Standstills in Change of Control Transactions

Posted by R. Christopher Small, Co-editor, HLS Forum on Corporate Governance and Financial Regulation, on Wednesday June 20, 2012 at 9:45 am
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Editor’s Note: The following post comes to us from Christina Sautter, Associate Professor of Law at Louisiana State University. 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.

Standstill agreements are ubiquitous in public company M&A deals. In fact, the execution of a standstill has been described as the “cost of entry” into negotiations and serves to indicate a bidder’s seriousness. Despite their ubiquity, there is surprisingly little Delaware case law on standstills and even less academic literature on the subject. In my paper, Promises Made to be Broken? Standstill Agreements in Change of Control Transactions, forthcoming in the Delaware Journal of Corporate Law, I attempt to begin to fill this gap in academic literature by examining and providing a blueprint for the resolution of various issues raised by the execution and enforcement of standstills in the context of sales resulting in a change of corporate control.

My paper concentrates on three issues the Delaware courts have yet to tackle: a target board’s ability to consider a third-party superior offer made in contravention of a standstill; a board’s promise not to waive a standstill; and a board’s ability to grant a “winning” bidder the right to enforce a previously executed standstill against a “losing” bidder. Each of these issues raises a conflict between two fundamental principles of Delaware M&A law: 1) a board’s Revlon duty to maximize stockholder value in a sale of corporate control; and 2) the sanctioning of certain deal protection provisions as permitted by the Delaware Supreme Court’s decision in Unocal Corp. v. Mesa Petroleum Co. and its progeny. As commonly argued, the availability of deal protection devices, including standstills and other promises made in relation to standstills, may assist a target board in extracting more value from bidders, thereby facilitating satisfaction of a board’s Revlon duties. Thus, at the pre-signing stage there may be good reason for a target board to agree to a standstill, and the provision may be permissible under Unocal but, pre-closing, the provision may inhibit the fulfillment of a board’s Revlon duties. Specifically, standstills may prevent a board from considering a third-party offer or deter a third party bound by a standstill from making an overbid in the first place.

My paper focuses on how Delaware courts will resolve this conflict between Revlon and Unocal when ultimately presented with the foregoing issues. It begins by detailing the role of confidentiality and standstill agreements in M&A deals and describes why standstills are such an integral part of the sales process. It then utilizes examples of deals, both litigated and un-litigated, where a standstill was used controversially to further depict the role of standstills and the tension they can create in the M&A process. Among the deals and cases featured are the following: In re Topps Shareholders Litigation; the Canadian case of Ventas, Inc. v. Sunrise Senior Living Real Estate Trust, involving a battle between Ventas and HCP, Inc. for Sunrise; the 1994 fight of Northrop Corporation and Martin Marietta Corporation for Grumman Corporation; Formation Capital, LLC and Fillmore Capital Partners, LLC’s 2007 fight for Genesis HealthCare Corporation; and Sun Capital Partners and Cardinal Paragon, Inc.’s 2006 battle for Marsh Supermarkets, Inc.

In examining a board’s ability to consider a superior overbid made in contravention of a standstill, the paper emphasizes the HCP-Ventas fight for Sunrise and related litigation in the Ontario Superior Court and Court of Appeal involving HCP’s standstill agreement and the Ventas-Sunrise merger agreement non-solicitation provision. The case served as an impetus for my research and provides a clear illustration of the potential arguments both for and against the enforcement of a standstill, including an interpretation of the common fiduciary out requirement that an acquisition proposal be a bona fide offer. This is of particular interest because the Delaware courts have yet to define bona fide in the context of a third-party overbid. The Ontario courts held HCP’s acquisition proposal was not a bona fide one and, thus, violated the Ventas-Sunrise merger agreement’s non-solicitation provision because HCP had made the offer in violation of its standstill agreement. My paper argues that when Delaware courts face the issue of whether an offer is bona fide, they will consider only whether the third party has a good faith intent and ability to close a transaction. Thus, unlike the Canadian standard, the standard my paper proposes and the one Delaware is likely to apply, would allow a target board to consider offers made by third parties even when that offer is made in contravention of a standstill.

In Topps, then-Vice Chancellor Strine indicated that, consistent with Unocal, standstills will be upheld only when a target board is using a standstill to further an “apparent legitimate purpose.” However, what types of purposes must be articulated to qualify as “legitimate” is an open question. Using the Northrop-Martin Marietta-Grumman and Formation-Fillmore-Genesis deals as examples, I contend the Delaware courts will scrutinize a target board’s actions to determine whether the enforcement of the standstill was being used to maximize stockholder value or further the board’s own self-interests. In determining whether a target board may waive a standstill to allow a “losing bidder” to make an overbid, I contend the Delaware courts will consider the overall reasonableness of the board’s decision-making process generally. Decades of Delaware precedent in the wake of Revlon has established that an auction process or, even an active bidding process, need not precede a target’s entry into a merger agreement. Concomitantly, a board more easily satisfies this reasonableness requirement the more extensive the sales process is pre-signing. Thus, in determining whether a board may (or must) consider an offer made in contravention of a standstill, the Delaware courts would likely examine the value maximization tools utilized by the board pre-signing, including the extent to which the board “shopped” the company.

The Delaware courts would likely engage in a similar analysis if confronted with a board’s pre-signing agreement not to waive a standstill. In Topps, Strine postulated that a board might agree not to waive a standstill if an extensive pre-signing sales process was held. As an example, Strine used a hypothetical multiple round auction involving three final round bidders occurring after a broad market canvass. Consistent with Strine’s hypothetical, a Delaware court may likely require that the target’s pre-signing shopping be more extensive when a board is agreeing not to waive a standstill in the future. The requirement of further shopping is necessary because of the greater restrictions imposed on a board of directors to exercise its fiduciary duties under Revlon.

The final issue the paper addresses is whether a target board may legitimately grant a winning bidder the right to enforce a standstill against an overbidder. Such a grant raises an issue as the winning bidder has, in most cases, an overwhelming interest in protecting the transaction for which it negotiated. As such, it has reasons for not granting a waiver of a standstill to allow a rebid. In such a case, the Delaware courts would likely look to Ace Ltd. v. Capital Re Corp. for guidance. In Ace, then-Vice Chancellor Strine indicated there are “limited circumstances” in which a board could be able to curtail its power to entertain superior proposals in the context of a transaction that is subject to a stockholder vote. If the courts were to extend Strine’s reasoning in Ace, a court considering a third party’s right to enforce a standstill, would likely again engage in the same examination of the pre-signing shopping process as previously described. In addressing these issues, my paper provides a blueprint on how the Delaware courts are likely to resolve the Revlon-Unocal conflict created by the execution and enforcement of standstills in change of control transactions.

The full paper is available for download here

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