Professor Lawrence A. Hamermesh

The Delaware Supreme Court handed down an interesting decision on December 27, 2012 in the Celera merger class action litigation.  The underlying litigation was a challenge to a squeeze-out tender offer and merger, and involved some hot button issues (“don’t ask/don’t waive” standstill agreements and a top-up option), but the opinion wasn’t really about them.

The Supreme Court’s opinion instead reviewed a decision by the Court of Chancery to approve a class action settlement without opt-out rights.  The original plaintiff, New Orleans Employee Retirement System (NOERS), had owned 10,000 Celera shares, which it sold in the market (at a price slightly higher than the $8.00/share deal price) before the second-step merger was completed.  The settlement, reached a year or so after that merger, when any possibility of injunctive relief was pretty much history, would as usual have barred all other stockholders from pursuing further litigation challenging the deal.

That bar would have affected BVF Partners, which owned over 5% of the stock when the deal was announced, and 24.5% by the time of the merger. BVF objected to the settlement on a variety of grounds, including the lack of opt-out rights in the settlement.

As is common in Delaware in this sort of litigation, the Court of Chancery certified a class, for settlement purposes, under Court of Chancery Rules 23(b)(1) and (b)(2), under which opt-out rights aren’t required.  The Supreme Court didn’t find fault with that certification; it didn’t reverse the determination to accept the settlement; and it didn’t accept BVF’s arguments that NOERS lacked standing because it sold its shares before the merger, or that NOERS was an inadequate class representative because it was a “frequent filer,” a term that the Supreme Court said it has not yet even recognized.

What the Supreme Court reversed was the determination not to require opt out rights.  In the following short analysis, the Court found that determination to have constituted an abuse of discretion:

The court could not deny a discretionary opt-out right where the policy favoring a global settlement was outweighed by due process concerns. Here, the class representative was “barely” adequate, the objector was a significant shareholder prepared independently to prosecute a clearly identified and supportable claim for substantial money damages, and the only claims realistically being settled at the time of the certification hearing nearly a year after the merger were for money damages. Under these particular facts and circumstances, the Court of Chancery had to provide an opt-out right.

What’s intriguing–and perhaps unsettling–about this brief analysis is whether it has logical limits in future litigation challenging mergers that are consummated after the litigation begins. If there were “due process concerns,” why should it matter that the objector was a “significant shareholder?” Are those concerns less pressing when the objector has only 100 shares? Why so, when even a 100-share holder can hire effective class counsel who could pursue the litigation effectively? Is adequacy a sliding scale? If so, what are the measuring marks on that scale, if, as the Court held, NOERS clearly had standing because it held shares when the merger was approved?

And most important, what do future settlement hearings now have to evaluate? Before denying opt-out rights, will the court have to examine the size of shareholdings of unrepresented class members in order to determine whether any of those stockholders own enough shares so that due process rights are offended?  Or does this responsibility arise only when an objection to the settlement is lodged?

The result in this case may have been the right one:  with the no opt-out condition of the settlement no longer satisfied, I imagine that the case will now proceed, perhaps to a revised settlement with BVF, or perhaps to full-blown litigation.  And there surely was something unseemly about a holder of 10,000 shares that weren’t even directly affected by the challenged transaction being able to achieve preclusion of the claims of a 24.5% stockholder.  But in achieving what may have been a good result, the Court has perhaps created an element of uncertainty over how to handle settlements in common deal litigation.

Submitted by Prof. Paul L. Regan

In a telephonic ruling announced earlier this week in In re Complete Genomics, Inc. Shareholder Litigation, Dec. Ch., Consol. C.A. No. 7888-VCL (Nov. 27, 2012), Vice Chancellor J. Travis Laster preliminarily enjoined Complete Genomics, Inc. from enforcing a standstill agreement containing a potentially problematic “don’t ask, don’t waive” provision. This provision purported to contractually preclude the other party to the standstill agreement (identified in the hearing only as “Party J”) from making a request — either publicly or privately — to the board of Genomics that the company waive the restrictions in the standstill that otherwise prevented Party J from making an acquisition proposal for Genomics. Thus under the “don’t ask” terms of the standstill, even a polite request by Party J to Genomics for permission to make a topping bid for Genomics would itself be a breach a contract in violation of Party J’s promise not to ask for such a waiver.

Vice Chancellor Laster concluded (on a preliminary basis involving an assessment of whether the shareholder plaintiff had shown a reasonable probability of success on the merits), that Party J’s “don’t ask, don’t waive” promise was unenforceable as tending to induce a violation of the Genomics directors’ fiduciary duties to be informed in continuing to recommend a sale of control transaction to the shareholders. Said the Court: “by agreeing to this provision, the Genomics board impermissibly limited its ongoing statutory and fiduciary obligations to properly evaluate a competing offer, disclose material information, and make a meaningful merger recommendation to its stockholders.”

