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In 2007, chancellor William B. Chandler III has had one of Delaware’s hottest dockets. In addition to two significant stock-options backdating cases, the chancellor issued a striking decision on judicial oversight of merger transactions. In Louisiana Municipal Police Employees’ Retirement System v. Crawford C.A., nos. 2635-N, 2663-N (New Castle Co., Del., Ch. Feb. 23, 2007) (better known as Caremark), the Delaware Court of Chancery was asked to enjoin a proposed merger of Caremark Rx Inc. and CVS Corp. While the outcome may seem benign � the Caremark shareholder vote was enjoined for at least 20 days after additional disclosures by the defendants � the case has potentially broad practical and doctrinal implications. Delaware jurisprudence has, since 1990, drawn a distinction between mergers of equals and mergers involving a change of control or breakup of a corporate entity. In Revlon v. MacAndrews & Forbes Holdings Inc., 506 A.2d 173 (Del. 1986), the Delaware Supreme Court held that enhanced judicial scrutiny applies when a corporation undertakes a transaction that will cause a change in corporate control or a breakup of the corporate entity. In Paramount Communications Inc. v. Time Inc., 571 A.2d 1140 (Del. 1989), however, the court exempted a certain category of business combinations from Revlon enhanced scrutiny: mergers of equals not involving a change of control. Those combinations, said the court, should be reviewed under the more deferential business judgment standard. Caremark appears to blur that critical � and often-criticized � distinction. It signals that Delaware courts will no longer uncritically defer to boards with respect to so-called mergers of equals, particularly when the transaction bears many badges of an outright acquisition and bestows substantial benefits to officers and directors. This may not be “new” in the sense that Delaware courts have not hesitated to condemn unfair dealing or terms in the past, but it does indicate a departure from the high business judgment rule deference accorded like transactions under Time Warner. At a minimum, Caremark reminds us that cases are decided on facts, and that bad facts can convert standard deal terms into offensive ones. The background to the CVS/Caremark deal The boards of Caremark and CVS entered into a merger agreement on Nov. 1, 2006. Under the agreement, Caremark shareholders would receive 1.67 shares of CVS stock for every Caremark share, resulting in aggregate ownership of approximately 45% of the combined company. Enter the would-be spoiler. Express Scripts Inc., another pharmacy benefits manager and Caremark competitor, made an unsolicited offer for Caremark. The Express Scripts offer valued Caremark at around $26 billion, more than $3 billion above CVS’ offer. It was structured as a cash-and-stock transaction, offering $29.25 in cash and 0.426 shares of Express Scripts stock for every share of Caremark stock. The Caremark board rejected the Express Scripts offer as not constituting a “Superior Proposal,” as defined in the CVS/Caremark merger agreement. But the Express Scripts offer did lead to a material change in the CVS/Caremark deal. CVS proposed that Caremark declare a special $2 dividend before the effective date of the merger, which would be paid only if the CVS/Caremark merger went through. The Caremark board approved the revised CVS proposal. Meanwhile, Express Scripts began an exchange offer for all outstanding Caremark stock, which the Caremark board again rejected as not constituting a “Superior Proposal.” In this hostile context, CVS shortly thereafter “allowed” an increase in the “special dividend” to $6 per share. The consummation of the CVS/Caremark merger was challenged by two groups of plaintiffs, one led by shareholders and the other by Express Scripts. Both sought a preliminary injunction to enjoin the Caremark shareholder vote on the CVS/Caremark merger, alleging that the Caremark directors breached their fiduciary duties by agreeing to the merger agreement, failing to investigate and consider other merger opportunities and failing to disclose material information. (CVS was alleged to have aided and abetted these breaches.) The chancellor found that the plaintiffs had not met the standard for a full-blown preliminary injunction. Instead, he ordered a delay of the vote based on inadequate disclosure of bankers’ fee structures and appraisal rights based on the “special dividend.” The unusual nature of the remedy, as well as the chancellor’s comments on director action, make Caremark essential reading for practitioners and observers alike. Several provisions of the CVS/Caremark agreement led the chancellor to question whether the board was focused more on its own interests than those of Caremark’s public shareholders. For one, the consummation of the merger would trigger