Flannery v. Genomic Health: Mixed consideration deal with 58% stock evades Revlon enhanced scrutiny

Quarterly Corporate / M&A Decisions update series

In Flannery v. Genomic Health, Inc., et al. (C.A. No. 2020-0492-JRS (Del. Ch. Aug. 16, 2021)), the Delaware Chancery Court made three key holdings regarding a merger involving mixed consideration of 58 percent stock and 42 percent cash. First, entire fairness review was not triggered because the Baker Brothers Entities (BBEs), were neither controlling stockholders nor conflicted. Second, the merger did not trigger Revlon duties because the company “stay[ed] in a large, fluid, changeable and changing public market.” Third, Exact was not an interested stockholder subject to 8 Del. C. § 203 because there was no voting agreement in place between the BBEs and Exact prior to the Board’s vote to approve the merger. This case explores the application of Revlon to mixed consideration deals and illustrates the detailed analysis Delaware courts apply to questions regarding independence and control.

In November 2019, Exact, a molecular diagnostics company, acquired Genomic, a diagnostic test company, for a mix of cash and stock valued at US$2.8 billion. The merger plan, announced in July, was approved by 84.56 percent of Genomic’s outstanding shares, including, pursuant to a voting agreement, four entities controlled by Felix and Julian Baker (the BBEs), which held approximately 25 percent of the outstanding shares.

Prior to the merger, in 2017, Genomic had conducted a robust market check for strategic combinations, contacting 27 potential suitors and signing confidentiality agreements with 16, although no suitor offered a definitive indication of interest. Then, in 2019, Exact contacted Genomic’s CEO with an “out of the blue” combination proposal, which led to six weeks of robust negotiations over the deal price and potential terms. During the negotiations, both Genomic’s and Exact’s stocks were trading at all-time highs, so the discussions included bartering over the mix of consideration and whether to include a collar on the stock portion of the deal. Exact was initially against the collar, but conceded on that point in order to quickly finalize the deal, which was approved by Genomic’s board on July 28.

During negotiations, Exact also reached out to the BBEs to demand a voting agreement and to discuss agreeable terms. The BBEs, on July 26, indicated that they would not agree to trading restrictions while the merger was pending but that they would still agree to vote in favor of the proposed transaction. Exact and the BBEs entered a voting agreement two days later, on July 28, after the Genomic Board approved the merger agreement.

For the plaintiff’s breach of fiduciary duty claims, the court found that the defendants’ arguments that the plaintiff’s claims were “after-the-fact quibbles with the exercise of business judgment by corporate fiduciaries that should not be subjected to judicial second guessing” carried the day. The court refused to apply entire fairness review based on the allegation that the BBEs controlled Genomic because those entities owned only 25 percent of the outstanding shares, held only two of eight board seats, and “d[id] not meddle in the day-to-day operations of the Company.” The fact that the BBEs’ Felix and Julian Baker were friends and business partners with the majority of the board and had investments in companies where the board members worked or sat on other boards was not enough to rebut the presumed independence of those board members. Even if the BBEs were controllers, there was no indication that they had a conflict of interest in the merger because there was nothing resembling a fire sale, substantial liquidity crisis, or other divergent interest.

Enhanced scrutiny under Revlon also was not justified because there were no allegations that the merger resulted in a change of control. The merger consideration was 58 percent stock and 42 percent cash and there was no allegation that Exact had a controlling shareholder. Under those facts, “it cannot be said that Genomic abandoned its long-term strategy,” and its shareholders were not prevented from obtaining a control premium for their shares in a future transaction. Even if Revlon did apply, the exculpatory clause in Genomic’s charter meant that the plaintiff had to allege bad faith or disloyal conduct, which she failed to do. The transaction was arms-length, the process leading to the merger was robust, it was preceded by an extensive market check in 2017, and the ultimate agreement to a 5 percent premium over Genomic’s then-current trading price was not beyond the bounds of reasonable judgment.

In reviewing the plaintiff’s claim under 8 Del. C. § 203, which prohibits an owner of 15 percent or more of a corporation’s voting stock from engaging in a business combination with the corporation within three years after acquiring such ownership, the court rejected the argument that Exact became an “interested shareholder” before the merger agreement was signed by having “an agreement, arrangement or understanding for the purpose of acquiring” the BBEs’ 25 percent stake in Genomic on July 26. The court said that there must be a meeting of the minds to form an agreement, and that there was not even an informal meeting of the minds on July 26 because the BBEs’ communication rejected the proposed voting agreement and conditioned their intent to vote their shares in favor of the transaction on a voting agreement that did not contain trading restrictions. The later voting agreement, executed after the merger agreement, did not change the analysis, because that agreement was evidence of only “the commonplace scenario where a large stockholder agrees to vote its shares in favor of a transaction approved and authorized by the board of the target company.” The court also noted that Genomic’s board implicitly approved the voting agreement by negotiating with the understanding that Exact would require a voting agreement. Overall, the court said, the conduct at issue was nothing like the kind of abusive takeover practices that § 203 was enacted to prevent.

 

 

Authored by Ryan M. Philp, Allison M. Wuertz, and Maura Allen.

Contacts
Ryan Philp
Partner
New York
David Michaeli
Counsel
New York
Allison Wuertz
Senior Associate
New York
Jon Talotta
Global Co-Lead
Northern Virginia
Michael Hefter
Partner
New York
William Regan
Partner
New York

 

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