Stapled Financing—Risk and Reward
By Thomas Sauermilch and David Cohen
Especially in light of the tightening credit conditions for leveraged buyouts, stapled financing remains an attractive technique to mitigate financing uncertainties in today’s market. In a typical stapled financing transaction, a seller arranges the availability of credit for a range of potential buyers through the seller’s financial advisors. In addition to increasing the pool of potential bidders for the asset to be sold, stapled financing can create a financing floor, speed the pace of the transaction and provide greater financing certainty at the inception of a deal. Following the Toys-R-Us decision, investment banks have implemented policies to address potential conflicts that can arise when a banker wears the hat of both financial advisor and lender. It has become a best practice to provide for a fairness opinion from an independent third-party advisor. Despite the adoption of these procedures, the recent Ortsman decision offers a cautionary tale.
In Ortsman v. Green (2007 Del. Ch. LEXIS 29 (Del. Ch. 2007)), the Delaware Court of Chancery (the Court) granted the plaintiffs, a class of stockholders, limited expedited discovery into the allegedly conflicted role played by an investment bank that both advised the seller, ADESA, Inc. (Adesa), and offered stapled financing to potential purchasers of Adesa.
Adesa, a publicly traded Delaware corporation, engaged the investment bank as its financial advisor in a proposed merger. Later, Adesa began to consider a complete sale of its operations rather than a merger and permitted the same bank to offer stapled financing to potential buyers. In hopes of staving off any appearance of potential conflicts of interest and preserving the integrity of the process, Adesa’s board engaged a second investment bank to provide an opinion regarding fairness in connection with the proposed sale.
Although Adesa obtained a fairness opinion from an independent third party, it was still sued by plaintiffs alleging that the bank’s dual role as both advisor and lender caused it to advise Adesa’s board not to pursue an indication of interest from an alternative buyer that was believed to be less inclined to seek financing from the bank. In addition, the plaintiffs alleged a number of deficiencies in Adesa’s proxy statement, particularly the lack of disclosure of amounts the second bank had earned in other transactions that involved the potential buyer, and, more broadly, the fees to be paid to both banks.
Although an appraisal remedy remained available to the plaintiffs, and evidence of any impropriety was scant, the Court concluded that the plaintiffs were entitled to limited expedited discovery and an opportunity to move for a preliminary injunction in advance of a stockholder vote. This case demonstrates that Delaware courts will scrutinize any potential conflicts of interest involving financial advisors and will require that sellers specifically disclose material information, including fee arrangements, to stockholders.
It also serves as a reminder that the mere appearance of impropriety can derail any transaction. Although Adesa had followed what were understood to be best practices in obtaining a fairness opinion from an independent advisor, potentially insufficient disclosures in the proxy statement concerning past dealings of the parties with both investment banks gave rise to litigation. Ortsman is not a reason to avoid stapled financing, but certainly a reason to approach stapled financing and related disclosures with great care and planning.
Practice Notes: 2007 Amendments to Delaware General Corporation Law
By Monique Ho
The following is a brief summary of certain recent amendments to the Delaware General Corporation Law (DGCL) that are relevant to corporate practitioners in merger and acquisition (M&A) transactions. Although many of the amendments are technical in nature and do not reflect any deep substantive changes in the law, they are nonetheless worth noting. These amendments became effective August 1, 2007.
Section 141(d) of the DGCL governs, among other matters, board committees and the voting power of directors. Subsection (d) of Section 141 permits a certificate of incorporation to confer upon one or more directors voting powers that are greater or less than those of other directors. Subsection (d) was amended to clarify that when a certificate of incorporation confers upon directors voting powers that vary from those of other directors, such varied voting powers will also apply to any votes cast by such director in any board committee or subcommittee, unless otherwise provided in the certificate of incorporation. Accordingly, if a special committee is established to approve or make a recommendation to the board regarding a change of control transaction, M&A practitioners should take care to ensure that any unusual voting powers of the directors are carefully considered when determining which board members will serve on such committee.
Stockholder Appraisal Rights
Section 262 of the DGCL, which governs stockholder appraisal rights, was amended as set forth below. These amendments will apply to transactions consummated pursuant to agreements entered into after August 1, 2007.
- Subsections (e) and (k) of Section 262 were amended to clarify that a stockholder who has demanded appraisal in connection with a merger or consolidation may withdraw that demand within 60 days after the effective date of the merger or consolidation so long as the stockholder has not filed a petition for appraisal in the Court of Chancery or joined any such proceeding as a named party.
- Subsection (e) of Section 262 was amended to permit beneficial owners of shares of stock to do each of the following in their own names: file a petition for appraisal before the Court of Chancery, and request a statement of shares with respect to which demands for appraisal have been made. Prior to this amendment, petitions for appraisal could only be filed by the stockholder of record. Accordingly, holders of record (such as Cede & Co.) will no longer have to serve as a nominee petitioner in an appraisal proceeding. Note, however, that the written demand for appraisal must still be submitted to the corporation by the holder of record.
