For whom should the corporation be sold? Diversified investors and efficient breach in Omnicare v. NCS.

• Author: Foulds, Christopher M.
• Position: Delaware

1. Introduction II. Factual and Procedural Background A. Genesis Offers a "Blowout" Price B. The Anatomy of a Lock-Up C. The Termination Provision and Termination Fees D. Omnicare's "Predatory and Highly Conditional" Bids E. Genesis Didn't Like Omnicare Either F. NCS Picks Genesis's "Sure-Thing" Bid G. Omnicare and NCS Shareholders Start the Litigation H. The Court Revives the Shareholders' Appeal I. The Supreme Court Majority Opinion J. The Dissents III. Omnicare's Duty and Interest Analysis IV. Omnicare and Efficient Non-Breach V. Conclusion I. Introduction

   For a decade, the Delaware Supreme Court's split decision in Omnicare v. NCS Healthcare1 has generated controversy, criticism and predictions of imminent demise. (2) What often gets lost in this criticism is the extremely difficult practical decision that the Delaware Supreme Court faced. Putting aside the numerous doctrinal issues flowing from the ultimate decision, consider the Supreme Court's unenviable position: if the court allowed the merger of NCS Healthcare, Inc. ("NCS") and Genesis Health Ventures, Inc. ("Genesis") to go through, NCS's stockholders would have received approximately $1.60 per share, as valued on the date of the merger agreement. By contrast, if the Supreme Court enjoined that merger, it was a virtual certainty that NCS's stockholders wo uld have received at least $3.50 per share from the interloping bidder, Omnicare Inc. ("Omnicare"). That decision put the Delaware courts in an awkward position.

   Indeed, one can imagine that no one understood just how awkward this position was better than NCS and its board. If NCS and its board prevailed in the litigation, the directors would not have been found to have violated their fiduciary duties, which is an outcome any director ordinarily would welcome. (3) On the other hand, if the directors were found to have breached their duties and the Genesis merger was enjoined as a result, NCS's stockholders would receive more than double the money. (4) It also bears noting that two members of NCS's board were very large stockholders who stood to reap a "windfall" if the court found that they breached their fiduciary duties. (5)

   In the trial court's opinion dismissing the breach of fiduciary duty claims, Vice Chancellor Lamb framed this exact issue: "If an injunction issues, it is obvious that the stockholders will wind up with a better deal than the one they will get under the existing merger agreement. The question before this court is not, however, whether one deal is better than the other." (6) "Instead," the Vice Chancellor wrote, "the question is whether there is a reasonable likelihood that, at trial, those directors will be shown to have breached the fiduciary duties they owe to all of the corporation's stakeholders when they approved the merger transaction and the attendant voting agreements." (7) This Article submits that one way (and perhaps the only way) to understand the Delaware Supreme Court's majority opinion is to view it from the perspective that the trial court rejected--i.e., "whether one deal is better than the other."

   From this perspective, the majority's fiduciary duty analysis could be seen to have been designed to address the immediate practical problem, which it did. By reversing the Court of Chancery's dismissal of the breach of fiduciary duty claims, NCS was effectively released from its commitment to close, which opened the door to an outcome that mimicked the results of an efficient breach. Despite the criticism of the majority opinion's reasoning, along with its effects on the broader mergers and acquisitions (M&A) market, it nevertheless is undeniable that the Delaware Supreme Court has since avoided facing this particular situation for another decade. Although this perspective has some allure, especially in terms of its parsimony, it also shortchanges the majority opinion's treatment of certain fundamental issues of Delaware corporate law, such as for whom the corporation should be sold and the possibility of efficiently breaching a merger agreement. If true, it also invites the question of whether the majority might have preferred to reverse the Court of Chancery's decision that the voting agreements did not trigger the transfer restrictions in NCS's certificate of incorporation by, for example, construing the agreements against "empty voting" (8) or on another basis, instead of reversing that ruling "to the extent that decision permits the implementation of the Voting Agreement contrary to this Court's ruling on the Fiduciary Duty claims." (9)

