June 15, 2011
Exploring the Boundaries of Revlon: Mixed Cash/Stock Transactions Under Heightened Scrutiny
By Stephen B. Brauerman
In a question of first impression, the Court of Chancery applied Revlon, Inc. v. MacAndrews & Forbes Holdings, Inc.’s heightened standard of review to determine whether to enjoin a merger split evenly between cash and stock consideration. As regular readers of DBCI know, Revlon requires corporate boards, under certain circumstances, to focus their efforts on maximizing the company’s value in order to obtain the best possible price for stockholders. Though the Court ultimately declined to enjoin the merger, In re Smurfit-Stone Container Corporation Shareholders Litigation, C.A. No. 6164-VCP, provides a detailed, if fleeting, glimpse into the Court’s consideration of increasingly complicated deals involving both cash and stock consideration. Since the Delaware Supreme Court ultimately will have the last word on Revlon’s scope, a reality Smurfit-Stone recognizes, this case is likely just a prelude to the next chapter of the Revlon saga.
Smurfit-Stone Container Corporation (“Smurfit-Stone” or the “Corporation”) emerged from bankruptcy in June, 2010, having shed “significant debt, clos[ed] several underperforming mills, and reduc[ed] its workforce by approximately ten percent,” and with a new board of directors (the “Board”) composed of nine independent, outside directors and two management holdouts who survived the bankruptcy with temporary consulting contracts. These consulting contracts, negotiated by the creditors’ committee and approved by the United States Bankruptcy Court, obligated the Corporation to pay the inside directors substantial bonuses if Smurfit-Stone engaged in a “change of control” transaction before September 30, 2011.
Following the bankruptcy, the new board launched a nationwide search for a permanent Chief Executive Officer. While conducting this search, in September, 2010, Smurfit-Stone received an unsolicited offer from Company A to sell the Corporation in an all-cash transaction for $29 per share (the “Company A Offer”). The Board created a special committee (the “Committee”) consisting of the nine outside directors to evaluate the Company A Offer. The Committee engaged independent financial and legal advisors and ultimately found the Company A Offer inadequate. Though Smurfit-Stone attempted to negotiate the Company A Offer to obtain a higher price, Company A withdrew its offer on December 17, 2010 and advised that it would not proceed with the transaction.
Independent of the Company A Offer, in late 2010, Rock-Tenn Company (“Rock-Tenn”), a Smurfit-Stone competitor, expressed interest in acquiring the Corporation. The Committee began to explore Rock-Tenn’s interest and initially offered an all-stock, no-premium merger that would have left Smurfit-Stone stockholders with 55% of the combined entity. From January 4, 2011 through January 23, 2011, the Committee negotiated the Rock-Tenn offer and, after obtaining several interim price increases, ultimately accepted Rock-Tenn’s “best and final” offer of $35 per share, split roughly between cash and stock (the “Rock-Tenn Transaction”). The Rock-Tenn Transaction represented a 27% premium over the Corporation’s then trading price and left Smurfit-Stone stockholders with 45% of the combined entity.
In approving the Rock-Tenn Transaction, the Committee obtained a fairness opinion from its financial advisor that valued the Corporation at a range of $27-$39 per share. The Committee also negotiated a merger agreement that contained a reciprocal “no-shop” provision with a “fiduciary out” clause that permitted the Board to consider unsolicited offers to acquire the Corporation notwithstanding its consent to the Rock-Tenn Transaction, matching rights for Rock-Tenn in the event of a superior competing offer, and a termination fee of $120 million (3.4% of the total deal value). Smurfit-Stone did not conduct a pre- or post-merger market check, though significant efforts were made to sell the Corporation in the bankruptcy proceedings.
After announcing the Rock-Tenn Transaction, numerous derivative, class action complaints were filed in Delaware and Illinois. These actions ultimately were consolidated in Delaware (which interestingly occurred after a conference between Vice Chancellor Parsons and the Circuit Court of Cook County, Illinois – no doubt a result of the Court of Chancery’s recent jurisprudence on the management of multi-jurisdictional derivative litigation) and the Court of Chancery expedited discovery and entertained the stockholder plaintiffs’ application for a preliminary injunction enjoining the Rock-Tenn Transaction.
