An update on the decision of the Delaware Court of Chancery in In re Compellent Technologies, Inc. Shareholder Litigation. In his decision, Vice Chancellor Laster reviewed the deal-protection measures in the original merger agreement between Dell and Compellent Technologies to determine the value of the plaintiffs' lawyers' success in negotiating a more neutral amended agreement.
On December 9, 2011, the Delaware Court of Chancery in In re Compellent Technologies, Inc. Shareholder Litigation awarded fees to the stockholder plaintiffs for their success in negotiating amendments to a merger agreement between Dell and Compellent Technologies that raised the likelihood of attracting a topping bid. In his decision, Vice Chancellor Laster reviewed in depth the various deal-protection measures that had been agreed to in the original merger agreement, raised several questions about whether some of those provisions could have been enforceable, and provided several suggestions for how the provisions could have been softened.
Although VC Laster emphasized that his ruling is not to be understood as a judgment on the deal protections' ability to survive enhanced scrutiny (as the substantive issues had already been settled), the decision is still invaluable for its guidance for what the Chancery Court may consider to be overly aggressive buyer-friendly provisions.Close speedread
On December 9, 2011, the Delaware Court of Chancery in In re Compellent Technologies, Inc. Shareholder Litigation (www.practicallaw.com/2-516-9035) awarded $2.4 million in fees to the stockholder plaintiffs for their success in negotiating amendments to a merger agreement between Dell and Compellent Technologies and the raised likelihood that a topping bid would emerge in light of those amendments. For a summary of the merger agreement and the amendments, see PLC What's Market, Dell International L.L.C./Compellent Technologies, Inc. Merger Agreement Summary. In his decision, Vice Chancellor Laster reviewed in depth the various deal-protection measures that had been agreed to in the original merger agreement and provided several suggestions for how the provisions could have been softened. Although VC Laster emphasized that his ruling is not to be understood as a judgment on the deal protections' ability to survive enhanced scrutiny (as the substantive issues had already been settled), the decision is still invaluable for its guidance for what the Chancery Court may consider to be overly aggressive buyer-friendly provisions.
Because a settlement on the substantive issues had already been approved by the Delaware Court of Chancery, the facts underlying the decision on fees were relatively simple. On December 12, 2010, Dell Inc.'s subsidiary Dell International L.L.C. and Compellent Technologies, Inc. signed a merger agreement pursuant to which Dell would acquire Compellent in a deal valued at $960 million. Dell had approached Compellent shortly after it lost out to Hewlett-Packard Company in a bidding war for 3PAR Inc. (For a timeline on the 3PAR bidding war, see Article, What's Market: Matching Rights in 2010: 3PAR Bidding War Timeline (www.practicallaw.com/5-503-9896)). Against that backdrop, Dell negotiated particularly aggressive deal-protection measures with Compellent in the hope of warding off potential third-party bidders.
The original merger agreement contained a common collection of deal protections, including:
A no-shop (www.practicallaw.com/9-382-3646) provision.
A force the vote (www.practicallaw.com/3-383-2187) provision.
A matching right (www.practicallaw.com/4-383-2200) for Dell.
A break-up fee (www.practicallaw.com/9-382-3284) payable by Compellent under several circumstances.
As VC Laster noted, however, simply referring to these provisions by type without referring to their details reveals little about their likelihood to preclude other bids or otherwise cause the target board of directors to breach its fiduciary duties.
Compellent also agreed to a unique covenant that required it to adopt a poison pill with a 15% trigger in a form previously approved by Dell. (For more about the use of a poison pill as a deal-protection device, see Practice Note, Poison Pills: Defending Against Takeovers and Protecting NOLs: Pill as Deal Protection Mechanism (www.practicallaw.com/3-386-0340).) Though this covenant was not invalid per se, it served as another example of the particularly buyer-friendly character of the merger agreement.
The day after signing the merger agreement, Dell and Compellent announced the deal. Several putative class action lawsuits shortly followed. After the actions were consolidated and certified as a class action, the plaintiffs negotiated with the parties to the deal and reached a settlement on January 31, 2011. The settlement came in exchange for amendments to the merger agreement, including complete elimination of the poison-pill covenant, and several supplemental disclosures. VC Laster had previously approved the settlement, reserving a decision on the fee. This opinion addressed the fee application.
To decide on an appropriate fee for the plaintiffs, VC Laster had to estimate the value of the benefit that the plaintiffs created by causing the parties to amend the merger agreement and provide additional disclosures. This benefit had to be assigned a monetary value in spite of the fact that no payment was made in the settlement and no topping bid ultimately came forward. However, as VC Laster explained, the value of the settlement had to be assessed as of the time it was reached, without the benefit of hindsight.
