In In re Essendant Inc. Stockholder Litigation (Dec. 30, 2019), the plaintiff-stockholders of Essendant, Inc. (the “Company”) brought claims against the Company’s directors for their decision to terminate an agreement for a stock-for-stock merger with Genuine Parts Company (“GPC”) in order to enter into an all-cash deal offered by Staples, Inc. and its private equity firm parent, Sycamore Partners. The Delaware Court of Chancery, at the pleading stage of the litigation, rejected the plaintiffs’ contention that Sycamore, although a minority stockholder, was a controlling stockholder of the Company. In so ruling, Vice Chancellor Slights dismissed the plaintiffs’ claims that (i) Sycamore had a fiduciary duty to the other stockholders and breached it by pressuring the Essendant board to accept its “inadequate” offer for the Company; and (ii) the Essendant board, by accepting Sycamore’s offer, breached its duty of loyalty to the stockholders by “caving to the will of [a] controller” rather than seeking to obtain the maximum value reasonably obtainable for the stockholders.
Key Points
- The decision reaffirms the well-established principle under Delaware law that a minority stockholder is a “controller” only if it actually “exercises control over the business affairs of the corporation.” The court reiterated that the standard requires an exercise of control such that “as a practical matter, [the minority stockholder is] no differently situated than if it had majority voting control.” In this case, there was little evidence of any significant influence by the Sycamore, which owned 11.6% of the outstanding shares. Thus, the decision does not meaningfully elucidate the parameters for a minority stockholder to be deemed to be a controller when it has, for example, appointed directors who take an active role on a board or otherwise has exerted a strong voice in a company’s affairs.
- The decision also reaffirms the presumptions of director independence and disinterestedness–and that independent, disinterested directors, as a fiduciary matter, even when Revlon duties apply, can legitimately prefer an all-cash deal over a stock deal that is valued higher than the cash offer price.
Background. Essendant initially entered into a merger agreement with GPC for a stock-for-stock deal in which 49% of the combined company would be retained by the Essendant stockholders. Essendant’s financial advisor opined that the merger would provide Essendant stockholders with value in the range of $13.30 to $23.90 per share. Both parties expected that the deal would present significant antitrust issues. The agreement contained a customary no-solicitation provision prohibiting Essendant from knowingly encouraging any competing offers for the company post-signing; a fiduciary out that permitted termination of the agreement by Essendant if it received a “superior offer” post-signing on an unsolicited basis; and a termination fee that would be payable to GPC if the termination right were exercised.
A few days before the GPC merger agreement was signed, Sycamore had expressed interest in acquiring the Company. A few days after the agreement was signed, Sycamore sent the Company a formal offer to acquire it in an all-cash deal for $11.50 per share. The Essendant board rejected Sycamore’s $11.50 offer as not reasonably likely to lead to a superior offer compared to the GPC deal. However, the board communicated to Sycamore that it would be “open to receiving a revised offer.” A few days later, Sycamore renewed its offer, at the same price and on the same terms. This time, the Essendant board decided that the offer was reasonably likely to lead to a superior offer. During the negotiations between Essendant and Sycamore, Sycamore was acquiring Essendant shares in market purchases. Essendant adopted a shareholder rights plan that effectively froze Sycamore’s ownership at 11.6% of the outstanding shares.
Essendant notified GPC of Sycamore’s $11.50 offer. In response, GPC added to its offer a contingent value right in the form of a cash payment of up to $4 per share. Sycamore ultimately raised its offer to $12.80 per share in cash, which the Essendant board accepted. That offer (approximately $1 billion in the aggregate) represented an 11% discount to Essendant’s then-current stock price of $14.24 per share but a 51% premium to the stock’s unaffected price before the GPC deal had been announced. GPC chose not to match Sycamore’s offer. Even though Sycamore’s $12.80 per share offer was below the value range of $13.20–$23.90 per share that Essendant’s financial advisor had estimated for the GPC proposal (exclusive of the contingent value right), the financial advisor provided an opinion that Sycamore’s offer was fair from a financial perspective. Essendant terminated the GPC merger agreement and paid GPC a $12 million termination fee. Essendant’s Schedule 14D-9 stated that the board preferred Sycamore’s all-cash deal over GPC’s all-stock deal because of “risk related to continued secular decline in the Company’s industry.” The Sycamore deal closed in January 2019.
Discussion
The plaintiffs contended that the Essendant board breached its duty of loyalty by “caving” to a controller. The court noted that, because the Essendant directors (as provided under DGCL Section 102(b)(7), and as is typical) were exculpated under the Company’s charter for breaches of the duty of care, only well-pled claims of breach of the duty of loyalty (which cannot be exculpated) could withstand the defendant directors’ motions to dismiss the fiduciary claims against them. It is well-established that a duty of loyalty claim requires a showing that a majority of the board lacked independence, was self-interested or acted in bad faith. The plaintiffs contended that the Essendant board breached its duty of loyalty by “having acceded to the will of Sycamore as a controlling stockholder at the expense of other stockholders” and having “operated under some broader conflict of interest” relating to Sycamore.
