Using Confidential Information in a Hostile Offer

Posted by Victor I. Lewkow, Cleary Gottlieb Steen & Hamilton LLP, on Tuesday June 5, 2012 at 9:23 am
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Editor’s Note: Victor Lewkow is a partner at Cleary Gottlieb Steen & Hamilton LLP. This post is based on a Cleary Gottlieb memorandum by Neil Whoriskey. This post is part of the Delaware law series, which is cosponsored by the Forum and Corporation Service Company; links to other posts in the series are available here.

“But, upon a close review of these model [confidentiality] agreements and other leading treatises, I cannot conclude that the use of a standard structure has led to a corresponding lack of ambiguity about important issues.” Martin Marietta Materials, Inc., v. Vulcan Materials Company. [1]

On December 12, 2011, Martin Marietta Materials, Inc. sued Vulcan Materials Company in Delaware Chancery Court, seeking declaratory judgment that the non-disclosure agreement between them (the “NDA”) did not prohibit Martin Marietta from making a hostile offer for the shares of Vulcan. The initial reaction of many deal professionals at the time was – well, if the parties wanted to agree to a standstill preventing a hostile offer, the firms involved certainly knew how to draft one. [2] However, it seems as if the idea of a standstill was not even discussed by the parties – leading perhaps to the several ambiguities found by the court in its opinion. The ambiguities, of course, required that the court resort to extrinsic evidence to determine the intent of the contracting parties. The court found that virtually all of the extrinsic evidence supported Vulcan’s contention that the parties intended the NDA to serve as a back-door standstill.

The two most significant questions examined by the court, both resulting from contractual ambiguities, were the following:

  • 1. Whether restricting the use of confidential information to evaluation of a “Transaction” effectively prohibited the use of the confidential information for the purpose of evaluating an unsolicited transaction?
  • 2. Whether the exception to confidentiality, permitting the disclosure of confidential information as “legally required,” permitted disclosure of confidential information “legally required” to be disclosed solely as a result of Martin Marietta’s own decision to launch a hostile offer?

Confidential Information Was Disclosed in the Hostile Offer

Before answering these questions, the court first found as a factual matter that Martin Marietta had indeed used confidential information in evaluating and launching its hostile exchange offer. Most substantively, the court found that confidential information was used to prepare Martin Marietta’s estimates of cost synergies, which cost synergies were then disclosed in Martin Marietta’s S-4. [3] It is worth pausing on this factual finding for a minute, because it is clear that a synergies estimate customarily would be disclosed in the context of a hostile exchange offer, and arguably, but not necessarily, would be legally required as a disclosure matter. And regardless of whether such cost synergies were disclosed, it seems inevitable that they would be used in evaluating whether to make a hostile bid.

The court also found that Martin Marietta’s S-4 contained confidential information regarding the views of the Vulcan CEO on synergies, alternative deal structures and tax leakage, as well as the views of the parties’ antitrust counsel regarding the antitrust impediments to a merger. [4] The court seemed particularly annoyed by these last disclosures, which in its view were made as a result of “a tactical decision, influenced by [Martin Marietta’s] flacks,” [5] in an “approach to disclosure that seems more designed to impugn the motives of Vulcan management than to address a topic in a balanced way.” [6] This tactic prejudiced the court against Martin Marietta’s claim, discussed below, that all of its disclosure was “legally required;” however, these disclosures were not decisive, as the court also found that the disclosure of cost synergies was also not “legally required” in the narrow sense that term was used in the NDA.

The practical question remains as to whether a hostile offer can ever be evaluated and made without the use of material and relevant confidential information received from the target. It would seem to be very difficult to “unring the bell” in cases where material and relevant confidential information (like the synergies estimates in this case) has been learned and materially affected the bidder’s decision to bid.