To determine a monetary value for the settlement, VC Laster analyzed the following:
The original drafting of the deal protections and how the amendments to the merger agreement softened those terms.
Various studies that measure market-wide topping-bid activity.
Those studies' estimates of the expected value of topping bids.
The benefit of the supplemental disclosures (found to be minimal).
The percentage of the expected benefit that was attributable to the plaintiffs.
For corporate practitioners, the opinion's analysis of the original agreement's deal protections is most illuminating. A summary of that analysis follows.
The no-shop as originally drafted provided broadly (subject to the window-shop) that Compellent could not solicit, provide information to, or engage in discussions with any potential bidder other than Dell. VC Laster noted "[s]everal buyer-friendly features [that] jump out":
The covenant imposed strict contractual liability on Compellent for any breach, whether direct or indirect, including by any representative of Compellent, without any qualifiers for the materiality of the breach or Compellent's knowledge.
The covenant prohibited solicitations and discussions of "Acquisition Proposals," defined by reference to a broad threshold of any transaction involving 15% of the stock or assets.
The covenant also prohibited solicitations and discussions of "Acquisition Inquiries," which included inquiries that "could reasonably be expected to lead to an Acquisition Proposal."
As VC Laster explained, "more balanced versions" of the no-shop would have:
Limited the universe of persons covered by the no-shop.
Included a knowledge qualifier (such as "not knowingly solicit").
Required that the company "use its best efforts and act in good faith to cause" covered persons not to engage in the prohibited activities, as opposed to flatly making the company responsible for any prohibited contacts.
Set a higher threshold for the definition of "Acquisition Proposals."
Limited the scope of the covenant to actual offers or proposals.
As part of the settlement, the parties modified the previously unqualified contractual liability by limiting the exposure for immaterial breaches to those committed by a director, officer or financial advisor. Compellent would only be responsible for breaches committed by any other representative if the action taken was "inconsistent in any material respect" with the covenant.
The no-shop covenant in the original agreement had a window-shop exception that allowed Compellent to enter into negotiations with a bidder who had not been solicited by Compellent and who made its own written Acquisition Proposal. The exception, as drafted, included several buyer-friendly features that VC Laster took note of, including:
A condition of strict compliance with the no-shop and stockholder-meeting covenants, with no qualifiers based on intent, materiality or the presence of a relationship between the breach and the third-party bidder, before Compellent could make use of the window-shop.
A requirement that the board of Compellent determine that the failure to discuss the potential topping bid with the third party "would constitute" a breach of its fiduciary obligations to the stockholders under Delaware law.
A requirement that Compellent give Dell two days' advance notice before entering into discussions with a competing bidder and 24 hours' advance notice of all information provided to that bidder. This effectively obligated the board to knowingly breach its fiduciary duties for one or two days because it would have already determined that the failure to discuss the bid with the third party would constitute a breach of those duties.
An obligation that the third-party bidder enter into a 275-day standstill (www.practicallaw.com/1-382-3834) with no exceptions or "sunset" provisions before Compellent enter into any discussions with that bidder.
Conditions on Compellent's ability to waive the standstill, including:
strict compliance with the no-shop, again with no qualifiers;
a fresh requirement that the Compellent board make a determination that the failure to waive the standstill "would constitute" a breach of its fiduciary duties; and
four business days' advance notice to Dell before waiving the standstill (which again by definition created a contractual agreement on Compellent's part to knowingly breach its fiduciary duties for that period of time).
As VC Laster explained, the window-shop would have been more balanced had it:
Been qualified regarding the breaches that render the window-shop unavailable, especially by requiring some connection between the breach of the non-solicitation covenant and the superior offer.
Used instead a formulation that the board determine that its failure to act "could constitute" a breach or "would be inconsistent with its fiduciary duties."
Allowed the board to proceed with the third-party bidder once it determined that the bid was likely to constitute a superior offer, without also making a determination regarding a potential breach of it fiduciary duties.
As part of the settlement, the parties amended the window-shop exception to:
Eliminate the requirement for a standstill provision.
Loosen the requirement that the board determine that the Acquisition Proposal "constitutes or is reasonably likely to result in a Superior Offer," instead requiring that the board determine that the Acquisition Proposal "constitutes, or could (after review by such Person of confidential information and after negotiations between such Person and the Company) reasonably be expected to lead to, a Superior Offer." (This way, Compellent's board would not be forced into breaching its fiduciary duties while waiting out the advance-notice period.)
If the conditions to the window-shop exception were satisfied, Dell was entitled to information about the third-party bid. While these information rights are common in public merger agreements, Dell's rights in the original agreement were particularly broad. As highlighted by VC Laster, Dell was entitled to:
The identity of the competing bidder at least two business days before Compellent could commence discussions.
