In re Orchid Cellmark Inc. Shareholder Litigation: Court of Chancery Addresses Deal Protections and Adequacy of Disclosures
August 1, 2011
In In re Orchid Cellmark Inc. Shareholder Litigation, C.A. No. 6373-VCN (Del. Ch. May 12, 2011), the Delaware Court of Chancery denied plaintiffs’ motion to enjoin preliminarily a cash tender offer by Laboratory Corporation of America Holdings, Inc. (“LabCorp”) for all of the shares of Orchid Cellmark Inc. (“Orchid”) for $2.80 per share under an Agreement and Plan of Merger, dated April 5, 2011 (the “Merger Agreement”). This decision reaffirms that the Court of Chancery is unlikely to overturn business decisions of boards comprised of a majority of independent directors that utilize special committees of independent directors in sale of control transactions. In addition, while not indicating at what point an amalgamation of deal protection devices becomes so burdensome and costly to render a fiduciary out illusory—but acknowledging that there could be such a point—the Court determined that the combination of deal protections in this transaction was reasonable under the circumstances. Of note, the Delaware Supreme Court declined to accept an interlocutory appeal of the decision.
Orchid has a six-member board of directors (the “Board”) consisting of five independent directors and one inside director, the CEO. The Board formed a special committee consisting of three independent directors (the “Special Committee”) to evaluate LabCorp’s initial indication of interest. The Special Committee selected Oppenheimer & Co. (“Oppenheimer”) as its financial advisor. After several rounds of negotiations and substantial work by the Special Committee and Oppenheimer, the Board ultimately voted to approve the Merger Agreement and recommended that Orchid’s stockholders tender their shares to LabCorp, with the CEO abstaining from the vote.
Plaintiffs alleged that the transaction, valued at $85.4 million, was the result of a flawed and inadequate process and that Orchid’s stockholders had been provided with materially misleading and incomplete information in a recommendation statement on SEC Form 14D-9 (the “Registration Statement”). Under the preliminary injunction standard, the Court first assessed whether there was a reasonable probability that plaintiffs would be successful on the merits of their claims at trial.
While plaintiffs challenged the sufficiency of the market check, the Court found that there was no indication that Orchid favored LabCorp over any other potential bidder, noting that LabCorp’s earlier expressions of interest were rejected and that during the market check Oppenheimer solicited the interest of six potential bidders. As for the language used by Oppenheimer in its market check that Orchid “was not putting itself up for sale but, having received an unsolicited indication of interest, was checking the indication against the market,” the Court noted that potential bidders seemingly understood that they were invited to make a bid. Most important to the Court, at the time Oppenheimer stated that the Company was not for sale, the statement was true because the Board had not formally decided to accept the LabCorp proposal.
Plaintiffs also alleged that the Board ignored the possibility that an alternative transaction involving only Orchid’s U.K. operations could provide substantially superior value to Orchid’s stockholders. The Court found that the Special Committee and the Board had adequately considered this alternative with Oppenheimer, which had calculated that one such indication of interest by a U.K. private equity buyer equaled approximately $2.93 per share. Nevertheless, due to the risks and uncertainties involved in pursuing an alternative transaction where no offer had yet been made by any of these private equity firms, the Board determined that a transaction with a private equity firm for only the Company’s U.K. business was not superior to the LabCorp offer. The Court found no reason to second guess the Board’s decision.
Plaintiffs also alleged that the Board and Oppenheimer disregarded management input, resulting in financial projections that undervalued Orchid. Despite plaintiffs’ claim that the projections were manipulated in favor of the transaction, the Court found no basis to question the motivations of the Special Committee or to doubt the independence and credentials of Oppenheimer. The Court stated that the Special Committee and its financial advisor “are not precluded from considering various sets of financial projections before determining that one set reflects the best estimate of future performance.” Also, with respect to the Board’s consideration of the CEO’s dissent, the Court found that the Board did not fail to consider it as plaintiffs alleged, but rather simply disagreed with the CEO’s optimism toward Orchid remaining as a stand-alone company.
