CURRENT MONTH (December 2019)
M&A Law
Stockholder Plaintiff Entitled to Documents Relied upon by Special Litigation Committee after Committee’s Determination that Plaintiff Should Proceed with Derivative Claims
By Sara M. Kirkpatrick
On December 4, 2019, the Delaware Court of Chancery held that a lead plaintiff was entitled to the production of all documents and communications reviewed and relied upon by the Special Litigation Committee (the “SLC”) formed by Oracle Corporation (the “Company”) or its counsel, in connection with the SLC’s consideration of such plaintiff’s challenge to Oracle’s acquisition of NetSuite Inc. The SLC had previously determined that (1) it was in the Company’s best interests that the lead plaintiff’s derivative action be pursued, and (2) the litigation asset (the derivative action) would be best monetized by allowing the lead plaintiff to persecute its claims. On the lead plaintiff’s motion to compel the production of documents, the Company argued that no documents reviewed by the SLC, outside of the documents regarding the NetSuite transaction, should be produced and that the lead plaintiff should proceed as if the SLC review never occurred. The Court rejected the Company’s arguments and found that the SLC’s review enhanced the litigation asset and it would be, in part, against the Company’s best interests to allow the lead plaintiff to continue with the litigation asset stripped of the value created by the SLC. Thus, the Court held that in order to preserve the value of the litigation asset and because the SLC returned such litigation asset to the lead plaintiff, the documents relied on by the SLC must be made available to the lead plaintiff.
Delaware Court Holds That Heartland Payment Systems Director/Officer not Entitled to the Advancement of Legal Fees
By John Adgent
On December 11, 2019, the Delaware Chancery Court (the “Court”) granted a motion to modify an order requiring litigation costs incurred by the plaintiff, Robert O. Carr (“Carr”), to be advanced by Heartland Payment Systems, Inc., a provider of payment technology and software solutions (“Heartland”), and Global Payments Inc., also a provider of payment technology and software solutions (“Global,” together with Heartland, “Defendants”). In modifying the initial advancement order, the Court found that the merger agreement (the “Agreement”) between Heartland and Global did not entitle Carr, the former CEO and Chairman of Heartland, to advancement of litigation expenses for a breach of contract claim brought against him by Heartland.
The Court noted that Delaware General Corporation Law §145 generally permits indemnification for litigation that arises “by reason of the fact that” a party is or was an officer or director. However, rather than importing the language of §145, the Agreement extended advancement rights for litigation that “pertains to” Carr’s status as an officer or director. Specifically, the Agreement provides that after the merger, Global will cause Heartland, to the fullest extent permitted by law, to indemnify and advance expenses to Carr for litigation that “arises out of or pertains to the fact that” Carr was an officer and director of Heartland prior to the merger. Giving effect to that language, the Court assumed the parties chose the verb “pertain” to purposely depart from the statutory standard. The plain-meaning of “pertain” required Heartland and Global to provide advancement for claims that relate to some attribute or duty of Carr’s service as a director or CEO.
The Court then reasoned that if a claim relies on the misuse of confidential information learned while employed as an officer or director, it “pertains to” the party’s former position, and that party is entitled to advancement under the standard in the Agreement. On the other hand, if the claim merely alleges post-employment breach of a non-compete agreement, and it does not allege that the party used confidential information previously learned to facilitate the breach, then the breach does not “pertain to”—that is relate to a duty or attribute of—the party’s position.
Applying that standard, the Court concluded that Carr was not entitled to advancement for the breach of contract claim because it did not relate to his position as a director or officer of Heartland. Instead, the claim alleged a breach of the non-compete and non-solicitation provisions in Carr’s employment agreement that occurred only after his employment with Heartland ended. As a result, the claim arose solely from Carr’s conduct after he was no longer an officer or director of Heartland. Therefore, Carr was not entitled to advancement.
Maryland District Court Holds Fairness Opinion Omissions Not Materially Misleading
By John Adgent
On December 4, 2019, the United States District Court for the District of Maryland (“the Court”) found that omissions in a fairness opinion provided by Morgan Stanley & Co., LLC, an investment bank and financial services firm (“Morgan Stanley”), for the merger proxy statement (the “Proxy”) filed by Gramercy Property Trust, a real estate investment trust (“REIT”) specializing in commercial real estate (“Gramercy”), were not materially misleading.
Gramercy issued the Proxy in connection with the sale of Gramercy to an affiliate of the Blackstone Group LP. Plaintiff Raul Hurtado (“Plaintiff”), a former shareholder of Gramercy, filed suit alleging that the Proxy was materially misleading in violation of Sections 14(a) and 20(a) of the Exchange Act (the “Act”). Plaintiff alleged that the Proxy was misleading due to omissions of material information in Morgan Stanley’s fairness opinion summarized in the Proxy that determined that the merger was financially fair to Gramercy’s shareholders. Specifically, Plaintiff challenged Morgan Stanley’s Comparable Public Companies Analysis (“CPC Analysis”) in the fairness opinion as “objectively flawed.” According to Plaintiff, the CPC Analysis mislead shareholders because the five companies that Morgan Stanley utilized in the CPC Analysis were not comparable to Gramercy. Only two of the five companies used in the CPC Analysis were industrial REITs like Gramercy, which Plaintiff claimed lowered the valuation of Gramercy. As a result, Plaintiff maintained that the failure to disclosure the comparison companies’ REIT classification prevented shareholders from discerning the flaws of the valuation and inadequacy of the merger consideration.
