Delaware Court of Chancery Decision Highlights Need for Care in Single-Bidder Sale Process

In a recent decision, the Delaware Court of Chancery held that the plaintiff had demonstrated a reasonable likelihood that the single-bidder sale process undertaken by the target's board of directors did not satisfy the board's duties to maximize stockholder value, i.e., its Revlon duties. In Koehler v. NetSpend Holdings Inc.,¹ Vice Chancellor Glasscock expressly endorsed the permissibility of single-bidder processes in sale of control transactions, but found that the remainder of the sale process resulted in the board's failure to adequately inform itself as to whether the price per share in the merger was the highest price reasonably available. The court chose, however, not to enjoin the sale because the agreed per share price represented a substantial premium and no viable alternative bidder had emerged during the protracted process, so the price could represent the stockholders' only opportunity to receive a substantial premium for their shares. The decision is an important reminder of the need to ensure that the overall process in a single-bidder sale transaction is reasonably designed to maximize price.

The board of NetSpend held discussions regarding a possible sale or merger with several companies between its formation in 2004 and going public at the end of 2010, including advanced negotiations with three companies. Each of those discussions fell through. Four companies contacted NetSpend regarding a potential M&A transaction in 2012. Two of those companies declined to make a bid, and one proposed a merger of equals that the board considered risky and unattractive. The fourth company, Total System Services, Inc. (TSYS), made a general inquiry in June 2012, and followed up with an expression of interest to acquire the company a few months later. TSYS then submitted a written indication of interest at a price of $14.50 per share on December 3, 2012, and a signed merger agreement with TSYS on February 19, 2013 at a price of $16.00 per share. The board refused to grant TSYS exclusivity during the negotiation process, but also decided against contacting other potential acquirers. The board believed that the others were unlikely to bid, and was concerned that a broader process would risk leaks and potential harm to the company. 

During the second half of 2012, two stockholders that owned approximately half of NetSpend's stock also embarked on a process to sell their shares. One of the stockholders entered into discussions with two private equity funds with respect to a potential sale of its interest; one expressed interest at a price of $12 per share. In conjunction with that process, the private equity funds entered into standstill agreements with NetSpend that contained don't-ask-don't-waive (DADW) provisions. Discussions with the private equity funds were discontinued in December 2012 after NetSpend's receipt of the indication of interest from TSYS.  

In considering the plaintiff's Revlon claims, the court first found that the board was likely to show at trial that its initial decision to engage in a single-bidder process was reasonable. The court based its finding on several factors. The court noted that NetSpend's directors were sophisticated professionals with extensive business and financial expertise, and that they hired highly regarded financial advisors. The board had engaged in prolonged negotiations with other merger partners three times in the past, and had conducted an IPO in 2010, which the court noted would have involved valuing the company on several occasions. The court noted that the board made a deliberate choice to pursue a single-bidder process, in part because of its past experience with three collapsed transactions. It also found the board's strategy of informing potential acquirers that the company was not for sale, while intimating it could be for sale at a high enough price, was a credible way of dissuading non-serious offerors. The court also noted other indicia of market value possessed by the board, including NetSpend's recent market price of around $8.00 per share even after share repurchases, the $12.00 sale price per share at which the company's largest investor was considering selling its shares, and the other sale or merger discussions in 2012 that did not result in offers, or involved an unattractive merger of equals.

While it found the single-bidder strategy was likely reasonable, the court found that the remainder of the sale process was inadequate. Deficiencies in the process included reliance on a weak fairness opinion and agreement to deal protection devices, such as the DADW provisions. The court concluded that the combined effect of the process deficiencies resulted in the board approving the merger consideration without adequately informing itself as to whether the $16.00 per share was the highest price reasonably available. 

The court was particularly critical of the fairness opinion. It found that the discounted cash flow (DCF) analysis indicated that the merger price per share was grossly inadequate, noting that it was 20 percent below the bottom of the range, and that the projections used were outside the range of management's customary projections. The court found that the comparable companies analysis was not useful because it involved companies that were dissimilar to NetSpend. It noted that the precedent transactions analysis was also not helpful because it involved dated transactions with targets that were not similar to NetSpend. 

The court distinguished, interestingly, between certain deal protection measure that it deemed reasonable, and others that it found could unreasonably deter competing bids. For example, it held that the 3.9 percent termination fee and matching rights, and voting agreements with respect to 40 percent of NetSpend's outstanding shares that terminated in connection with the board's termination of the merger agreement pursuant to its ability to withhold support for the NetSpend transaction in light of a superior offer (i.e., a fiduciary out), would not deter a serious bidder. The court also noted that the board's failure to obtain a go-shop, i.e., a post-signing affirmative market check, was not per se unreasonable.

The court found, by contrast, that the window shop provision (i.e., the ability post-signing to entertain, but not actively solicit, offers) did not provide an adequate alternative to a market check. The court was  critical of the short time frame allowed for the window shop as originally agreed-to, since the deal was originally scheduled to close in April. The court noted, however, that as a practical matter postponements of the closing date provided adequate time for a competing bidder to emerge.

The court was particularly critical of the DADW provisions and corresponding prohibition in the merger agreement from waiving them. Those provisions prevented two private equity funds, who had been in discussion to acquire shares from NetSpend's largest stockholder, from considering a bid for the entire company. The court discussed two recent Delaware decisions concerning DADW provisions, one recognizing the utility of the provisions in maximizing bids² and the other holding that the clauses resulted in a board willfully blinding itself to a possibility of a competing offer.³ Nonetheless, the court did not base its main criticism on the guidance in either of those cases. Instead, the court expressed concern that the NetSpend board neither considered nor understood the import of the DADW clauses, explaining that "[i]n order to fulfill its fiduciary duty to construct a sales process reasonably designed to maximize value, the action of the Board must be informed, and 'logical and reasoned.'" The court found that the retention of the DADW provisions, and the importation of the provisions into the merger agreement, was neither informed, logical or reasoned.

The decision provides important guidance to boards that undertake a single-bidder process in a sale of control transaction:

• A board needs to consider the entire sales process when proceeding with a sale of the corporation without a pre-signing market check. Having a sophisticated board whose members have extensive business and financial expertise, that hires highly regarded financial advisors, and that has recent evidence of valuation through M&A and financing transactions, may not, in and of themselves, be deemed sufficient to establish that the board obtained the best price reasonably available. 
• Target boards should be cautious of relying on a window shop where the pre-closing period is expected to be very short. 
• In considering the overall reasonableness of the sale process, target boards should pay attention to the strength of the fairness opinion, including the relevance of the comparable companies and precedent transactions, and where the merger price falls relative to the DCF range. 
• The board should be thorough in its evaluation of deal protection mechanisms, including the effect of DADW provisions that would prevent an approach by parties who entered into the provisions in connection with their consideration of a different deal. 

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¹ C.A. No. 8373-VCG (Del. Ch. May 21, 2013)

² See In re Ancestry.com Inc. S'holder Litig., C.A. No. 7988-CS (Del. Ch. Dec. 17, 2012)

³ See In re Complete Genomics S'holder Litig., C.A. No. 7888-VCL (Del. Ch. Nov. 27, 2012).

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