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EXHIBIT 99.1
IN THE COURT OF CHANCERY OF THE STATE OF DELAWARE
IN AND FOR NEW CASTLE COUNTY
ROBERT L. KOHLS and LOUISE A. )
KOHLS, )
Plaintiffs, )
v. ) Civil Action No. 17762-NC
)
ANGUS M. DUTHIE, MARK D. )
LERDAL, GERALD R. ALDERSON, )
CHARLES CHRISTENSON, )
GERALD R. MORGAN, JR., )
MICHAEL D. WINN, and )
KENETECH CORPORATION, )
)
Defendants. )
MEMORANDUM OPINION
Submitted: December 5, 2000
Decided: December 11, 2000
Edward M. McNally, Esquire (argued) James W. Semple, Esquire, and Stephanie M.
Tarabicos, Esquire, MORRIS, JAMES, HITCHENS & WILLIAMS LLP, Wilmington,
Delaware, Attorneys for Plaintiffs.
Charles F. Richards, Jr., Esquire (argued), Raymond J. DiCamillo, Esquire and J.
Travis Laster, Esquire, RICHARDS, LAYTON & FINGER, Wilmington, Delaware,
Attorneys for Defendants.
Todd C. Schiltz, Esquire, WOLF, BLOCK, SCHORR & SOLIS-COHEN, LLP, Wilmington,
Delaware, Attorneys for Nominal Defendant.
LAMB, Vice Chancellor
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I. INTRODUCTION
This is an application for a preliminary injunction against a management
buy-out transaction being sponsored by a third-party venture capital fund. The
corporation's CEO, who owns 35 percent of the common stock, has agreed to
participate in the buyout by contributing his shares to the purchaser in
exchange for a portion of its equity. The transaction was negotiated by a
Special Committee of outside directors that was advised by independent legal and
financial experts, and is subject to a condition that 85 percent of the
corporation's shares owned by persons other than the participating CEO must be
tendered in the first-step tender offer. Ordinarily, in the absence of some
other circumstance, my review of the proposed transaction would be under the
deferential business judgment standard.
Plaintiffs argue that the disclosures made in connection with the proposed
transaction are deficient and that elements of the valuation work performed on
behalf of the Special Committee are materially in error. Plaintiffs' main line
of attack, however, stems from the fact that, if the transaction succeeds, they
will lose standing to continue pursuing a derivative claim seeking the
cancelation of the very shares of stock the CEO is using to finance his
participation in the transaction. Moreover, they suspect and urge me to accept
as true that the buyout transaction was conceived in reaction to my recent
decision denying a motion to dismiss the derivative claim. Finally, they argue
that because one member of the two-person Special Committee is also a defendant
in the derivative litigation, that committee's work was tainted by his self-
interest in seeing an end to the litigation.
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For these reasons, they urge me to review the transaction under the more
rigorous entire fairness standard.
The derivative litigation and the effect of the proposed transaction on it
do not materially influence my decision on this motion. Those considerations
are, I am led to conclude, essentially red herrings. Admittedly, if the
derivative action were to succeed, it would substantially and negatively affect
the fortunes of the CEO and would also substantially and positively affect the
other stockholders. Nevertheless, the record on this motion establishes two
things that lead me to discount its significance. First, the evidence now in the
record strongly suggests that the likelihood of success on the merits of the
derivative claim is remote. Second, even if that litigation were to succeed, it
would be unlikely to result in adverse consequences to anyone other than the
CEO. Thus, I am unable to agree with plaintiffs' argument that the work of the
Special Committee is tainted with self-interest merely because one of its
members is named as a defendant on the derivative claim.
Rather, I am persuaded from my review of the record and consideration of
the issues raised by the parties that the transaction is one which the
stockholders of the corporation should be able to accept or not, as they choose.
The price offered is at a substantial premium to the pre-existing market. And no
other proposal has emerged notwithstanding both the corporation's substantial
effort to secure a suitable transaction and the accommodating terms of the
merger agreement that would permit the board of directors to respond to any
competing bid.
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II. FACTUAL BACKGROUND
For a more detailed understanding of certain aspects of the background of
the present controversy, the reader is directed to the memorandum opinion
denying defendants' motion to dismiss the derivative claim in this action,/1/ to
then-Vice Chancellor Steele's opinions in the Quadrangle cases,/2/ and to the
memorandum opinion dismissing the complaint in Kohls v. Kenetech,/3/ a related
class-action involving preferred equity rights in Kenetech.
A. Kenetech's Liquidity Crisis
Kenetech Corporation ("Kenetech") is a small publicly traded company,
operating largely in the electric utility market. All of the individual
defendants in this action are current or former Kenetech directors. Defendants
Alderson, Duthie and Christenson were directors in 1997, when certain events
relevant to this matter occurred. Of these three, only Christenson remains on
the board. Defendants Winn and Morgan currently serve.
In the mid-1990s, Kenetech faced a serious liquidity crisis when its
largest wholly-owned subsidiary, Kenetech Windpower, Inc. ("KWI"), was forced to
file
____________________
/1/ Kohls v. Duthie, Del. Ch., C.A. No. 17762, Lamb, V.C. (July 26, 2000).
/2/ Quadrangle Offshore (Cayman) LLC v. Kenetech Corp., Del. Ch., C.A. No.
16362, Steele, V.C. (Oct. 21, 1998) (denying defendants' motion to dismiss) and
Del. Ch., C.A. No. 16362, Steele, V.C. (Oct. 13, 1999), aff'd, Del. Supr., 751
A.2d 878 (2000) (ORDER).
