In re Cogent, Inc. Shareholder Litigation: Court of Chancery Allows Tender Offer to Proceed, Finding that Deal Protection Devices, Including the Use of a Top-Up Option, Were Not Unreasonably Preclusive
October 28, 2010
In In re Cogent, Inc. Shareholder Litigation, Cons. C.A. No. 5780-VCP (Del. Ch. Oct. 5, 2010), the Delaware Court of Chancery denied plaintiffs’ motion for a preliminary injunction, which sought to enjoin a two-step acquisition in which a third-party acquiror, 3M Company (“3M”), agreed to commence a tender offer for the stock of the target corporation, Cogent, Inc. (“Cogent”), to be followed by a back-end merger at the same tender offer price.
In 2008, Cogent, with the aid of financial advisors, began exploring strategic opportunities and in connection therewith reached out to 27 potential suitors. By the summer of 2010, however, only two of these potential suitors emerged as bona fide potential counter-parties?3M and Company D. Both 3M and Company D had been discussing a transaction with Cogent at various levels since 2008. No competitive offers materialized, however, until July 2, 2010, when 3M submitted a written nonbinding proposal to acquire Cogent for $10.50 per share in cash, followed by a formal written proposal and draft merger agreement on August 11. On August 17, Company D responded by submitting a preliminary nonbinding indication of interest in acquiring Cogent for between $11.00 and $12.00 per share, contingent, however, upon completion of satisfactory due diligence. On August 19, 3M responded to Company D’s expression of interest by notifying Cogent that it would formally withdraw its offer, if not accepted, at 5 p.m. on August 20. After reviewing the merits and risks associated with each offer, the Cogent board decided to negotiate a merger agreement with 3M at the $10.50 per share price.
On August 29, Cogent entered into an agreement and plan of merger (the “Merger Agreement”) with 3M at the $10.50 per share price. The Merger Agreement included several deal protection devices, including granting 3M five days to match any superior proposal, a no-shop provision with a fiduciary out clause, a termination fee of $28.3 million, and a top-up option through which 3M had the option to purchase approximately 139 million shares of Cogent stock at the tender offer price of $10.50 per share, which could be financed with a promissory note due in one year. Pursuant to the terms of the Merger Agreement, the Cogent board filed a Schedule 14D-9 recommending that Cogent’s stockholders accept 3M’s proposal (the “Recommendation Statement”).
Plaintiffs filed suit on September 1, 2010, asserting that the Cogent directors breached their fiduciary duties of loyalty and good faith as well as their fiduciary duty to disclose all material information regarding the transaction, and thereafter sought a preliminary injunction to prevent the transaction with 3M from moving forward.
Plaintiffs first attacked the sale process undertaken by the Cogent board. The Court determined that the Cogent board followed a reasonable course of action and found plaintiffs’ criticism of the board’s sale process unwarranted, citing the number of potential suitors that were contacted, the board’s engagement in various levels of discussions with strategic acquirors and reengagement with potential suitors on multiple occasions, the independence and disinterestedness of three of the four members of Cogent’s board, and that the interests of Cogent’s founder, CEO and 38.88% stockholder appeared to be closely aligned with the interests of the Cogent stockholders as a whole. Plaintiffs also attacked the board’s determination that $10.50 per share was a fair price on the ground that there was potential for a higher offer from Company D. The Court found that the Cogent board “acted reasonably when it effectively discounted Company D’s [$11.00 to $12.00 per share] offer based on, among other things, the risk that Company D would not make a firm offer.”
Plaintiffs then attacked the Merger Agreement as providing unreasonably preclusive defensive measures such that a superior proposal was unlikely to emerge. Plaintiffs alleged that the no-shop provision and the matching rights provision discouraged potential buyers because they unfairly tilted the playing field towards 3M, that the $28.3 million termination fee was unreasonably high, and that the top-up option was exceedingly broad.
The Court rejected each of plaintiffs’ contentions. First, the Court found that the no-shop and matching rights provisions were reasonable and mitigated by the fiduciary out provision, which provided the Cogent board with sufficient ability to engage with any bidder who makes a definitively higher or reasonably competitive bid. Second, the Court found that the termination fee (representing approximately 3% of Cogent’s equity value and 6.6% of its enterprise value) was not unreasonably high, rejecting plaintiff’s argument that the cash on Cogent’s balance sheet should be excluded (which would increase the percentage of the fee in relation to the transaction value) for purposes of evaluating the reasonableness of the termination fee. The Court held that the relevant transaction value should be quantified as the amount of consideration flowing to the stockholders, not the amount of money coming exclusively from the bidder. Third, the Court found that the top-up option was likely reasonable because: (1) the exercise of the option was conditioned upon a majority of the outstanding shares being tendered to 3M (i.e., a minimum tender condition), subject to waiver only with the consent of the Cogent board; (2) in order for 3M to meet the 90% threshold necessary to effect a short-form merger, 3M would have to acquire a majority of the minority’s outstanding shares; and (3) the Merger Agreement explicitly provides that a promissory note issued by 3M to pay for the top-up shares is a recourse obligation against 3M. In light of these findings, the Court concluded that the deal protection provisions, separately and in combination, were not unreasonable or preclusive.
Finally, plaintiffs alleged that the Cogent directors breached their fiduciary duty of disclosure with regard to material omissions in Cogent’s Recommendation Statement. The Court summarily rejected plaintiffs’ contentions, finding that the information requested by plaintiffs was either sufficiently disclosed or immaterial and cumulative.
Ultimately, the Court found that plaintiffs failed to demonstrate a reasonable probability of success on the merits or an imminent threat of irreparable harm and that the balance of equities weighed against enjoining the tender offer. The Court therefore denied plaintiffs’ motion for a preliminary injunction.
In response to the Court’s denial of their motion, plaintiffs filed an application for certification of an interlocutory appeal from the portion of the Court’s opinion concerning the validity of the top-up option. In a letter opinion dated October 15, 2010, the Court of Chancery denied plaintiffs’ application, finding that its opinion did “not involve such exceptional circumstances that the challenged ruling can be said to have determined a substantial issue, established a legal right, or satisfied one of the criteria in Rule 42(b)(i)-(v) sufficient to warrant an interlocutory appeal.” In re Cogent, Inc. S’holder Litig., C.A. No. 5780-VCP (Del. Ch. Oct. 15, 2010). The Delaware Supreme Court affirmed the Court of Chancery’s letter opinion denying plaintiffs’ application for an interlocutory appeal. In re Cogent, Inc. S’holder Litig., No. 648, 2010 (Del. Oct. 19, 2010).