Since the controversial Delaware Supreme Court decision in Omnicare v. NCS Healthcare, Inc., 818 A.2d 914 (Del. 2003) (Omnicare), corporate practitioners have debated the extent to which a target board may permissibly employ deal protection devices to effectively "lock-up" a merger transaction without violating the principles of Omnicare. One deal structure utilized by practitioners and believed to be legally permissible in the wake of Omnicare was the so-called sign-and-consent structure in which stockholder approval of the merger agreement was obtained by written consent almost immediately after its execution, rather than through a vote at a stockholders' meeting several weeks to several months after execution of the merger agreement. In the recent Court of Chancery decision in In re OPENLANE, Inc. S'holders Litig., 2011 WL 4599662 (Del. Ch. Sept. 30, 2011) (OPENLANE), the court confirms that the sign- and-consent structure does not violate Omnicare. In addition, the court held that the OPENLANE board conducted an adequate sales process in compliance with its Revlon duties to obtain the best value reasonably attainable for its stockholders despite failing to implement traditional value maximizing tools, such as conducting an auction or negotiating for a "go-shop" provision, due, in large part, to the board's "impeccable knowledge" of the company's business.
The Delaware Supreme Court's 2003 decision in Omnicare involved a rare 3-2 split of the supreme court, with the majority holding that the directors of NCS Healthcare breached their fiduciary duties by agreeing to terms with Genesis Health Ventures that completely locked-up the deal through a combination of three components. First, the merger agreement contained a "force-the-vote" provision, which required the board to submit the merger agreement with Genesis to the NCS shareholders for a vote regardless of whether the NCS board continued to recommend the transaction. Second, the merger agreement did not include a fiduciary-out clause that would allow the NCS board to terminate the merger agreement in the event of receipt of a superior proposal by a third party. And third, two stockholders of NCS (who were also officers and directors of the company), who together held a majority of the outstanding voting power of NCS, entered into a voting agreement in which they irrevocably agreed to vote in favor of the transaction at a later stockholders meeting. After announcement of execution of the NCS-Genesis merger agreement, but before stockholder approval of the merger, Omnicare submitted a superior unconditional offer to NCS.
The Delaware Supreme Court ultimately determined that the actions of the NCS board in adopting the aforementioned deal protections should be reviewed under the enhanced judicial scrutiny standards set forth in Unocal Corp. v. Mesa Petroleum Co., 493 A.2d 946 (Del. 1985) (Unocal), which requires a board to demonstrate that (1) it had reasonable grounds for believing a danger to corporate policy and effectiveness existed and (2) its defensive response was reasonable in relation to the threat posed. In holding that the deal protections violated the requirements set forth inUnocal, the court concluded that the structure collectively constituted a coercive and preclusive defensive device that rendered the merger a " fait accompli" in that the arrangements made it "mathematically impossible" and "realistically unattainable" for any other proposal to succeed. Further, the court noted that the NCS board was required to negotiate for an effective fiduciary-out in light of their continued fiduciary responsibilities to the minority stockholders of the company prior to stockholder approval of the transaction. The court's concern did not derive from any of the deal protection measures individually, but rather from the absolute lock-up created by the combination of the force-the-vote provision, the irrevocable voting agreement and the lack of a fiduciary-out, collectively.
The dissent in Omnicare fervently advocated for a narrow interpretation of the majority holding, and most academics and practitioners, who thereafter commented on the decision agreed. Although never readdressed by the Delaware Supreme Court, more recent Court of Chancery decisions have lead many to question the continued vitality of Omnicare. This view emerged, in particular, after a transcript ruling in Optima Int'l of Miami, Inc. v. WCI Steel, Inc., C.A. No. 3833-VCL (Del. Ch. June 27, 2008) (Optima), where then Vice Chancellor Lamb approved a merger in which directors signed the merger agreement and stockholders approved the merger by written consent the next day. Thus, the transaction at issue in Optima did not involve circumstances similar to those in Omnicare, in which there was a significant period of time between board approval and the stockholder vote where the board was powerless to terminate the transaction prior to the stockholder vote, or to give stockholders a meaningful opportunity to vote against the transaction after a change of board recommendation, once a superior proposal emerged. The court distinguished stockholder approval by written consent from the lock-up present in Omnicare and explained that nothing in the Delaware General Corporation Law (DGCL) mandates a particular time between the board's authorization of a merger agreement and the subsequent stockholder approval. Notably, the court found the fact that the Optima merger agreement permitted termination of the transaction if the requisite consents were not obtained to be an important factor in its decision. With that in mind, the court upheld the stockholder approval by written consent and stated that the stockholders acted in accordance with the statute by submitting their consents after the board signed the merger agreement.