The Court concluded that the omissions did not violate Sections 14(a) or 20(a) of the Act. First, the omissions were not material in the total mix of information. The Proxy contained extensive financial disclosures such as the history of the merger negotiations and twenty-nine material factors the board considered in recommending the merger that made clear the fairness opinion was only one variable in the board’s decision. Additionally, the Proxy contained an exhaustive summary of the fairness opinion that identified the results of seven other financial analyses performed by Morgan Stanley. Further, the Proxy detailed the methodology and assumptions underlying each of these analyses and included comprehensive warnings. Thus, there was not a substantial likelihood that the omissions would have altered the total mix of information available. Next, even assuming the omissions were material, they did not render the Proxy false or misleading. The Proxy explained the comparison companies were selected due to their similar business characteristics with Gramercy, but were not identical to Gramercy. The Proxy also fully disclosed Morgan Stanley’s steps in performing the CPC Analysis and its subjective judgments used in the process. Finally, Plaintiff’s section 20(a) claim failed because a primary violation of the Act was not established.
Sinclair Directors Must Face Suit Over Failed Tribune Merger
By Mary Lindsey Hannahan
On December 9, 2019, a Maryland federal judge refused to dismiss a derivative suit filed by two shareholders of Sinclair Broadcast Group, Inc. (“Sinclair”), a publicly traded telecommunications conglomerate and one of the largest television station operators in the U.S., against two Sinclair directors related to the company’s failed merger with Tribune Media Co., a multimedia company (“Tribune”). The directors argued that the shareholders failed to comply with federal derivative complaint pleading requirements by not making a demand on Sinclair’s special litigation committee (“SLC”) or stating their reasons for not making such a demand in their pleading. The court determined that the Sinclair directors’ entire argument hinged on whether the court would take judicial notice of the fact that Sinclair had formed an SLC before the shareholders filed suit. The directors pointed to Sinclair’s Quarterly Report on Form 10-Q filed in November 2018—which mentions that an independent committee had been formed to address shareholder demands related to the Tribune merger—as evidence that the SLC was formed prior to the shareholders’ complaints. However, although courts can take judicial notice of the existence of SEC filings, the court held it could not take judicial notice of the fact that the SLC existed at any certain time because the fact was “subject to reasonable dispute,” and thus denied the directors’ motion to dismiss.
The suit arose from accusations that the Sinclair directors breached their fiduciary duties to Sinclair and its shareholders by self-dealing and making misrepresentations to the Federal Communications Commission (“FCC”) in connection with the Tribune merger. Sinclair had agreed to acquire Tribune for $3.9 billion in May of 2017. In an effort to obtain FCC approval, the merger agreement required Sinclair to sell off certain of its television stations to third parties. Several of the individuals and entities that it sought to sell its stations to had close ties to the family of Sinclair’s founder, several of whom sat on Sinclair’s board and controlled a majority of its shareholder votes. The FCC voiced its concerns that buyers of the divested stations would allow Sinclair to control those stations in substance, if not in form. The FCC ultimately voted to refer the merger to an administrative law judge based on its concerns that Sinclair made material misrepresentations in its FCC disclosures. Shortly thereafter, Tribune pulled out of the merger, and Sinclair shareholders then filed derivative suits.
Boston Scientific Cannot Escape $275 Million Merger with Medical Device Startup
By Mary Lindsey Hannahan
On December 18, 2019, the Delaware Chancery Court (the “Court”) ruled that Boston Scientific Corporation, a medical device manufacturer (“Boston Scientific”), could not terminate its $275 million merger with Channel Medsystems, Inc., a medical device startup (“Channel”). The case arose when, after signing the merger agreement, Channel discovered that its former Vice President of Quality Assurance, Dinesh Shankar (“Shankar”), had stolen $2.6 million from the company. Shankar had developed an elaborate scheme that involved him falsifying expense reports and other documents, some of which were part of Channel’s submissions to the U.S. Food and Drug Administration (“FDA”) regarding approval of its Cerene device. The Cerene device was a large part of what Boston Scientific sought to gain from the parties’ merger. Accordingly, Channel promptly notified both Boston Scientific and the FDA of the scheme. Over the next few months, Channel engaged in an aggressive and fully transparent investigation to alleviate the effects of the fraud. As a result, the FDA approved Channel’s remediation plan, strongly signaling that the fraudulent scheme would not have a negative impact on the FDA’s determination of whether to approve the Cerene device.
