X

Thank you for sharing!

Your article was successfully shared with the contacts you provided.
Delaware courts place a high value on a thorough process in evaluating a board’s decision to sell a company. They place an especially high value on that process when the board faces a conflict of interest. The four men on the boards of both Intermedia Communications Inc. and its subsidiary, Digex Inc., did not follow a process calculated to satisfy a Delaware court when they agreed on Digex’s behalf to sell Intermedia to WorldCom Inc. As a result, their deal is in jeopardy, and their Intermedia stock has fallen to $7 a share from $12 in the wake of Delaware Chancellor William Chandler’s Dec. 13 decision. Intermedia shareholders approved the deal Dec. 18, leaving WorldCom to decide what it will do next. The decision is remarkable on several levels. First, it marked the end of a painful year for WorldCom: Its proposed deal with Sprint Corp. collapsed, as has its stock price, which has fallen to $17 a share on Tuesday from $50 a share in January. Second, the decision may prove to have a more significant affect on dealmaking than any Delaware ruling in several years, because it takes a step toward defining a confusing but key statute of Delaware law dealing with a key anti-takeover provisions. The deal involved some of the brightest lights in M&A, such as Bernie Ebbers, the chairman and CEO of WorldCom. On the advisory side, Robert Kindler, a managing director at Chase who had represented WorldCom as a lawyer at Cravath, Swaine & Moore, represented WorldCom on the deal. (Kindler’s former Cravath partner, Robert Townsend III, provided legal counsel to WorldCom.) Kindler, who recently left the law firm for investment banking at Chase, managed to get WorldCom when the company’s usual banker, Salomon Smith Barney’s Eduardo Mestre, found himself conflicted out. Chandler savaged Intermedia’s lawyer, Ralph Sutcliffe, a partner at New York’s Kronish Lieb Weiner & Hellman LLP, for the advice he rendered. However, Stuart Grant, a partner at Wilmington, Del.’s Grant & Eisenhofer PA, who represented the Digex shareholders, stands to make millions of dollars if the defendants are found liable for damages at a trial in the case. The plaintiffs had sued to halt WorldCom’s $3.9 billion purchase of Tampa, Fla.-based Intermedia, an integrated communications company that provides data services to business and government. WorldCom’s motive was to obtain control of Digex, a Beltsville, Md.-based Web and application hosting company that is 52 percent owned by Intermedia. Web hosting is a key part of WorldCom’s strategy to beef up its data services business as long distance revenues decline. FAITHLESS ACTS Digex’s public shareholders would receive no financial compensation in the deal, but WorldCom required that Digex’s board grant it a waiver of Delaware General Corporate Law Section 203, which otherwise might have prevented WorldCom from combining some of its assets with those of Digex. The plaintiffs claimed that the conflicted directors who — in their Digex guise — approved the waiver violated the fiduciary duties they owed Digex shareholders. Chandler agreed. In an 88-page opinion, he detailed what he termed the “faithless acts” of the directors. The chancellor did not enjoin the transaction. Instead, he left Intermedia and WorldCom to decide whether to proceed with a deal that, if it is litigated at a full trial, would have slim chances of success, and which could result in monetary damages running into the billions. Intermedia’s position was precarious because Digex’s three independent directors all voted against the WorldCom deal, but the Intermedia directors on the Digex board outnumbered them. To successfully defend against the litigation inevitable in such cases, “You’d really need a record of the board meeting,” said J. Michael Schell, a partner at Skadden, Arps, Slate, Meagher & Flom LLP in New York, which did not work on the matter. “You need a basis on which to make the case.” Intermedia couldn’t offer such a record. The Delaware statute at the heart of Chandler’s decision, Section 203, is meant to protect Delaware corporations against hostile takeover bids. WorldCom wanted to avoid the statute’s restrictions and asked the Digex board to opt out of it. This could have been prevented. “When the company went public, it could have avoided this issue by opting out of Section 203,” said David Katz, a partner at Wachtell, Lipton, Rosen & Katz, not involved in the deal. But Intermedia did not. Sutcliffe advised Intermedia and Digex on the latter’s 1999 IPO. Sutcliffe didn’t return phone calls for this story. Intermedia stock was punished severely in this spring’s Nasdaq downturn. In March, the company’s stock fluctuated around $60 a share, giving it a market capitalization of $3.3 billion. By mid-summer, its value had been shaved by two-thirds. The company hired Bear, Stearns & Co. on June 29 to consider whether it should sell itself, Digex, or both. AS THE DEAL TURNS By August, Intermedia’s Digex stake was worth $3.3 billion while the parent’s own market capitalization had dwindled to $1.2 billion. Five of the Digex board’s eight members are Intermedia board members or executives, and a sixth, Digex president and CEO Mark Shull, reports to Intermedia. The Digex board appointed independent Digex board members Jack Reich and Richard Jalkut to a special committee to consider the various offers for Intermedia and Digex. They tapped James Clark, a partner at New York’s Cahill Gordon & Reindel, and Boon Sim and Chris Tice at Credit Suisse First Boston to represent them. Three serious bidders emerged: Exodus Communications Inc. Global Crossing Ltd. and WorldCom. On Aug. 30, WorldCom called Bear Stearns banker Andrew Decker to express interest in Digex at a price of $120 or more a share. But the next day, WorldCom’s Ebbers decided to buy Intermedia instead, and leave Digex as a public company, since that was the cheapest way to gain control of Digex. He offered $39 a share for Intermedia, a 70 percent premium to its pre-announcement price of $22.63 a share. The two sides negotiated the deal through the night. WorldCom demanded that Digex’s board waive Section 203. Intermedia acceded but negotiated in exchange an agreement to amend Digex’s certificate of incorporation to require independent director approval of any deal between WorldCom and Digex. Digex independent directors Jalkut and Reich and their advisers were not involved in the negotiations that led to WorldCom’s purchase of Intermedia or the granting of the waiver and talked to Ebbers the morning of Sept. 1, only after the terms of the waiver had been set. The two men were suspicious about WorldCom’s sudden decision to buy Intermedia rather than Digex, Chandler noted in his opinion. Nonetheless, the judge ruled, the plaintiffs had little “concrete evidence to refute the defendants’ claim that the decision to buy Intermedia was solely WorldCom’s decision.” The lack of any such evidence supported Chandler’s decision to reject the plaintiff’s claim that Intermedia had usurped a corporate opportunity of Digex in selling itself rather than its subsidiary to WorldCom. Had the Section 203 waiver not been an issue, WorldCom and Intermedia would have been home free. But WorldCom insisted on the waiver. And that’s where Intermedia was most vulnerable. TROUBLED WATERS The Digex board’s decision to grant the waiver needed to be handled delicately, since five of the board’s members were also Intermedia directors. If the waiver were given, that conflict meant Digex shareholders would undoubtedly sue the two merging companies and the Intermedia directors for monetary damages. The conflict also meant that a Delaware court would demand that the transaction be entirely fair to Digex shareholders. Under that standard, Intermedia had to show that the Digex board issued the waiver for a fair price after a process of fair dealing. The defendants failed to do so. “The court found the negotiating table had only two sides, but that the law required a third and gave the independent directors reserved seats,” said Paul Rowe, a partner at Wachtell, Lipton, Rosen & Katz. Brian Gallagher, a Kronish Lieb partner who’s representing Intermedia in the litigation, said that such an expectation is unrealistic. “What that assumes is a metaphorical table,” he said. Referring to the talks between WorldCom and Intermedia on the night of Aug. 31, he added, “In the middle of the night the question came up, there were discussions, and consideration was obtained. The Digex people were informed of the discussion in the morning.” That was the problem, according to Chandler. “There was simply no meaningful participation by any of the independent Digex directors in the negotiations leading to the Section 203 waiver, the terms of the waiver, or the vote [on the waiver] itself,” Chandler wrote. At the Digex board meeting on Sept. 1, Chandler wrote, “without any debate whatsoever on the merits of the waiver or the applicability of the statute,” the Digex board approved the merger, with the four conflicted directors voting for and the three independent directors voting against. That was precisely the wrong way for Digex to approach the process, Chandler wrote: “The Section 203 waiver negotiation is exactly where the special committee should have been most relevant in the whole process. But this is precisely the point at which the special committee is missing in action — not through any failure of its own, but as a result of the control by the conflicted directors over the process.” HE SAID, SHE SAID Gallagher disagrees with that version. “At the time the independent directors spoke with Ebbers on Sept. 1, they knew about the Section 203 waiver. They spoke with Ebbers. They could have asked him for anything they wanted.” Instead of focusing on the waiver in either their conversation with Ebbers or the Digex board meeting on Sept. 1, Gallagher said, Jalkut and Reich tried to get WorldCom to buy Digex rather than Intermedia. “The independent directors never asked for anything for the Section 203 waiver,” Gallagher said. “Presumably, if it had been important to them, they would have raised it.” Gallagher said that there was discussion of the waiver in the context of the benefits Digex would obtain in the deal. “It is absolutely the case that there was no discussion of the 203 waiver between the making of the motion and the vote, but that is not to say there was no discussion at the meeting,” he said. Intermedia would have been aided in the litigation by a record of debate on the Section 203 waiver at the Digex board meeting, but there was none. “Particularly if the parent is going to make the judgment over the objection of the independent directors of the subsidiary, they need to have a pretty persuasive rationale as to why that’s good for the minority shareholders,” Schell said. “This is clearly a case where if the record had been done well, this would not have been any issue at all,” said one person familiar with the deal. “I would have taken a lot more time with the independent directors to explain the rationale for the deal.” Gallagher claimed that such criticism is unwarranted. “I don’t believe we could have created a better record,” he said. “It would have been different if someone had asked about the waiver. Jalkut and Reich were concerned about trying to move the deal back to Digex.” However good the process could have been, the Digex board’s vote on the waiver was still along party lines. And the vote motivated Chandler’s decision, said Lawrence Hamermesh, a professor at Widener University