- Subsection (h) of Section 262 was amended to establish a presumption that interest will be awarded in appraisal proceedings for the period from the effective date of the merger until the date of payment of judgment, and will compound quarterly and accrue at a rate of 5 percent over the Federal Reserve discount rate. The Court of Chancery, however, retains the discretion to depart from this presumption if good cause, such as bad faith on the part of one of the litigants, is shown. Previously, Section 262 did not state what interest rate should apply in appraisal cases. This amendment was intended to eliminate needless litigation concerning the rate of interest in these cases and the presumptive rate reflects what had become, as a practical matter, the default rate in the Court of Chancery.
- Subsection (h) of Section 262 was also amended to clarify that in appraisal proceedings the Court of Chancery will not determine the fair value of shares on its own initiative. Appraisal proceedings are adversary proceedings, and the Court will determine the fair value of the shares in these proceedings only upon demand by the surviving corporation or the stockholder seeking appraisal.
The following amendments were made to the DGCL relating to filing requirements in connection with mergers or consolidations:
- Several amendments to Section 251 eliminate the requirement that an agreement of merger or consolidation include a certification from the secretary or assistant secretary of the corporation to the effect that the agreement of merger or consolidation was adopted by the requisite vote of the stockholders or members, as applicable, if a certificate of merger is filed with the Delaware Secretary of State in lieu of the agreement.
- Similar amendments were made to Section 255 regarding a merger or consolidation of domestic non-stock corporations. The certification requirement was also eliminated from Sections 252, 254, 256, 257, 258, 263 and 264 by cross-references to Sections 251 and 255.
- An amendment to subsection (b) of Section 258 clarifies that each constituent foreign corporation must also certify the agreement of merger or consolidation in accordance with the laws under which it was formed.
Court Finds Disclosed Information Relating to Fairness Opinion Sufficient
By Jeffrey Rothschild
In In re CheckFree Corp. Shareholders Litigation, Consol. C.A. No. 3193 – CC (Del. Ch. Nov. 1, 2007), Chancellor Chandler of the Delaware Court of Chancery held that CheckFree Corporation was not required to disclose all of the data underlying the fairness opinion included in its definitive proxy statement. The court reiterated its previous decision’s finding that “an adequate and fair summary” of the substantive work done to derive the fairness opinion was sufficient.
After considering a fairness opinion from its financial advisor, CheckFree’s board approved a $4.4 billion all-cash merger between CheckFree and Fiserv, Inc. CheckFree filed a definitive proxy statement with the U.S. Securities and Exchange Commission that included a summary of financial analyses underlying the fairness opinion. The proxy statement also detailed the sources upon which CheckFree’s financial advisor relied, explained some of the assumptions and calculations CheckFree’s management made to formulate its estimates, noted the precedent transactions and selected public companies the financial advisor used, and disclosed management’s estimated earnings and estimated EBITDA for 2007 and 2008, as well as a range of earnings derived from management estimates for 2009.
Plaintiffs moved for a preliminary injunction on disclosure grounds, claiming that the proxy failed to disclose management’s “raw” financial projections for the company. Plaintiffs argued that these financial projections were shared with Fiserv and that the financial advisor used these projections in performing a discounted cash flow analysis, one of the financial analyses it used in deriving its fairness opinion.
The court held that Delaware law does not require the disclosure of “all financial data needed to make an independent determination of fair value,” nor is there a “checklist” of things that must be disclosed relating to a fairness opinion. Instead, the court cited In re Pure Resources, Inc. Shareholders Litigation, 808 A.2d 421 (Del. Ch. 2002) for the proposition that “stockholders are entitled to a fair summary of the substantive work performed by the investment bankers upon whose advice the recommendations of their board as to how to vote on a merger or tender rely” and reiterated its holding that directors need only disclose material information, i.e., that which significantly alters the total mix of information available, and which stockholders would likely consider important in determining whether to vote in favor of the proposed transaction.
In reaching its opinion, the court distinguished its recent decision in In re Netsmart Technologies, Inc. Shareholders Litigation, 924 A.2d 171 (Del. Ch. 2007). In Netsmart , the court found that further disclosure was required because the proxy at issue “affirmatively disclosed an early version of some of management’s projections.” The court reasoned that management was required to give materially complete information “once a board broaches a topic in its disclosures.” CheckFree’s proxy, on the other hand, did not purport to disclose management’s projections. In fact, the proxy included an explicit warning indicating that the projections failed to account for risks that threatened the accuracy of the projections. This omission of risk, the court reasoned, rendered the projections incomplete and non-material, and therefore disclosure was not required.
Rule 2290 Update
On November 8, 2007, the Financial Industry Regulatory Authority, formerly the National Association of Securities Dealers, announced that Rule 2290 (regarding fairness opinions) will be effective on December 8, 2007.