Delaware Supreme Court Reverses Mandatory Injunction Issued by Court of Chancery; Addresses Revlon Duties and Third-Party Contract Rights
In an important ruling addressing the scope of Revlon duties and the Delaware courts’ reluctance to “blue pencil” contractual provisions, C&J Energy Services, Inc. v. City of Miami General Employees’ and Sanitation Employees’ Retirement Trust, the Delaware Supreme Court has reversed a mandatory injunction order issued by the Court of Chancery that (i) required a target to “go-shop” itself (notwithstanding the merger agreement’s “no-shop” provision), and (ii) declared, in advance, that the Court-ordered “go shop” would not constitute a breach of the merger agreement.
C&J involved a transaction between C&J and a division of Nabors Industries Ltd. The entity surviving the transaction would be a Bermuda entity of which Nabors would maintain slight majority control. As part of the transaction, C&J negotiated for limitations on Nabors’ ability to utilize that majority control, including a guarantee that all stockholders would share pro rata in a future sale of the surviving entity, as well as certain governance rights. In addition, C&J negotiated for a “fiduciary out,” allowing it to terminate the merger in favor of a superior proposal during the post-signing period, subject to a “modest” 2.27% termination fee. Following announcement of the transaction, plaintiff filed suit alleging that the board of C&J breached its fiduciary duties by approaching the transaction as an acquisition of the Nabors division rather than a sale of control of C&J, and thus eschewing any pre-signing market check. The plaintiff also claimed that Nabors aided and abetted the alleged breach of fiduciary duty.
The Court of Chancery held that plaintiff made a “plausible” showing of a likelihood of success on the merits that the C&J board breached its fiduciary duty of care in approving the transaction. The Court based its decision on its perception that the “C&J board did not approach this transaction as part of a sales effort,” which the Court determined it should have done because control of C&J was changing hands. Importantly, the Court made no finding as to the aiding and abetting claim against Nabors. As a remedy, and notwithstanding the no-solicitation clause in the merger agreement, the Court ordered certain of the C&J directors “to solicit alternative proposals to purchase the Company (or a controlling stake in the Company) that are superior to the Proposed Transaction” and further stated that “[t]he solicitation of proposals consistent with this Order and any subsequent negotiations of any alternative proposal that emerges will not constitute a breach of the Merger Agreement in any respect.”
The Supreme Court reversed. Assuming Revlon applied (the Court declined to address whether the limitations on Nabors’ exercise of control negotiated by C&J were sufficient to render Revlon inapplicable), the Supreme Court held that the Court of Chancery misapplied the Revlon doctrine by suggesting Revlon requires “a company to actively shop itself.” The Supreme Court characterized Revlon and the subsequent QVC decision largely as involving questions of loyalty—i.e., “board resistance to a competing bid after the board had agreed to a change of control, which threatened to impede the emergence of a higher-priced deal.” Importantly, the Court stated that “Revlon does not require a board to set aside its own view of what is best for the corporation’s stockholders and run an auction whenever the board approves a change of control transaction.” Here, because the independent and disinterested C&J board “exercise[d] its judgment in good faith, test[ed] the transaction through a viable passive market check, and [gave] its stockholders a fully informed, uncoerced opportunity to vote to accept the deal,” it did not violate its Revlon duties.
The Supreme Court also held that the Court of Chancery erred by entering a mandatory injunction before trial when there were disputed facts and where there was no finding of wrongdoing on the part of Nabors. Characterizing the Court of Chancery’s order as “forc[ing] Nabors to endure a judicially-ordered infringement of its contractual rights that would, by judicial fiat, not even count as a breach of Nabors’ rights,” the Supreme Court reaffirmed Delaware’s reluctance to “blue-pencil” commercial agreements. “Even after a trial, a judicial decision holding a party to its contractual obligations while stripping it of bargained-for benefits should only be undertaken on the basis that the party ordered to perform was fairly required to do so, because it had, for example, aided and abetted a breach of fiduciary duty.”
C&J reflects one of the Supreme Court’s most in-depth discussions of Revlon duties and vested contract rights, and the scope of the Court of Chancery’s equitable power to issue preliminary injunctions, since the battle between Viacom and QVC for control of Paramount in the mid-1990’s.
Copyright © Morris, Nichols, Arsht & Tunnell LLP. These materials have been prepared solely for informational and educational purposes, do not create an attorney-client relationship with the author(s) or Morris, Nichols, Arsht & Tunnell LLP, and should not be used as a substitute for legal counseling in specific situations. These materials reflect only the personal views of the author(s) and are not necessarily the views of Morris, Nichols, Arsht & Tunnell LLP or its clients.