“Transaction” Means a Negotiated Transaction

Having decided that confidential information had been disclosed, the court analyzed whether the use of that information in evaluating and making a hostile offer constituted a breach. The court focused first on the question of whether the term “Transaction”, defined as “a possible business combination transaction between” the parties, [7] limited the use of confidential information to consensual transactions, or if a hostile bid could also fit within the definition of “Transaction”. Generally, as a drafting matter, deal lawyers concerned about a subsequent hostile approach will insert the word “negotiated” before the words “business transaction”, clearly limiting the use of confidential information to consensual deals. However, had the word “negotiated” appeared in that particular spot in the NDA, this would not have been an interesting aspect of the case, as it would have eliminated the ambiguity that the court found in the definition of “Transaction.” While the court’s analysis of the ambiguity of the phrase “business combination transaction” and of the word “between” goes on for a learned 22 pages, all that we need to say about it here is that the court found the phrase “business combination transaction” not to necessarily include or exclude deals consummated by way of hostile offer, and that the word “between” while it probably does mean a transaction consensually entered into between the two parties, and not a transaction entered into by one party and the shareholders of another party, in this context is ambiguous as it was not preceded by the word “negotiated.”

Having found this ambiguity, the court then turned to extrinsic evidence, [8] and found that the trial testimony and drafts of the NDA exchanged between the parties demonstrated that the parties intended to preclude the use of the confidential information in evaluating or making a hostile offer. In fact, in an ironic twist, it turned out that Martin Marietta, the hostile bidder, was the party that had initially most feared a hostile approach, and as a result had made changes to the NDA that ultimately weakened their position in the litigation – for example, changing the definition of “Transaction” from “a business combination involving” to “a business combination between” the parties. [9] (As this is now the second case involving a backdoor standstill that turned, in part, on the use of the word “between”, the court did not find this change to be insignificant). [10]

Accordingly, the court found that the hostile bid did not constitute a “Transaction” as defined in the NDA, and that Martin Marietta, by using confidential information “in deciding upon, formulating and selling its” hostile bid, [11] had breached its obligation to use the confidential information “‘solely’ for the purpose of ‘evaluating’ a ‘Transaction’.” [12]

“Legally Required” Does Not Include Self-Imposed Legal Requirements

Vulcan additionally argued that, even if the confidential information could be used for evaluating a hostile bid, the confidential information was still confidential information and so could only be disclosed if “legally required” – the ambiguity here being whether “legally required” should include self-imposed legal requirements, such as those that arose when Martin Marietta launched its bid.

The precise words giving rise to the ambiguity here were of the ever treacherous “subject to” variety. In this case “Subject to Section 4,” was inserted (by Martin Marietta) at the very beginning of Section 3 of the NDA. Section 3 is the core confidentiality provision in the NDA – the one that says, that the parties will not disclose any confidential information, “other than as legally required.” As the court notes, “Without any qualifying language, the degree of compulsion necessary for something to be ‘legally required’ may be construed broadly.” [13] Here, the qualifying language was provided by the reference to Section 4.

Section 4, entitled “Required Disclosure” is the standard paragraph that tells the parties what to do if they are “requested or required (by oral questions, interrogatories, requests for information or documents in legal proceedings, subpoena, civil investigative demand or other similar process) to disclose any of the other party’s” confidential information. In short, in these circumstances, the disclosing party is required to notify the other party, permit the other party to seek a protective order, and limit any disclosure to the minimum that its counsel advises is legally required – these procedures are what the court called “Notice and Vetting” procedures. By making Section 3, the general non-disclosure obligation, “subject to” Section 4, Vulcan argued that the parties had limited “legally required” disclosure to the type of disclosure required under Section 4 – i.e., disclosure required pursuant to a legal proceeding – and made such disclosure subject to the “Notice and Vetting” provisions of Section 4. Oversimplifying for brevity, Martin Marietta essentially argued that “subject to Section 4” was there to clarify that “legally required” disclosures of the type specified in Section 4 were subject to the limitations in Section 4, but that any other “legally required” disclosures were not. So that a self-imposed legal requirement, not arising from a legal proceeding, but rather from a need to file an S-4 without any material misstatements or omissions, was not subject to the limitations of Section 4.

