In the latest decision in the developing area of the standard of review for stockholder-approved transactions, the Delaware Court of Chancery dismissed a Revlon complaint brought against a target board and its financial advisor, holding that the rule described in the Delaware Supreme Court's Corwin applies equally in the context of a front-end tender offer followed by a back-end merger, even though no stockholder vote is actually held (In re Volcano Corp. S'holder Litig., (Del. Ch. June 30, 2016)). Corwin had established that the standard of review shifts from enhanced scrutiny to the business judgment rule when a majority of the disinterested stockholders approve a single-step merger in an informed and uncoerced vote. Barring overrule on appeal, the decision settles the open question of whether Corwin applies to two-step mergers in which the stockholders tender their shares without voting on the transaction, holding that it does.

In dismissing the claim against the financial advisor for aiding and abetting a breach by the board of directors, the decision also illustrates the high burden that a plaintiff carries to demonstrate that a financial advisor's bad-faith acts were committed with the requisite scienter to support a claim of liability for aiding and abetting.

The case arises from a merger agreement entered into on December 16, 2014, between the target company Volcano Corporation and its acquiror Philips Holding USA Inc., a domestic subsidiary of Koninklijke Philips N.V., a Dutch technology company. For a summary of the merger agreement, see What's Market, Koninklijke Philips N.V. (Royal Philips)/Volcano Corporation Merger Agreement Summary. The transaction was structured as a front-end tender offer pursuant to Section 251(h) of the DGCL. Section 251(h) was adopted in 2013 to allow front-end tender offers to proceed to the closing of the two-step merger if a majority of the target company's shares are tendered into the offer, thus obviating the need for top-up option mechanics.

Goldman, Sachs & Co. served as the Volcano board's financial advisor for the sale. Volcano and Goldman Sachs had an existing relationship stemming from a convertible note offering that closed in 2012. In that offering, Volcano issued $460 million of convertible senior notes due in 2017 pursuant to an underwriting agreement with Goldman and J.P. Morgan Securities LLC. To protect against any eventual dilution resulting from conversion of the notes, Volcano entered into two hedging transactions with the underwriters that involved Volcano's purchase of call options from the underwriters and sale of warrants to them. Goldman Sachs sold 65% of the options and bought 65% of the warrants. By their terms, the options and warrants would require redemption on consummation of a change of control of Volcano.

In 2014, Volcano began discussions with potential merger partners and retained Goldman Sachs to help perform a market check. Goldman Sachs advised the board on the effect that a sale would have on the options and warrants. The board concluded that the hedging transaction did not render Goldman Sachs incapable of advising the company on a sale and engaged it for a $17 million fee, contingent on a sale. The company eventually reached an agreement with Philips on a merger structured as a front-end tender offer. Goldman Sachs provided a fairness opinion to the board; the board did not seek a second fairness opinion from another advisor. Regarding the potential impact of the hedging transaction on Goldman Sachs's advice, the company disclosed in supplemental disclosures to its Schedule 14D-9 recommendation statement that all else being equal, the value of the warrants decrease over time until their expiration. This signaled that Volcano's redemption payment to Goldman Sachs would decrease as more time went by.

The tender offer closed on February 17, 2015, with 89.1% of Volcano's outstanding shares being tendered into the offer. As a result of the required redemption of the options and warrants, Volcano owed Goldman Sachs $24.6 million.

The plaintiff stockholders sued, alleging that the board had breached its duties of care and loyalty under the traditional Revlon standard of enhanced scrutiny applicable to change-of-control transactions. The plaintiffs also alleged that Goldman Sachs aided and abetted the board's breaches. Central to the plaintiffs' complaint was a contention that Goldman Sachs was "highly conflicted" as a result of the payment it stood to earn on a sale of the company (which would fall "exponentially" the longer a sale was delayed) and that this conflict had not been adequately disclosed to the stockholders.

The defendant directors moved to dismiss, arguing that:

The court granted the defendants' motion to dismiss, holding that the Corwin rule for shifting the standard of review from enhanced scrutiny to business judgment when a merger is approved in an informed vote of the disinterested stockholders applies equally when the disinterested, informed, uncoerced stockholders tender their shares into an offer. With the Corwin rule available, the court held that the fact that Goldman Sachs's redemption payment would shrink with time had been adequately disclosed and that the stockholders' acceptance of the tender offer had therefore been informed. As such, the board was entitled to the presumptions of the business judgment rule, which in turn meant that the transaction could only be challenged on grounds of waste (Singh v. Attenborough, (Del. May 6, 2016) (ORDER); see Legal Update, Delaware Supreme Court Affirms Dismissal in "Zale," but Changes Standard of Review of Board Conduct after Stockholder Vote). The court held that the transaction did not constitute waste and that Goldman Sachs therefore could not be found to have aided and abetted a breach of fiduciary duty when there was no underlying breach by the board.

The decision in Volcano confirms the intuitive notion that the structure of a transaction should be irrelevant to the standard of review applied to that transaction and, therefore, the business judgment rule should be equally available for tender offers conducted under Section 251(h) of the DGCL. Unless and until the decision is overturned by the Delaware Supreme Court, practitioners can safely assume that the business judgment rule is available in such deals. Therefore, the target company should be fulsome in its disclosures to the stockholders so that the transaction will survive a challenge that the stockholders were inadequately informed.

The decision raises anew a similar open question under Delaware law, which is whether the rule in the Delaware Supreme Court's decision in Kahn v. M & F Worldwide to allow restoration of the business judgment rule in controlling-stockholder transactions should similarly be extended to tender offer transactions. The debate on this issue is recounted in Practice Note, Fiduciary Duties in M&A Transactions: Controlling-Stockholder Transaction Structured as a Front-End Tender Offer. The policy discussion in Volcano would seemingly apply equally in the context of entire-fairness transactions.

Volcano also gives new comfort that the bar for finding financial advisors liable for aiding and abetting is high and not easily met, as long as any potential conflicts are disclosed to the stockholders. In Volcano, several facts could have presented difficulty for Goldman Sachs in the pre-Corwin, pre-RBC Capital Markets era. Consider that:

Though it might still be considered best practice to obtain a second fairness opinion when there is reason to suspect that the primary financial advisor is conflicted, there is little reason to insist on it in circumstances similar to this case. In light of RBC, Attenborough, and now Volcano, only a particularly egregious conflict that is not disclosed to the stockholders can establish a basis for an aiding and abetting claim against a financial advisor.