Background of the OPENLANE-KAR Merger
OPENLANE involved a stockholder class action seeking to enjoin a proposed merger of OPENLANE with and into a wholly-owned subsidiary of KAR Auction Services, Inc. (KAR). The OPENLANE board consisted of eight directors, including the CEO and affiliates of two private equity investors in the company. The directors (or their affiliated stockholders) held or controlled beneficial ownership of approximately 60 percent of OPENLANE's outstanding capital stock.
In anticipation of a significant decline in business, the board engaged a financial advisor to assist in selling the company. The financial advisor identified numerous potential financial and strategic acquirers, but the board limited its market check to three strategic buyers. The board ultimately settled on KAR and signed a merger agreement. The merger agreement required OPENLANE to obtain stockholder approval (through written consents) within 24 hours of execution of the agreement. Specifically, under Delaware law and the OPENLANE charter, the adoption of the merger agreement required the written consent of the holders of (1) a majority of the outstanding preferred stock of the company (voting together as a single class on an as converted to common stock basis) and (2) a majority of the outstanding capital stock of the company (voting together as a single class on an as converted to common stock basis)(together, the "Majority Consent"). If the Majority Consent was not obtained within 24 hours after the board executed the merger agreement, OPENLANE or KAR could terminate the agreement without paying a termination fee. The merger agreement also contained a condition to closing, which was waivable by KAR, requiring that holders of at least 75 percent of OPENLANE's outstanding shares (voting together as a single class on an as converted to common stock basis) execute and deliver written consents approving the merger. The board also agreed to a no-solicitation clause with no fiduciary-out and an escrow agreement that would hold part of the merger consideration for over a year to protect KAR from certain contingencies. Within 24 hours of the execution of the merger agreement, OPENLANE received written consents from the holders of a majority of OPENLANE's shares sufficient to approve the merger. Shortly thereafter, the 75 percent consent condition was also satisfied.
Sign-and-Consent Structure Confirmed
Consistent with the holding in Optima, the Court of Chancery in OPENLANE also concluded that the sign-and-consent structure did not violate Omnicare. In applying Unocal and distinguishing the transaction in OPENLANE from the transaction in Omnicare, the court determined that the OPENLANE-KAR merger was not a fait accompli. Unlike in Omnicare, where stockholder voting agreements were coupled with a merger agreement that lacked a fiduciary-out permitting the board to terminate the merger agreement for a superior proposal, the no-solicitation clause in the OPENLANE merger agreement appeared reasonable to the court because the board could terminate the merger agreement if the company's stockholders did not consent to the merger within 24 hours after execution. Thus, according to the court, the no-solicitation clause, which was the one defensive device employed by the OPENLANE board, was of "little moment" because the board could back out of the deal if the consents were not obtained in a timely manner. Further, the court rejected the argument that the combined voting power of OPENLANE's directors and executive officers constituted a defensive device that impermissibly locked-up the stockholder approval. Rather, the court found that the record suggested that there was no voting agreement and that nothing in the DGCL prevents stockholders from submitting their written consent to a merger soon after board approval. In light of the foregoing, the court determined that the merger agreement did not force a transaction on stockholders or "deprive them of the right to receive alternative offers" and characterized the transaction as "a matter of majority rule by shareholders who were under no obligation to act in any particular way."
Although certain commentators have characterized the OPENLANE decision as another step toward burying Omnicare, the decision is consistent with Omnicare. Omnicare cautioned against completely locking up a deal for directors and stockholders before the time to vote. Omnicare involved a situation in which neither the board of directors nor the stockholders could accept or consider a superior proposal before the stockholder vote, and it was contractually impossible for the board to back out of the merger, even before the stockholder vote. Irrevocably locking-up a merger before stockholders have an opportunity to vote regardless of receipt of a superior proposal arguably continues to remain impermissible under Unocal and the principles of Omnicare. OPENLANE did not change that; rather, it illustrates an acceptable merger approval process where stockholders merely submit their consent after the board signs the merger agreement, thereby satisfying the statutory requirement of stockholder approval. Whether those stockholders decide how they will vote before submitting their consent is of no consequence, as long as they can freely exercise their ability to give their written consent when the time for stockholder approval arises. This protects the stockholders' right to receive alternative offers before they approve the merger and falls in accordance with longstanding Delaware case law.
Despite the holding in OPENLANE, in determining to utilize the sign-and-consent structure and facilitating swift stockholder approval of the transaction, a target board should be confident that other superior offers do not exist or its decision to implement the sign-and-consent structure may nevertheless give rise to a breach of the board's fiduciary duties under Revlon, Inc. v. MacAndrews & Forbes Holdings, Inc., 506 A.2d 173 (Del. 1986) (Revlon) despite not being a violation under Omnicare.