School of Law in Wilmington. The defendants argued that Digex benefited in two ways by granting the waiver. First, they claimed, the company was far better off under WorldCom than under the financially shaky Intermedia, and those were the only two options the Digex board had to weigh. Second, the Digex shareholders benefited from the amendment to Digex’s certificate of incorporation whereby Digex’s independent directors would have to approve any future material transaction between WorldCom and Digex. Gallagher said that those advantages were thoroughly explained to the Digex directors. FAIR COMPENSATION The advantages of the amendment to Digex weren’t trivial. It was unclear at the time of the deal whether Digex falls under Section 203, which does not apply to shareholders with more than 85 percent of a company’s “voting stock.” Intermedia controls 94 percent of the vote attached to Digex’s outstanding stock. That exempts Digex from the statute, the defendants’ lawyers argued. Chandler explored that issue but ultimately sidestepped it. Instead, he emphasized that that the mere fact that WorldCom had asked for the waiver was proof of its value — and proof that it “granted some degree of bargaining leverage to Digex.” Intermedia argued at trial that the Digex board had to make a decision before 5 p.m. Sept. 1. That was when Global Crossing’s offer for Intermedia and Digex was set to expire. Chandler disagreed. “The only entity that really stood to lose should the Digex board decide to further analyze Section 203 and vote to at least delay the grant of the waiver by a day or two was Intermedia, not Digex. This leverage was simply not used — could not be used — because of the decision of the interested directors.” Intermedia could have averted the problem had it simply given Digex shareholders fair compensation. “Had a different company, such as General Electric Corp., been the parent, it would have insisted that all shareholders of Digex be treated equally,” said an M&A lawyer familiar with the deal. As for WorldCom, it’s unclear what the company or its lawyer, Townsend, did or could have done to avoid the situation that Intermedia largely created. Hamermesh said the bidder’s options were limited. “WorldCom should have said, this is what we’re prepared to pay,” he said. “If you have this Section 203 problem, you’re going to have to work it out between yourselves.” Hamermesh said he did not know if WorldCom’s advisors had made such a statement. “The fact that they raised the Section 203 waiver shows they were cognizant of that question. WorldCom couldn’t have done more that that.” Townsend did not return calls for comment. One M&A professional said WorldCom was at the mercy of the process that occurred on the opposing side. “In the history of dealmaking, no one has ever figured out how you can create the record for the other side,” the person said. “Part of every deal is the risk that the other side has not created a good record.” WorldCom is left with unappealing options. It can go ahead with the deal as signed and risk the outcome of a full trial in the litigation. It could declare that the failure to gain the waiver means that the merger agreement is void and risk the results of a lawsuit brought by Intermedia’s shareholders. It could go ahead with the deal and either abide by Section 203 — which would mean leaving Digex alone for three years — or argue that as the owner of more than 85 percent of Digex’s voting stock it is not bound by the statute. It could also do what might have avoided the problem to begin with: Let Digex shareholders in on the deal. Perhaps with that result in mind, Chandler was vague as to what the damages resulting from a full trial might be, but he left no doubt about his displeasure with the actions of the Intermedia directors. “Now, intentionally on Chandler’s part, it’s in never-never land,” Hamermesh said. “It’s up to the parties to buy off the minority Digex stockholders.” That’s certainly what Grant, the plaintiffs’ lawyer, has in mind. “Clearly there’s a business resolution that can take care of this,” he said. “I’m confident that at a fair price, the Digex shareholders would be willing to sell their shares, which would eliminate any problem that WorldCom or Intermedia had.” Copyright (c)2000 TDD, LLC. All rights reserved.

This content has been archived. It is available exclusively through our partner LexisNexis®.

To view this content, please continue to Lexis Advance®.

Not a Lexis Advance® Subscriber? Subscribe Now

Why am I seeing this?

LexisNexis® is now the exclusive third party online distributor of the broad collection of current and archived versions of ALM's legal news publications. LexisNexis® customers will be able to access and use ALM's content by subscribing to the LexisNexis® services via Lexis Advance®. This includes content from the National Law Journal®, The American Lawyer®, Law Technology News®, The New York Law Journal® and Corporate Counsel®, as well as ALM's other newspapers, directories, legal treatises, published and unpublished court opinions, and other sources of legal information.

ALM's content plays a significant role in your work and research, and now through this alliance LexisNexis® will bring you access to an even more comprehensive collection of legal content.

For questions call 1-877-256-2472 or contact us at [email protected]

 
 

ALM Legal Publication Newsletters

Sign Up Today and Never Miss Another Story.

As part of your digital membership, you can sign up for an unlimited number of a wide range of complimentary newsletters. Visit your My Account page to make your selections. Get the timely legal news and critical analysis you cannot afford to miss. Tailored just for you. In your inbox. Every day.

Copyright © 2020 ALM Media Properties, LLC. All Rights Reserved.