January 28, 2010
In NACCO Industries, Inc. v. Applica Inc., C.A. No. 2541-VCL (Del. Ch. Dec. 22, 2009), the Court of Chancery considered motions to dismiss a jilted bidder’s claims against the target corporation and the successful topping bidder. In its opinion, the Court confirmed Delaware’s commitment to enforcing deal protection devices such as a no-shop clause and a prompt notice clause. The Court also held that it had jurisdiction over common law fraud claims even where such claims were based on misleading statements made in federal securities filings. While the Court noted the plaintiff-friendly standards governing its disposition of the motions to dismiss, it also stressed Delaware’s interest in ensuring that the entities it charters are not used as vehicles of fraud, as well as Delaware’s commitment to honoring and enforcing deal partners’ contractual commitments.
In early 2006, plaintiff NACCO Industries, Inc. (“NACCO”) approached defendant Applica Incorporated (“Applica”) proposing a strategic transaction between Applica and a NACCO-owned entity. In February 2006, the parties entered into a nondisclosure agreement that included a standstill provision (the “Standstill Agreement”) limiting NACCO’s ability to acquire Applica stock. Five months later, the parties entered into a merger agreement (the “NACCO Agreement”) that included both a broad no-shop clause (the “No-Shop Clause”) and a clause requiring Applica to give NACCO prompt notice of any possible competing transaction (the “Prompt Notice Clause”).
However, unbeknownst to NACCO, Applica insiders had allegedly begun providing inside information to Harbert Management Corporation and its affiliated entities (together, “Harbinger”) immediately after the Standstill Agreement was executed. Harbinger, uninhibited by any standstill agreement and interested in taking Applica private through a transaction with an Applica competitor, Salton, Inc. (“Salton”), began acquiring Applica stock. In its Schedule 13G and 13D filings, Harbinger claimed to have an investment purpose for its serial acquisitions of Applica stock, disclaiming any intention to gain control of the company. Around this same time, Harbinger also obtained a controlling stake in Salton in order to facilitate its plan to merge Salton and Applica. When Harbinger’s stake in Applica reached nearly 40%, however, Harbinger discovered that its increased holdings had triggered the Florida Control Shares Act (the “Florida Act”), which eliminated Harbinger’s right to vote its shares. While Applica subsequently advised NACCO of Harbinger’s request for a waiver of the vote-stripping effect of the Florida Act, Applica assured NACCO that Harbinger planned to vote in favor of the NACCO Agreement, despite Applica’s knowledge to the contrary.
Immediately after the NACCO Agreement became effective, Applica management informed Harbinger that an all-cash offer for Applica would likely be successful. In response, a Salton representative contacted Applica to discuss a possible bid financed by Harbinger. Despite its obligations under the NACCO Agreement, Applica did not relay either of these communications to NACCO. Then, on September 14, 2006, Harbinger announced a topping bid to acquire all outstanding shares of Applica that it did not already own for $6.00 per share. At that same time, Harbinger also filed amendments to its prior Schedule 13D disclosures indicating that it had acquired its stake in Applica to acquire control and later disclosed its purpose to acquire all of Applica’s outstanding stock. One month later, Applica notified NACCO that it was terminating the NACCO Agreement in order to accept Harbinger’s superior proposal and paid NACCO a $4 million termination fee and $2 million in expense reimbursement pursuant to the NACCO Agreement. Applica and Harbinger then entered into a merger agreement (the “Harbinger Agreement”).
In November 2006, Applica filed a preliminary proxy statement to solicit proxies in favor of the Harbinger Agreement. The proxy solicitation, for the first time, notified NACCO along with the general public of communications between Applica and Harbinger that had taken place during the negotiation and pendency of the NACCO Agreement. In light of the information contained in the proxy statement, NACCO filed suit in the Court of Chancery. NACCO and Harbinger subsequently entered a bidding war for Applica that culminated with Harbinger’s winning bid of $8.25 per share. Shortly thereafter, Salton and Applica entered a merger agreement at Harbinger’s urging, which closed on December 28, 2007, leaving Harbinger as the 92% owner of the combined company. After the topping deal successfully closed, NACCO pursued its litigation in the Court of Chancery against Applica and Harbinger seeking, among other things, damages for breach of the NACCO Agreement.