Nonetheless, Boston Scientific terminated the parties’ merger agreement in May of 2018, claiming that Channel breached its representations and warranties as of the agreement date by providing false information, due to Shankar’s fraud, about its business that had a material adverse effect on Channel. Channel countered—and the Court agreed—that Boston Scientific’s termination actually breached the provision of the merger agreement requiring Boston Scientific to “take all further action that is necessary or desirable to carry out the purposes” of the agreement after signing. The Court reasoned that Channel itself was a victim of the fraudulent scheme and took immediate steps to remedy the situation as soon as it came to light. Further, the Court found that “although Shankar’s fraud caused a number of representations to be inaccurate as of the date of the agreement, Boston Scientific failed to prove that the failure of such representations to be true and accurate reasonably would be expected to have a material adverse effect.” Thus, “Boston Scientific did not have reasonable grounds to terminate the merger agreement when it did, particularly given that the FDA had already accepted Channel’s remediation plan.” The Court ordered specific performance of the merger, noting that by closing the deal, Boston Scientific would get the “essence of what it bargained for”: the FDA-approved Cerene device.
Delaware Chancery Court Finds Tutor Perini Owes $8 Million to Sellers Following 2011 Merger Based on Interpretation of Holdback Agreement’s Provisions
By Whitney Robinson
On December 4, 2019, the Delaware Chancery Court (the “Court”) found that Tutor Perini Corporation, a large general contracting and construction management company (“Tutor Perini”), owes $8 million in holdback payments to the sellers of Greenstar Services Corporation, an electrical and mechanical construction company (“Greenstar”), following a lengthy dispute after Greenstar became Tutor Perini’s wholly-owned subsidiary, along with the acquisition of Greenstar’s subsidiaries, in a 2011 merger. Disagreements over the holdback provisions in the 2011 merger agreement led the parties to sign a Holdback Settlement and Release Agreement (the “Holdback Agreement”) in 2013. This resulted in further disagreement between the parties on the interpretation of the Holdback Agreement’s provisions. Plaintiffs, Greenstar IH Rep, LLC, and Gary Segal, the former CEO of Greenstar, filed suit following these disagreements.
Under Delaware law, to prove a breach of contract claim, the plaintiff must establish by a preponderance of the evidence: “(1) the existence of a contract; (2) the breach of an obligation imposed by the contract; and (3) damages suffered because of the breach.” At issue is only whether Tutor Perini breached an obligation imposed by the contract. In determining if the Holdback Agreement was ambiguous, the Court looked to see if there was only one reasonable interpretation “when read in full and situated in the commercial context between the parties.”
Under the Holdback Agreement, the $8 million holdback payment was conditioned on Greenstar converting specific costs in excess of billings assets into cash. Specifically, to get the holdback, “Greenstar must collect certain claims listed on Exhibits B and C [of the Holdback Agreement] in amounts sufficient to reach the Bogey (i.e., $60.529 million). For collections from Exhibit C to count, they must ‘result in additional net profit . . . after March 31, 2013.’ And any counterclaims against Greenstar on projects listed on Exhibit C effectively increase the Bogey.” The parties also included, in Exhibit D, examples of how the Holdback Agreement was to work, which the Court found insightful to the parties’ intent.
While the parties agreed on several points of construction, they disagreed on which of the claims from Exhibit C counted towards the Bogey and on the definition of additional net profit regarding Exhibit C claims. The Court found the sellers identified in the merger agreement offered the only reasonable construction of the Holdback Agreement based on its term, the examples in Exhibit D, and the commercial context. Tutor Perini’s proposed interpretation failed because it included limitations that were not in the Holdback Agreement. Next, the Court considered specific construction projects that counted toward the Bogey and found only one counterclaim applicable; thus, the Sellers could credit $66.515 million towards the Bogey, entitling the Sellers to the full $8 million holdback payment.
International Flavors & Fragrances, Inc. and DuPont Merger to Utilize a Reverse Morris Trust
By Whitney Robinson
International Flavors & Fragrances, Inc., a company that produces flavors and fragrances for use in a large variety of industries (“IFF”), and the Nutrition and Biosciences Business of DuPont de Nemours Inc., a large chemical company (“DuPont”), announced on December 15, 2019 that they plan to merge. Interestingly, the deal will utilize a unique deal structure: a reverse Morris trust. A reverse Morris trust structure would give DuPont and its shareholders a tax advantage because the transaction would be tax-free for them.
A reverse Morris trust is a complex deal structure that is relatively uncommon given its intricacies, but its tax advantages can be intriguing for companies considering how to structure a deal. There are, however, certain requirements that the transaction must meet. Simplified, a reverse Morris trust is a combination of a spin-off and subsequent merger. First, a parent company spins off into a subsidiary the assets or business it plans to sell to a third-party company and distributes the equity of the subsidiary to its stockholders. Then, a merger takes place between the subsidiary and the third party. After the merger, the parent company’s stockholders need to own more than 50% of the stock, in both voting rights and value, in the newly formed company. Thus, the reverse Morris trust structure works best when the third-party company is smaller than the parent company. Section 355 of the Internal Revenue Code provides additional specific requirements that the deal must meet to be tax-free for the parent company and its shareholders. In addition to the tax considerations, there are corporate law issues and securities law considerations that parties should contemplate when deciding on deal structure. Despite its complex structure, a reverse Morris trust can be an effective way to structure a merger while allowing the parent company to enjoy tax benefits.
