January 31, 2013

DELAWARE INSIDER: "Don't Ask, Don't Waive" Standstill Provisions: Impermissible Limitation on Director Fiduciary Obligations or Legitimate, Value-Maximizing Tool?

Under Revlon and its progeny, directors of Delaware corporations have a duty to take reasonable steps to ensure that stockholders receive the highest price reasonably available in a sale of the company. One way that target boards ensure such value maximization is by conducting an auction or sales process and requiring potential bidders to enter into confidentiality agreements with standstill provisions before providing them access to confidential information or allowing them to participate in the process. Generally, such standstill agreements protect confidential information, promote an orderly auction, prevent unsolicited acquisition attempts, and provide target companies leverage to extract concessions from bidders. In structured public company auctions, such standstill agreements often include provisions that (1) prohibit the bidder from making an offer for the company without an express invitation from the company's board of directors, and (2) preclude the bidder from publicly and/or privately asking the board of directors to waive the foregoing restriction. The inclusion of such provisions in standstill agreements, colloquially referred to as "Don't Ask, Don't Waive" provisions, is designed to extract the highest possible offer from the bidder because the bidder only has one opportunity to make an offer for the company unless the company invites the bidder to make another offer sua sponte. Notably, however, bidders who do not execute standstill agreements with "Don't Ask, Don't Waive" provisions are not precluded from submitting multiple offers for the company, even after a winning bidder emerges from an auction.

Several recent court rulings and decisions by the Delaware Court of Chancery have prompted discussion regarding the continued validity of "Don't Ask, Don't Waive" standstill provisions under Delaware law. Challengers of such standstill provisions argue that a board's use of these restrictive provisions constitutes a breach of the duty of care, duty of disclosure, and value-maximizing Revlon duties. Such arguments are premised largely upon the differences between a public company auction and a traditional auction. While the latter ends definitively at the drop of the gavel, the former effectively continues until an affirmative stockholder vote on the proposed sale transaction. Because the sales process continues even after the auction "concludes," challengers of "Don't Ask, Don't Waive" provisions contend that by prohibiting receipt and consideration of unsolicited offers from losing bidders who would otherwise make topping bids, such provisions impermissibly limit directors' ongoing fiduciary obligations to evaluate competing offers fully, disclose all material information to stockholders, and provide stockholders with a current, candid, and meaningful recommendation at the time of the stockholder vote to approve the proposed transaction.

Proponents of "Don't Ask, Don't Waive" standstill agreements contend that such agreements serve a legitimate, value-maximizing purpose consistent with directors' fiduciary duties. In their view, fully informed directors can maximize stockholder value in an auction by utilizing these provisions to replicate a traditional auction and extract the highest offer from bidders. By creating a contractual definitive end to the auction, proponents argue that such provisions ensure that bidders submit their best offer, because they know the auction constitutes their only chance to make an offer for the company, and because they are less concerned that the winning party in the auction will be used as a stalking horse for other bidders.

Due to arguably conflicting rulings in the Delaware Court of Chancery, the validity of "Don't Ask, Don't Waive" standstill provisions currently is unclear under Delaware law. Given this uncertainty, practitioners who advise Delaware corporations should fully evaluate whether in a particular transaction such provisions are appropriate and reasonably designed to achieve value-maximization at the auction stage and, if utilized, consider whether at the latter stages of the transaction such provisions potentially could preclude directors and stockholders from being fully informed and fulfilling their fiduciary obligations.

Judicial Views of "Don't Ask, Don't Waive" Provisions

The Delaware Court of Chancery recognized the legitimacy of "Don't Ask, Don't Waive" provisions in In re Topps Co. Shareholders Litigation, 926 A.2d 58 (Del. Ch. 2007). In Topps, then-Vice Chancellor, now-Chancellor, Strine enjoined a stockholder vote on a merger until the target waived a standstill agreement that its board had improperly employed. The Topps board had refused to waive the restrictions in a standstill agreement it had entered into with rival competitor Upper Deck in order to permit Upper Deck to make a tender offer on the same terms it had offered to the board and to communicate with Topps stockholders in connection with the vote on the proposed transaction the board had entered into with a private equity investor. The Vice Chancellor held that these facts provided powerful evidence that the Topps board was misusing the standstill agreement solely in order to deny its stockholders the opportunity to accept an arguably more attractive deal and to preclude them from receiving additional information about Upper Deck's version of events.

