Delaware Supreme Court Reverse Chancery Court Decision on Revlon Obligations
By Lisa Stark and Lauren Garraux
In C&J Energy Services, Inc. v. City of Miami General Employees’ and Sanitation Employees’ Retirement Trust, C.A. No. 655/657, 2014 (Del. Dec. 19, 2014) (Strine, C.J.), the Delaware Supreme Court reversed the Delaware Court of Chancery’s decision to (1) enjoin the stockholder vote on a merger between C&J Energy Services, Inc. (“C&J”) and a division (Nabors CPS) of Nabors Industries Ltd. (“Nabors”) for 30 days, and (2) require C&J to shop the company during the injunction period. The Chancery Court determined that the C&J board’s decision to forego actively shopping the company in favor of a passive, post-signing market check constituted a plausible breach of its Revlon obligations. On appeal, the Delaware Supreme Court found that the Chancery Court erred by: (1) applying an improper standard for a preliminary injunction, (2) holding that a company must affirmatively shop itself under Revlon absent possessing “impeccable knowledge” of the market, and (3) issuing a mandatory injunction on a preliminary record.
This action arose from the proposed acquisition by C&J of a subsidiary of Nabors, which contained the assets of Nabors’ CPS division, for $2.86 billion. To gain favorable tax treatment, Nabors will retain a majority interest (53%) in the entity surviving the merger (“New C&J”), and New C&J will be domiciled in Bermuda. C&J’s stockholders will own the minority interest. To mitigate the loss of control, a supermajority vote of New C&J’s stockholders will be required to effect major corporate actions. In addition, C&J stockholders will have the right to (1) designate a majority of the members of New C&J’s board, and (2) receive the same pro rata consideration as Nabors in any subsequent sale of New C&J. C&J’s current Chairman, CEO and chief negotiator, Joshua Comstock, also negotiated for the right to be New C&J’s CEO at a higher compensation level.
Before signing the deal with Nabors, C&J did not seek out other potential strategic partners. However, recognizing that it was in the unusual position of being both the buyer of assets as well as a seller of control, the C&J board insisted on the corporate governance provisions discussed above which would remain in place for five years after closing. C&J also negotiated for a fiduciary-out to the non-solicitation covenant in the parties’ merger agreement and a modest termination fee of 2.27% of the deal value. In addition, although C&J’s CEO negotiated the deal, he kept the board well-informed throughout the sale process.
The plaintiffs argued that C&J’s board entered into a change of control transaction without conducting an active market check and without possessing the impeccable knowledge of the value of Nabors CPS that a single bidder strategy requires. The plaintiffs also argued that Mr. Comstock unduly influenced the independent C&J board majority while laboring under a conflict which prevented him from getting the best transaction price reasonably available. The Chancery Court found that plaintiffs had met their evidentiary burden with respect to their Revlon claims and enjoined the stockholder vote on the deal for 30 days. The Chancery Court also ordered C&J to shop the company during the injunction period. The plaintiffs appealed.
On appeal, the Delaware Supreme Court found that the Chancery Court committed reversible error on three issues. First, the Supreme Court found that the Chancery Court failed to apply the appropriate standard for issuance of a preliminary injunction which requires the plaintiffs to demonstrate: (1) a reasonable probability of success on the merits; (2) that they will suffer irreparable injury without an injunction; and (3) that the balance of the equities favors the injunction. The Chancery Court erroneously articulated the first prong as requiring “a plausible showing of a likelihood of success on the merits.”
Second, the Supreme Court found that the Chancery Court erred in holding that Revlon required C&J’s board to conduct a pre-signing, market check unless the board possessed an “impeccable knowledge of the value of the company that it is selling”. The Supreme Court held that a board may engage in a passive, post-signing market check in lieu of an active pre-signing market check if the merger agreement contains reasonable deal protection provision which afford a potential topping bidder a reasonable opportunity to make its bid and the target board the flexibility to eschew the original transaction in favor of a higher-value deal. The Supreme Court also noted that the target stockholders must have the opportunity to accept or reject the deal on a fully-informed basis.
Finally, the Supreme Court found that the Chancery Court erred by entering an injunction which required a party to take affirmative action (as opposed to merely enjoining a party from doing something) without applying the correct procedural standard. According to the Supreme Court, the Chancery Court could not require C&J to affirmatively shop the company for thirty days except after a trial on the merits unless the injunction was issued solely on undisputed facts.