Delaware Court Hinders Buyers From Locking Up Deals: A Split Ruling in the Omnicare Case Opens The Window for a Superior Bid at Any Time

Dealmakers and their legal advisers have a new reason for jitters as a result of a Delaware Supreme Court decision that has sent shock waves across the m&a market. The opinion, delivered through a rare 3-2 split decision in the key state that sets judicial rules for business decisions, suggests, according to a consensus of m&a lawyers, that a deal is not complete until it is finally and officially declared closed by both sides. By extension, that means that every day the deal remains open, the door is ajar for another bidder to come crashing in with a superior offer that can blow the pending agreement to bits – no matter how many airtight agreements have been signed or attestations of fairness have been delivered. If the lawyers generally agree that, to paraphrase Yogi Berra, the deal isn’t over until it’s over, they otherwise don’t find much common ground in the opinion issued in early April in what has become known as the Omnicare case. Tensions have been further heightened by widespread disagreement over just how far the opinion reaches and how much impact it will wield on dealmaking over the long run. As is typical in the absence of a bright line from the bench, m&a lawyers are taking clients down a cautious path in friendly deals and warning: * Don’t expect pre-closing agreements to bullet-proof any deal from outside competition until there is an official closing; * Avoid intricate “lockup” combinations that give the appearance of rigging the transaction in favor of the target’s preferred acquirer; * Unless absolutely necessary, avoid contract language that bars the target from entertaining a higher bid and precludes the so-called “fiduciary out,” a clause that can nullify the original agreement if a superior offer surfaces; * Get the deal closed as fast as possible so it is literally not left hanging. While admonitions not to push the envelope may represent sound legal advice, some buying and selling companies may find it hard to follow. Preferred acquirers spend considerable time and money to stake out favored positions with targets and they want some assurances that they won’t lose out to a latecomer that is free riding on its efforts. Acquirers, moreover, are being asked to speed up deals at the very time they also are under pressure to do more thorough due diligence on a wider range of issues. In addition, dealmakers may probe for new techniques they believe can slide by in the unsettled post-Omnicare environment. The biggest drivers of the confusion are the way the opinion threaded through Delaware’s judicial network and the fact pattern of the deal, which is not likely to be replicated. Not only was the 3-2 split an uncommon outcome at the high court level, but the decision was almost equally unique because it overturned a lower court ruling last November by Chancellor Stephen Lamb. The opinion, long-awaited by the m&a bar, was written about four months after the Supreme Court’s actual decision last December. The centerpiece in the case was a complex agreement last year for Genesis Health Ventures Inc.to acquire NCS Healthcare Inc., a financially troubled health services company, in a stock swap. Genesis secured a three-legged deal protection device that included a commitment by NCS’s two largest shareholders to tender their stock to Genesis, a stockholder vote that was sure to back Genesis because the two big holders controlled two-thirds of the stock, and the barring of a fiduciary out. NCS also was given 24 hours to accept the deal. Omnicare Inc., a large provider of institutional pharmacy services, later submitted a higher, all-cash bid, got the NCS board to swing support to its offer, and sued in Delaware to bust the agreement with Genesis. Skirmishing prior to the Genesis/NCS agreement figured importantly in the case. NCS had actively tried to sell itself and checked the market for buyers. Omnicare showed interest but wanted extensive due diligence and balked at assuming liabilities. NCS finally accepted the Genesis terms in the belief that the offer had the best chance of going through. “Coercive” deal protections Lamb, in a decision supported by many members of the m&a bar, ruled that the Genesis board had acted correctly because of conscious efforts to get the best deal with the highest odds of closing. However, the Supreme Court majority concluded that the deal protection features were “coercive” and “preclusive” because they deprived NCS shareholders of the opportunity to get the richest bid. The board, it said, “disabled itself” at the time when it should have been free to exercise its fiduciary obligations when a higher offer came in. The minority said Lamb’s take on the situation was correct and that the majority’s view was “clearly erroneous” because it did not respect the “reasoned judgment” of the NCS board and wishes of its key stockholders. Caught between dueling decisions, most m&a lawyers say on balance, buyers and sellers have to consider a deal vulnerable to a swipe by a third party at any time until the actual close. The high court further is reinforcing the message that price trumps all. Because of what went down prior to the disputed agreement, it “made sense (for NCS) to take the bird in the hand,” says William Lawlor of Dechert. “But the majority is saying you can never have a bird in the hand,” he says. They also believe that the outcome strongly affirms the Delaware court’s long-held distaste for elaborate arrangements that combine a number of deal protections to wall off the deal from third-party competition. Up in the air is the status of the contract clause barring a fiduciary out. Lawyers say that the decision is ambiguous as to whether the court knocked out the ban against an out because it was woven in with other preclusive features or it was ruled objectionable on its own. Some attorneys think the no-bid language can survive given the right conditions. But others say it soon will be legally extinct, given the way the Delaware courts are going. Larry Yanowitch of the law firm of Shaw Pittman says that as far as he is concerned prohibitions of fiduciary outs are history in the practical sense, even though the issue is technically alive. “I wouldn’t want to risk my client’s deal by insisting on eliminating the fiduciary out when it looks vulnerable,” he says. Lawyers and other dealmakers also are trying to sort through the likely developments to assess the effects of Omnicare on competitive bidding, including auctions, and pricing. Although the decision was aimed at maximizing prices, some believe it may boomerang and actually depress prices. Even a sealed bid, winner take-all auction may not guarantee the deal, says Yanowitch. “The auction agreement may have to contain a fiduciary out,” he notes. That would mean a non-bidder could upset everything if there is a long gap between the time the bids are opened and the closing of the acquisition, he says. Sitting out the bidding hassle One result is that a non-bidder could later pick off the target after deal parameters have been set by the hard work of others. That could encourage likely acquirers to sit out the bidding hassle and act later while discouraging others from getting into the act at all if there is a risk of losing a “done deal.” A second key result could be downward pressure on pricing. “The auction is designed to get the highest bid,” Lawlor notes. “But if a bidder knows there is a fiduciary out, he may not put his best bid on the table but come in later. I think this (the decision) was a meat-axe approach.” Sean Griffith, a law professor at the University of Connecticut School of Law, agrees that the post-agreement window could work against the fullest price. “The purpose of an auction is to maximize the price,” he says. “People may not submit the highest bid and stay out of the auction. If they do not submit the best bid, they get the company on the cheap.” Conversely, some observers say that the Delaware decision gives more leverage to distressed companies like NCS that are selling out, a segment of the target population that is expected to grow in coming months. The decision, they say, indicates that the courts will not look kindly on onerous terms dictated by buyers. Meanwhile, lawyers already are beginning to look at ways to seal up the deal by shutting the pre-closing window. In a memo to clients, Meredith M. Brown and William D. Regner of Debevoise & Plimpton suggest telescoping a shareholders vote perhaps by a written consent poll “up front. ” “… stockholder approval should extinguish the board’s fiduciary duty to be able to entertain a superior bid.” The caveat is that shareholders get an information statement 20 days before the vote to comply with SEC rules. Copyright 2003 Thomson Media Inc. 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