Gibson Dunn discusses Important New Guidance on Revlon Duties

On December 19, 2014, the Delaware Supreme Court issued a ruling reversing an order of the Court of Chancery granting a preliminary injunction that would have enjoined an agreed-to merger and required a mandatory post-signing 30-day go-shop period.  In C&J Energy Services, Inc. v. City of Miami General Employees’ and Sanitation Employees’ Retirement Trust, No. 655/657 (Del. Dec. 19, 2014), the Supreme Court held, among other things, that the Court of Chancery had imposed a non-existent requirement that a selling company must engage in an active market process as a matter of law.

The Transaction.  The transaction that gave rise to the lawsuit was a merger between a Delaware corporation, C&J Energy Services, Ltd., and a Bermuda company, a subsidiary of Nabors Industries, Ltd.  The merger was structured as an inversion transaction through which C&J would acquire the Nabors subsidiary, and the C&J management team would run the combined entity, but Nabors would retain a majority equity stake in the surviving company.

Prior to entering the deal, the C&J Board did not engage in an active market check, but the Board did negotiate for a standard “fiduciary out” to the non-solicitation clause in the merger agreement to allow C&J to negotiate with third parties under certain circumstances.  This was coupled with a “modest” deal termination fee equal to 2.27% of the deal value.  The Board also secured several corporate governance protections for C&J shareholders spanning a five-year period, including limits on Nabors’ exercise of control and the right for C&J stockholders to participate pro rata in any sale of the surviving entity.

The Chancery Court Decision.  On November 24, 2014, at the conclusion of the preliminary injunction hearing, the Court of Chancery announced its decision from the bench.  In assessing the merger process in C&J, the Court of Chancery focused on what it considered a “major problem”:  the fact that the C&J Board did not approach the merger as a sales process, but instead was focused on a strategic acquisition that happened to turn into a sale due to tax considerations.  Accordingly, although the Court of Chancery determined the C&J Board was informed of the company’s value and was not conflicted, it nevertheless concluded that it was “plausible” that the Board transgressed Revlon’s requirement that it seek the highest immediate value reasonably available, because the Board did not have “impeccable” knowledge of the assets of the company acquiring it.  Thus, the Court of Chancery enjoined the stockholder vote for 30 days and instructed C&J to actively shop itself during that 30-day period.

The Supreme Court Decision.  In an opinion authored by Chief Justice Strine, the Supreme Court, en Banc, unanimously held that a mandatory injunction enjoining the merger was not proper for several reasons:

  • First, the Supreme Court held that the lower court applied the wrong legal standard for issuance of a preliminary injunction.  Rather than requiring that Plaintiffs demonstrate a reasonable probability of success on the merits in order to secure preliminary injunctive relief, the lower court granted relief based on a mere “plausible” ability to succeed on the merits.
  • Second, the Supreme Court held that, in determining success on the merits was “plausible,” the lower court erred in holding that an affirmative go-shop period was required in order to satisfy Revlon, because Revlon imposed no such requirement; it only required a market check appropriate to ensure a bidder willing to pay more for a company had a meaningful opportunity to submit a viable bid.
  • Third, the Supreme Court held the lower court applied the wrong procedural standard.  By ordering C&J to take certain action–a 30-day go-shop period–it issued a mandatory injunction.  This was error because a mandatory injunction must be premised on a factual record derived from either a trial or undisputed facts.

Accordingly, the Supreme Court reversed the lower court and its entry of a preliminary injunction delaying the shareholder meeting and requiring a go-shop period.

Takeaways.  The Supreme Court’s decision in C&J Energy offers important guidance for companies and boards considering change-in-control transactions:

  • Revlon Requires Reasonable Decision, Not Perfect Decision.  The Court reaffirmed the Delaware law principle that “‘there is no single blueprint that a board must follow to fulfill its [Revlon] duties.'”  The question, therefore, under Revlon is “‘whether the directors made a reasonable decision, not a perfect decision.'”  When properly articulated, the Revlon standard gives a board significant discretion to “pursue the transaction it reasonably views as the most valuable to stockholders”–provided that decision is accompanied by at least a market check.
  • Active Market Checks Not Always Necessary.  The Supreme Court made clear that the Revlon standard is tied to its specific facts–namely, that it focused on a Board’s resistance to a specific bidder and the subsequent barriers the board erected to obstruct that bidder.  Thus, a board may satisfy Revlon if it ensures there are reasonable limits on barriers to alternative bidders.  A critical component to limiting barriers is “an effective market check.”  This mandate does not require an active check in all circumstances; rather, it is flexible, requiring only what is appropriate under the circumstances to be “effective.”  A check is “effective” where it gives “any bidder interested in paying more for a company an opportunity to do so,”i.e., it gives a higher bidder the opportunity to present its bid and the board has the means to choose the higher bid and forgo the alternative transaction.  A passive market check (for instance, a “fiduciary out” allowing for the Board’s consideration of competing offers), when employed with other safeguards, can suffice to satisfy Revlon duties.  For example, the post-deal passive market check used by C&J was coupled with a relatively low termination fee and an almost five-month period before a shareholder vote on the proposed transaction–two provisions the Supreme Court highlighted as alleviating “material barriers” to any alternative bids from being submitted.
  • Equitable Authority of the Court of Chancery Has Limits.  Although the Supreme Court had sufficient grounds for reversing the injunction based on the misapplied legal standard, it nonetheless dedicated almost five pages to discussing the proper exercise of equitable authority.  It noted that the Court of Chancery’s equitable authority is remarkably broad, but “it is not uncabined.”  In holding that the Court of Chancery’s exercise of its equitable authority was overly broad, the Supreme Court highlighted as “unusual” the fact that the Injunction Order not only instructed C&J to solicit and negotiate alternative proposals, but also stated that doing so would not breach the plain language of the merger agreement–though the agreement explicitly provided that such action would constitute a breach.  The Supreme Court held that the lower court failed to provide a basis for forcing Nabors to “endure a judicially-ordered infringement of its contractual rights that would, by judicial fiat, not even count as a breach” and indicated that establishing such a basis would require a “viable claim[]” that Nabors aided and abetted the C&J Board’s alleged breach of fiduciary duties.  In other words, the preliminary injunction may not be used “to divest third parties of their contractual rights.”

In the face of evolving and multiplying challenges to M&A deals, practitioners can take some comfort in the Chief Justice’s clear guidance that Delaware Courts should be reticent to take decisions on corporate transactions out of the hands of stockholders.  This is “especially the case” where stockholders have no alternative bid to consider and have the non-coerced and adequately informed ability to address the harm claimed by Plaintiffs via the simple act of casting a “no” vote.

The opinion is available here.

The full and original memorandum was published by Gibson Dunn on December 22, 2014 and is available here