Recent Delaware Court of Chancery Pronouncement on Deal Protections

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In bench rulings on November 9, 2012, and November 27, 2012 in In re Complete Genomics, Inc. S'holder Litig., the Delaware Court of Chancery temporarily enjoined a merger between Complete Genomics, Inc. ("Genomics") and BGI-Shenzhen ("BGI") pending corrective disclosure regarding, among other things, BGI's willingness to employ Genomics' current CEO and let him operate Genomics as an independent entity under BGI ownership. The Court further enjoined Genomics from enforcing a confidentiality agreement with a third-party bidder that contained a "Don't Ask, Don't Waive" standstill provision.  Notably, the Court also addressed a series of deal protections that were put in place such as a 4.8% break-up fee and change-of-recommendation limitations.  Although the Court held that the break-up fee was permissible, the Court found the provision restricting the Board's ability to change its recommendation troubling, but premature to adjudicate. 

Genomics, as the Court noted, faces severe financial distress even though it continues to generate significant revenues.  In June 2012, Genomics publicly announced that it was pursuing strategic alternatives and it contacted 42 parties that might be interested in an equity investment, a strategic partnership, or an acquisition.  Of these 42 parties, nine parties signed confidentiality agreements, four of which contained standstill agreements that prohibited the potential bidder from making any public request to be released from the standstill agreement.  The number of interested parties then dwindled after the Genomics board asked the parties to submit nonbinding proposals, and, eventually, BGI remained as the sole bidder. 

In September 2012, the Genomics board approved a merger agreement where Genomics would be acquired by BGI in a two-step transaction.  As part of the transaction, BGI agreed to pay a 54% per share premium over the stock price the day before the public announcement that Genomics was exploring strategic alternatives, and further agreed to provide $30 million in bridge financing until closing of the merger.  The merger agreement contained a variety of deal protections, including a 4.8% break-up fee (and if a topping bidder emerged, BGI could convert the bridge loan into shares of Genomics and also participate in the higher topping price), a prohibition on terminating the merger agreement to accept a superior proposal and restrictions on the Genomics board's ability to change its recommendation of the merger agreement or waiving any standstill agreements (at least one potential bidder had entered into a standstill agreement that prevented the bidder from publicly or privately requesting or proposing that Genomics consider waving or amending its terms - a so-called "Don't Ask, Don't Waive" standstill when coupled with the merger agreement restriction on waiving standstills). 

Specifically, the Court held that:

• The break-up fee was permissible -The Court recognized that Delaware Supreme Court precedent aggregated a termination fee together with any other topping bid consideration to calculate the "termination fee" to be received by the initial bidder. The ability to convert the bridge loan in this situation could be distinguished, however, because it provided a substantial benefit in the form of extra liquidity that allowed Genomics to avoid bankruptcy. 
• The superior proposal restriction was not preclusive or coercive even when combined with the break-up fee - Although the merger agreement prevented the Genomics board from accepting a superior proposal, this restriction was permissible because a fully informed board could enter into an exclusivity agreement.  Further, even when combined with the break-up fee, this restriction was not preclusive or coercive because the break-up fee only applied if a topping-bid emerged and the stockholders declined to tender, the board no longer recommended the merger, or Genomics breached the merger agreement.  That is, the transaction as structured gave the stockholders the option to reject transaction by not tendering into the offer and maintain the status quo without any repercussion.
• Limitations on the Genomics board's ability to provide updated merger recommendations were problematic, but the Court would not enjoin the merger when the board had no impetus to change its recommendation - In regard to the limitations on the Genomics board's ability to provide updated merger recommendations, the Court said that these limitations were "fundamentally different" than other deal protections, such as no-shop and other termination provisions, because they "implicate[] duties to target stockholders to communicate truthfully.  Unlike in the no-shop and termination outs, fiduciary duty law in this context can't be overridden by contract."  The Court, however, declined to enjoin the merger on this basis because the facts did not indicate that the board had any need or desire to change its recommendation.  Importantly, the Court said that if the Genomics board thought that it might need to change its recommendation, Genomics would have to provide "prompt notice" to the plaintiffs.  The Court indicated that it would then reconsider the issues at such time.
• The "Don't Ask, Don't Waive" standstill provision was unacceptable - In the Court's initial November 9 ruling, the Court found that the provision in the merger agreement that prevented Genomics from waiving any standstills worrisome, but it declined to enjoin the merger on that basis because the issue was unripe at that time. However, when the Court was alerted that at least one standstill agreement that Genomics had entered into with a potential bidder prevented that bidder from publicly requesting or privately proposing that Genomics consider waving or amending its terms, the Court enjoined Genomics from enforcing that agreement (even though there was no indication that such bidder had any intention to request a waiver or submit a topping bid).  According to the Court, these types of "Don't Ask, Don't Waive" standstill arrangements resemble bidder-specific no-talk clauses which compromise the target board's ongoing obligation to remain informed.  The Court, therefore, held that by agreeing to the "Don't Ask, "Don't Waive" provision, the "Genomics board impermissibly limited its ongoing statutory and fiduciary obligations to properly evaluate a competing offer, disclose material information, and make a meaningful merger recommendation to its stockholders" and enjoined Genomics from enforcing this provision. 
• Genomics had to disclose its CEO's negotiations with BGI relating to his post-merger employment - Discovery revealed that Genomics' CEO had been in discussion with BGI in regard to his post-transaction employment.  In particular, BGI suggested that Genomics' CEO could continue to operate Genomics as an independent entity under BGI with his current management team.  This information, however, was not disclosed.  The Court held that this information was material and "those discussions need[ed] to be described and disclosed to stockholder."  As a result, the court enjoined the merger until that information was provided.

This memorandum is not intended to provide legal advice, and no legal or business decision should be based on its content. Questions concerning issues addressed in this memorandum should be directed to: 

 Justin Shuler and Cara Grisin contributed to this memorandum.