The Benefits of Impeccable Knowledge
The OPENLANE decision also sheds light on factors the court may consider when analyzing directors' compliance with their fiduciary duties under Revlon to secure the best value reasonably attainable in a change of control transaction. Plaintiffs asserted that the OPENLANE board failed to undertake an adequate sales process in violation of Revlon by only contacting three potential acquirers, failing to perform an adequate market check, not obtaining a fairness opinion, and relying on scant financial information. After reiterating the courts' past proclamations that a board is not bound to a single path in order to maximize shareholder value, but instead must follow a path of reasonableness leading toward that end, the court stated that "if a board fails to employ any traditional value maximization tool, such as an auction, a broad market check, or a go-shop provision, that board must possess an impeccable knowledge of the company's business for the Court to determine that it acted reasonably."
The court determined that "[a]lthough the Board's decision-making process was not a model to be followed," there was a reasonable likelihood that at trial the board would be able to demonstrate an adequate decision-making process. The court supported this determination by emphasizing the board's yearlong-targeted-market check, serious pursuit of transactions with two legitimate strategic buyers, receipt of data on the company's value from a financial adviser, and the potential decline in business that the company faced. Most importantly, the court found that OPENLANE was "one of those seemingly few corporations that is actually 'managed by' as opposed to 'under the direction of' its board of directors" and "one of those few boards that possess an impeccable knowledge of the company's business." In light of this impeccable knowledge, the court accepted the board's argument that it failed to pursue financial buyers because it knew financial buyers had no interest in OPENLANE, giving considerable weight to the fact that two directors were affiliated with private equity firms and would likely have known whether the company would be of interest to a financial buyer.
With respect to the reasonableness of the board's actions in determining not to conduct an extensive market check or obtain a fairness opinion, the court noted that OPENLANE was a small public company and stated that while that fact does not alter the board's core fiduciary duties, "[w]here, however, a small company is managed by a board with impeccable knowledge of the company's business, the court may consider the size of the company in determining what is reasonable and appropriate." In addition, the court found the fact that the board and the current officers of the company held over 68 percent of the company's outstanding capital stock to be a "circumstance" of the merger suggesting that the directors would be motivated to get the best price reasonably available.
Although practitioners may be tempted to read the OPENLANE decision as providing a free pass to OPENLANE's board in terms of an adequate process under Revlon merely because they had "impeccable knowledge" of the company's business, the decision does not appear to be that broad. In fact, the court points to several factors that lead to the conclusion that the board undertook an adequate decision-making process (e.g., yearlong-targeted-market check, serious pursuit of alternative transactions, seeking and receiving advice from a financial advisor, and the anticipated decline in company business). Vice Chancellor Noble focused on the board's knowledge in order to explain away plaintiffs' contention that the board's failure to pursue financial buyers was unreasonable. In other circumstances, a failure on the part of a target board to pursue either financial or strategic buyers may not be viewed by the court as being a reasonable decision under Revlon (as in In re Netsmart Tech. Inc. Shareholders Litig., 924 A.2d 171, (Del. Ch. 2007)). Thus, having a small company with an extremely knowledgeable board is merely one factor of many considered by the court when determining if directors acted reasonably.
Escrow Agreements Do Not Violate Mandatory Standard
Finally, it bears noting that the court also determined that the inclusion of the escrow agreement as part of the overall OPENLANE-KAR transaction structure did not violate any "mandatory standard" under Delaware law. The OPENLANE merger agreement contemplated an escrow arrangement pursuant to which $26 million of the merger consideration would be held in escrow for at least 18 months to provide KAR with protection from numerous contingencies, such as its indemnification obligations to the members of the OPENLANE board and successful appraisal proceedings. The court further stated that although the escrow agreement exposed the deal price to risk, it was proper under the circumstances because it was part of the transaction, fairly disclosed to shareholders, and within the board's decision-making authority. The decision, however, does not contain any detail regarding the mechanics of the escrow agreement itself or otherwise go into any sort of extensive analysis regarding escrows generally so the extent to which the OPENLANE decision will provide precedential value if the specifics of an escrow arrangement are challenged is uncertain.
From a practitioner's perspective, the OPENLANE decision is important because it confirms that a sign-and-consent transaction structure does not violate the principles of Omnicare. The decision also sheds light on the impact that company size and the board's intimate knowledge of a company's business may have upon a court's review of a target board's actions in a change of control transaction. The court's insights with respect to each of the foregoing provides helpful guidance to companies attempting to consummate a merger successfully, validly, and in accordance with Delaware law.