December 03, 2019

MONTH-IN-BRIEF: Mergers & Acquisitions

Ryan Thomas, Chauncey Lane

M&A Law

Delaware Supreme Court Affirms Ruling Refusing to Unwind $170 Million Merger

By Mary Lindsey Hannahan

On November 18, 2019, the Delaware Supreme Court (the “Court”) affirmed a Delaware Chancery Court ruling and refused to void the merger between Design Within Reach, Inc., a furniture retailer (“DWR”), and Herman Miller, Inc., a manufacturer of furniture (“Herman Miller”). The Court rejected the DWR stockholders’ claim that they received less merger consideration than they were entitled to due to invalid stock transactions that came to light post-merger.

This suit arose out of the acquisition of DWR by Herman Miller for roughly $170 million in July 2014. After the merger, a pre-merger defective stock split came to light that diluted the number of shares of DWR common stock into which the Series A preferred stock could be converted by a factor of 2,500-to-1, instead of the intended 50-to-1. This mistake was unknown when DWR’s Series A stock was converted to common stock prior to the merger and when the merger closed in 2014.

Two stockholders that brought suit after the merger asserted that the merger was void due to the defect. Pursuant to Delaware corporate law, Herman Miller then ratified the defective corporate acts relating to the mistaken reverse stock split and conversion of the Series A preferred stock, and asked the court to validate those acts. The Chancery Court judicially validated Herman Miller’s corrective actions and found that the stockholders lacked standing to bring claims that DWR’s directors breached their fiduciary duties and profited from overpayment prior to the merger, reasoning that those claims were derivative in nature and thus the merger extinguished the stockholders’ standing to maintain a derivative suit.

Attorneys’ Fees for First-Party Claims Not Provided for under Viacom Indemnification Provision

By John Adgent

On November 6, 2019, the Delaware Superior Court (the “Court”) granted Defendant Viacom International Inc.’s (“Viacom”) Motion for Reargument regarding the interpretation of the indemnification provision of its 2006 merger agreement with Harmonix Music Systems (“Harmonix”). Former Harmonix stockholders brought the action for breach of the merger agreement and sought indemnification for the losses incurred. The plaintiffs claimed that the indemnification provision implicitly provided for the reimbursement of attorneys’ fees and expenses on first-party claims between the parties.

The provision at issue provided:

(a) Indemnification. Subject to the limitations set forth in this Article VIII, from and after the Effective Time, each of Parent [Viacom] and MergerCo, jointly and severally, shall indemnify, defend and hold harmless each Merger Consideration Recipient [Stockholders’ Representative and Plaintiff Stockholders] against any and all Losses actually incurred or suffered by any such Merger Consideration Recipient as a result of:

(i) the breach of any representation or warranty of Parent or MergerCo set forth in this Agreement or in any Ancillary Document; and

(ii) the breach of any covenant or agreement of Parent or MergerCo contained in this Agreement or in any Ancillary Document.

(b) Certain Limitations. Parent and MergerCo shall not be obligated to indemnify any Merger Consideration Recipient pursuant to Section 8.6(a) to the extent the aggregate amount of all indemnifiable Losses exceeds the aggregate unpaid amount of the Merger Consideration then payable.

From the outset, the Court noted the general “American Rule” of awarding attorneys’ fees applies in Delaware, and parties are responsible for their own attorneys’ fees unless the parties shift fees to another party through a clear, unequivocal contractual provision. Additionally, the Court reiterated that there is a presumption that the term “indemnify” in indemnification provisions applies to third-party claims, not first-party claims. A contrary presumption would permit standard indemnification provisions to “swallow” the American Rule. As a result, an indemnification provision must unequivocally state that it applies to suits between the parties to apply to first-party claims.

Based on these principles, the Court found that the indemnification provision did not provide for attorneys’ fees related to first-party claims. First, there was no explicit language that the provision applied to the reimbursement of attorneys’ fees and expenses on first-party claims between parties. Instead, the indemnification provision applied only to third-party claims brought against the parties relating to indemnifiable Losses, as defined in the merger agreement to include “reasonable attorney’s fees and expenses.” Moreover, the Court considered that the parties’ sophisticated counsel knew how to draft a general indemnification and fee shifting provision under Delaware law. Therefore, the language of the provision did not reflect an intention to shift fees to another party.

