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Delaware Chancery Court Upholds "Go-Shop" Provisions—But Enjoins Shareholder Votes Pending Supplemental Proxy Disclosures and Waiver of Standstill Agreement

June 21, 2007

In two recent cases examining the sale of public companies to private equity purchasers, the Delaware Chancery Court upheld the validity of board decisions to forego a public auction or pre-agreement market check and instead agree to a post-agreement "go-shop" provision. In both cases, however, the Chancery Court issued limited injunctions requiring additional proxy disclosures prior to the shareholder vote, and in one case also required the board to release a bidder from a standstill agreement that prevented the bidder from pursuing a competitive bid. The cases provide guidance on: (i) when it is appropriate to forego a pre-agreement market check in favor of a post-signing go-shop provision and associated deal-protection measures, (ii) the proper and improper uses of standstill agreements, and (iii) disclosure obligations in a change-of-control transaction. More broadly, the cases once again demonstrate the Chancery Court's sophisticated approach to—and scrutiny of—private equity transactions, as well as the court's general deference to an informed board's decision-making process.

In re The Topps Company Shareholders Litigation

On June 14, 2007, the Chancery Court enjoined a shareholder vote on a proposed private buyout of The Topps Company (Topps) pending supplemental proxy disclosures and the release of a potential strategic buyer from a standstill agreement.¹

On March 5, 2007, Topps (the maker of sports cards and bubble gum) entered into a merger agreement in which private equity buyers aligned with former Disney CEO Michael Eisner agreed to acquire Topps for $9.75 per share, or a total purchase price of approximately $385 million. At the insistence of Eisner, and taking into account a failed attempt in 2005 to sell a portion of the company through an auction process, a majority of the Topps board of directors decided not to conduct another auction for the company prior to entering into an agreement with Eisner. Instead, the merger agreement contained a post-agreement go-shop provision that authorized Topps to solicit alternative bids for 40 days after the execution of the merger agreement. Topps also was allowed to consider unsolicited superior proposals after expiration of the go-shop. The go-shop provision allowed Eisner to match a superior proposal and provided for a termination fee if Topps terminated the merger agreement to accept a superior proposal amounting to approximately 4.3 percent of the transaction value.

Only one serious bidder emerged from the go-shop process—Topps' main competitor in the sports cards business, The Upper Deck Company (Upper Deck). Topps insisted, as it did with all other potential bidders, that Upper Deck sign a confidentiality agreement containing a standstill agreement. Under the terms of the standstill, Upper Deck agreed not to publicly disclose any proposed transaction between Upper Deck and Topps, and agreed not to acquire or offer to acquire any of Topps' common stock without the company's consent for two years. While the standstill agreement was subject to a fiduciary out, allowing the Topps board to release Upper Deck from the standstill should the board be required to do so to satisfy its fiduciary duties, Upper Deck could not terminate the agreement.

The board rejected Upper Deck's contingent indication of interest made during the go-shop period. After expiration of the go-shop, Upper Deck made a new, unsolicited proposal to acquire Topps for $10.75 per share. The Topps board again decided not to pursue the Upper Deck proposal, stating that there continued to be material outstanding issues associated with Upper Deck's offer. In particular, Topps claimed that the Upper Deck proposal had potential antitrust and financing issues.

The Chancery Court enjoined the stockholder vote on the Eisner transaction pending additional disclosures and a release of Upper Deck from the standstill agreement. First, the Chancery Court found that Topps' proxy omitted several material facts that should have been disclosed, including: (i) Eisner's discussions with management concerning plans to retain existing management after the merger, and (ii) substantive changes in the financial advisor's analysis that were made after receipt of the Eisner bid and that made the bid look more attractive. In addition, the court required Topps to release Upper Deck from the standstill provisions for purposes of: (a) publicly commenting on its negotiations with Topps, and (b) making a non-coercive tender offer on conditions as favorable as or more favorable than those it has offered to Topps' board.

