Delaware's Top Five Worst Shareholder Decisions for 2014 (#4: C&J Energy Services v. City of Miami General Employees and Repealing Revlon)
Revlon is a vestige of those halcyon days back in the 1980s when the Delaware Supreme Court could be convinced to adjust the law in a manner that at least sometimes benefited shareholders. See Revlon v. MacAndrews & Forbes Holdings, Inc., 506 A.2d 173 (Del. 1986). Think Unocal or Van Gorkom.
Those days are over. As if there was any doubt, that was made absolutely clear in C&J Energy Services v. City of Miami General Employees' and Sanitation Employees' Retirement Trust, 2014 WL 7243153 (Del. Dec. 17, 2014), a case that brings Revlon duties full circle by effectively overturning the 1986 decision and eliminating any need for boards to even realize they are selling control, much less actually engage in a sales process reasonably designed to ensure that shareholders received the best value in the absence of a competing bidder.
After a long line of decisions representing that there was no “blue print” for complying with Revlon, the Supreme Court provided a blue print. Boards pursuing negotiations with a single bidder could meet Revlon by signing an agreement that prohibited other solicitations so long as there was a “fiduciary out” that permitted directors to act in the event “a more favorable deal" happened to emerge.
In many respects, the facts of the case are unique. C&J sought to purchase a division from Nabors Corporation. The combined entities would receive tax benefits by forming in Bermuda. The twist, however, was that the transaction would result in a shift in control. Once the acquisition was completed, Nabors would own almost 53% of the shares of the surviving entity, reducing the stockholders of C&J to minority owners in a subsidiary of Nabors.
The transaction was structured as an asset purchase. The board of C&J did not, apparently, see itself as selling the company and triggering Revlon duties. As a result, the board "took no steps to sell or shop the company". As the Chancery Court found:
- "In approving the transaction, the board did not consider alternative transactions. The board did not seek out other potential buyers. The board's review of the merger process was more akin to what one would expect from a board pursuing an acquisition rather than one selling a company, but that is not necessarily fatal to the arguments that C&J makes.”
Moreover, while the court did not find that the board of C&J had a disabling conflict of interest, it did note that the decision to purchase the subsidiary was surrounded by "noise." Four of the C&J directors would be appointed as a majority of the board of the new entity and would be guaranteed six-year terms. Management (including the CEO who served on the board) were, according to the Chancery Court, promised "very generous employment packages as a result of the merger, although those agreements were not negotiated until a couple of months after the merger agreement was signed."
Tthe Chancery Court responded to these circumstances with a "relatively modest" solution. The merger would be enjoined for 30 days so that C&J could "solicit interest" in the company.
The Supreme Court overturned the injunction. There was no duty to consider alternative transactions or to consider other means of maximizing shareholder value. According to the Supreme Court, the Chancery Court opinion:
- "rested on the erroneous proposition that a company selling itself in a change of control transaction is required to shop itself to fulfill its duty to seek the highest immediate value. But Revlonand its progeny do not set out a specific route that a board must follow when fulfilling its fiduciary duties, and an independent board is entitled to use its business judgment to decide to enter into a strategic transaction that promises great benefit, even when it creates certain risks. When a board exercises its judgment in good faith, tests the transaction through a viable passive market check, and gives its stockholders a fully informed, uncoerced opportunity to vote to accept the deal, we cannot conclude that the board likely violated its Revlon duties. It is too often forgotten that Revlon, and later cases like QVC, primarily involved board resistance to a competing bid after the board had agreed to a change of control, which threatened to impede the emergence of another higher-priced deal. No hint of such a defensive, entrenching motive emerges from this record.”
The Court also sharply rebuked the Chancery Court for requiring the C&J board to solicit alternative transactions that could maximize shareholder value pending the 30-day preliminary injunction. Once a deal was signed, the Chancery Court could do little to remedy any unfairness. Absent allgations that the bidder aided and abetted the breaches of duty, a contract was, essentially, immutable.
- "Mandatory injunctions should only issue with the confidence of findings made after a trial or on undisputed facts. Such an injunction cannot strip an innocent third party of its contractual rights while simultaneously binding that party to consummate the transaction. To blue-pencil a contract as the Court of Chancery did here is not an appropriate exercise of equitable authority in a preliminary injunction order. That is especially true because the Court of Chancery made no finding that Nabors had aided and abetted any breach of fiduciary duty, and the Court of Chancery could not even find that it was reasonably likely such a breach by C&J‟s board would be found after trial."
The Court treated the Chancery Court decision as effectively rewriting the contract.
- To blue-pencil an agreement to excise a provision beneficial to a third party like Nabors on the basis of a provisional record and then declare that the third party could not regard the excision as a basis for relieving it of its own contractual duties involves an exercise of judicial power inconsistent with the standards that govern the award of mandatory injunctions under Delaware law. In those cases, plaintiffs were effectively left with after-the-fact monetary damages (notwithstanding that duty of care violations cannot lead to money damages because every public company has an exculpatory provision).
As for the fact that a majority of the C&J board was offered board seats for five years on the surviving entity, the Supreme Court simply ignored it. Similarly, the Supreme Court ignored that C&J’s CEO who negotiated the sale of C&J to Nabors had, as the Chancery Court observed, used "some arguably optimistic values and did increase the multipel for EBITDA to get a number that would support the transaction".
Perhaps most egrigiously, the Court ignored the apparent threat by the CEO of C&J to "not sign [the agreement]. . . and not announce the transaction'" unless Nabors agreed in a side leter to "endors[e] a generous compensation packag". See Id. ("When [the CEO of Nabors] hesitated to sign the letter, objecting to some of [the CEO of C&J's] demands, [the CEO of C&J] threatened to 'not sign . . . and not announce the transaction.' . . . But a few hours later, [the CEO of Nabors] agreed to sign the letter with some modifications, and the deal was announced as planned.").
Despite the "noise," despite the failure to shop the company, despite, for the most part, the board's apparent lack of awareness that Revloneven applied, the blue brint for meeting the requirements of Revlon required only a passive market test and fiduciary out.
In Revlon, the Supreme Court announced boldly that, once a company was for sale, the "directors' role changed from defenders of the corporate bastion to auctioneers charged with getting the best price for the stockholders at a sale of the company." The decision tasked the board with an active role in auctioning the company and maximizing the return for shareholders. After C&J, however, that is no longer the case. The Court reduced these duties to "an effective market check" that allowed another bidder a reasonable opportunity to provide an offer but without any "active solicitation" by management.
In short, active auctioneer has been reduced to passive mannequin.
The transcript and the opinion by the Delaware Supreme Court is posted on the DU Corporate Governance web site.