Delaware Chancery Court Rejects Proposed Expansion to Stockholders’ Inspection Rights

By John Adgent

On November 14, 2019, the Delaware Chancery Court (the “Court”) declined to recognize a proposed rule that would expand stockholders’ rights to inspect books and records under Section 220 of the Delaware General Corporation Law (the “DGCL”). Plaintiff stockholders sent a demand letter to Occidental Petroleum Corporation, a company engaged in hydrocarbon exploration and petrochemical manufacturing (“Occidental”), on May 21, 2019, to inspect books and records related to Occidental’s merger with Anadarko Petroleum Corporation. Two days later, Plaintiffs filed an action under Section 220 of the DGCL to inspect the same documents requested in the demand letter.

In that action, Plaintiffs admitted that their primary purpose for demanding to inspect the books and records was to aid them in their proxy contest to replace members of Occidental’s board of directors with a new slate of directors they proposed to Occidental’s stockholders. Accordingly, Plaintiffs asked the Court to adopt a new rule entitling a stockholder to inspect books and records relating to targeted, board-level business decisions that are questionable, but not actionable, when the stockholder states and then demonstrates that his or her purpose is to communicate with other stockholders in furtherance of a potential, bona fide proxy contest.

In rejecting the proposed rule, the Court conceded that Section 220 of the DGCL is an important part of the corporate governance landscape that is unsettled and in need of clarity. However, the Court found this was not the “right case” to provide that clarity. Instead, the Court concluded that where, as here, the documents sought by Plaintiffs relate to a dispute with management about substantive business decisions, pleading an imminent proxy contest is not enough to earn access to broad sets of books and records relating to the details of questionable transactions, particularly when the board’s decision-making is subject to the business judgment rule, and the facts of record reveal that Plaintiffs already have what they need to fulfill their stated purpose. Nevertheless, the Court left open the possibility of endorsing such a rule in a different set of facts that presents the “right case.”

Delaware Supreme Court Affirms Dismissal of Investor Suit Because Business Judgment Review Applies, Not Entire Fairness

By Whitney Robinson

On November 1, the Delaware Supreme Court affirmed the Delaware Chancery Court’s March 2019 judgment dismissing the plaintiffs’ two claims in English et al. v. Narang et al. for failure to state a claim for relief. The plaintiffs, two former stockholders of NCI, Inc. (“NCI”), a technology services company focusing on technology systems, network engineering, system development and enterprise systems management services, initiated this action following a tender offer and merger of the company in 2017.

The transaction that sparked the suit arose after an extensive bidding process with multiple potential buyers, and ended with a signed merger agreement with H.I.G. Capital, LLC, a private equity company (“H.I.G.”). The deal was structured so that H.I.G., through its affiliates Cloud Intermediate Holdings, LLC and Cloud Merger Sub, Inc., would acquire NCI’s outstanding common stock for $20 a share and then follow with a merger. Importantly, NCI board member and former CEO, Charles Narang owned 34% of NCI’s shares and was the largest stockholder. The NCI stockholders tendered about 82% of the total shares outstanding through the tender offer, and the merger closed in August 2017. In March 2018, the plaintiffs filed this action, alleging, in Count I, a breach of fiduciary duties by the NCI board and, in Count II, a claim of aiding and abetting against H.I.G.

The Supreme Court agreed that the plaintiffs failed to state a claim against the board for a breach of fiduciary duties because the transaction was subject to business judgment review under Corwin v. KKR Financial Holding LLC. The plaintiffs asserted that the stricter entire fairness standard applied because the deal was a conflicted transaction, one Narang orchestrated because of his need for liquidity based on his large stake in NCI, and because stockholders were not fully informed about the deal due to deficiencies in the recommendation statement issued in connection with the tender offer. The Chancery Court found there was no unfair benefit creating a conflict because the plaintiffs failed to allege that Narang controlled the transaction because he needed liquidity. Plaintiffs merely alleged that Narang had accumulated significant wealth during his 26 years with NCI by the time he retired as CEO.