Any non-public information at least 24 hours before Compellent could provide it to the competing bidder.
An ongoing right to receive copies of written communications and summaries of oral communications.
As amended as part of the settlement, the agreement:
Shortened the two-business-day and 24-hour time periods to simply "prior to."
Provided Dell with an entitlement to written summaries of oral communications only if they were material communications made in connection with an initial Acquisition Proposal or Acquisition Inquiry.
For further oral and written communications, eliminated Dell's ongoing right to receive reports and summaries, substituting an obligation for Compellent to keep Dell "reasonably informed."
Public merger agreements commonly grant the buyer a period of time to match any competing bid, and in many cases mandate the target company's board to bring the agreement to a vote even if the board no longer recommends the transaction. The original agreement between Dell and Compellent included these features, giving Dell four days to match any competing bid (or three days to match any material change to the competing bid) or otherwise raise its bid to eliminate the need for Compellent's board to change its recommendation because of some intervening change in circumstances. Until the expiration of these time periods, Compellent's board was prohibited from changing its recommendation (which was defined as anything less than a unanimous recommendation), and in any event was forbidden from submitting any competing bid to a stockholder vote unless the agreement had been terminated.
However, the original agreement contained some features that VC Laster described as "novel" and which could have raised a host of potential legal questions had the litigation not been settled. These included:
How, if the stockholders are entitled to a current and accurate board recommendation, can the board contractually agree to delay a needed change for up to four days (or longer, if there are further changes to the competing offer).
How the board can agree that it will not give any less than a unanimous recommendation if the company's organizational documents contemplate that the board takes action by a majority of those present at a meeting where a quorum exists.
If the board determines that its fiduciary duties require it to postpone or adjourn the stockholders meeting so that the stockholders can consider new information or a change in recommendation, can it still be bound contractually to not postpone or adjourn that meeting?
The original merger agreement required Compellent to adopt a poison pill with a 15% trigger in a form previously approved by Dell. Though novel, the provision was not per se invalid and was not fundamentally different from covenants that require a target corporation to keep a previously adopted pill in place. However, similar to the drafting of the other deal-protection measures, the covenant also prohibited the pill's redemption unless there had been no breach at all of the no-shop and associated provisions, and only if the board first gave Dell four days' advance notice. The advance-notice clause again raised the question of whether the board could delay its decision to redeem the pill even after it had determined that not redeeming it would breach the board's fiduciary duties.
As part of the settlement, the rights plan was rescinded.
The break-up fee in the original agreement was set at $37 million, or 3.85% of the deal value, plus up to $960,000 (0.1%) in expense reimbursement, in the event of a termination to accept a competing bid. If the agreement were terminated because of another intervening event, the fee rose to $47 million, or 4.9%. These values are not problematic in and of themselves under Delaware law. However, the triggering events for payment of the fee were, as VC Laster called them, "hair-trigger events." Under the agreement, Compellent would be required to pay the fee and expense reimbursement if it received an Acquisition Proposal, then either the agreement's termination date came and went or the stockholders disapproved the deal, and one of the following triggering events had occurred:
The board's recommendation for the merger was no longer unanimous.
The board failed to publicly and unanimously reaffirm its recommendation for the merger within five business days of a request from Dell.
The company failed to publicly and unanimously reaffirm its recommendation for the merger within five business days of the public announcement of an Acquisition Proposal or failed to include its recommendation in the proxy statement.
The board released any party from, or waived any provision of, any standstill agreement.
The company materially breached the no-shop provision.
If, however, none of these triggering events occurred, then Compellent would only be required to reimburse Dell its expenses. Moreover, Compellent would later be required to pay the fee if, within a nine-month tail period of the agreement's termination, Compellent agreed to be acquired by another company. The import of these provisions was that Compellent's board had a strong financial incentive to not engage with a bidder who may be offering better value, to not provide the stockholders with an updated recommendation and to not engage in any other discussions post-termination for a period of nine months, all in possible contravention of the board's fiduciary duties.
As part of the settlement, the amount of the break-up fee was lowered to $31.1 million, or 3.24% of the deal value.
The decision in this case reads like a checklist for the drafting of deal-protection provisions and the avoidance of conflicts with the board's fiduciary duties. Although VC Laster did not make any definitive pronouncements of the legality of any the provisions of the Dell-Compellent agreement, his warnings, especially in the areas of the buyer's matching rights and the triggering events for payment of the break-up fee, should be strongly considered by all deal practitioners. The opinion especially provides counsel representing target companies with several powerful arguments for their negotiations.