/3/ Del. Ch., C.A. No. 17763, Lamb, V.C. (July 26, 2000).
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for bankruptcy protection. In response, Kenetech began selling assets and
reducing its staff size. In 1996, Kenetech defaulted on $99 million of its
senior secured notes ("Senior Notes")/4/ and on the payment of dividends on its
preferred stock.
By 1997, Kenetech's most significant remaining asset was a 50 percent
interest in a Puerto Rican utility project known as EcoElectrica, L.P.
("EcoElectrica"), the sale of which Kenetech consummated after securing
construction financing. Despite management's expectations that Kenetech would
have to file for bankruptcy even with the sale of the EcoElectrica interest,
Kenetech sold its interest for $247 million (cash and assumption of debt),
satisfying and discharging the Senior Notes.
Using Net Operating Losses ("NOLs") stemming from the bankruptcy of KWI,
Kenetech was able to offset the taxable gains generated by the sale of the
EcoElectrica interest, essentially allowing Kenetech to take the gain "tax
free." To protect against the risk that the IRS disagreed with its tax filing
position, Kenetech established a $33.9 million balance sheet reserve
("contingent tax liability reserve") on the advice of Arthur Andersen and KPMG
tax professionals. In a later period, this reserve was reduced to $10.3 million.
________________________
/4/ In December 1992, Kenetech had issued $100 million of 12.75 percent
Senior Notes, scheduled to mature in 2002 and with interest due biannually.
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While Kenetech had weathered its serious liquidity crisis, it did so only
by selling most of its operating assets and firing most of its employees.
Because of its small equity capitalization and lack of access to financial
markets, Kenetech publicly announced in March 1999 its intention to explore
strategic alternatives, including going private or seeking a merger or
acquisition partners. Kenetech then contacted a large number of consultants and
investment bankers to develop a plan for its future./5/ Furthermore, the board
formally determined at its October 15, 1999 meeting that it would "engage an
investment banking firm to explore all possible strategic alternatives," and at
least three presentations were made at different board meetings prior to April
20, 2000/6/ regarding potential strategic alternatives.
B. The Derivative Litigation
In October 1997, Mark Lerdal, president and chief executive officer of
Kenetech, was approached by Mark Laskow of The Hillman Company ("Hillman"), the
owner of nearly a third of Kenetech's common shares. Laskow told Lerdal that
Hillman planned to sell its shares by year-end in order to take a tax loss in
1997. Laskow asked Lerdal if he knew of anyone who might be willing to
__________________________
/5/ These included Arthur Andersen, PriceWaterhouseCoopers, Salomon Smith
Barney, Legg Mason, Hagler Bailey, Texas Pacific Group, Blum Capital, Granite
Holdings, ING Bank, CIBC, Apollo Advisors, Thomas Weisel, Entegrity Partners,
Bank America Securities, Credit Suisse First Boston, Rockport Partners,
Robertson Stephens, the Gordian Group, and ILC.
/6/ Defendants' motion to dismiss the complaint in the derivative action
in Kohls v. Duthie was argued before me on this date, and I indicated from the
bench that plaintiffs' complaint would sustain defendants' motion to dismiss.
Logically, this is the cut-off for when plaintiffs claim that Kenetech's board
developed an intent to pursue a merger for the sole purpose of depriving the
Kohlses standing to pursue this derivative action.
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pay a meaningful amount for the stock. Laskow also told Lerdal that Hillman
would, as a last resort, sell its shares at a nominal price and asked if Lerdal
might be interested in purchasing them. Lerdal said he would be. The record also
reflects that, either in this initial conversation or at a later time, Lerdal
and Laskow discussed whether Kenetech could buy the shares and, apparently,
agreed that it could not due to its several financial defaults and its apparent
capital impairment. Moreover, Laskow's deposition testimony is that Hillman did
not offer the shares to Kenetech and would not have sold them to it because
Hillman's primary objective was to make a sale without risk of its later being
undone. As Laskow testified at pages 49-50 of his deposition:
I never offered to sell Hillman's shares . . . to Kenetech. Because
Kenetech was prohibited from purchasing its common stock, any purchase . .
. would be subject to challenge. Any successful challenge may have resulted
in rescission of the transaction. In addition, in the event that Kenetech
filed for bankruptcy, it was possible that the transaction could be set
aside . . . I was unwilling to subject Hillman to the risk that a sale of
the shares . . . would be rescinded or otherwise set aside.
Defendant Angus Duthie also learned of Hillman's plans to sell its shares from a
different Hillman representative. Duthie forwarded this information to Lerdal.
The record now shows that, after receiving Laskow's call in October 1997,
Lerdal discussed the potential share purchase with various people, including
Kenetech's general counsel, his personal counsel, Kenetech's outside corporate
counsel, Ronald Fein, Esquire, and a partner at Arthur Andersen who provides tax
advice to Kenetech. Fein's deposition testimony supports a conclusion that he
and
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Lerdal thoroughly explored the legal ramifications of Laskow's call, the
possibility that Kenetech could purchase the Hillman shares, and the fiduciary
duty implications of Laskow buying the shares himself. These conversations
appear to have reinforced the conclusion that a repurchase by Kenetech, even if
Hillman would agree to consider such a transaction, would violate both the note
indenture for the Senior Notes and the certificate of designations of the
preferred stock. Additionally, Kenetech was precluded from repurchasing any of
its own capital stock by Section 160 of the Delaware General Corporation Law
that prohibits the repurchase of a corporation's own shares "when the capital of
the corporation is impaired or when such purchase or redemption would cause
impairment of the capital of the corporation." On an historic book value basis,
Kenetech's capital was substantially impaired.
