Omnicare's silver lining.

• Author: Laster, J. Travis
• Position: Fiduciary out in the merger agreement - Delaware

1. THE LITIGATION PATH A. The Court of Chancery Decision B. The Delaware Supreme Court Majority Opinion C. The Dissents D. The Response II. GOOD DOCTRINE: ENHANCED SCRUTINY FOR DEAL PROTECTION III. GOOD DOCTRINE, BAD APPLICATION: COERCION AND PRECLUSION IV. GOOD THINKING, BAD DRAFTING: DIRECTORS AS SOOTHSAYERS V. GOOD POLICY: A PRE-COMMITMENT RULE FOR DIRECTORS VI. CONCLUSION Fashion dictates that Omnicare (1) be criticized. The majority opinion provoked two vigorous dissents, and commentators echoed them in a chorus of denigration. (2) One of the dissenters famously predicted that Omnicare would have "the life expectancy of a fruit fly." (3) But 11 years later, a geriatric fruit fly flaps on.

   Perhaps it is time to realize that like people, problems, and broken hearts, Omnicare isn't all bad. Although saying anything good about Omnicare smacks of heresy, four aspects of the decision deserve positive reinforcement. First, Omnicare made a helpful contribution to Delaware law by confirming that enhanced scrutiny applies to deal protection devices, regardless of the form of merger consideration. Second, the decision properly separated the elements of coercion and preclusion from the question of overarching reasonableness. Third, the timing of the majority's fiduciary analysis has been overly criticized. Finally, from a policy standpoint, the decision gave target directors greater bargaining leverage, particularly in distressed situations, by establishing a pre-commitment rule against majority voting lockups. There is still plenty to disagree with, but Omnicare does have a silver lining. (4)

1. The Litigation Path

   Omnicare involved a bidding contest for NCS Healthcare, Inc. between two rival health care companies, Genesis Health Ventures, Inc. and Omnicare, Inc. The health care industry was rapidly consolidating because of changes in government and third party medical reimbursement policies, and the regulatory changes had hit NCS hard. Its stock had traded at $20 per share in January 1999, but by the end of the year, its stock hovered around $5. NCS also carried approximately $350 million in debt, comprising $206 million in senior bank debt and $102 million in convertible subordinated debentures. (5)

   In early 2000, the NCS board of directors decided to explore strategic alternatives and tapped a financial advisor for assistance. (6) The board had four members: Boake Sells, Richard Osborne, Jon Outcalt, and Kevin Shaw. Osborne and Sells were outside directors. Outcalt and Shaw founded NCS and were its two senior officers. They also controlled a majority of NCS's stockholder voting power by virtue of owning the high-vote shares under NCS's dual class structure. To state the obvious, the board did not have a majority of independent, outside directors, and management's positional influence and informational advantages were backed up by hard voting control and founder status.

   NCS's effort to develop strategic alternatives generated little interest. Despite contacting over 50 parties, NCS received only one indicative response, and that party proposed consideration below the face value of the company's senior bank debt. In December 2000, NCS terminated its process. (7)

   By the beginning of 2001, NCS's financial condition had deteriorated further. In April, NCS received a formal notice of default on its debentures, and the holders of the debentures organized a Noteholders Committee to protect and enforce their rights. (8) With the threat of bankruptcy looming, the board began discussing a pre-packaged bankruptcy plan with various investors. The trading range for NCS's common stock fell to $0.09-$0.50 per share. (9) Under the scenarios being considered by the board, the common stockholders would have been wiped out and the creditors unlikely to be made whole.

   In this environment, Omnicare expressed unsolicited interest in acquiring NCS. In summer 2001, one year after NCS's process of exploring strategic alternatives, Omnicare proposed to acquire the company in a bankruptcy sale for $225 million. (10) In August, Omnicare increased its proposal to $270 million. (11) Both offers were below the value of the company's debt and would not have generated any return for the common stockholders.

   In October 2001, NCS representatives met with Omnicare to pitch a merger outside of bankruptcy. (12) Omnicare rejected the idea and went silent for three months. During this period, Omnicare secretly communicated with the Noteholders Committee. Then, in February 2002, Omnicare reopened the lines of communication with NCS, again proposing to purchase the company out of bankruptcy for approximately $313 million. (13) During the same period, the Noteholders Committee reached out to Genesis, a company that had recently confronted, successfully, the same financial troubles facing NCS.