Next, the Chancery Court found that the stockholders were fully informed regarding the tender offer despite the plaintiffs’ allegations that “(i) ‘the Board made material misrepresentations or omissions regarding NCI’s financial projections;’ (ii) ‘the Board failed to disclose material information concerning potential conflicts of interest arising out of post-close opportunities for NCI’s management;’ and (iii) ‘the Board failed to disclose material information concerning potential conflicts affecting NCI’s financial advisors.’” These arguments were unsuccessful because the plaintiffs failed to allege any support or reasonable inference as to how these statements were false or misleading or material to stockholders. Because the complaint against the NCI board failed to state a claim for a breach of fiduciary duties, Count II’s claim for aiding and abetting likewise failed.

Second Circuit Upholds Dismissal of Suit Brought by Eaton Corporation Shareholders Following 2012 Merger and Failure to Divest Vehicle Business

By Whitney Robinson

On November 6, 2019, the Second Circuit affirmed a S.D.N.Y. dismissal of a proposed class action by shareholders of Eaton Corporation (“Eaton”), a power management company. The suit arose following Eaton’s merger with Cooper Industries, PLC (“Cooper”), a manufacturer of electrical products. The plaintiff, led by South Carolina Retirement Systems Group Trust, alleged on appeal that it stated a claim under Section 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78j(b), and Rule 10-b, 17 C.F.R. §240.10b-5 in its second amended complaint. Specifically, the plaintiff argued that Eaton, and two of its executives, misrepresented and omitted material information about Eaton’s plans to divest its vehicle business tax free after the Cooper merger by alleging that 10 separate statements contained misrepresentations or omissions.

The Court stated that “an alleged misrepresentation is material if there is a substantial likelihood that a reasonable person would consider it important in deciding whether to buy or sell shares of stock. . . . The statement must also be mislead[ing], evaluated not only by literal truth but by context and manner of presentation.” For omissions, the Court stated, “an omission is actionable under the securities laws only when the corporation is subject to a duty to disclose the omitted facts.” And there is no duty to disclose information that a reasonable investor would like to know.

The plaintiff alleged that many of the statements failed to disclose the tax burdens and consequences that Eaton would face when it divested its vehicle business after the Cooper merger, a move the plaintiff alleged that Eaton represented it would make. Regarding several of the statements, the Court found that this potential divestiture was instead a hypothetical transaction and one that Eaton had “repeatedly asserted it was not considering.” Additionally, Eaton was not prevented from divesting its vehicle business because of tax consequences, as the plaintiff alleged. Thus, there were not misrepresentations or omissions because Eaton did not have a duty to disclose information of a hypothetical transaction and had repeatedly stated it was not considering such a transaction. On appeal, the Second Circuit reached only the issue of material misrepresentations and omissions, and affirmed the District Court’s dismissal that none of the 10 statements stated a claim for securities fraud.

Ryan Thomas

Counsel, Bass Berry & Sims PLC

As mergers and acquisitions (M&A) and securities counsel to numerous national companies and private equity firms, Ryan Thomas has closed more than $50 billion in M&A transactions, and more than $60 billion in overall transactions, including both the largest domestic LBO, and the largest private equity-backed IPO at the time. Ryan’s practice focuses on public and private companies within the healthcare, media, retail, government services, life sciences and technology industries, among others.

Chauncey Lane

Counsel; Husch Blackwell, LLP

Boards and senior executives of public and private companies and investment management firms call on Chauncey for his knowledge and experience in mergers and acquisitions and capital market transactions. In this role, Chauncey regularly assists domestic and international clients with buy-side and sell-side mergers, divestitures, asset acquisitions, going-private transactions, debt and equity offerings, corporate governance and corporate restructurings. Chauncey is an active member of the Business Law Section’s Mergers and Acquisitions Committee and Federal Regulation of Securities Committee.