Laskow called Lerdal again around December 15, 1997 and told him that
Hillman had not found a buyer for its shares. He offered to sell Lerdal the
stock for either $1,000 or $5,000. Naturally, Lerdal chose to pay $ 1,000 for
the 12.8 million shares, and the transaction closed December 29, 1997.
This transaction forms the core basis of plaintiffs' claim that Lerdal
usurped a corporate opportunity. The complaint alleges that the timing of this
purchase by Lerdal renders the transaction suspect. Allegedly, Lerdal knew that
construction financing for the EcoElectrica, project was close at hand and that,
once such financing became available, Kenetech "would be able to sell its
interest in EcoElectrica, pay off all of its debts, and make a handsome profit."
It is also
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alleged that the other apparent obstacles to Kenetech repurchasing its own
shares could have been overcome.
The derivative action was filed on February 3, 2000 and seeks the
cancelation of Lerdal's shares. The complaint alleges that, at the time of
filing, the shares acquired by Lerdal for $1,000 were worth over $8.2 million.
In the context of the current transaction, in which $1.04 is being offered for
each share of Kenetech common stock, Lerdal's shares are worth even more.
The defendants moved to dismiss the derivative complaint both for failure
to make a pre-suit demand on the Kenetech board of directors and for failure to
state a claim for relief. At the conclusion of oral argument on May 31, 2000, I
informed counsel that I was likely to rule that that demand was excused under
Court of Chancery Rule 23.1 and that the complaint stated a claim upon which
relief may be granted. My written decision denying the motion to dismiss was
issued on July 26, 2000. Central to my decision on the Rule 23.1 motion was the
conclusion that, based on the well-pleaded allegations of the complaint,
Christenson was "conflicted" for the purpose of considering a demand. Thus,
because half of the current board (i.e. Christenson and Lerdal) were
"conflicted," demand was excused.
C. The ValueAct Merger Proposal
In June 2000, Jeffrey Ubben of the venture capital fund, ValueAct Capital
Partners, L.P., approached Lerdal with the possibility of taking Kenetech
private.
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Ubben was personally familiar with Lerdal and with Kenetech's search
for strategic alternatives./7/
1. Creation of the Special Committee
---------------------------------
Lerdal reported Ubben's contact at a special board meeting held on June 21,
2000. The board decided to pursue the possibility of a ValueAct transaction and,
by June 29, a confidentiality agreement was reached between ValueAct and
Kenetech. Shortly thereafter, Ubben raised with Lerdal the possibility that
Lerdal should take an equity position in the purchaser by contributing his
Kenetech shares. Lerdal informed the Kenetech board of this development at a
July 5 meeting of the directors. Lerdal then withdrew from the meeting and the
remaining directors decided to create a Special Committee for the purpose of
evaluating any offers from ValueAct. The resolution creating the committee
delegated to it broad powers to control the negotiation of a transaction,
including the power to "say no." The resolution also provided that the board
would not recommend or approve any transaction not first recommended by the
Special Committee. Finally, the resolution gave the Special Committee full power
to retain independent legal and financial advisors and complete access to the
corporation's informational resources and personnel.
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/7/ Of course, the Kohlses are suspicious about the timing of these events
and characterize the ValueAct proposition as "a solution to the threat presented
by the corporate opportunity litigation." Defendant's respond that the
possibility of a cash-out transaction had been considered prior to April 2000,
but that the ongoing Quadrangle litigation had discouraged any business
combination with Kenetech.
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The Special Committee was, at first, comprised of all of the Kenetech
directors other than Lerdal--Michael D. Winn, Gerald R. Morgan, Jr., and Charles
Christenson. Winn, who became chairperson of the Special Committee, is the
president, sole stockholder, and a director of Terrasearch, Inc., a financial
consulting company, which has a substantial consulting arrangement with
Kenetech. Morgan is the chief operating officer of Francisco Partners, L.P., a
then-$1.3 billion fund that Kenetech agreed to invest $5 million in over a
period of six years. Morgan also has other personal connections with Lerdal that
plaintiffs argue deprive him of his independence. Christenson, a director of
Kenetech since 1980, is a professor emeritus at the Harvard Business School and
a director of at least one other public corporation. Christenson (but not Winn
or Morgan) was on the Kenetech board at the time of Lerdal's acquisition of the
Hillman shares and is named as a defendant in the derivative claim.
The Special Committee met on July 5, 2000, immediately after its creation,
and next met on August 17 for the purpose of hiring the Wilmington, Delaware law
firm of Potter, Andersen & Corroon, L.L.P. ("Potter"). The committee also
discussed the need to hire a financial advisor and discussed several possible
candidates. Defendants say that, at this meeting, Christenson raised the issue
of his status as a defendant in the derivative litigation. Potter advised him
and the Special Committee that, due to the weakness of the merits of the
derivative claim, Christenson's status as a defendant in that action did not
preclude his service on the committee. At the end of the August 17 meeting, Winn
resigned from the
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Special Committee to avoid any appearance of impropriety arising from the
Terrrasearch/Kenetech consulting relationship and other potential business
dealings between Winn and Kenetech. Christenson took his place as chairman of
the committee.
2. Negotiations with ValueAct
--------------------------
On August 23, ValueAct made an offer priced at $0.95 per share to close
before December 31, 2000./8/ The proposed structure was a two-step transaction
with a first-step cash tender offer for any and all shares followed by a second-
step freeze-out merger on the same payment terms. This structure is the same as
that in the proposed transaction.