As a threshold issue, the Court of Chancery considered whether the Board’s approval of a half cash, half stock transaction implicates Revlon or should be judged by the more deferential business judgment rule. The Court noted that Revlon duties apply in at least three scenarios: “(1) when a corporation initiates an active bidding process seeking to sell itself or to effect a business reorganization involving a clear break-up of the company; (2) where, in response to a bidder’s offer, a target abandons its long-term strategy and seeks an alternative transaction involving the break up of the company; or (3) when approval of a transaction results in a sale or change of control.” Though noting that plaintiffs advocated for a “yet unarticulated fourth Revlon category” apparently applicable to half cash/half stock transactions, Vice Chancellor Parsons observed that the Rock-Tenn Transaction would fall, if at all, into the third Revlon category as a change of control transaction.
It is relatively well-settled that all cash transactions trigger Revlon duties because they represent stockholders’ last chance to maximize the value of their investment. Conversely, all stock transactions generally do not trigger Revlon duties unless the target’s stockholders are relegated to minority status in the new entity. Under the latter circumstance, the new minority stockholders, like stockholders in an all cash deal, would lack leverage to maximize the value of their investment in any subsequent transaction – a concern not present when post-transaction ownership is consolidated in a large, unaffiliated group of public stockholders. Mixed stock and cash transactions fall within these two extremes and pose unique questions of their own.
Two earlier Delaware decisions, In re Sante Fe Pacific Corp. (1995) and In re Lukens Inc. Shareholders Litigation (1999), provide some guidance in the application of Revlon duties to mixed cash and stock transactions. Santa Fe declined to apply Revlon to a transaction comprised of 33% in cash and the balance in stock because the allegations in the complaint left little reason to doubt that control of the post-merger entity would remain “in a large, fluid, changeable and changing market.” Lukens on the other hand, applied Revlon to a transaction that contemplated a cash payout equal to 62% of the total consideration, with the balance in stock. Assuming Revlon’s applicability, the Lukens Court observed that the “directors were obligated to take reasonable steps to ensure that the shareholders received the best price available because, in any event, for a substantial majority of then-current shareholders [i.e. 62% of them], ‘there is no long run.’”
In Smurfit-Stone, the Court of Chancery observed that “there is no tomorrow” for approximately 50% of each stockholder’s investment in the Corporation, which would be cashed out following the closing. Relying heavily on Lukens, Vice Chancellor Parsons reasoned that Revlon should apply because the Rock-Tenn Transaction “constitutes an end-game for all or a substantial part” of the stockholders’ investment in Smurfit-Stone. The Court’s decision to apply Revlon to review a mixed cash and stock merger is not, however, “free from doubt,” as the Court acknowledged that such a transaction tests the boundaries of Revlon as the merger consideration becomes more weighted in stock.
Further complicating this analysis is absence of a collar keeping the ratio of stock to cash in the Rock-Tenn Transaction at fifty percent. Instead, the proportions of stock and cash consideration would vary with changes in the Rock-Tenn stock price until the closing date. The Court dismissed this issue, and Smurfit-Stone’s argument that fluctuations in stock price counseled against the application of Revlon’s because stockholders would benefit from the market’s anticipation of future synergies, noting that the Court necessary must assess the transaction, and the Board’s decision, at the time the merger agreement was signed, not at the time of closing. To hold otherwise would require the Court to “guess” as to the value of the stock consideration at the closing, creating an inherently unworkable situation that could lead to inequitable results. As a result, the Court of Chancery evaluated the Rock-Tenn Transaction as fifty percent stock and cash transaction and found Revlon applied to the transaction.