As an initial matter, the court found that while the proxy provided the literal truth in its disclosures concerning the possibility of management retention following a deal with Eisner, it failed to disclose that Eisner previously had expressed his "high regard" for management. In this regard the court found that the proxy disclosed that Topps' board "instructed the Company's management not to have any discussions with [Eisner before a merger agreement was signed] regarding any employment arrangements following the consummation of a transaction." While this statement was correct, the court found that "Eisner has premised his bid all along as one that is friendly to management and that depends on their retention," and that the proxy needed to disclose this "reality."

The Chancery Court further found that the moving parties (which included a purported class of Topps' shareholders as well as Upper Deck) had shown a likelihood of success on the merits of their claims that Topps' board was breaching its fiduciary duty by misusing the standstill agreement to prevent Upper Deck from communicating with Topps' stockholders and presenting a bid that Topps' shareholders could find materially more favorable than the Eisner-led bid. While noting that standstill agreements have legitimate purposes to ensure that confidential information is not misused, to promote an orderly auction, and to give the target leverage, the Chancery Court found that the Topps board had no legitimate reason not to release Upper Deck from the standstill agreement so that it could communicate with shareholders and pursue its higher bid. The court held that "[a]lthough the Standstill is a contract, the Topps board is bound to use its contractual power under that contract only for proper purposes." The decision by the Topps board not to release Upper Deck from the standstill "not only keeps [Topps'] stockholders from having the chance to accept a potentially more attractive higher priced deal, it keeps them in the dark about Upper Deck's version of important events, and it keeps Upper Deck from obtaining antitrust clearance, because it cannot begin the process without either a signed merger agreement or a formal tender offer." As a result, the court found that "[g]iven that the Topps board has decided to sell the company, and is not using the Standstill Agreement for any apparent legitimate purpose, its refusal to release Upper Deck justifies an injunction. Otherwise, the Topps stockholders may be foreclosed from ever considering Upper Deck's offer, a result that, under our precedent, threatens irreparable injury."

Other than the refusal to waive the standstill agreement, the Chancery Court found that the general process Topps engaged in to secure the Eisner transaction was reasonable. It found that the board's decision not to conduct a full auction for the company was reasonable given the fact that Topps had conducted an auction for a portion of its business in 2005 without success and that dissident board members had advocated publicly for a sale of the company, yet no bidders emerged with an acceptable offer. Having forgone a pre-signing market check, the board secured the go-shop provision, which the Chancery Court found reasonable. The termination fee and expense reimbursement, likely to be at approximately 4.3 percent of the total deal value, while "a bit high in percentage terms," was deemed not to be a deterrent to another bidder, and the Chancery Court acknowledged the potential utility of having a credible and committed first buyer to set the floor for other potential bidders and to validate their interest.

In re Lear Corporation Shareholder Litigation

On June 15, 2007, the Chancery Court issued a limited injunction requiring additional proxy disclosure in a case that also upheld a go-shop provision in the context of a private equity buyout. Lear, a Fortune 200 corporation that supplies automotive interior systems, faced tough times during the downturn in the U.S. automotive industry. In January 2007, Lear's CEO met with Carl Icahn, who owned 24 percent of Lear's shares. Icahn broached the possibility of acquiring Lear and allowing it to take a more long-term focus as a private company. The CEO was receptive, and more in-depth discussions ensued for at least a week after which the CEO informed the board. The board formed a special committee that allowed the CEO to continue to take the lead and negotiate with Icahn. After the CEO's negotiation, the board agreed to sell the company to Icahn's firm for $36 per share.

The board discussed the fact that engaging in a formal auction of the company would disrupt the company's business and customer relationships and might cause Icahn to withdraw his bid. Given the pitfalls, the board decided that the go-shop structure of securing a firm commitment to merge before soliciting others was the best solution to maximize shareholder value. The merger agreement contained a 45-day go-shop period during which Lear could actively solicit interest from third-parties and a match right for Icahn. The likely termination fee was approximately $100 million, or 3.52 percent of the equity value of the transaction. No alternative bids emerged during the go-shop period.