On August 24, the Special Committee retained Houlihan, Lokey, Howard &
Zukin Financial Advisors, Inc. to assist in evaluating the ValueAct proposal and
negotiating a transaction. On September 1, the Special Committee retained the
law firm of Morrison & Foerster regarding issues of federal securities law and
California state law. Plaintiffs do not attack the independence of any of the
Special Committee's legal or financial advisors.
The Special Committee and ValueAct engaged in extensive negotiations over
price and other terms of the proposed transaction. After considering a range of
alternatives and a presentation by Houlihan, Lokey that described a preliminary
______________
/8/ This proposal included a 120-day exclusive negotiation period, a termination
fee of $1 million, and a stock option lockup of 19.9 percent.
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range of fairness of $0.93 to $1.27 per share, the Special Committee made a
counter-offer priced at $1.17./9/
ValueAct responded on September 11, agreeing to certain aspects of the
Special Committee's proposal, but offering only $1.00 per share. After further
analysis, Houlihan, Lokey revised its fairness range to between $0.94 and $1.15
per share, and on September 15, the Special Committee responded by demanding
$1.08 per share. After several more rounds of bidding, ValueAct stated that it
would not go beyond $1.04 and, on September 26, agreement was reached at that
price.
Among the non-price conditions that the Special Committee sought was a
condition to ensure that the transaction would not proceed if fewer than a
majority of the shares not held by Lerdal were tendered in the first-step
transaction ("Minimum Tender Condition"). ValueAct responded by proposing a
minimum condition of 85 percent of the non-Lerdal shares. That level not only
assures a high level of approval by the non-Lerdal stockholders but guarantees
that, together with the shares to be contributed by Lerdal, the purchaser will
have enough shares
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/9/ Additionally, the Special Committee asked for a 45-day exclusive negotiation
period, a 30-day post-transaction market check, a reduction of the termination
fee to $750,000, the elimination of the stock lockup, and a minimum tender
condition (requiring the approval of a majority of Kenetech's disinterested
shares).
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to effect the second-step merger pursuant to the short-form merger statute, 8
Del. C. (S) 253./10/
The Special Committee met on October 24 and 25 to review the final
agreements. The Committee's counsel discussed the proposed agreements in
detail, including the Minimum Tender Condition, the termination clause, and the
post-market check mechanism. During the course of these meetings, Houlihan,
Lokey made its final presentation, explained that it had narrowed its range of
fairness to $0.96 to $1.13, and delivered its formal opinion that the
consideration offered in the transaction was fair to the Kenetech stockholders
other than Lerdal from a financial point of view. At the conclusion of its
meetings, the Special Committee voted unanimously to approve the transaction and
to recommend it to the full board of Kenetech. On October 25, the full board,
with Lerdal abstaining, approved the merger agreement after receiving advice
from the Special Committee, Houlihan, Lokey, and Potter.
Of particular interest on this motion for preliminary injunction is
Houlihan, Lokey's $0.01 per share valuation of the derivative claim, formally
presented to the Special Committee on October 25, 2000. Houlihan, Lokey based
its valuation of that claim on Potter's assessment of the probable outcomes of
the litigation. Houlihan, Lokey also estimated the costs associated with the
various outcomes
_______________
/10/ The terms of the merger agreement permit ValueAct to waive this condition
but only with the written consent of Kenetech. Kenetech is, apparently,
committed not to waive this condition if the level of tenders is less than 50
percent of the non-Lerdal shares.
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and the likely net result to the corporation. It then created a "decision tree"
that yielded the expected value. Plaintiffs have criticized Houlihan, Lokey's
work for any number of reasons but have not submitted any evidence of their own
valuing the litigation. I will discuss plaintiffs' criticisms of Houlihan,
Lokey's work later in this opinion.
E. Motion for Preliminary Injunction
Plaintiffs filed a second amended and supplemental complaint on November 9,
2000, and promptly sought expedited discovery and the scheduling of a
preliminary injunction hearing. Plaintiffs claim unfair dealing, arguing that
the directors are "interested," the approval process for the cash out,/11/ and
that Lerdal improperly affected the process./12/ Moreover, their complaint
alleges several deficiencies with Kenetech's disclosures regarding the proposed
merger. These relate, among other things, to (i) Christenson's alleged conflict
of interest, (ii) mistakes in valuing the derivative claim, (iii) an unexplained
valuation of the contingent tax liability reserve, (iv) an unexplained deduction
in the valuation of overhead costs, and (v) an unexplained valuation to
Kenetech's NOLs. Oral argument on the motion for a preliminary injunction was
held on December 5, 2000.
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/11/ Plaintiffs maintain that Houlihan, Lokey's valuation of the derivative
action was "devalued . . . in an improper manner."
/12/ Chiefly, plaintiffs accuse Lerdal of controlling the Special Committee,
denying the Special Committee's advisors certain valuation materials or
information, and acting to favor ValueAct.