To make a long story short, the court again found ambiguity, turned to external evidence, found (again ironically) that Martin Marietta had requested the insertion of “subject to Section 4” in order to provide “maximum confidentiality” [14] and that accordingly “legally required” disclosures were intended to be limited to disclosures of the type described in Section 4 and subject to the Notice and Vetting provisions of Section 4.

Absent this limiting language, which was both unclear and somewhat uncommon, the court may well have “construed broadly” the “legally required” disclosure exception to confidentiality – but it is unclear whether “legally required” would have been construed to be so unambiguous as to prevent recourse to extrinsic evidence. Accordingly, the question lying dormant in thousands of confidentiality agreements across the country – does the “legally required” exception include self-imposed legal requirements – while answered in this case, remains more generally unanswered.

Remedy

The court granted a four month injunction against Martin Marietta’s hostile bid. The four month period roughly matched the period between the date when the hostile offer was launched (December 12, 2012) and the expiration of the NDA (May 3, 2012), meaning that the hostile offer was stayed by during a period equivalent to the period during which the hostile offer was in violation of the NDA. The four month stay also precluded Martin Marietta from running its slate of directors at Vulcan’s June 1, 2012 annual meeting. The court emphasized that the four month stay, which was the relief sought by Vulcan, could have been longer, given the “pervasiveness of Martin Marietta’s breaches.” [15] It is hard not to wonder whether an injunction would have been issued if Martin Marietta had prevailed on its argument that all of its disclosure was legally required, and the only breach had been the use of material confidential information in evaluating the hostile bid.

Vulcanizing Your Confi

Perhaps the first lesson to be learned here is that, if your client wants a standstill, you should raise the topic and ask for a standstill, even if deemed to be impolite. The standstill will cost a lot less than the litigation. The second lesson is that if your client wants to retain the option to make an unsolicited offer, you should ask for a standstill with a clear end date, and a clear right to use confidential information for your bid as soon as the standstill ends (and to disclose the confidential information to the extent required by law or disclosure principles). While you could instead simply try to sign up a confidentiality agreement with a broad definition of Transaction (e.g., any business combination or purchase transaction involving the parties, their assets, subsidiaries or shareholders), and a broad definition of “legally required” (e.g., any disclosure required or customarily made in connection with any legal process or Transaction), it is unlikely that, after this case, you will get any points for candor in taking this approach. However, given that clients often discount the possibility of making an unsolicited approach, and, particularly in merger of equals contexts, often loathe to raise the subject, the most practical approach may be to simply try to limit the confidentiality obligation to one year, assuming that a backdoor standstill of that duration would be acceptable.

Endnotes

[1] Martin Marietta Materials, Inc. v. Vulcan Materials Co., No. 7102-CS, slip op. at 111 (Del. Ch. May 4, 2012).
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[2] The parties’ respective general counsels were asked to draft the NDA, but it is unclear in the opinion whether either consulted outside counsel.
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[3] Id at 49.
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[4] Id at 49-50.
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[5] Id at 50.
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[6] Id at 51-52.
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[7] Note that the case involved two confidentiality agreements, a non-disclosure agreement and a joint defense agreement entered into in connection with the analysis of antitrust concerns. The joint defense agreement had a different definition of “Transaction” – it meant “a possible transaction being discussed by” the parties. Since it was clear that the parties were not discussing the possibility of a hostile bid (not even daring to broach the topic of a standstill), it was significantly easier for the court to find a breach of the confidentiality provisions of the joint defense agreement. As a result, the joint defense agreement is a good bit less interesting for purposes of this article, which will focus just on the non-disclosure agreement.
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[8] It is interesting to speculate as to how the court would have resolved these ambiguities in the absence of the ample extrinsic evidence present here.
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[9] Martin Marietta, at 83.
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[10] Id at 75.
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[11] Id at 89.
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[12] Id at 88.
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[13] Id at 113.
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[14] Id at 105.
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[15] Id at 137.
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