Party J was one of a handful of potential suitors with whom Genomics had signed confidentiality and standstill agreements before providing access to the company’s confidential financial and business information. Genomics is a biotech life sciences company that has developed and commercialized an innovative DNA sequencing platform so it made especially good sense to protect its propriety know-how and confidential financial data as part of any auction process. Following due diligence by potential bidders and the ensuing auction, Genomics entered into a merger agreement pursuant to which it agreed to be acquired in a two-step tender offer and merger transaction with a U.S-based subsidiary of Chinese firm BHI-Shenzen.

A few weeks before this most recent, decision Vice Chancellor Laster denied the shareholder plaintiff’s earlier attempt to obtain a preliminary injunction against enforcement of the Genomics merger agreement with BHI and that transaction remains pending. The effect of this latest ruling is to free Party J to make a topping bid while the BHI tender offer is outstanding. Whether Party J might make such an offer is unknowable and the Court found irreparable harm, justifying the preliminary injunction against enforcement of the standstill with Party J, in the contract’s prevention of this information from flowing to the Genomics board from Party J as a potential bidder.
In preliminarily enjoining Genomics from enforcing the “don’t ask, don’t waive” standstill with Party J in the context of a pending change of control transaction with BHI, Vice Chancellor Laster relied in significant part on former Chancellor Chandler’s bench ruling in Phelps Dodge Corp. v. Cyprus Amax Minerals Co., 1999 Del. Ch. LEXIS 202 (Sept. 27, 1999). There it will recalled, the Court reasoned that a “no-talk” provision in a merger agreement was improper because it prevented the directors of Cyprus Amax, in advance and under all circumstances, from making an informed decision whether to refuse to negotiate with potential suitor Phelps Dodge. Chancellor Chandler memorably described such a provision as improper because it was “the legal equivalent of willful blindness, a blindness that may constitute a breach of a board’s duty of care….”

In Genomics Vice Chancellor reasoned that the “don’t ask, don’t waive” provision was equivalent to “a bidder-specific no-talk clause” of the type the Court in Phelps Dodge found troublesome. The Genomics directors effectively prevented themselves from being fully informed because the standstill contractually precluded Party J from even requesting a possible waiver of the standstill so as to make a further acquisition proposal. Under those circumstances, the Court reasoned, the Genomics board could not fulfill the fiduciary obligation to be informed in continuing to recommend the BHI transaction to Genomics shareholders.

Vice Chancellor Laster made clear that a “don’t ask, don’t waive” standstill that only precluded public requests for a waiver could pass fiduciary muster so long as the agreement allowed for a private, non-public request. Under such circumstances the potential bidder has a contractually viable path forward to communicating (albeit privately) to the target its interest in making a bid. Likewise the target directors would maintain their ability to fulfill their fiduciary duty to remain fully informed in continuing to recommend an already-approved pending transaction or, if warranted, changing that recommendation in favor of a new superior proposal.

The Court’s decision in Genomics understandably relies on Phelps Dodge and perhaps a visceral aversion to contractual provisions that would seem to handcuff the board of a company undergoing a sale of control from receiving a later topping bid, or even more embryonically, from even receiving a request for permission to make a topping bid.

On the other hand, one could argue that a well-advised board of a corporation undergoing a sale of control might legitimately make use of a “don’t ask, don’t waive” standstill in furthering stockholder welfare. For example, the board of the selling corporation might ask its financial advisor to solicit interest from possible bidders, with due diligence access and subsequent auction participation conditioned on each bidder agreeing to a “don’t ask, don’t waive” standstill. Under the auction rules set out by the board, all bidders would be given a timeline, and contractual permission, for the submission of one bid and one bid only — the highest and best offer each bidder is able and willing to make. Such bids would be made with the understanding (and contractual limitation) that there would be no further rounds of bidding, and topping etc. The standstill thus would prevent any such serial attempts to bid. One could argue that such an auction arrangement could benefit stockholders by shortening the auction process and encouraging the highest and best offers up front. Any other bidder not part of the original auction process, i.e., who had not signed a standstill, could theoretically lob in a topping bid later and the board of would have to consider that new information in keeping with its fiduciary duties.

Of course one might prefer to run an auction differently than in the manner suggested above, but our law makes clear that while the directors have an obligation (in Revlon mode) to act reasonably to seek the highest value for the stockholders, there is no legally required blueprint for how to run an auction. And there’s the rub. Does a “don’t ask, don’t waive” standstill, when used as suggested above, amount to just another one of many legitimate ways to run an auction in good faith? Or, as Genomics suggest, does a “don’t ask, don’t waive” standstill cross the fiduciary line by creating an improper impediment to the realization of that value by preventing the directors from having all information reasonably available in making their continuing recommendation to stockholders?