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III. LEGAL ANALYSIS
A. Legal Standards
Preliminary injunctive relief will be granted only where the moving party
demonstrates the following: (1) a reasonable probability of success on the
merits, (2) irreparable harm if the injunction is not granted, and (3) a balance
of equities in favor of granting the relief./13/ Moreover, a preliminary
injunction is an extraordinary remedy, which will not issue unless it has been
earned and will be denied where the remedy sought is excessive in relation to,
or unnecessary to prevent, the injury threatened./14/
B. Likelihood of Success on the Merits
In determining the merits of plaintiffs' challenge to the directors'
decision to approve the proposed transaction, I must determine the appropriate
standard of review. It is not entirely clear whether I should judge plaintiffs'
challenge under the standard of the business judgment rule or under the stricter
standard of entire fairness. If the business judgment rule operates, it is fair
to say that plaintiffs cannot meet their burden of showing a reasonable
probability of success on the merits of their claim attacking the substance of
the transaction. By contrast, if entire fairness is the appropriate standard of
review, they can shoulder their burden
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/13/ Unitrin, Inc. v. American General Corp., Del. Supr., 651 A.2d 1361, 1371
(1995); SI Management L.P. v. Wininger, Del. Supr., 707 A.2d 37, 40 (1998);
Revlon, Inc. v. MacAndrews & Forbes Holdings, Inc., Del. Supr., 506 A.2d 173,
179 (1986).
/14/ Ivanhoe Partners v. Newmont Mining Corp., Del. Ch., 533 A.2d 585, 600
(1987), aff'd, Del. Supr., 535 A.2d 1334 (1987).
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of persuasion in the context of this motion for a preliminary injunction by
showing "such a lack of fairness in the Challenged Transaction as to establish a
reasonable likelihood that the defendants will be unable to meet their burden of
proving fairness at trial."/15/
1. Business Judgment Rule
----------------------
The defendants make several arguments for the application of the business
judgment rule. First, they argue that the Special Committee was independent and
disinterested, was properly advised, exercised due care, and acted vigorously to
protect the interests of the Kenetech stockholders. In particular, defendants
argue to support Morgan's independence and Christenson's lack of interest. The
more difficult of these issues relates to the nature of Christenson's interest
in the transaction due to his status as a defendant in the derivative
litigation. Second, defendants argue that the Minimum Tender Condition is the
practical equivalent of a disinterested stockholder vote and should serve to
invoke the protections of the business judgment rule./16/ Plaintiffs, by
contrast, argue that the entire fairness standard of review applies due to the
interest of Lerdal and Christenson in the transaction and (less forcefully)
Morgan's lack of independence from Lerdal.
________________
/15/ T. Rowe Price Recovery Fund, L.P. v. Rubin, Del. Ch., C.A. No. 18013, Lamb,
V.C., mem. op. at 34 (June 23, 2000).
/16/ In re Wheelabrator S'holder Litig., 663 A.2d 1194, 1205 (1995).
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a. The Special Committee
The argument that Christenson had a disabling interest in the proposed
transaction rests entirely on my decision denying the motion to dismiss the
derivative litigation. There, I concluded that "the allegations of the
complaint, if true, would establish that Christenson faced a 'substantial
likelihood' of personal liability for breach of fiduciary duty and aiding and
abetting Lerdal's breach of duty."/17/. It needs little explanation to
understand that I made that finding in performing the "gatekeeper" role of the
court under Rule 23.1. The matter is now in a very different posture, since the
question of Christenson's interest or lack of interest in the derivative
litigation can be judged on more than the allegations of the unverified
complaint. In particular, the record in this proceeding includes the testimony
of Laskow that Hillman did not offer and would not have sold its shares to
Kenetech due to Kenetech's distressed financial condition and Hillman's need for
a certain and final sale to meet its tax planning objectives. Moreover, Lerdal
and Christenson (as well as other former directors) have been deposed, and, so,
it is now possible to make a more informed assessment of Christenson's potential
exposure in the derivative litigation.
On the record in this proceeding, Christenson's status as a defendant in
the derivative litigation is not such a material interest in the proposed
transaction as to taint the Special Committee by his involvement. Not only does
the record suggest
______________
/17/ Del. Ch., C.A. No. 17762, mem. op. at 17, Lamb, V.C. (July 26, 2000).
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the overall weakness of the derivative claim, but it also appears more clearly
that the remedy available to plaintiffs on that claim is the cancelation of the
shares acquired by Lerdal. The possibility of a money judgment against
Christenson and the other director defendants in the derivative litigation is
exceedingly remote.
The challenge to Morgan's independence does not, on the present record,
raise a substantial concern. "Control over individual directors is established
by facts demonstrating that 'through personal or other relationships the
directors are beholden to the controlling person.'"/18/ Plaintiffs point to
Morgan's friendship with Lerdal and the fact that Lerdal gave Morgan a summer
job while he was in business school to show that Morgan lacks independence.
Nevertheless, the law is clear that "[e]vidence of personal and/or business
relationships does not raise an inference of self interest."/19/ There is
nothing about Morgan's relationship with Lerdal to suggest that he could not
exercise independent judgment, in accordance with his fiduciary duties, when
acting as a member of the Special Committee./20/
______________
/18/ Odyssey Partners v. Fleming Companies, Del. Ch., 735 A.2d 386, 407 (1999)
(citing Aronson v. Lewis, Del. Supr., 473 A.2d 805, 815 (1984)).
/19/State of Wisconsin Investment Board v. Bartlett, Del. Ch., C.A. No. 17727,
mem. op. at 17, Steele, V.C. (Feb. 24, 2000).
/20/ Similarly, Lerdal's role in Morgan's appointment to the Kenetech board does
not impair Morgan's independence. This court has held repeatedly that "[t]he
fact that a company's executive chairman or a large shareholder played some role
in the nomination process should not, without additional evidence, automatically
foreclose a director's potential independence." In re Western Nat'l Corp.
Stockholders Litig., Del. Ch., C.A. No. 15927, mem. op. at 40-1, Chandler, C.
(May 22, 2000) (noting, "Directors must be nominated and elected to the board in
one fashion or another"); see also Aronson, 473 A.2d at 816.