Enforcement of Deal Protection Devices in Delaware
Addressing the plaintiffs’ breach of contract claim, the Court found that the complaint adequately alleged that Applica management had actively solicited an offer from Harbinger in violation of the No-Shop Clause and had failed to promptly inform NACCO of the competing proposal it received from Salton in violation of the Prompt Notice Clause. In reaching this conclusion, the Court noted the breadth of both the No-Shop Clause and the Prompt Notice Clause. The Court also found that the complaint stated a claim for breach of these same provisions of the NACCO Agreement when Applica requested a waiver of the vote-stripping effect of the Florida Act while simultaneously misleading NACCO concerning Harbinger’s true intent. Finally, the Court found that the complaint stated a claim for breach of the Prompt Notice Clause based on Applica’s silence after Harbinger announced its initial competing bid. During its negotiations with Harbinger, Applica had refused to give NACCO any more information than was disclosed in various public filings. The Court criticized Applica’s silence, stating that the Prompt Notice Clause created an affirmative obligation on the part of Applica to “regularly pick up the phone,” especially in the context of a topping bid where, the Court noted, every day matters. In holding that the complaint had stated a claim for breach of the NACCO Agreement, the Court emphasized Delaware’s commitment to enforcing deal protection devices.
The Court rejected the defendants’ argument that the plaintiffs had failed to adequately plead damages in light of Applica’s payment of a termination fee and expense reimbursement pursuant to the NACCO Agreement. The Court stated that merger partners do not provide for such payments in order to reimburse a party for a breach of contract but, rather, to reimburse a party in the event of a target’s acceptance of a superior proposal. While the Court recognized that NACCO ultimately may have a difficult task in establishing that the breach by Applica was willful, it refused to address such questions at the motion to dismiss stage. The Court similarly rejected the defendants’ argument that, because NACCO participated in and lost a bidding contest for Applica in the marketplace, it could not seek a judicial remedy. Instead, the Court held that NACCO was permitted to pursue expectancy damages, explaining that Delaware courts must provide an enforcement mechanism for deal protection provisions or such provisions would be rendered meaningless, which in turn “would have serious and adverse ramifications for merger and acquisitions practice and for our capital markets.”
Federal Securities Law Does Not Preempt Common Law Fraud
The Court then turned to the plaintiffs’ fraud claim, which was based solely on statements in Harbinger’s Section 13 filings. The Court held that a Delaware court can provide a common law fraud remedy for false statements in a filing made under the Securities Exchange Act of 1934 (the “Exchange Act”), noting that (i) the Delaware Supreme Court has held that such a remedy exists, and (ii) the ability of the Court to enforce such a remedy where a Delaware entity has been accused of fraud serves important Delaware interests. Despite federal jurisdiction over violations of the Exchange Act, the Court noted that it retained jurisdiction over common law fraud claims based on false statements in federal filings pursuant to the reservation in Section 28(a) of the Exchange Act for “rights and remedies that may exist at law or in equity.” The Court held that, in its evaluation of conduct related to a fraud claim, it may use federal securities law as a guidepost without giving rise to a basis for federal preemption of the action. The Court described the threshold question for state jurisdiction as requiring a determination of whether the state law claim raises a truly federal issue—e.g., whether federal law creates the cause of action or the plaintiff’s right to relief necessarily depends on resolution of a substantial question of federal law. The Court held that such a determination must be made on a case-by-case basis. In applying this analysis to the plaintiffs’ claim, the Court held that the complaint supported an inference of common law fraud. In coming to this conclusion, the Court stressed Delaware’s interest in ensuring that the entities it charters are not used as vehicles of fraud, cautioning that “[i]f a Delaware entity engages in fraud or is used as part of a fraudulent scheme, that entity should expect that it can be held to account in the Delaware courts.”
Having found that it had jurisdiction to evaluate the fraud claim, the Court then struggled with the element of justifiable reliance in light of the sheer size of Harbinger’s stake in Applica. The defendants argued that, at some point, the size of Harbinger’s position should have put NACCO on notice of its intent. However, the Court recognized that there is a thin line between a creeping takeover and the typical position arbitrageurs and hedge funds take in a company, such as Applica, that openly asserts its consideration of strategic alternatives. The Court declined to penalize NACCO, the victim of an alleged fraud, for failing to judge with precision when that line was crossed. With respect to damages, the Court recognized that, in reliance on Applica’s assurances and Harbinger’s misleading public disclosures, NACCO was forced to forego actions it could have otherwise taken to respond to Harbinger’s advances, such as requesting an amendment or suspension of the Standstill Agreement, suggesting Applica adopt a rights plan, or bringing suit earlier to enforce the terms of the NACCO Agreement. Thus, the Court found that the elements of fraud were adequately pled and declined to dismiss that count of the complaint.