Despite the ruling, the court acknowledged that standstill agreements can have legitimate purposes, including, for example, in the final round of an auction where a board of directors in good faith seeks to extract the last dollar from the remaining bidders. The court explained that in such circumstances the board could set a bid deadline and promise that the target will not waive the standstill agreements as to the losing bidders. Topps, 926 A.2d at 91 & n.28.

Subsequent Court of Chancery decisions, however, have called into question the validity of "Don't Ask, Don't Waive" provisions. For example, in a 2011 settlement hearing, Vice Chancellor Laster questioned whether "Don't Ask, Don't Waive" provisions in standstill agreements could withstand judicial scrutiny. The Vice Chancellor expressed his doubts that such provisions would ever hold up if actually litigated after Topps because their use "optically looks bad" when the court reviews the terms of the transaction. In addition, the court questioned the ultimate benefit of such provisions in light of the ability of a losing bidder to "get a Topps ruling" or ask the target board "in a back channel way" if it may make a competing offer. See In re RehabCare Grp., Inc. S'holders Litig., C.A. No. 6197-VCL, at 38 (Del. Ch. Sept. 8, 2011) (Transcript).

More recently, Vice Chancellor Parsons commented on the use of "Don't Ask, Don't Waive" provisions in In re Celera Corp. Shareholder Litigation, C.A. No. 6304-VCP (Del. Ch. Mar. 23 2012) (Transcript), aff'd in part rev'd in part on other grounds, 2012 WL 6707746 (Del. Dec. 27, 2012). In Celera, the court considered the waiver of "Don't Ask, Don't Waive" provisions in connection with his evaluation of the proposed settlement of an action challenging a merger. Noting that his analysis should not be read to suggest that such restrictive provisions are per se invalid, Vice Chancellor Parsons held that although in isolation the "Don't Ask, Don't Waive" provisions arguably fostered the legitimate objectives set forth in Topps, when viewed with the no-solicitation provision in the merger agreement, a colorable argument existed that the collective effect created an informational vacuum, increased the risk that directors would lack adequate information, and constituted a breach of fiduciary duty.

In reaching this decision, the court emphasized that the "Don't Ask, Don't Waive" standstill provisions blocked certain bidders from notifying the board of directors of their willingness to bid, while the no-solicitation provision in the merger agreement contemporaneously blocked the board of directors from inquiring further into those parties' interests. The court stated that the information vacuum created by such restrictions imposed by the "Don't Ask, Don't Waive" standstill provision and the no-solicitation provision diminished the benefits of the board's fiduciary-out in the no-solicitation provision and created the possibility that the board would lack the information necessary to determine whether continued compliance with the merger agreement would violate its fiduciary duty to consider superior offers. The court noted that contracting into such a state could conceivably constitute a breach of fiduciary duty.

Vice Chancellor Laster took a similar view in In re Complete Genomics, Inc. S'holder Litig., C.A. No. 7888-VCL (Del Ch. Nov. 27, 2012) (Transcript), decided last fall. In Genomics, Vice Chancellor Laster analogized a "Don't Ask, Don't Waive" standstill provision to a "bidder-specific no-talk clause," finding that no-talk clauses and "Don't Ask, Don't Waive" standstill provisions suffered from the same disabling effects. In so doing, the Vice Chancellor reviewed long-standing Delaware precedent discussing how no-talk clauses can compromise a target board's ongoing obligation to remain informed and noting that "directors cannot willfully blind themselves to opportunities that are presented to them...." (referencing Phelps Dodge Corp. v. Cyprus Amax Minerals Corp., 1999 WL 1054244, at *2 (Del. Ch. Sept. 27, 1999)). He explained that a board of directors has an ongoing statutory and fiduciary obligation with respect to the merger recommendation and such standstill provisions interfere with the board of directors' ability to determine whether to change its recommendation, "because they absolutely preclude the flow of information to the board." Vice Chancellor Laster ultimately enjoined the "Don't Ask, Don't Waive" standstill provision at issue and concluded that such provisions prohibit incoming information from bidders under any circumstances and constitute an impermissible limitation on a board of directors' "ongoing statutory and fiduciary obligations to properly evaluate a competing offer, disclose material information, and make meaningful merger recommendation to its stockholders." This arguably constitutes the most strident view to date against the validity of such provisions.