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Kenetech's investment of $5 million in a fund where Morgan was Chief
Operating Officer and Chief Financial Officer also does not make Morgan
dependent upon or subject to the domination of Lerdal. First, the fund at the
time of the Kenetech commitment was valued at approximately $1.3 billion, and
has since closed to new investors at a value in excess of $2 billion.
Kenetech's commitment of $5 million to be paid over 6 years is, thus, of
immaterial concern. Secondly, even if it were somehow material to Morgan's
employment (about which there is no evidence), the commitment is a contractual
obligation of Kenetech, not subject to Lerdal's discretion.
Beyond the issues of interest or independence, plaintiffs are not able to
mount a credible challenge to the functioning of the Special Committee.
Concededly competent and independent legal and financial experts advised the
committee throughout the course of its existence. The record also supports the
conclusion that the committee acted deliberately and in a fully informed manner.
The committee met more than twenty times and approved the final merger proposal
at the conclusion of a two-day meeting at which it received reports from both
its legal and financial advisors. The committee had the power to "say no" and
appears to have exercised that power during the course of vigorous arm's-length
negotiations with ValueAct. The committee and its advisors bargained for and
obtained terms in the merger agreement that allow for an effective post-
announcement market check. Finally, the Special Committee obtained and relied
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on an opinion from Houlihan, Lokey that $1.04 per share was fair to the Kenetech
stockholders other than Lerdal from a financial point of view.
Plaintiffs make some effort to show that the Special Committee was
controlled by Lerdal and deprived by him of needed information./21/ I am
satisfied that the issues they raise are not material to the decision on this
motion. The committee appears to have functioned independently and diligently,
and there is no reason to conclude that it or its advisors were deprived of
timely access to needed information. For these reasons, I conclude that it is
likely that, at the final hearing, the existence and functioning of the
committee will result in the application of the deferential business judgment
standard of review to the transaction at issue./22/
b. The Minimum Tender Condition
Defendants argue that, because Lerdal is neither the majority nor the
controlling stockholder of Kenetech, the effect of the Minimum Tender Condition
(assuming full and fair disclosure) will be to invoke business judgment as the
standard of review for the merger, relying on the decision of Vice Chancellor
______________
/21/ Plaintiffs point to the following: (i) an ambiguous note taken by Ubben's
associate suggesting that Lerdal told him that he could control the committee,
(ii) Lerdal's having previewed ValueAct's proposal to the Special Committee to
give his reaction, and (iii) the failure to provide cash flow projections even
though Kenetech did not, in the ordinary course, prepare or possess such
projections. On the present record, none of these matters can be thought
seriously to undermine or call into question the independence or proper
functioning of the Special Committee.
/22/ In re RJR Nabisco Shareholders Litig., Del. Ch., C.A. No. 10389, Allen, C.
(Jan. 31, 1989).
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Jacobs in Wheelabrator./23/ In other words, because the terms of the
transaction condition the tender offer on its acceptance by more than 50 percent
of the Kenetech shares held by persons other than Lerdal, the non-Lerdal
stockholders have the power to approve or disapprove the transaction as a group,
and a fully informed collective decision to approve the transaction should be
given the same effect as a ratifying vote. The argument has considerable force
although, before deciding the question, I would want to consider further whether
the decision to tender or not is one that can be exercised without incurring the
economic risk of being treated materially differently than other stockholders--a
risk not associated with the right to vote./24/
2. Entire Fairness
---------------
Plaintiffs make two arguments for the application of the entire fairness
standard of review. First, they contend that the proposed transaction is an
"interested" transaction since both Lerdal and Christenson have interests in it
that differ from those of Kenetech or its stockholders. Second, they argue that
the business judgment rule is rebutted because "there is evidence of disloyalty
. . . [or]
______________
/23/ Del. Ch., 663 A.2d 1205.
/24/ Most obviously, shares not tendered will not be purchased in the tender
offer, but only when the second-step merger is accomplished. Although the plan
is to accomplish that transaction immediately after the completion of the tender
offer closes, there is always some risk as to its timing and completion.
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abdication of directorial duty," citing Bomarko, Inc. v. International
Telecharge, Inc./25/
Of course, Lerdal is interested in the deal, as his economic interests are
aligned with ValueAct's, not Kenetech's. For reasons already discussed,
however, plaintiffs have not persuaded me that Christenson likewise suffers from
a disabling conflict of interest. Similarly, I cannot conclude from the
existing record that Morgan, the other member of the Special Committee, was
disabled from acting in the best interests of Kenetech and its stockholders or
from basing his decision-making on the merits of the transaction./26/
Similarly, plaintiffs have not carried their burden of showing such
disloyalty or abdication of duty as might justify the application of the entire
fairness standard at this stage of the proceeding. On the contrary, the record
of the Special Committee's conduct appears, at this stage of the proceeding,
fully consistent with the proper discharge of the directors' fiduciary duties of
loyalty and care. Plaintiffs focus their argument largely on the derivative
claim and attack both the manner in which the Special Committee and its advisors
valued the claim and the disclosure of that valuation. As I will discuss later
in this opinion, plaintiffs have not carried their burden of showing a
reasonable likelihood of success on this aspect of their claim because they have
not introduced evidence
______________
/25/ Del. Ch., C.A. No. 13052, Lamb, V.C. (Nov. 16, 1999), aff'd, Del. Supr.,
___ A.2d ___ (2000).
/26/ Aronson v. Lewis, 473 A.2d at 812.