2. FACTUAL AND PROCEDURAL BACKGROUND

   1. Genesis Offers a "Blowout" Price

      Starting in medias res, NCS and Genesis signed the merger agreement at issue on July 29, 2002.10 During the years leading up to this agreement, NCS had been a troubled company. "By early 2001, NCS was in default on approximately $350 million in debt ... After these defaults, NCS common stock traded in a range of $0.09 to $0.50 per share until the days before the announcement of the transaction." (11) The merger agreement with Genesis provided, among other things, that NCS stockholders would receive one share of Genesis common stock for every ten shares of NCS stock, which meant approximately $1.60 per share of NCS stock-what a defense attorney might call a "blowout" price. (12) The merger agreement also provided for all NCS debt. (13)

   2. The Anatomy of a Lock-Up

      The merger agreement contained a "force the vote" provision pursuant to what was then Section 251(c) of the Delaware General Corporation Law ("DGCL"), (14) which provided that the NCS board could not terminate the merger before the NCS stockholders voted. (15) Genesis and NCS also entered into voting agreements with two of NCS's four board members, Outcalt and Shaw, who were both current or former members of management. (16) Importantly, Outcalt and Shaw owned approximately 20% of the economic interest of NCS's equity, but by virtue of their ownership of a super- voting class of shares, Outcalt and Shaw collectively controlled approximately 65% of the equity holders' voting power. (17)

      With the exception of both NCS and Genesis amending the merger agreement and "(i) such amendment not being approved by the Board of Directors of [NCS] or a special committee thereof or (ii) such amendment result[ing] in [Outcalt or Shaw] receiving different treatment of consideration for his Shares than is received on a per share basis" from each other, the voting agreements irrevocably committed Outcalt and Shaw to vote in favor of the NCS and Genesis merger. (18) Outcalt and Shaw also granted Genesis an irrevocable proxy to vote their shares in favor of the merger agreement. (19) In addition, each voting agreement contained a stipulation to irreparable harm and provided for the right to seek specific performance:

      The parties hereto agree that the failure for any reason of the Stockholder to perform any of his agreements or obligations under this Agreement would cause irreparable harm or injury to the Company and Parent with respect to which money damages would not be an adequate remedy. Accordingly, the Stockholder agrees that, in seeking to enforce this Agreement against the Stockholder, each of Parent and the Company shall be entitled to specific performance and injunctive and other equitable relief in addition to any other remedy available at law, equity or otherwise. (20) C. The Termination Provision and Termination Fees

      The merger agreement contained a termination provision, which provided that Genesis could terminate the agreement under a variety of circumstances. (21) In contrast, other than as a result of a breach by Genesis, NCS's ability to terminate the agreement was essentially limited to (i) an intervening act of a government authority, including an "injunction" or (ii) "if, at the Company Stockholders Meeting (including any adjournment or postponement thereof), the Required Company Stockholder Approval [(i.e., a majority of outstanding shares eligible to vote)] shall not have been obtained." (22)

      The merger agreement also provided for the payment of contingent termination fees. (23) For example, if "for any reason" NCS failed to call or hold a meeting within four months of the merger agreement's execution, Genesis would have been entitled to a termination fee of $6,000,000 and up to $5,000,000 in expenses. (24) Similarly, if Outcalt or Shaw breached the voting agreements (or if a majority of shares eligible to vote did not approve the merger) and if NCS entered into an alternative agreement within 12 months, Genesis would be entitled to a $6,000,000 fee. (25) If any party "willfully" breached the agreement, however, the agreement could be interpreted to provide for "other remedies at law or equity" in addition to the termination fees. (26)

   4. Omnicare's "Predatory and Highly Conditional" Bids

      In the years leading up to the merger agreement between Genesis and NCS, Omnicare had made several non-binding overtures to purchase NCS's assets, but it insisted that it would do so only as part of a Section 363 bankruptcy sale. (27) As then-Vice Chancellor, now-Chancellor Strine described it, Omnicare had "previously expressed a desire to pick the company's bones in a bankruptcy deal." (28) None of those offers would have satisfied NCS's debt holders, and none of them provided for any payment to NCS's equity holders. (29) At the same time, Omnicare had been engaged in an "NCS Blitz," which "was an effort by Omnicare to target NCS customers." (30) Additionally, Omnicare began having secret discussions with an ad hoc committee of NCS's creditors. (31) Thus, from NCS's perspective, Omnicare "had historically targeted NCS's financial weakness and sought to exploit it by proposing various bankruptcy asset purchase offers and negotiating directly with NCS's creditors." (32)

   5. Genesis Didn't Like Omnicare Either

      Genesis also had a history with Omnicare. "Genesis previously lost a bidding war to Omnicare...