The Court’s Revlon analysis is unremarkable, especially in light of recent precedent including In re Dollar Thrifty Shareholders Litigation and Lyondell Chemical Co. v. Ryan, which upheld deal protection devices and prompt approval processes analogous to those at issue in Smurfit-Stone. Though the Smurfit-Stone Board’s process was “not perfect,” the Court of Chancery nevertheless declined to enter a preliminary injunction because Revlon requires “reasonableness, not perfection.”
The application of Revlon duties to mixed cash and stock transactions presents interesting doctrinal questions for a jurisdiction like Delaware that abhors bright-line rules. In the absence of a bright-line rule from the Supreme Court identifying the percentage of cash necessary to justify Revlon scrutiny, the Court of Chancery must consider mixed cash and stock transactions on a case by case basis. Though the Smurfit-Stone Court recognized some yet unidentified limit to Revlon’s application – that presumably lies where cash consideration falls somewhere between 33% and 49% of total deal value – it did not suggest where parties should draw the line. Instead, both Smurfit-Stone (and Lukens before it) left that task to the Delaware Supreme Court. The problem with line drawing in this context, is that percentage of total deal value is an imprecise metric by which to measure the “substantiality” of the investment cashed out by the transaction. Instead, other factors unique to the capital structure of the pre- and post- merger entity undoubtedly influence and inform this assessment, especially where stockholders can share in the upside of the transaction through the stock component of the deal.
This imprecision is compounded where the ratio of cash to stock consideration can vary until closing. While the Court’s concerns about the difficulty of evaluating an ever-changing deal are certainly understandable, market fluctuation presents an additional opportunity for soon-to-be cashed out stockholders to maximize the value of their deal. Counseling against a bright line rule, the Court of Chancery should continue to have the flexibility to consider what, if any, impact this changing ratio should have in its analysis of the deal. Certainly sophisticated parties could permissibly make this market benefit an integral part of the merger consideration. Ultimately, however, the Supreme Court will have the last word and Smurfit-Stone is but a prelude to the next chapter of the Revlon saga.
Reprinted with permission from the June 15, 2011 issue of Delaware Business Court Insider. (c) 2011 ALM Media Properties, LLC. Further duplication without permission is prohibited.
In a question of first impression, the Court of Chancery applied Revlon, Inc. v. MacAndrews & Forbes Holdings, Inc.’s heightened standard of review to determine whether to enjoin a merger split evenly between cash and stock consideration. As regular readers of DBCI know, Revlon requires corporate boards, under certain circumstances, to focus their efforts on maximizing the company’s value in order to obtain the best possible price for stockholders. Though the Court ultimately declined to enjoin the merger, In re Smurfit-Stone Container Corporation Shareholders Litigation, C.A. No. 6164-VCP, provides a detailed, if fleeting, glimpse into the Court’s consideration of increasingly complicated deals involving both cash and stock consideration. Since the Delaware Supreme Court ultimately will have the last word on Revlon’s scope, a reality Smurfit-Stone recognizes, this case is likely just a prelude to the next chapter of the Revlon saga.
FACTUAL AND PROCEDURAL CONTEXT
Smurfit-Stone Container Corporation (“Smurfit-Stone” or the “Corporation”) emerged from bankruptcy in June, 2010, having shed “significant debt, clos[ed] several underperforming mills, and reduc[ed] its workforce by approximately ten percent,” and with a new board of directors (the “Board”) composed of nine independent, outside directors and two management holdouts who survived the bankruptcy with temporary consulting contracts. These consulting contracts, negotiated by the creditors’ committee and approved by the United States Bankruptcy Court, obligated the Corporation to pay the inside directors substantial bonuses if Smurfit-Stone engaged in a “change of control” transaction before September 30, 2011.
Following the bankruptcy, the new board launched a nationwide search for a permanent Chief Executive Officer. While conducting this search, in September, 2010, Smurfit-Stone received an unsolicited offer from Company A to sell the Corporation in an all-cash transaction for $29 per share (the “Company A Offer”). The Board created a special committee (the “Committee”) consisting of the nine outside directors to evaluate the Company A Offer. The Committee engaged independent financial and legal advisors and ultimately found the Company A Offer inadequate. Though Smurfit-Stone attempted to negotiate the Company A Offer to obtain a higher price, Company A withdrew its offer on December 17, 2010 and advised that it would not proceed with the transaction.