The court found that Sycamore did not actually “exercise control” of the Company and therefore was not a controller. The court reaffirmed that, for a minority stockholder to be deemed a controller, it must have “exercised such formidable voting and managerial power that, as a practical matter, it was no differently situated than if it had majority voting control.” In other words, the court wrote, for Sycamore to be considered a controller, it must be reasonably conceivable that Sycamore’s “minority stake was so potent that independent directors could not freely exercise their judgment, fearing retribution from Sycamore.” The court commented that this test “is not an easy one to satisfy.” The court observed that Sycamore did not (i) nominate any members of the Essendant board; (ii) wield coercive contractual rights; (iii) maintain personal relationships with any of the Essendant board members; (iv) maintain any commercial relationships with Essendant board members that would afford leverage in its negotiations; (v) threaten removal, challenge or retaliate against any of the Essendant board members; or (vi) otherwise exercise “outsized influence” in Essendant’s board room. Further, the court stated, it would have been “difficult for Sycamore to achieve any of these markers of control because two other entities held larger voting blocks than Sycamore.” Thus, the court found that Sycamore was not a controller and, therefore, dismissed the claims that (i) Sycamore had (and breached) fiduciary duties to the other stockholders and (ii) the Essendant board breached its duty of loyalty by succumbing to Sycamore’s will.
The court also found that the Essendant board was independent and not self-interested. The court emphasized that there is a presumption that directors are independent and not self-interested. To rebut the presumption, the court stated, a plaintiff must do a “director-by-director analysis” and a “head count” to show that a majority of the directors lacked independence or were self-interested. In this case, the plaintiffs made a general claim of lack of independence of the board based on the board’s: (i) deciding not to inform GPC of Sycamore’s initial expression of interest in acquiring the Company (which was made just before the GPC merger agreement was signed); (ii) communicating to Sycamore that it would be open to considering a revised offer from Sycamore; (iii) not requiring Sycamore to sign a standstill agreement; (iv) “slow-walking” the GPC merger’s regulatory approval process (allegedly in order to facilitate negotiations with Sycamore); and (v) ultimately deciding to prefer the Sycamore deal over the GPC deal (notwithstanding its lower valuation). In the court’s view, these alleged facts did not support an inference that a majority of the board was “beholden” to Sycamore. Rather, the court stated, they reflected simply that the board, as it had expressed, preferred an all-cash deal with Sycamore to an all-stock deal with GPC. The only factual allegation made that “possibly” related to the directors’ being self-interested in the Sycamore deal, the court wrote, was that certain of them had ”possible ongoing roles” with Staples (a company that had recently been acquired by Sycamore and was in the same business as Essendant). This “vague” allegation could not rebut the presumptions of independence and disinterestedness of the directors, the court stated.
The court rejected the plaintiffs’ claim that the board acted in bad faith by accepting Sycamore’s offer given that it was lower than GPC’s offer. The plaintiffs claimed that Sycamore’s $12.80 offer was “unfair” because it (i) represented a discount to Essendant’s GPC merger-affected trading price and (ii) was below the DCF range Essendant’s financial advisor had calculated for the GPC merger on a pro forma basis. Even accepting these criticisms at face value, the court stated, “criticizing the price at which a board agrees to sell a company, without more, does not a bad faith claim make.” The court noted that the $12.80 price represented a 51% premium over Essendant’s unaffected trading price. The court also stated that the decision to accept Sycamore’s offer was “imminently explicable as a measured determination that a cash payment today is superior to uncertain returns derived from remaining in the highly competitive office supply business tomorrow.” As noted, the board stated in the 14D-9 that it preferred Sycamore’s all-cash offer over GPC’s all-stock offer “because of risk related to continued secular decline in the Company’s industry.” A board “might prefer an all cash deal to a deal that may be thought to represent a somewhat higher price, but is not all cash,” the court wrote. The court stated that, after the Sycamore offer was received, the choices that the Essendant board made “[fell] well within the many available ‘blueprints’ a board might choose to employ while negotiating a transaction within the Revlon paradigm.” Preference for a cash deal over a stock deal is “a judgment call well within a board’s prerogative when pursuing the highest value reasonably available to the Essendant shareholders,” the court wrote. Further, the court observed that the Essendant financial advisor’s pro forma DCF valuation of the GPC stock deal (i.e., $13.30 to $23.90 per share) included a valuation of expected synergies in a range of $8.35 to $11.25 per share. When compared with Sycamore’s initial offer of $11.20 and final offer of $12.80 per share, “it is not reasonable to infer that the Essendant Board’s preferences for the Sycamore deal, even when considering GPC’s revised offer with a contingent value right, was so ‘unusual’ or ‘inexplicable’ that it reflects a breach of the duty of loyalty,” the court wrote.
