In re Smurfit-Stone Container Corp. Shareholder Litigation: Court of Chancery Considers Applicability of Revlon in Cash/Stock Transaction
August 1, 2011
In In re Smurfit-Stone Container Corp. Shareholder Litigation, C.A. No. 6164-VCP (Del. Ch. May 24, 2011), the Delaware Court of Chancery addressed “whether and in what circumstances Revlon applies when merger consideration is split roughly evenly between cash and stock.” Although “not free from doubt” because the issue has not been addressed directly by the Delaware Supreme Court, Vice Chancellor Parsons found that the stockholder plaintiffs were likely to prevail on their argument that the enhanced reasonableness scrutiny required by Revlon, Inc. v. MacAndrews & Forbes Holdings, Inc., 506 A.2d 173 (Del. 1986), would apply to the challenged merger transaction under which the target’s stockholders would receive merger consideration consisting of 50% cash and 50% stock of the acquiring company in return for their shares. The Court, however, ultimately denied the plaintiffs’ motion for a preliminary injunction because it found that the plaintiffs did not demonstrate a reasonable probability of success on their claim that the director defendants breached their fiduciary duties by approving the challenged merger.
In Smurfit, the board of directors of the target, Smurfit-Stone Container Corp. (“Smurfit”), unanimously approved a merger agreement whereby Smurfit would be acquired by Rock-Tenn Company (“Rock-Tenn”) for $35 per share. Under the merger agreement, Smurfit’s stockholders would receive $17.50 in cash and 0.30605 shares of Rock-Tenn common stock for each share of Smurfit common stock. Following the merger, Smurfit’s stockholders would own approximately 45% of Rock-Tenn’s outstanding common stock and control of Rock-Tenn would remain in a large, fluid market. Following the announcement of the merger, several Smurfit stockholders filed putative class actions and moved to enjoin the merger.
The Delaware Supreme Court has determined that enhanced reasonableness scrutiny under Revlon applies in at least three scenarios: (i) when a corporation initiates an active bidding process seeking to sell itself or to effect a business reorganization involving a clear break-up of the company; (ii) where, in response to a bidder’s offer, a target abandons its long-term strategy and seeks an alternative transaction involving the break-up of the company; or (iii) when approval of a transaction results in a sale or change of control. If Revlon applies, the board’s actions in approving the sale are subject to enhanced reasonableness scrutiny, rather than the business judgment rule.
In Smurfit, the Court considered “when a mixed stock and cash merger constitutes a change of control transaction for Revlon purposes.” On the one hand, pure stock-for-stock transactions do not necessarily trigger Revlon. On the other hand, Revlon will govern a board’s decision to sell a corporation where stockholders will receive cash for their shares. Based on economic implications and relevant judicial precedent, including In re Lukens Shareholders Litigation, 757 A.2d 720 (Del. Ch. 1999), the Court found Revlon to be applicable to the merger because the 50% cash and 50% stock consideration qualified the merger as a change of control transaction. According to the Court, “there is no ‘tomorrow’ for approximately 50% of each stockholder’s investment in” Smurfit. While Smurfit’s stockholders would have half of their equity transformed to Rock-Tenn equity, with the potential for future value, half of their investment would be liquidated and deprived of its “long-run” potential. The Court therefore concluded that the plaintiffs were likely to succeed on their argument that the 50% cash and 50% stock consideration triggered enhanced reasonableness scrutiny under Revlon.
The Smurfit decision is consistent with Steinhardt v. Howard-Anderson, C.A. No. 5878-VCL (Del. Ch. Jan. 24, 2011) (TRANSCRIPT), where Vice Chancellor Laster reviewed a board’s actions for reasonableness in connection with a challenged merger under which the target’s stockholders would receive approximately 50% cash and 50% stock of the acquiring company in return for their shares but, unlike in Smurfit, would own approximately 15% of the combined entity. Vice Chancellor Laster stated, “This is a situation where the target stockholders are in the end stage in terms of their interest in [the target].… This is the only chance that [the target] stockholders have to extract a premium, both in the sense of maximizing cash now, and in the sense of maximizing their relative share of the future entity’s control premium.”