Independent of the Company A Offer, in late 2010, Rock-Tenn Company (“Rock-Tenn”), a Smurfit-Stone competitor, expressed interest in acquiring the Corporation. The Committee began to explore Rock-Tenn’s interest and initially offered an all-stock, no-premium merger that would have left Smurfit-Stone stockholders with 55% of the combined entity. From January 4, 2011 through January 23, 2011, the Committee negotiated the Rock-Tenn offer and, after obtaining several interim price increases, ultimately accepted Rock-Tenn’s “best and final” offer of $35 per share, split roughly between cash and stock (the “Rock-Tenn Transaction”). The Rock-Tenn Transaction represented a 27% premium over the Corporation’s then trading price and left Smurfit-Stone stockholders with 45% of the combined entity.
In approving the Rock-Tenn Transaction, the Committee obtained a fairness opinion from its financial advisor that valued the Corporation at a range of $27-$39 per share. The Committee also negotiated a merger agreement that contained a reciprocal “no-shop” provision with a “fiduciary out” clause that permitted the Board to consider unsolicited offers to acquire the Corporation notwithstanding its consent to the Rock-Tenn Transaction, matching rights for Rock-Tenn in the event of a superior competing offer, and a termination fee of $120 million (3.4% of the total deal value). Smurfit-Stone did not conduct a pre- or post-merger market check, though significant efforts were made to sell the Corporation in the bankruptcy proceedings.
After announcing the Rock-Tenn Transaction, numerous derivative, class action complaints were filed in Delaware and Illinois. These actions ultimately were consolidated in Delaware (which interestingly occurred after a conference between Vice Chancellor Parsons and the Circuit Court of Cook County, Illinois – no doubt a result of the Court of Chancery’s recent jurisprudence on the management of multi-jurisdictional derivative litigation) and the Court of Chancery expedited discovery and entertained the stockholder plaintiffs’ application for a preliminary injunction enjoining the Rock-Tenn Transaction.
APPLYING REVLON
As a threshold issue, the Court of Chancery considered whether the Board’s approval of a half cash, half stock transaction implicates Revlon or should be judged by the more deferential business judgment rule. The Court noted that Revlon duties apply in at least three scenarios: “(1) when a corporation initiates an active bidding process seeking to sell itself or to effect a business reorganization involving a clear break-up of the company; (2) where, in response to a bidder’s offer, a target abandons its long-term strategy and seeks an alternative transaction involving the break up of the company; or (3) when approval of a transaction results in a sale or change of control.” Though noting that plaintiffs advocated for a “yet unarticulated fourth Revlon category” apparently applicable to half cash/half stock transactions, Vice Chancellor Parsons observed that the Rock-Tenn Transaction would fall, if at all, into the third Revlon category as a change of control transaction.
It is relatively well-settled that all cash transactions trigger Revlon duties because they represent stockholders’ last chance to maximize the value of their investment. Conversely, all stock transactions generally do not trigger Revlon duties unless the target’s stockholders are relegated to minority status in the new entity. Under the latter circumstance, the new minority stockholders, like stockholders in an all cash deal, would lack leverage to maximize the value of their investment in any subsequent transaction – a concern not present when post-transaction ownership is consolidated in a large, unaffiliated group of public stockholders. Mixed stock and cash transactions fall within these two extremes and pose unique questions of their own.
Two earlier Delaware decisions, In re Sante Fe Pacific Corp. (1995) and In re Lukens Inc. Shareholders Litigation (1999), provide some guidance in the application of Revlon duties to mixed cash and stock transactions. Santa Fe declined to apply Revlon to a transaction comprised of 33% in cash and the balance in stock because the allegations in the complaint left little reason to doubt that control of the post-merger entity would remain “in a large, fluid, changeable and changing market.” Lukens on the other hand, applied Revlon to a transaction that contemplated a cash payout equal to 62% of the total consideration, with the balance in stock. Assuming Revlon’s applicability, the Lukens Court observed that the “directors were obligated to take reasonable steps to ensure that the shareholders received the best price available because, in any event, for a substantial majority of then-current shareholders [i.e. 62% of them], ‘there is no long run.’”
