May 5, 2015
By Joseph J Basile, Foley Hoag LLP
Shareholder litigation around M&A continues to be nearly inevitable. With 93% of those M&A deals valued over $100 million attracting at least one law suit in 2014, directors are understandably looking over their shoulders in the boardroom whenever they consider a deal of any significance. In this environment, Vice Chancellor Glasscock’s recent decision in Southeastern Pennsylvania Transportation Authority v. AbbVie Inc.1 is a refreshing reminder that it is the job of the board – not the stockholders and not the courts – to assess the risk inherent in M&A transactions.
The case arose from the highly publicized attempt in 2014 by AbbVie Inc., a Delaware corporation, to combine with Shire plc, a company incorporated in Jersey and headquartered in Dublin, Ireland. After three months of intensive negotiation and six successively higher offers by AbbVie, Shire’s board eventually agreed and the parties announced a deal on July 18, 2014, with Shire’s shareholders to receive a combination of cash and shares in the surviving parent entity worth approximately $54 billion at the time of the announcement. The parties structured the deal as a so-called “tax inversion” with both AbbVie and Shire ending up as indirect wholly-owned subsidiaries of a newly formed Jersey publicly owned company (“New AbbVie”). If, as hoped, U.S. taxing authorities recognized New AbbVie as a foreign corporation for U.S. tax purposes, AbbVie expected that New AbbVie’s effective tax rate would be reduced to approximately 13% by 2016. However, the expected tax benefits would materialize only if U.S. tax law or its interpretation by the IRS did not change in a manner that would negate those benefits, a risk that AbbVie recognized and disclosed in its preliminary proxy statement.
The deal was subject to a number of closing conditions, including approval by the stockholders of both parties. AbbVie agreed in the deal documents to pay Shire a reverse breakup fee of approximately $1.635 billion (about 3% of the value of the deal) if prior to closing the AbbVie board withdrew its recommendation of the transaction and either AbbVie’s stockholders voted not to authorize the deal or no stockholders’ meeting took place within 60 days after the board’s change in recommendation. Despite the importance of the hoped for U.S. tax consequences, the deal documents did not include any provision permitting AbbVie to terminate the transaction without paying the reverse breakup fee if the U.S. Government acted to curtail tax inversions before the closing.
On September 22, 2014, the U.S. Treasury Department and the IRS announced their intention to issue new regulations that would operate retroactively and eliminate the tax benefits that AbbVie hoped for from the inversion transaction. As a result, on October 15 the AbbVie board withdrew its favorable recommendation and recommended instead that AbbVie’s stockholders vote against the deal. On October 20, the parties formally agreed to terminate the deal and AbbVie agreed to pay the $1.635 billion reverse breakup fee to Shire.
Shortly thereafter, two AbbVie stockholders served written demands on AbbVie to inspect certain of the corporation’s books and records for the purpose of investigating possible breaches of fiduciary duties, mismanagement, wrongdoing and waste by the AbbVie board. The stockholders based their demands on a Delaware statute2 that gives a person who is a stockholder a limited right to examine a corporation’s books and records for “any proper purpose”, which the statute (somewhat unhelpfully) defines to mean “a purpose reasonably related to such person’s interest as a stockholder”. AbbVie rejected those demands and the stockholders predictably sued. Vice Chancellor Glasscock denied the stockholders’ inspection demand, relying on fundamental, common sense principles of corporate governance.
The Vice Chancellor began his analysis by pointing out that under Delaware case law the investigation of potential corporate wrongdoing is a well-established “proper purpose” for a stockholder’s books and records inspection. In this case the plaintiffs argued that they sought inspection to evaluate the potential for derivative litigation on behalf of AbbVie against its board. To obtain inspection for this purpose the plaintiffs were required to produce some evidence demonstrating a “credible basis” from which the court could infer that the directors had committed actionable corporate wrongdoing, i.e. either a breach of the directors’ duty of care or a breach of their duty of loyalty. The plaintiffs’ theory in this case was that the risk of governmental action to curtail tax inversions was so substantial and so obvious during the summer of 2014 that the AbbVie directors breached their fiduciary duties by agreeing to a deal with such a sizable reverse breakup fee and no “out” for changes in tax law. Without saying it in so many words, the plaintiffs’ argument was that in retrospect the deal looked so dumb that the board must have done something illegal in agreeing to it.
The burden of showing only a “credible basis” to infer corporate wrongdoing applicable in this case is a conspicuously low standard intended to give stockholders a reasonable opportunity to inspect corporate records at a point in time when by definition the stockholders lack nonpublic information. Nonetheless the Vice Chancellor found that that plaintiffs failed to meet even this relatively light burden.
Unpacking the plaintiff’s claims one by one, the Vice Chancellor first determined that the AbbVie directors were insulated from monetary liability for any breach of duty of care, even if proven at trial, because AbbVie’s charter included a standard exculpatory provision that protected AbbVie’s board from such liability. Further, the plaintiffs did not even allege, much less prove, that the AbbVie directors breached their duty of loyalty by reason of being self-interested or by lacking independence from any interested party in the transaction.
The remaining thrust of the plaintiffs’ corporate wrongdoing theory was that the AbbVie directors breached their duty of loyalty by acting in bad faith - that is, by an intentional or conscious disregard of their duties, or by committing corporate waste. In response, the Vice Chancellor stated that agreeing to a 3% reverse breakup fee was not intrinsically unusual and certainly not by itself evidence of bad faith. The record further showed that the AbbVie board was fully informed of the risk of a change in tax law, weighed that risk against the potential benefits of the deal and agreed to the reverse breakup fee that was actively negotiated by a reluctant merger partner as part of the price of securing a deal. That the risk and its unfortunate (for AbbVie) consequences became a reality did not provide a basis for retroactively characterizing the board’s judgment to accept that risk as bad faith.
Turning to the plaintiffs’ waste theory the Vice Chancellor cited Delaware precedent defining waste as “an exchange of corporate assets for consideration so disproportionately small as to lie beyond the range at which any reasonable person might be willing to trade”3. Applying this standard, Vice Chancellor Glasscock wrote:
[T]he AbbVie board entered into a deal that, if not for the change in tax law, would have created value for AbbVie’s stockholders. The Break Fee was one of the cogs in the Co-Operation Agreement that helped bring Shire into that deal. It is inappropriate for this Court to attempt, in retrospect and under the guise of the waste standard, to judge whether including the Break Fee was appropriate given the risk that government action might sink the deal, or to judge whether paying the Break Fee was better for the Company than forging ahead with the deal without the tax benefit: “Any other rule would deter corporate boards from the optimal rational acceptance of risk . . . . Courts are ill-fitted to attempt to weigh the ‘adequacy’ of consideration under the waste standard or, ex post, to judge appropriate degrees of business risk.”4
While hardly groundbreaking, the decision reconfirms the important principle that Delaware courts are highly unlikely to second guess the business judgment of fully informed, independent directors, even when that judgment in retrospect turns out badly. In the words of Vice Chancellor Glasscock “Evaluating risk is the raison d’être of a corporate director”.