   At this point, the landscape began to change. By March 2002, NCS's financial condition was improving. (14) It was now two years after the company's earlier effort to explore alternatives. Recognizing the company's changed circumstances, the board formed an independent committee composed of Sells and Osborne to consider potential transactions. Authority to approve any transaction remained vested in the full board.

   On June 25, 2002, Genesis proposed a merger that contemplated full repayment of the NCS senior debt, an exchange or purchase of the debentures at par, and consideration consisting of Genesis common stock worth $20 million for NCS's stockholders. (15) On June 26, Genesis increased the stock portion to $24 million, but asked NCS to enter into an exclusivity agreement. (16) The next day, Genesis provided a draft exclusivity agreement, a draft voting agreement for Outcalt and Shaw, and a proposed merger agreement. The Genesis negotiators made no bones about why Genesis wanted the voting agreement: they expected that Omnicare would bid as soon as Omnicare heard about the deal.

   On July 3, 2002, the committee considered the Genesis proposal. (17) The directors knew that Genesis wanted exclusivity because of the threat of a topping bid from Omnicare. The directors also knew that Genesis was particularly concerned about an Omnicare overbid because Genesis had recently lost a different acquisition target to Omnicare.

   Although it seemed likely that Omnicare would compete, and although NCS's exploration of alternatives was now two years in the past, the committee executed the exclusivity agreement and agreed not to enter into discussions with another bidder until July 19. NCS continued to negotiate the terms of the Genesis merger agreement through July. (18) The exclusivity period was automatically extended to July 26, and then voluntarily extended to July 31. (19)

   On July 26, 2002, after hearing rumors that NCS was in discussions with Genesis, Omnicare made another unsolicited proposal--effectively bidding against itself. (20) The new offer would pay off NCS's debt and provide $3 in cash for each share of NCS common stock. (21) The total consideration for the equity was $71 million, nearly three times the value of Genesis' proposal at the time. (22) Omnicare's proposal was conditioned on due diligence, as unsolicited proposals often are. When NCS management responded, they pushed back on the due diligence condition, but Omnicare declined to make an unconditional proposal--at least at that time. After the NCS-Genesis transaction was announced publicly, Omnicare would drop the due diligence condition.

   The next day, July 27, 2002, Genesis submitted an improved proposal with a deadline for acceptance of midnight on July 28. (23) The proposal offered NCS stockholders one share of Genesis stock for every ten shares of NCS common stock. The exchange ratio valued NCS common stock at approximately $1.60 per share based on Genesis' then-current trading price. (24) The total consideration for the equity was $38 million, just over half the Omnicare proposal. (25) The Genesis draft merger agreement included (i) a force-the-vote provision; (ii) a no-talk provision prohibiting NCS from third party acquisition discussions unless presented with a proposal likely to result in better terms than the Genesis merger; and (iii) a $5-6 million termination fee. Proposed voting agreements continued to require that Outcalt and Shaw vote for the merger. Genesis said it was its best and final bid, but like Omnicare's insistence on due diligence, that would turn out to be a negotiating position. After the Delaware Supreme Court's decision reopened the bidding contest, Genesis would increase the proposed exchange ratio to offer stock worth $3.50 per NCS share. Omnicare would then win the contest with a bid of $5.50 per share in cash, plus a payment of $22 million to Genesis. But on July 28, 2002, the committee could not foresee those developments.

   Facing the midnight deadline from Genesis, the committee decided not to pursue further negotiations with Omnicare in light of the uncertainty the due diligence condition created and the perceived risk to the Genesis bid. The committee reviewed the terms of the Genesis proposal and voted to recommend it to the full board. The full board met thereafter. Like the committee, the board regarded the Omnicare proposal as insufficiently definite because of the due diligence condition and concluded that the Genesis transaction presented the best available alternative for the company.

   The board then voted on and approved three items. First, the board authorized the voting agreements for purposes of Section 203 of the Delaware General Corporation Law (DGCL). (26) Second, the board considered and approved the merger agreement. (27) Third, the board recommended the transaction to NCS's stockholders. (28)

   The day after execution of the Genesis merger agreement, Omnicare contacted NCS to reiterate its July 26 proposal. (29) Omnicare also issued a press release disclosing its terms. (30) On August 1, Omnicare filed a lawsuit to enjoin the merger and launched...