change-of-control provisions for Caremark executives and outside directors, who would then benefit from lucrative options accelerations. But the Caremark board members nevertheless maintained that the merger was not a change of control for the purposes of judicial review in a Delaware court. The chancellor, while not engaging in a Revlon analysis, clearly articulated his displeasure at the directors’ inconsistency. The merger agreement also created a more subtle benefit for Caremark directors: indemnification for liabilities in pending options-backdating class actions. As the chancellor noted, indemnification under the agreement is a contractual obligation and is arguably not subject to Delaware statutory law, which sets limits on indemnification by a corporation of its own directors. Del. Code tit. 8, �� 102(b)(7), 145. All of which would be of interest to the Caremark directors who are named defendants in a Tennessee action alleging breach of fiduciary duty relating to improperly backdated stock options. In re Caremark Rx. Inc. Derivative Litig., No. 3:06-cv-00535 (M.D. Tenn.). The CVS/Caremark deal contained a “full complement” of deal-protection devices: a force-the-vote provision for both boards; a “no-shop” provision for both boards; and a last-look provision for the acquiring party in the event that a competing “Superior Proposal” is entertained. Last � but certainly not, for the chancellor, least � was the $675 million reciprocal termination fee. In a lengthy footnote, he strongly cautioned against a bright-line approach to acceptable and unacceptable deal protections, instead underlining the “fact intensive” nature of the inquiry. Significantly, he emphasized that deal-protection measures are not examined in isolation; in assessing whether they are unreasonable, preclusive or coercive, they must be looked at as a “set.” The plaintiffs submitted that the director defendants fell short of their duty of disclosure on eight separate grounds. The court agreed with only one: misleading disclosure on fee agreements between Caremark and its financial advisers. The court found that additional disclosure was required to clarify that “the fee arrangements for Caremark’s bankers were structured, from the start, to provide that the bankers would be entitled to receive the lion’s share of the bankers’ fees only if Caremark entered into an initial agreement with CVS.” The lesson here is clear: Fee agreements must be drafted with absolute clarity, and disclosed with utmost care. The court also found, in no uncertain terms, that the $6 “special dividend” constituted merger consideration, triggering appraisal rights. Key to this finding was the court’s judgment that the “dividend” had no legal significance independent of the merger. The facts indicated that CVS, not Caremark, controlled the nature and quantum of the payment. In light of these facts, the chancellor found the dividend to be “simply cash consideration dressed up in a none-too-convincing disguise.” The remedy? Revised disclosure to reflect the availability of appraisal and a delay of the shareholder meeting for at least 20 days, the minimum statutory notice period when appraisal rights attach under Del. Code tit. 8, � 262(d)(1). Bad facts invariably trump good law The court was clearly troubled by certain features of the deal and the process leading to it. Foremost among these were the indicia that it was more akin to an outright acquisition of Caremark by CVS than a true merger of equals. The court noted the “indifference” of the Caremark board in negotiations, as well as its “supine acceptance” of additional consideration from CVS. Time Warner was not mentioned, but its specter was certainly present. Caremark appears to be a raised hammer for the final nail in the coffin of Time Warner. The taxonomy of deals is more nuanced than permitted by the Time Warner approach; Caremark clearly signals that no category of deal is due complete deference. Instead, the Delaware Chancery Court will apply the best of what equity has to offer: a remedy designed to suit the facts of the case. In Caremark, that meant calling the bluff of the “special dividend,” creating an essentially substantive remedy (cash compensation) from a statutory right (appraisal) and granting a delay without a full-blown injunction. Having roundly rebuked the Caremark and CVS boards, in the end the chancellor left the fate of Caremark not to its interested directors, but to those the directors are obligated to serve: the shareholders. Alan S. Goudiss is a partner, and E. Alexandra Dosman is an associate, in the litigation group of New York-based Shearman & Sterling. Their practices focus on M&A-related and securities litigation. The firm represented Express Scripts’ financial advisors in the proposed transaction, but was not directly involved in the case itself.

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