We have had a few things to say about Chancellor Allen's well-known Caremark decision, but this post is about the new Caremark case, which is called Louisiana Municipal Police Employee Retirement System v. Crawford. If you are too busy to read the case, you might want to try the summary and critique from the Delaware law firm, Potter Andersen & Caroon.

Crawford involves the proposed "merger of equals" of Caremark and CVS. According to Chancellor Chandler, "Neither party would receive a premium. The board of directors would be evenly split between Caremark and CVS shareholders, and management positions would be divided between the two companies."

Unfortunately for the betrothed companies, Express Scripts wants to disrupt the union and has made an unsolicited offer for Caremark's shares. Express Scripts's offer values Caremark at about $26 billion -- more than $3 billion higher than the CVS merger valuation. Of course, the deals are not identical, and the CVS merger had some advantages, including the fact that it had received HSR clearance.

CVS responded to the Express Scripts' offer by proposing a modification of the merger agreement, which would allow Caremark to declare a special $2.00 dividend to be paid either at the time of or immediately after the merger. The Caremark board endorsed the amended merger agreement. Caremark and Express Scripts then proceeded to wage a proxy contest over their respective plans.

While the proxy contest was pending, CVS and Caremark agreed to increase the special dividend from $2.00 to $6.00 per share. That special dividend lies at the heart of the most interesting aspect of the opinion.

The plaintiffs in this case sued for an injunction, arguing that Caremark's board of directors breached their fiduciary duty of disclosure. Chancellor Chandler's opinion addresses each of the plaintiffs' disclosure claims, concluding that most of the disclosure defects were not material. Nevertheless, Chancellor Chandler enjoined the vote of the Caremark stockholders so that the Caremark's board of directors could "properly disclose to shareholders (a) their right to seek appraisal and (b) the structure of fees paid to Caremark’s bankers."

That may not seem very interesting, but embedded in the first part of that ruling is the judge's conclusion that the special dividend was part of the merger consideration to Caremark's stockholders. (Only if the special dividend were considered part of the merger consideration would the Caremark stockholders have appraisal rights. Otherwise, this stock-for-stock merger would be subject to the "market out" provisions of Section 262 of the DGCL.) According to Chancellor Chandler:

Plaintiffs contend the $6 special cash dividend triggers appraisal rights under 8 Del. C. § 262. Defendants respond that the special dividend has been approved and will be payable by Caremark and, thus, has independent legal significance preventing it from being recognized as merger consideration. Thus, according to defendants, dissenting Caremark shareholders will have no appraisal rights after the CVS/Caremark merger.

Section 262 of the DGCL grants appraisal rights to stockholders who are required, by the terms of the merger, to accept any consideration other than shares of stock in the surviving company, shares of stock listed on a national securities exchange, or cash received as payment for fractional shares. The $6 "special dividend," although issued by the Caremark board, is fundamentally cash consideration paid to Caremark shareholders on behalf of CVS.

Defendants are unsuccessful in their efforts to cloak this cash payment as a "special dividend." ... [D]efendants specifically condition payment of the $6 cash "special dividend" on shareholder approval of the merger agreement. Additionally, the payment becomes due upon or even after the effective time of the merger. These facts belie the claim that the special dividend has legal significance independent of the merger. CVS, by terms of the CVS/Caremark merger agreement, controls the value of the dividend. Defendants even warn in their public disclosures that the special cash dividend might be treated as merger consideration for tax purposes. In this case, the label "special dividend" is simply cash consideration dressed up in a none-too-convincing disguise. When merger consideration includes partial cash and stock payments, shareholders are entitled to appraisal rights. So long as payment of the special dividend remains conditioned upon shareholder approval of the merger, Caremark shareholders should not be denied their appraisal rights simply because their directors are willing to collude with a favored bidder to "launder" a cash payment. As Caremark failed to inform shareholders of their appraisal rights, the meeting must be enjoined for at least the statutorily required notice period of twenty days.

According to the lawyers at Potter Andersen & Caroon, "The Court’s ruling is a surprise to many practitioners and seems contrary to the well-settled Delaware corporate law doctrine of independent legal significance." They also assert that the decision was "startling to some practitioners."

Here are a few thoughts on this aspect of the decision. First, if you are interested in the doctrine of independent legal significance -- and who wouldn't be? -- you might check out my article on the subject, which you can download here.

Second, if you read that article, you will note that the doctrine has been used in only a few contexts. The most common is the "de facto merger," a concept that the doctrine of independent legal significance rejects by maintaining the distinction between a sale of assets and a merger. The doctrine also has been used to maintain the distinction between an amendment of the corporate charter and a merger. But I am reasonably certain that the doctrine of independent legal significance has never been used in a context like the one proposed in Crawford. (I did a quick check of Westlaw and didn't find anything close, but I can't claim to have done a thorough job of it.)

Third, what prevents a dividend from being treated as merger consideration? The defendants argue that the doctrine of independent legal significance should require the $6 payment to be treated as a dividend, not as merger consideration, but nothing in Section 262 of the DGCL precludes a "dividend" from being part of the merger consideration. So when Chancellor Chandler writes that the dividend was "fundamentally cash consideration," we could understand him to be saying that the payment is both a dividend (in form) and merger consideration (in substance).

The important point is that the doctrine of independent legal significance only matters when two characterizations of a transaction are mutually exclusive. A merger and a sale of assets are mutually exclusive because the statute provides different rights with respect to the two transactions, and the same goes for a chater amendment and a merger. Stated another way, the two transactions have different implications. But this is not true for a dividend and merger consideration. The $6 payment could be both.

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