Another Twist on the Delaware Two-Step: Tender of Shares in Section 251(h) Transaction Has Same Cleansing Effect on Standard of Review as a Stockholder Vote
Yesterday the Delaware Court of Chancery extended a line of recent cases concerning the effect of fully informed, disinterested and uncoerced stockholder approval on the standard of review applicable to tender offers made in connection with a two-step merger under Section 251(h) of the Delaware General Corporation Law (the “DGCL”). Specifically, Vice-Chancellor Montgomery-Reeves’ opinion in In re Volcano Corp.1 establishes that a tender of shares to the acquiror in a Section 251(h) transaction “essentially replicates [the] statutorily required stockholder vote in favor of a merger.” Therefore, when such a tender is made by a majority of a corporation’s fully informed, disinterested and uncoerced stockholders, it will reduce the standard of review of the transaction to the business judgment rule. The opinion effectively allows parties to utilize the favorable two-step structure under Section 251(h) without losing the benefit of a lower standard of review obtained through a formal stockholder vote.
Section 251(h) is a recently adopted provision of the DGCL which, as the vice-chancellor noted:
permits a merger agreement to include a provision eliminating the requirement of a stockholder vote to approve certain mergers if, among other requirements, the acquiror consummates a tender or exchange offer that results in the acquiror owning at least such percentage of the shares of stock of the target corporation that, absent Section 251(h), would be required to adopt the agreement of merger by the DGCL and by the certificate of incorporation of the target corporation.2
By structuring an acquisition of a Delaware corporation as a tender offer followed by a merger, parties are often able close transactions more quickly and at lesser cost than by holding a proxy solicitation and stockholder vote to approve a transaction. Before the adoption of Section 251(h), parties attempting to structure an acquisition as a two-step merger often had to develop complicated mechanics (such as a so-called “top up option”) or use elaborate strategies in order to bring their ownership over the 90 percent threshold required under the Delaware short form merger statute.3 Section 251(h) has been seen as the Delaware General Assembly’s approval of the two-step merger transaction structure without requiring parties to resort to such measures.4 By holding that the tender of shares by stockholders in a Section 251(h) transaction can reduce the standard of review to the business judgment standard, In re Volcano Corp. opens the door for easy dismissal of post-closing claims. “That is because the vestigial waste exception,” the sole grounds on which a plaintiff can challenge corporate action under such standard, “has long had little real-world relevance, because it has been understood that stockholders would be unlikely to approve a transaction that is wasteful.”5
In order to apply the business judgment standard of review to this case, the vice-chancellor examined a line of recent Delaware cases clarifying that the business judgment standard was the appropriate standard to apply where stockholders had approved the transaction at issue through a fully informed, disinterested and uncoerced vote.6 In examining whether to apply those cases to the matter at hand, the vice-chancellor looked at whether (1) stockholder acceptance of a tender offer in connection with a Section 251(h) transaction was equivalent to a stockholder vote to approve a merger, and (2) such tendering stockholders were fully informed, disinterested and uncoerced.
With respect to the first requirement, the vice-chancellor examined the requirements of Section 251(h). She found that Section 251(h) adequately addressed two key concerns that might distinguish a tender offer from a stockholder vote and thus preclude such an offer from shifting the standard of review. First, a tender offer generally does not require any action or disclosure from a target’s board of directors. However, this concern is not present in a two-step transaction under Section 251(h), which is predicated on the existence of a negotiated merger agreement, and which must be approved by the target’s board. Further, the target board’s recommendation that stockholders tender their shares in such a transaction is subject to the same state law disclosure requirements as any other communication with stockholders soliciting their approval of a similar transaction. Second, tender offers are often thought of as more coercive than a stockholder vote, because they may be seen as implying a threat that failure to tender will leave dissenting stockholders at the mercy of a controlling stockholder. Because a tender offer in connection with a Section 251(h) transaction must be made for all of the outstanding stock of a target and must involve a merger providing the same consideration as the tender offer promptly after the conclusion of such offer, Section 251(h) mitigates this coercive concern. In this case, the non-tendering stockholders of Volcano Corp. who were cashed out in the second-step of the merger received the exact same consideration – $18 per share – as the stockholders who accepted the tender offer. Accordingly, the vice-chancellor found that Section 251(h) “appears to eliminate the policy bases on which a first-step tender offer in a two-step merger may be distinguished from a statutorily required stockholder vote, at least as it relates to the cleansing effect rendered therefrom.”
