accompli, and the Acquisition Agreement contains a fiduciary out.
Whatever the result of that line of analysis, the plaintiffs in this initial motion are not limiting themselves to the coercive-or-preclusive standard (aka Unocal/Unitrin). They are also arguing that the "lock up stock sale is designed primarily, if not solely, to eviscerate the voting franchise of the current Bear Stearns stockholders." Sound familiar? This is language designed to invoke the dreaded Blasius "compelling justification" standard.
The Delaware Supreme Court has limited Blasius to cases involving a "contested election for directors" (MM Companies, Inc. v. Liquid Audio, Inc.), but Vice-Chanceller Strine seems to have a more expansive view of the standard, suggesting that it might be applied to any "vote touching on matters of corporate control." Mercier v. Inter-Tel (Delaware), Inc. (2007).
If Blasius applied in this case, the Bear Stearns board would be required to show a "compelling justification" for its actions. According to Strine, "When directors act for the purpose of preserving what the directors believe in good faith to be a value-maximizing offer, they act for a compelling reason in the corporate context."
Could the Bear Stearns board meet that standard? Almost certainly, since they agreed to the lock-up as part of a negotiation to quintuple the price of the deal. A deal that was brokered by the Fed at a time when the prospects of the company looked bleak, to put things charitably. They may not have acted courageously or with all of the skill Bear Stearns' shareholders might have wanted, but this doesn't look like bad faith.
UPDATE: Writing with the benefit of the actual filing, Steve Davidoff analyzes the plaintiffs' claims. Lots of interesting insights, though Steve got a bit carried away at the end:
Here’s one thought. Delaware recently announced a procedure for the Delaware Chancery Court to accept certified questions from the Securities and Exchange Commission. The Delaware court could use this principle to turn the tables and certify a question to the Fed (or even perhaps the S.E.C.) asking this question: "If the share issuance and other lock-ups are knocked out on the usual grounds, would it endanger the financial system and therefore they should still be validated." You can fiddle with the wording but you get the idea.
If the Fed is actually going to orchestrate this deal, they and the Bush administration should bear the responsibility for pushing it through without upending Delaware and its well-reasoned doctrine and rules of law.
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1. Posted by Lawrence Cunningham on March 26, 2008 @ 9:15 | Permalink
Another great post. To probe the fiduciary out point, the Omnicare merger agreement had an out from the no-shop (board could discuss potentially superior unsolicited proposals and did so after clarifying with friendly bidder that it could) but there was no fiduciary out from the commitment to submit the agreement to a shareholder vote.
The Bear-JP merger agreement has a wider fiduciary out from the no-shop and from the board recommending the deal, but does not have a fiduciary out from the commitment to submit the agreement to a shareholder vote. (Section 6.3 of Amended Merger Agreement.)
The mathematical possibility of a no-vote may save the Bear arrangement from being draconian, but the absence of a fiduciary out from the board’s commitment to submit remains a negative factor.
2. Posted by Gordon Smith on March 26, 2008 @ 9:56 | Permalink
Thanks, Larry. That is very helpful.
3. Posted by richard on March 26, 2008 @ 13:23 | Permalink
Delaware amended 251 to allow the board to submit merger proposals the board is no longer recommending, so that you can have a "force the vote" provision. I don't see the absence of "a fiduciary out from the commitment to submit the agreement to a shareholder vote" as a problem.
The deal is not absolutely locked. As such it passes Omnicare.
It may have Unocal problems, but I can't think of a Delaware case in which deal protection has been thrown out absent a higher bid.
4. Posted by Lawrence Cunningham on March 26, 2008 @ 17:47 | Permalink
Nice points. There is a difference between statutory authorization and contractual obligation, though, right?
5. Posted by Jake on March 26, 2008 @ 21:50 | Permalink
When Gordon delivers these erudite lectures on Delaware corporation law, I am reassured that I made the right choice in becoming a dumb old litigator of tax cases. I mean this quite sincerely.
6. Posted by ART BYRNE on March 27, 2008 @ 10:46 | Permalink
" issued insured deposits? holds insured deposits.
7. Posted by ART BYRNE on March 27, 2008 @ 10:46 | Permalink
" issued insured deposits? holds insured deposits.
8. Posted by Papou on April 4, 2008 @ 9:57 | Permalink
Ladies and Gentlemen:
Say all you want. The political powers are on the side of JPMorgan. The so called law does not make an iota of difference.