In re Synthes, Inc. S’holder Litig.: Court of Chancery Holds that the Business Judgment Rule Applies Where Controlling Stockholder Receives Pro Rata Share of Merger Consideration
September 5, 2012
In In re Synthes, Inc. Shareholder Litigation, 2012 WL 3594293 (Del. Ch. Aug. 17, 2012), the Court of Chancery dismissed an amended class action complaint alleging that Synthes, Inc.’s (“Synthes”) chairman and controlling shareholder Hansjoerg Wyss (“Wyss”) and its board of directors (the “Board”) breached their fiduciary duties by approving a merger with Johnson & Johnson (“J&J”). Significantly, the Court rejected the plaintiffs’ claim that Wyss had conflicts of interest with the minority stockholders that required application of the entire fairness standard, holding that the business judgment rule applied because Wyss would receive pro rata treatment with the minority stockholders.
Synthes was a global medical device company headquartered in Switzerland. Wyss owned approximately 38.5% of the company’s outstanding stock. The plaintiffs alleged that Wyss also beneficially controlled 52% of Synthes’s stock held by family members and trusts. In April 2010, the Board approached Wyss regarding a potential sale of the company, appointed an independent director to lead the sale process, and retained Credit Suisse as its financial advisor. Three of the nine strategic buyers contacted by the Board, including J&J, executed confidentiality agreements and began due diligence. The Board also approached six private equity firms, four of which executed confidentiality agreements and received due diligence.
In December 2010, three of the potential financial buyers submitted separate non-binding indications of interest to acquire Synthes at ranges up to CHF (Swiss franc) 150 per share in cash. J&J submitted its first non-binding offer of CHF 145-150 per share, with more than 60% of the consideration to be paid in J&J stock. The private equity buyers sought, and were granted, permission to join together to attempt to secure sufficient financial resources. By February 2011, the private equity consortium offered a firm CHF 151 per share, conditioned on Wyss converting a substantial portion of his equity investment in Synthes into an equity investment in the post-transaction company. Having considered these offers, the Board negotiated with J&J to seek a higher price, and ultimately J&J increased its offer to CHF 159 per share—composed of 65% stock (subject to a collar) and 35% cash. Notably, under J&J’s proposal, Wyss was to receive only his pro rata share of the transaction proceeds. Then the Board and J&J negotiated a merger agreement containing several deal protection provisions, including a no-shop clause with a fiduciary out, a force-the-vote provision, matching rights and a termination fee of 3.05%. Wyss, together with family members and family trusts, agreed to vote approximately 37% of the company’s stock in favor of the transaction.
The parties announced the $21.3 billion acquisition of Synthes by J&J on April 26, 2011. The deal represented a 26% premium to Synthes’s 30-day trading price (the “Merger”). The plaintiffs filed suit alleging breach of fiduciary duty claims against Wyss and the Board. The plaintiffs argued that the Merger was subject to entire fairness review because Wyss had financial motives adverse to the best interests of Synthes’s stockholders and was supposedly anxious to sell his equity stake rapidly to facilitate his own exit. The plaintiffs further alleged that the Merger was subject to enhanced scrutiny under Revlon because it was an “end stage” transaction. The Court rejected the plaintiff’s claims and dismissed the complaint with prejudice.
The Court rejected a review under entire fairness, holding that the business judgment rule applies to a merger resulting from an open and deliberative sale process when a controlling stockholder shares the control premium ratably with the minority stockholders. Because a large stockholder’s interests are generally aligned with the minority’s interest in obtaining the highest price reasonably available, the Court observed that “there is a good deal of utility to making sure that when controlling stockholders afford the minority pro rata treatment, they know that they have docked within the safe harbor created by the business judgment rule.” Thus, the Court held that the plaintiffs failed to plead facts to suggest that Wyss forced a fire sale of the company in order to satisfy some urgent need for liquidity or that he was in any particular rush to sell his stake in Synthes. Rather, the plaintiffs’ arguments ran contrary to the facts pled about the strategic process that the Board pursued. The Court also rejected the plaintiffs’ claim that they were unfairly deprived of the chance to sell all of their shares for cash because Wyss refused to support a deal that would require him to remain a substantial investor in the post-transaction entity. The Court stated that the plaintiffs’ argument was “astonishing” and reflected “a misguided view of the duties of a controlling stockholder under Delaware law.” That is, Delaware law does not impose on controlling stockholders a duty to engage in self-sacrifice for the benefit of the minority stockholders.
The Court also rejected the plaintiffs’ Revlon and Unocal claims. The plaintiffs argued that the Merger was subject to Revlon’s enhanced scrutiny because Synthes’s stockholders received mixed consideration of 65% J&J stock and 35% cash. Relying on Delaware Supreme Court precedent, the Court held that a change of control for purposes of Revlon does not occur where control of the corporation post-merger is in a large, fluid market. Here, J&J’s stock is widely held. Lastly, the Court dismissed the plaintiffs’ challenge to the deal protection measures under Unocal. The Court concluded that the plaintiffs made no attempt to show how the deal protections would have unreasonably precluded the emergence of a genuine topping bidder willing to make a materially higher bid.