In addition, the vice-chancellor addressed the argument that a stockholder tender of shares does not ratify a corporate action approved by a board of directors, but actually effects the action in the first place and therefore cannot serve as ratification in light of the holding of Espinoza v. Zuckerberg.7 She found that whether or not an action constitutes “ratification” was not relevant to the question of whether it had a “cleansing effect” on the applicable standard of review. Accordingly, “the acceptance of a first-step tender offer by fully informed, disinterested, uncoerced stockholders representing a majority of a corporation’s outstanding shares in a two-step merger under Section 251(h) has the same cleansing effect under Corwin8 as a vote in favor of a merger by a fully informed, disinterested, uncoerced stockholder majority.”
Having so determined, and with no questions raised as to interest or coercion, the vice-chancellor examined whether the stockholder tender in the transaction at hand was fully informed. In order for stockholders to be considered to be fully informed under Delaware law, they must be apprised of “all material information,” defined as those facts that a reasonable stockholder “would consider important in deciding [whether to approve the challenged transaction.]”9 When a defendant argues that stockholder approval has cleansed a challenged transaction, the defendant bears the burden of proof to show that such approval was fully informed.
One disclosure was relevant to the case at hand. Volcano Corp.’s financial adviser had a set of warrants and options that would pay out in the event of a change of control transaction like the transaction at issue. The value of these options and warrants would decrease “exponentially” over time, and accordingly, the adviser had a financial incentive to sell the corporation quickly. While Volcano Corp. disclosed the existence of these warrants and the fact that their value would decrease over time, it did not disclose that this decrease was “exponential.” Although a “more exhaustive disclosure” may have been “somewhat more informative” the court found that the disclosure was sufficient to permit a reasonable stockholder to conclude that the adviser would prefer to consummate a deal “sooner rather than later.” Thus, the disclosures made were adequate to permit the stockholders to act in a fully informed manner.
In re Volcano continues the trend of the Delaware courts to defer to the fully informed and uncoerced judgment of disinterested stockholders by relying on this judgment rather than enhanced judicial scrutiny to approve a transaction. By bringing Section 251(h) transactions within this deference, the case can allow parties to reap the benefits of a two-step merger structure without sacrificing the protection of a stockholder vote.
1 C.A. No. 10485-VCMR (Del. Ch. Jun. 30, 2016). All quotes herein are to the decision unless otherwise attributed.
2 In re Volcano Corp. Internal quotations and punctuation omitted.
3 See DGCL Section 253.
4 See In re Comverge, Inc., C.A. No 7368-VCP, 2014 WL 6686570 (Del. Ch. Nov. 25, 2014).
5 In re Volcano at *27 (citing Singh v. Attenborough, C.A. No. 9388-VCM, 2016 WL 2765312 (Del. May 6, 2016)). In re Volcano itself permitted the dismissal, under Delaware Rule 12(b)(6), of claims in light of the business judgment standard. Without the cleansing effect of stockholder approval, it is undisputed that the transactions discussed in In re Volcano would be subject to enhanced scrutiny under Revlon, Inc. v. MacAndrews & Forbes Holdings, Inc., 506 A.2d 173 (Del. 1986), which likely would have precluded dismissal at such an early stage.
6 The vice-chancellor’s discussion on pages 22 through 27 of the opinion provides a useful summary of this line of cases.
7 124 A.3d 47 (Del. Ch. 2015) (holding that “stockholder ratification of an interested transaction, so as to shift the standard of review from entire fairness to the business judgment presumption, cannot be achieved without complying with the statutory formalities in the DGCL for taking stockholder action”).
8 125 A.3d 304 (Del. 2015).
9 It is worth noting that the determination as to whether stockholder approval is fully informed for the purposes of cleansing a transaction is a state law issue. Accordingly, the information required under Delaware law may differ, in certain circumstances, from the information required to be provided to stockholders under the federal securities laws.