The court rejected the plaintiffs’ contention that their allegations that the disclosure to stockholders was materially false and misleading supported an inference that the directors acted in bad faith. The court observed the well-established principle under Delaware law that “[a] director acts in bad faith when she intentionally fails to act in the face of a known duty to act, demonstrating a conscious disregard for her duties.” Thus, a breach of the duty of loyalty based on inadequate disclosure requires a showing not only that the disclosure was materially false or misleading but that the directors “knowing[ly] or intentional[ly]” misstated or omitted material facts. The court found that the plaintiffs’ allegations reasonably supported neither an inference that the alleged disclosure flaws were material nor that there was “any reason that the directors would have abandoned their duties to intentionally mislead the stockholders into tendering into the Sycamore deal.” The court found that some of the alleged disclosure omissions (for example, that the board “intentionally slow-walked the GPC merger’s regulatory approval process in order to delay consummation of that transaction”) were merely examples of the board declining to adopt the plaintiffs’ characterization of its behavior (i.e., to engage in “self-flagellation,” which is not required). Indeed, according to the court, the alleged omitted facts supported an inference that the board was “making business decisions, whether right or wrong, in an effort to maximize stockholder value.” Finally, the court stated, the omission of certain “details” (such as the exact amount of the financial advisor’s post-closing compensation, the exact date management projections were calculated, or details on Essendant executives’ post-closing compensation) “cannot support an inference of bad faith.”
The ongoing, separate breach of contract case did not foreclose dismissal of the fiduciary claims in this case. GPC brought a separate contract suit against Essendant (GPC v. Essendant), which is currently pending before the Court of Chancery. In that case, GPC claims that Essendant breached its obligations under the no-solicitation and the reasonable-best-efforts-to-close provisions of the GPC merger agreement. On September 9, 2019, Vice Chancellor Slights, at the pleading stage of that case, refused to dismiss the case. Notably, the court’s denial of the motions to dismiss the contract claims in that case did not foreclose dismissal in this case of the fiduciary duty claims that were based on the same allegations.
Practice Points
- To show that a board was independent or self-interested, a plaintiff must analyze the individual directors. The court criticized the plaintiffs for having made general allegations of non-independence and self-interest of the board without doing a “director-by-director analysis” to determine whether a majority of the directors lacked independence or were self-interested.
- If a board changes its mind in the course of a sale process, it should document and disclose the reasons for the change. Much of the skepticism about the Essendant sale process centered on the board’s having determined, at first, that Sycamore’s $11.50 initial offer was not reasonably likely to lead to a superior offer as compared to the GPC deal, and then, just days later, “suddenly” determining that the very same offer was reasonably likely to lead to a superior offer. The court, in ruling for the board, pointed to the 14d-9 disclosure that a cash deal was preferred given uncertainty in its industry. Clear disclosure about the reason for the board’s changing its mind over just a few days likely would have been helpful.
- During a non-solicitation period, a board should be careful not to make any statements that could be viewed as encouraging competing offers. Non-solicitation provisions typically are very broad in their applicability, without specific guidelines. There have been very few instances of litigation over a target’s acceptance of a “superior offer” during the post-signing pre-closing period. In GPC v. Essendant (the separate contract case brought by GPC, which alleges that Essendant breached the GPC merger agreement), at the pleading stage, the court viewed none of Essendant’s actions standing alone as likely having constituted a material breach.
However, the court refused to dismiss the case because the target’s actions, viewed together, suggested a “furtive pattern of communications and cooperation” that raised “concerns.” The decision in the contract case highlights the importance not only of a target’s compliance with any specified requirements of a non-solicitation provision, but also, in most cases, the advisability as a general matter, post-signing, of not engaging in any communications with a potential competing bidder until an offer is received and the board determines that it is (or, depending on the drafting of the non-solicitation provision, may lead to) a “superior offer.” Otherwise, there is a risk that the court could view the target’s actions as constituting a breach of the non-solicitation provision–and that result, as the Essendant contract and fiduciary cases both reflect, could have far-reaching consequences.
- A merger agreement should be drafted to clearly reflect whether payment of a termination fee is the sole remedy when a target has terminated an agreement after breaching a no-solicitation obligation. The court’s decision in the contract case also highlights the importance of clear drafting of the interrelationship between the non-solicitation and termination fee provisions in a merger agreement. The GPC merger agreement specified that the termination fee was an exclusive remedy. However, at the pleading stage, the court found that the agreement did not “clearly and unambiguously” provide that that was the case in the event that the target had breached the non-solicitation provision.
This post comes to us from Fried, Frank, Harris, Shriver & Jacobson LLP. It is based on the firm’s memorandum, “Court of Chancery Reaffirms High Bar for a Minority Stockholder to be Deemed a Controller – Essendant,” dated January 29, 2020.