The Chancery Court found that because the CEO was the chief negotiator with Icahn, the proxy should have disclosed the CEO's negotiations with the company about his retirement benefits. The CEO had decided not to pursue the acceleration of such benefits due to the potential negative reaction of public shareholders. The court recognized that the CEO would be able to pursue acceleration of such benefits without regard to public criticism if the company were private and, in any event, would receive a significant payment in a change-of-control transaction. The court found that "a reasonable stockholder would want to know an important economic motivation of the negotiator singularly employed by a board to obtain the best price for the stockholders, when that motivation could rationally lead the negotiator to favor a deal at a less than optimal price, because the procession of a deal was more important to him, given his overall economic interest, than only doing a deal at the right price." While the court did not find that the CEO acted inappropriately in any way, it once again found that when an insider has interests that are potentially different from the public shareholders, facts that may show how those interests impacted the transaction must be disclosed. Thus the court issued a "very limited injunction prohibiting the procession of the merger vote until supplemental disclosure is made."

While the Chancery Court found that the special committee's delegation of negotiating responsibility to the conflicted CEO "was less than confidence inspiring" and that it would have been preferable for the special committee to have had its chairman or its lead banker participate in the negotiations with Icahn, it found that "[r]easonableness, not perfection, measured in business terms relevant to value creation, rather than by what creates the most sterile smell, is the metric." Looking at all of the circumstances, the course taken by the board was not unreasonable from a maximizing-shareholder-value point of view. The court pointed out that the company had eliminated its poison pill in 2004, thus signaling a willingness to ponder the merits of unsolicited offers, and that no one other than Icahn had expressed interest even though Lear was obviously open to offers. The court also found that the termination fee amounting to 3.5 percent of equity value and 2.4 percent of enterprise value "is hardly of the magnitude that should deter a serious bid." The court also rejected the notion that potential bidders would be scared away by Icahn or his ability to match a topping bid. In the end, the court found that the board had a reasonable basis to accept the Icahn bid of $36 per share and thereafter engage in a go-shop process to see whether a superior deal would emerge.

Lessons from Topps and Lear

There are a number of lessons that may be taken from these two recent decisions by the Delaware Chancery Court:

1. These decisions reinforce long-standing Delaware law that even in the context of a sale to a private equity entity, there is no requirement that a board engage in a public auction so long as it fulfills its fundamental duty of care. This can include entering into a post-signing go-shop clause, particularly when it is known (as was the case in both Topps and Lear) that a corporation has been considering strategic alternatives and when a board can point to serious reasons why a public auction is not in the best interests of the corporation or its shareholders.
2. The use of standard termination fees, in the range of 3 to 5 percent of the transaction value, remains appropriate and reasonable under Delaware law. Such fees long have been recognized as legitimate, and these cases reinforce this well-established case law.
3. A board attempting to satisfy its Revlon obligations to maximize shareholder value must continually scrutinize all aspects of the bidding process, including preexisting contracts, to ensure that nothing is limiting the board's efforts to obtain the highest price reasonably obtainable for the benefit of the target company's shareholders. As the Chancery Court stated, "When directors bias the process against one bidder and toward another not in a reasoned effort to maximize advantage for the stockholders, but to tilt the process toward the bidder more likely to continue current management, they commit a breach of fiduciary duty."
4. Practitioners and boards should scrutinize all disclosures in recognition that sometimes more than the literal truth may be required to be disclosed. As a practical matter, additional context may be appropriate in a going-private transaction in which shareholders are being asked to cash out of their interest in the company. In such circumstances, in addition to the duty to provide stockholders with the material facts relevant to making an informed decision, "the directors must also avoid making materially misleading disclosures, which tell a distorted rendition of events or obscure material facts."

For more information on these cases or any related matter, please contact David Berger or Elizabeth Saunders in Wilson Sonsini Goodrich & Rosati's securities litigation department.

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