The recent decision in Badowski v. Corrao, No. 652986/2011, NYLJ 1202642854864 (Sup. Ct. N.Y. County, Commercial Division), is a timely application by a New York court of the limitations of so-called Revlon duties to stock-for-stock mergers.
In Badowski, the court dismissed with prejudice a class action brought by a shareholder of the target (Vertro, Inc.), challenging Vertro’s stock-for-stock merger with Inuvo, Inc. The court applied Delaware law under the internal affairs rule because Vertro is incorporated under the laws of Delaware. In applying Delaware law, the court clearly adhered to the principle that Revlon duties are not implicated where the challenged transaction does not result in a true change of control.
Because there was no change of control, the court applied the more deferential "business judgment rule" presumption to the merger decision, and concluded that the complaint failed to plead any viable basis to rebut the presumption that the target’s directors, in approving the merger, acted in an informed basis, in good faith, and in the honest belief that their actions were in the best interests of the company. The court further determined that deal protection devices approved by the Vertro board were well within the board’s business judgment, and that the proxy statement issued by Vertro did not contain any material non-disclosures.
Revlon duties are implicated when there is a sale of control or where the break-up of the company is inevitable. Revlon, Inc. v. MacAndrews & Forbes Holdings, Inc., 506 A.2d 173 (Del. 1986). In such circumstances, "the duty of the board . . . change[s] from the preservation of [the company] to the maximization of the company’s value at a sale for the stockholders’ benefit." Revlon, 506 A.2d at 182. When Revlon duties are triggered, the courts will then apply a less deferential standard of review, i.e., "enhanced" or "heightened" scrutiny. This inquiry, with its subjective and objective components, places on the board the ultimate burden of persuading the court that their motivations were proper and not selfish, and that their actions were reasonable in relation to their legitimate objective. See, e.g., Mercier v. Inter-Tel, Inc., 929 A.2d 786, 810 (Del. Ch. 2007); In re Comverge Inc. S’holders Litig., No. 7368–VCP, 2013 WL 1455827 (Del. Ch. Apr. 10, 2013).
However, as the court in Badowski noted, subsequent Delaware decisions have made it clear that Revlon duties are only triggered when a company embarks on a transaction, whether on its own or in response to an unsolicited offer, that will result in a change of control. Citing well-established Delaware authority, the court in Badowski stated as follows:
In the context of a stock-for-stock merger, a change of control for Revlon purposes can be triggered if the target's shareholders are relegated to a minority in the resulting entity, and the resulting entity has a controlling stockholder or stockholder group. Where, however, ownership of the merged company will remain in "a large, fluid, changeable and changing market," Revlon is not implicated.
Badowski, at *7 (citing, inter alia, Arnold v. Society for Savings Bancorp. Inc., 650 A.2d 1270, 1290 (Del 2009); Smurfit-Stone Container Corp. S’holder Litig., No. 6164-VCP, 2011 WL 2028076, *12 n. 92 (Del Ch. May 24, 2011)).
The court in Badowski found that the facts, as pleaded, would not support the imposition of Revlon duties in part because there was no allegation that the shares of the resulting entity will not be freely traded in the marketplace, or that the former Vertro shareholders will be subjected to a controlling shareholder or block of shareholders. Badowski, at *7-*8. The court also recognized that the allegations of the complaint were contradicted by the proxy statement, as the final proxy statement stated that upon completion of the merger, current Vertro stockholders would hold approximately 52.8 percent of the outstanding shares of the new company, which would change to 51.4 percent, assuming exercise of all outstanding options (whether or not vested) and warrants. Id. at *8 n.3.
Plaintiff also argued that Revlon duties were implicated because the Vertro board had actively solicited a merger with a party other than Inuvo, and because Vertro’s officer and director contracts contained "change in control" provisions that were triggered by the merger. The court, however, rejected both of these arguments. The court held that the board’s initiation of an active bidding process does not render Revlon applicable unless the board seeks to sell control or takes other actions that would break up the company. Id. at *8. As to the officer and director contracts, the court found that plaintiff had cited no authority that change in control provisions in employment contracts establish change of control for Revlon purposes. Id.
Because Revlon’s enhanced scrutiny standard did not apply, the court then applied the deferential business judgment rule standard and found no reason to rebut the presumption of the business judgment rule protecting the board’s decision-making. The court cited these factors to support the application of the business judgment rule:
- Plaintiff failed to plead that a majority of the Vertro directors had material conflicts of interest, were not independent, or were dominated by an interested director.
- The deal protection devices agreed to by the Vertro board – a non-solicitation provision with a "fiduciary out" clause, matching rights, and a 3 percent termination fee – were within the board’s business judgment.
The plaintiff also asserted claims that the proxy statement omitted to disclose the underlying financial projections, calculations, and data considered by both the Vertro board and its financial advisor. The court rejected the proxy disclosure claims and stated that Delaware courts "have repeatedly rejected claims that insufficiently specific disclosures were made of a board's reasons for recommending a merger, or of data relied on by a financial advisor in issuing a fairness opinion, provided that material data was disclosed." Id. at *21.
Because the proxy statement included an extensive description of the financial analyses, such as the materials relied on by its investment adviser in arriving at its fairness opinion – as well as a detailed chronology of the sales process – the court held that plaintiff had failed to show the omitted material would have had a substantial likelihood of significantly altering the total mix of information. Id. at *21-*22.
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