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could reasonably conclude that the method of valuing the derivative claim
employed by Houlihan, Lokey was so improper and unreliable as to undermine the
reliance on it by the Special Committee and the board of directors as a whole.
3. Summary
-------
Because the business judgment rule will most likely apply in evaluating the
directors' consideration and approval of the proposed transaction, I conclude
that plaintiffs have not carried their burden on this motion of establishing a
reasonable likelihood of success on the merits of their claim challenging the
substance of the proposed transaction.
C. Adequacy of the Disclosures
When proposing a transaction to stockholders for their consideration and
approval, directors have a fiduciary obligation to provide full and fair
disclosure of all material information within their control./27/ As a general
rule, information is considered material if a reasonable investor would have
viewed it as altering the total mix of information available./28/ Plaintiffs
maintain that defendants have not provided shareholders with adequate disclosure
by both omitting facts and misleading shareholders regarding several aspects of
the proposed transaction with ValueAct.
______________
/27/ Stroud v. Grace, Del. Supr., 606 A.2d 75, 85 (1992).
/28/ In re Anderson Clayton Shareholder Litigation, Del. Ch., 519 A.2d 680, 690
(1986).
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After the complaint attacking the proposed transaction was filed, the
defendants published extensive supplemental disclosures ("Supplemental
Disclosures"), no doubt intended to moot all of plaintiffs' disclosure claims.
The Supplemental Disclosures describe the allegations of the second amended
complaint, and contain additional detailed information on a number of topics
addressed at the scheduling conference on the instant motion. Most
significantly, these address issues relating to Houlihan, Lokey's valuation
work, including its valuation of the derivative claim, Christenson's personal
interest arising from his status as a defendant on that claim, and the workings
of the Minimum Tender Condition. Defendants also amended their SEC filings and
sent them to Kenetech's stockholders, as required.
After reviewing plaintiffs' claims, I am unpersuaded that they establish a
reasonable probability of success in showing a material misstatement or omission
in the disclosures made.
1. Christenson's Conflict
----------------------
Plaintiffs argue that Christenson's conflict of interest is never fully
explained in the tender offer material sent to shareholders. Kenetech's
shareholders received copies of both the plaintiffs' derivative complaint as
well as my opinion denying defendants' motion to dismiss. Moreover, Kenetech's
Schedule 14D-9, as supplemented, was sent to all Kenetech shareholders and
discloses information regarding Christenson's status as a defendant in the
derivative action, his potential liability, and his role in the approval of the
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proposed cash-out transaction. Also included in the amended 14D-9 was a
description of the derivative litigation, and the statement, "If the Merger is
consummated, then the plaintiffs may lose standing to pursue the action." The
supplemental disclosures plainly state plaintiffs' concerns regarding
Christenson's role on the Special Committee: "Dr. Christenson is a defendant in
Kohls v. Duthie. If the Merger is consummated, the plaintiffs may lose standing
to pursue the action." This is adequate disclosure.
2. Corporate Opportunity Claim
---------------------------
The materials sent to stockholders tell them that Houlihan, Lokey valued
the derivative action at $0.01 per share. Plaintiffs object both because they
take issue with Houlihan, Lokey's methodologies and conclusions and because they
say the disclosure materials do not adequately explain what Houlihan, Lokey did.
In his November 22, 2000 deposition, James R. Waldo, Jr., a senior vice
president of Houlihan, Lokey who performed the valuation, explained his
methodology for valuing the derivative action. He arrived at his conclusion by
employing a "decision tree" methodology that allowed him to calculate the
expected value of the litigation by taking into account all of the factors he
deemed relevant to the calculation, including the likelihood of success on the
merits, attorney's fees and other costs, taxes, probability that the suit would
be maintained, probability of success, and probability that the cancelation of
shares or
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equivalent damages would be awarded if successful./29/ In preparing the
valuation, Houlihan, Lokey relied on the expert advice of Potter in assessing
the probabilities of events occurring. Substantially the same information is
found in the Supplemental Disclosures and is adequate disclosure of what
Houlihan, Lokey did.
On its merits, the Houlihan, Lokey valuation of the derivative claim
appears to be the product of a logical methodology, and plaintiffs provide no
alternative to it. They cavil about details of Houlihan, Lokey's work but, on
the whole, their objections do not suggest a material deficiency in the
result./30/
3. Contingent Tax Liability Reserve
--------------------------------
Kenetech created this reserve (and later reduced it) in reliance on the
expert advice of Arthur Andersen. In performing its valuation analysis,
Houlihan, Lokey present valued the current balance sheet amount of the reserve
($10.3 million) to $4.5 million. Plaintiffs have not provided expert opinion to
suggest any impropriety in the establishment of this balance sheet reserve.
Likewise, they have provided no basis on which to question Houlihan, Lokey's
decision to
______________
/29/ Houlihan, Lokey's analysis is as follows: canceling the shares would be
worth $0.4781 per share to the remaining shareholders. With a 25 percent
attorney's fee awarded and a corporate tax of 40 percent, this yields an extra
$0.2152 per share. Discounting this by a 25 percent chance of success (as
suggested by Potter), and a 35 to 40 percent chance that the suit would be
maintained by plaintiffs, and factoring the costs associated with the
litigation, the valuation of the derivative action comes to $0.0172 to $0.0151
per share.
/30/ I note one aspect of Houlihan, Lokey's valuation that might appear at odds
with the objective of valuing the derivative claim to the corporation, which is
the fact that Houlihan, Lokey took into account the fact that the merger, if
accomplished, will result in a loss of standing on the part of plaintiffs. This
appears to have caused a 60-65 percent reduction in the value of the claim since
the other outcome (the maintenance of a class action) was, by definition, of no
value to Kenetech. The difference in the valuation conclusion is not, however,
material.