Finally, the Court turned to the numerous deal protection terms: a top-up option, a no-shop clause, match rights, informational match rights, a termination fee payable either where Orchid pulls out of the deal or where stockholders fail to tender a majority of shares, and Orchid’s agreement to pull its rights plan with respect to LabCorp only. Taken individually, the Court found these provisions insufficient to deter a serious bidder. The Court noted that the no-shop provision was balanced by a fiduciary out that allows the Board to negotiate and exchange confidential information with a bidder who presents what is, or is likely to become, a superior offer. Rejecting plaintiffs’ argument that termination fees should be measured by a company’s enterprise value (i.e., Orchid’s value after discounting its cash on hand), the Court followed Cogent1 and found the $2.5 million termination fee to be 3% of Orchid’s equity value and therefore reasonable. In evaluating the cumulative effect of all the deal protection devices, as it was also required to do, the Court found that a sophisticated buyer could overcome them if it wanted to make a serious bid; accordingly, they were reasonable under the circumstances.
Plaintiffs also alleged that defendants had made several inadequate or misleading disclosures in the Registration Statement. First, plaintiffs alleged that the disclosures surrounding several U.K. private equity firms’ interest in purchasing only Orchid’s U.K. operations were inadequate. While the Court stated that the materiality of disclosing the $2.93 per share price was a close call, the Court ultimately determined that such disclosure was not required. Relatedly, plaintiffs alleged that the terms of Oppenheimer’s engagement biased it towards recommending the LabCorp tender offer and against a sale of only Orchid’s U.K. operations. Plaintiffs argued that Oppenheimer was only engaged to advise Orchid regarding transactions involving the sale of “all or substantially all of the assets or outstanding securities of the Company,” which would exclude a transaction involving only a sale of Orchid’s U.K. operations, but the Court found that the engagement involved a broader range of transactions. Distinguishing the recent Atheros decision,2 the Court found that the terms of Oppenheimer’s engagement did not create an unavoidable conflict of interest that required a curative disclosure.
Second, plaintiffs alleged that Orchid should have disclosed projections by Orchid’s management regarding its prospects as a continuing stand-alone entity, which were more optimistic than those used by Oppenheimer in its fairness opinion and disclosed to stockholders in the Registration Statement. However, given that (i) the Board was independent and deemed a different set of projections more reliable, (ii) such projections were disclosed, and (iii) stockholders were cautioned about the reliability of such projections, the Court found that plaintiffs had not shown a reasonable probability that they would succeed in showing that disclosure of management’s projections would be material to a reasonable stockholder’s decision, although the Court noted that this too was a close call.
Third, plaintiffs argued that Orchid should have disclosed that Oppenheimer told potential bidders that the company was not conducting an auction. The Court reiterated that sophisticated buyers knew that they could have indicated their interest in response to Oppenheimer’s inquiries and found that further disclosures would not be material to a stockholder’s decision.
Fourth, plaintiffs argued that Orchid should have disclosed the reasons why its two largest stockholders decided not to enter tender agreements sought by LabCorp in conjunction with the transaction. The Court confirmed that Orchid should not be held responsible for or otherwise required to report on a third-party stockholder’s thought process.
Fifth, plaintiffs alleged that additional details regarding conflicts within the Board over negotiations with LabCorp must be disclosed. Although the Registration Statement did not disclose a preliminary 4-to-2 vote to continue negotiations with LabCorp (with the CEO opposing), the Court found that disclosing the CEO’s opposition to the transaction and his abstention from the final vote put the stockholders on notice that there was disagreement within the Board about whether to proceed.
Finding no reasonable probability of success on plaintiffs’ price and process or disclosure claims, the Court briefly commented that the irreparable harm prong counseled against an injunction as well. Finally, in balancing the equities, the Court noted that it should be careful about depriving stockholders of their opportunity to make a choice to tender, especially with a significant premium of 40% to market price, and that this tipped the balance against an injunction.