Notwithstanding the Vice Chancellor's decision in Genomics, it appears that certain types of "Don't Ask, Don't Waive" standstill agreements are less troubling to the Vice Chancellor than others. "Don't Ask, Don't Waive" standstill agreements such as the one at issue in Celera purport to forbid a counterparty from ever asking for a waiver. Other "Don't Ask, Don't Waive" standstill agreements, however, only prevent signatories from publicly requesting or proposing that the company waive the standstill, but allow the counterparty to make non-public requests. Based on his ruling in Genomics, it seems that Vice Chancellor Laster finds the latter form of standstill agreements less troubling than the former form. Chancellor Strine, however, has raised issues with this public/private distinction, focusing on the need to disclose the existence of such waiver requests in the company's proxy disclosures. See In re Ancestry.com, Inc. S'holder Litig., C.A. No. 7988-CS, at 69, 156 (Del. Ch. Dec. 17, 2012).

Most recently, Chancellor Strine expressed the view that "Don't Ask, Don't Waive" provisions are not per se invalid. See In re Ancestry.com, Inc. S'holder Litig., C.A. No. 7988-CS (Del. Ch. Dec. 17, 2012). Chancellor Strine explained that a well-motivated seller could use the provisions in a public company auction as a gavel to run an effective process and incentivize bidders to submit their best bid. Chancellor Strine held, however, that the particular facts of the Ancestry.com case did not evidence the use of the provisions as legitimate, value-maximizing tools because the target's directors were unaware of the provisions, the winning bidder was not assigned the standstills, and the directors failed to waive the "don't ask" clause for losing bidders. Chancellor Strine criticized the target's failure to disclose the existence of the "Don't Ask, Don't Waive" standstill agreements, their purpose (i.e., value maximization) and effect, and the directors' decision not to waive the "don't ask" clause despite not assigning the standstills to the winning bidder, and he enjoined the stockholder meeting until supplemental disclosures were made by the company.

Chancellor Strine emphasized that determining the validity of these provisions is contextual. The Chancellor's ruling in Ancestry.com suggests that for directors to utilize these agreements consistently with their fiduciary duties, they must at least: (1) be fully informed and determine that utilizing the provisions constitutes the best way to maximize stockholder value, (2) inform stockholders of the provisions' purposes and effects, and (3) allow the winner to enforce the provisions, or if not, waive the "don't ask" clauses for the losing bidders.

Suggest Limited Utilization of "Don't Ask, Don't Waive" Provisions

Until the Supreme Court of Delaware has occasion to review the validity of "Don't Ask, Don't Waive" provisions, practitioners who advise the boards of Delaware corporations should exercise caution in using such provisions. In advising clients, practitioners must seek to ensure that, if employed, such provisions actually will serve legitimate, value-maximizing purposes consistent with the directors' fiduciary duties. In accordance with the Chancellor's decision in Ancestry.com, if directors choose to utilize these provisions, they should only do so in limited circumstances where (1) the clear purpose of the provision is to attempt to maximize stockholder value, (2) directors are fully informed about and understand the provisions, (3) stockholders are fully informed about the provisions, (4) bidders are informed of the provisions' value-maximizing purpose and incentivized with assignment of the standstills if they emerge as the winning bidder, and (5) if the company does not assign the standstills to the winning bidder, the directors should waive the "don't ask" clauses for the losing bidders and inform the stockholders in the proxy statement.

Moreover, practitioners who advise Delaware companies should review and evaluate any "Don't Ask, Don't Waive" standstill provisions that exist when negotiating the terms of a merger agreement with the winning bidder of the auction. This consideration is important because the combination of the standstill and a no-solicitation provision (or similarly restrictive deal protection) could create a circumstance where the board would lack the information necessary to determine whether continued compliance with the terms of the merger agreement would violate its fiduciary duty to consider superior offers. As Vice Chancellor Parsons noted in Celera, the creation of such a circumstance could constitute a breach of the directors' fiduciary duties.