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discount the amount of the liability to its present value. In the circumstances,
there was no duty to make detailed disclosure about this matter./31/
4. The Astoria Project
-------------------
Astoria is an electrical utility project in Queens, New York, and is one of
Kenetech's most significant assets. In response to plaintiffs' initial
complaint about the limited disclosures made relating to this project and its
valuation, the Supplemental Disclosures describe Houlihan, Lokey's valuation of
the Astoria Project, along with a feasibility report prepared by Navigant
Consulting, Inc.
Plaintiffs continue to urge that the defendants fail to disclose that a
"significant milestone was achieved when El Paso committed to fund out the rest
of the development." Plaintiffs point to Ubben's testimony that a signed term
sheet with El Paso exists, and to the fact that neither Morgan nor Christenson
was aware of it when they were deposed. The record does not support the
conclusion that this is a material omission. Even if a signed term sheet has
now been received, its existence does not materially change the total mix of
information about the Astoria Project. First, a term sheet is not the same
thing as a contract guaranteeing financing of the project. The draft El Paso
term sheet produced during discovery makes this plain, when it states as
follows: "This letter is a proposal to be used as a basis for continued
discussions and does not constitute a commitment,
______________
/31/ Schlossberg v. First Artists Prod., Co., Del. Ch., C.A. No. 6670, mem. op.
at 11-13. Berger, V.C. (Dec. 17, 1986).
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a contract or an offer to enter into a contract and does not obligate [the
parties] in any manner whatsoever, except as expressly provided in the section
entitled 'Binding Terms' herein." Moreover, the valuation ascribed to the
Astoria Project during the course of negotiations reflects an expectation that a
term sheet for financing would be obtained and, more importantly, that that
financing would eventually be arranged, along with the satisfaction of numerous
other financial or regulatory hurdles to the completion of the project.
Plaintiffs also complain that Houlihan, Lokey's valuation of the Astoria
Project disclosures in the supplemental disclosures (a range of $0.20 to $0.31
per share), ascribes a lower value to the project than a $0.576 per share value
they say is found in a report prepared by director Winn. Defendants, however,
correctly answer that this higher, undisclosed value was merely the highest of
three reviewed by Winn and is an asset value figure that does not properly
account for associated liabilities.
5. Other Matters
-------------
Plaintiffs also complain that there is no disclosure that Houlihan, Lokey
reduced to zero its valuation of Kenetech's NOLs but provide no expert valuation
to counter Houlihan, Lokey's conclusion. Defendants' expert gave a reason why
the NOLs were reduced to zero, and there is no basis in the record for me to
conclude that defendants' expert acted inappropriately. I am similarly unable
to assess the merits of plaintiffs' claim that additional disclosure is required
to
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explain the difference between Houlihan, Lokey's estimation of overhead costs
and those of ValueAct.
D. Irreparable Injury
I also conclude that plaintiffs have not demonstrated that the proposed
cash-out transaction will cause them to suffer irreparable harm. As this court
stated in State v. Delaware State Educational Association, "It is not necessary
that the injury be beyond the possibility of repair by money compensation but it
must be of such a nature that no fair and reasonable redress may be had in a
court of law and that to refuse the injunction would be a denial of
justice."/32/ While plaintiffs will likely lose standing to maintain the
derivative claim once the merger is effected, it will be possible to value that
claim in the context of an appraisal action./33/ As this court has held before,
loss of standing to bring a derivative action is not irreparable harm./34/
Moreover, should plaintiffs prove that the disclosures disseminated by the
defendants were materially incomplete or misleading, plaintiffs will be entitled
to maintain their direct action to seek money damages. Because I cannot now
conclude that they are being asked to make decisions regarding the transaction
on
______________
/32/ Del. Ch., 326 A.2d 868, 875 (1974).
/33/ Bomarko v. International Telecharge, Inc., Del. Ch., C.A., No. 13052, mem.
op. at 5, Berger, V.C. (May 16, 1994); In re Radiology Assocs., Inc. Litig.,
Del. Ch., C.A. No. 9001, mem. op. at 33-34, Chandler, V.C. (May 16, 1990).
/34/ Porter v. Texas Commerce Bancshares, Inc., Del. Ch., C.A. No. 9114, mem.
op. at 15-16, Allen, C. (Oct. 12, 1989).
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the basis of improper disclosures, there is no irreparable harm in putting them
to the decision of how to respond to the proposed transaction.
E. Balancing of the Equities
Finally, in balancing the equities, defendants and Kenetech's other
stockholders are threatened with real injury if this transaction is enjoined.
Kenetech is a small company seeking to go private. Apart from the proposed
ValueAct transaction, no other potential premium transaction has emerged over
the last several years despite Kenetech's search for strategic alternatives.
This court is understandably cautious when the issuance of an injunction "would
deprive . . . shareholders of the benefits of [a] merger transaction without
offering them any realistic prospect of a superior alternative, or for that
matter, any alternative."/35/
In light of the full disclosures made by the corporation, as well as
protective mechanisms of the 85 percent Minimum Tender Condition, I see no
reason why shareholders should not be the final authority on whether this cash-
out transaction takes place.
______________
/35/ Wheelabrator, mem. op. at 20.
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IV. CONCLUSION
For all of the foregoing reasons, the motion for preliminary injunction
will be denied. IT IS SO ORDERED.
/s/ Stephen P. Lamb
-------------------
Vice Chancellor
31