In Smurfit-Stone, the Court of Chancery observed that “there is no tomorrow” for approximately 50% of each stockholder’s investment in the Corporation, which would be cashed out following the closing. Relying heavily on Lukens, Vice Chancellor Parsons reasoned that Revlon should apply because the Rock-Tenn Transaction “constitutes an end-game for all or a substantial part” of the stockholders’ investment in Smurfit-Stone. The Court’s decision to apply Revlon to review a mixed cash and stock merger is not, however, “free from doubt,” as the Court acknowledged that such a transaction tests the boundaries of Revlon as the merger consideration becomes more weighted in stock.
Further complicating this analysis is absence of a collar keeping the ratio of stock to cash in the Rock-Tenn Transaction at fifty percent. Instead, the proportions of stock and cash consideration would vary with changes in the Rock-Tenn stock price until the closing date. The Court dismissed this issue, and Smurfit-Stone’s argument that fluctuations in stock price counseled against the application of Revlon’s because stockholders would benefit from the market’s anticipation of future synergies, noting that the Court necessary must assess the transaction, and the Board’s decision, at the time the merger agreement was signed, not at the time of closing. To hold otherwise would require the Court to “guess” as to the value of the stock consideration at the closing, creating an inherently unworkable situation that could lead to inequitable results. As a result, the Court of Chancery evaluated the Rock-Tenn Transaction as fifty percent stock and cash transaction and found Revlon applied to the transaction.
The Court’s Revlon analysis is unremarkable, especially in light of recent precedent including In re Dollar Thrifty Shareholders Litigation and Lyondell Chemical Co. v. Ryan, which upheld deal protection devices and prompt approval processes analogous to those at issue in Smurfit-Stone. Though the Smurfit-Stone Board’s process was “not perfect,” the Court of Chancery nevertheless declined to enter a preliminary injunction because Revlon requires “reasonableness, not perfection.”
IMPACT OF SMURFIT-STONE
The application of Revlon duties to mixed cash and stock transactions presents interesting doctrinal questions for a jurisdiction like Delaware that abhors bright-line rules. In the absence of a bright-line rule from the Supreme Court identifying the percentage of cash necessary to justify Revlon scrutiny, the Court of Chancery must consider mixed cash and stock transactions on a case by case basis. Though the Smurfit-Stone Court recognized some yet unidentified limit to Revlon’s application – that presumably lies where cash consideration falls somewhere between 33% and 49% of total deal value – it did not suggest where parties should draw the line. Instead, both Smurfit-Stone (and Lukens before it) left that task to the Delaware Supreme Court. The problem with line drawing in this context, is that percentage of total deal value is an imprecise metric by which to measure the “substantiality” of the investment cashed out by the transaction. Instead, other factors unique to the capital structure of the pre- and post- merger entity undoubtedly influence and inform this assessment, especially where stockholders can share in the upside of the transaction through the stock component of the deal.
This imprecision is compounded where the ratio of cash to stock consideration can vary until closing. While the Court’s concerns about the difficulty of evaluating an ever-changing deal are certainly understandable, market fluctuation presents an additional opportunity for soon-to-be cashed out stockholders to maximize the value of their deal. Counseling against a bright line rule, the Court of Chancery should continue to have the flexibility to consider what, if any, impact this changing ratio should have in its analysis of the deal. Certainly sophisticated parties could permissibly make this market benefit an integral part of the merger consideration. Ultimately, however, the Supreme Court will have the last word and Smurfit-Stone is but a prelude to the next chapter of the Revlon saga.
Reprinted with permission from the June 15, 2011 issue of Delaware Business Court Insider. (c) 2011 ALM Media Properties, LLC. Further duplication without permission is prohibited.