Legal challenge to Caremark - CVS merger

• Delaware Chancery twice delayed merger vote, but declined to enjoin the merger despite finding improprieties
• Court left fate of merger to shareholder vote after requiring additional disclosures

• CVS/Caremark merger closed on 3.22.07
  See Caremark - CVS Merger

Concludes that Caremark stockholders were entitled to appraisal rights

• As Court treated a special dividend and a stock-for-stock merger as an integrated transaction

Court was critical of process and management conflicts

Opinion

• Chancellor Chandler 
• ___ A.2d __  C.A. Nos. 2635-N, 2663-N

Hyperlinked outline

Top  ++

Facts  I

• Parties  I.A

• Factual background  I.B

• Preliminary negotiations  I.B.1
• CVS / Caremark merger agreement  I.B.2
• Express Scripts makes an unsolicited offer  I.B.3
• CVS bumps its offer  I.B.4
• Express Scripts begins its exchange offer  I.B.5

Contentions  II

Standing of Express Scripts And Kew Corp  III

Preliminary injunction standard  IV

Disclosure issues  V

• True purpose of the supplement  V.A
• Relationships among parties and advisors  V.B
• Crawfords expected tenure  V.C
• Negotiations of conditional "special dividends"  V.D
• Relevance to CVS of the backdating investigation  V.E
• Impact of merger on backdating litigation  V.F
• Disclosure re: Express anti-trust risks  V.G
• Investment bankers compensation  V.H

Appraisal rights  VI

Irreparable harm - Balance of the equities  VII

Conclusion  VIII

Opinion

• Chancellor Chandler 
• Three page letter opinion enjoined shareholder vote from Feb 20 until at least March 9

Text of opinion

From 2.23.07 Del Ch opinion

Facts  I

• Parties  I.A

• Factual background  I.B

• Preliminary negotiations  I.B.1
• CVS / Caremark merger agreement  I.B.2
• Express Scripts makes an unsolicited offer  I.B.3
• CVS bumps its offer  I.B.4
• Express Scripts begins its exchange offer  I.B.5

For more, see Caremark - CVS Merger

From 2.23.07 Del Ch opinion

• Opinion Section VI

Background

• Caremark used a special dividend to equalize the value of its CVS merger to the value of Express Scripts' competing offer

• Originally $2 per share, payable by Caremark but payment  contingent on closing of CVS merger
• Increased to $6 per share, then to $7.50 per share

• See Caremark - CVS Merger

Court held that this dividend triggered appraisal rights

• As Court treated a special dividend and stock-for-stock merger as an integrated transaction

• Under Delaware law appraisal rights would not apply to a stock-for-stock merger
• Court did not apply the Delaware corporate law doctrine of independent legal significance

• Concluded that the Caremark stockholders were entitled to appraisal rights  per DGCL §262

• The $6 "special dividend," although issued by the Caremark board, is fundamentally cash consideration paid to Caremark shareholders on behalf of CVS.
• "... facts belie the claim that the special dividend has legal significance independent of the merger"
•  "the label 'special dividend' is simply cash consideration dressed up in a none-too-convincing disguise."
• Caremark stockholders "should not be denied their appraisal rights simply because their directors are willing to collude with a favored bidder to 'launder' a cash payment."

From 2.23.07 Del Ch opinion

• Section I.B.2

Court is critical of compensation arrangements

• CVS merger is a "change of control" for benefit purposes, accelerating option and other benefit programs

• Even though Caremark asserts that the CVS merger isn't a change of control for fiduciary duty purposes
• Which would trigger Revlon duties
• Note footnote 6
  It is an unfortunate and disappointing spectacle, however, to watch a board of directors insist that it simultaneously deserves the protection of the business judgment rule because the company is not changing hands, while a massive personal windfall is bestowed because it is.

Court is critical of option backdating conflicts

• Terms of merger protect Caremark insiders from option backdating issues

• As option grants will be honored
• As Caremark directors will be indemnified

From 2.23.07 Del Ch opinion

• Section I.B.2

Deal protection measures used by Caremark - CVS

• Force the vote provision

• Both boards were contractually bound to submit the merger to their shareholders

• No shop provision

• Neither board could speak with a competing bidder unless its board concluded that a competing offer was a Superior Proposal or is likely to lead to one

• Last look provision - Matching rights

• Obligated the target board to disclose the terms of a competing Superior Proposal, and allows the other party a five-day window to match the bid

• Reciprocal break-up fee

• $675 million (~ 3%)
• Triggered if, for almost any reason, either board withdraws or changes its recommendation of the merger
• Fee must also be paid if either companys shareholders reject the merger agreement and then accept any other merger proposal within twelve months

• Combined effect

• Company can only enter into a "conditional" merger agreement" for a Superior Proposal from a competing bidder
• Conditioned on putting original agreement to a shareholder vote and paying break-up fee

Court is critical of these deal protections

• Note footnote 10
• Defendants maintain that these are no more than a customary set of devices employed regularly by market participants and their lawyers. Particularly with respect to the termination fee, this argument by custom fails to convince
• Though a "3% rule" for termination fees might be convenient for transaction planners, it is simply too blunt an instrument, too subject to abuse, for this Court to bless as a blanket rule

Court statements

• The Court stated that deal protections of any type or magnitude may be unlawful if they "operate in an unreasonable, preclusive or coercive manner, under the standards of this Courts Unocal jurisprudence, to inequitably harm shareholders."
• Factors to consider

• Overall size of the termination fee,
  as well as its percentage value
• Benefit to shareholders, including a premium (if any) that directors seek to protect
• Absolute size of the transaction, as well as the relative size of the partners to the merger
• Degree to which a counterparty found such protections to be crucial to the deal, bearing in mind differences in bargaining power
• Preclusive or coercive power of all deal protections included in the transaction, taken as a whole

Sources

• 2.13.07 Del Ch opinion
• 2.23.07 Del Ch Opinion: Opinion Section V

Background

• Several lawsuits claimed that Caremark's proxy disclosures were flawed
• To address many of these claims, Caremark filed a Form 8-K on 2.12.07 in advance of its shareholder meeting originally scheduled for March 9

• Caremark 8-K supplemental disclosures  2.12.07

Issues dealt with in 2.13.07 opinion

• Court found that two disclosure matters addressed in Caremark's 2.12 8-K warranted delaying shareholder vote

Issues dealt with in 2.23.07 opinion

• Characterization of Form 8-K disclosure as an "update" of proxy statement -- Opinion § V.A
• Failure to declare that no material relationships exist between Caremark directors, other parties and their advisors -- Opinion § V.B
• Failure to disclose tenure of of Caremark CEO's tenure as Chairman of the combined company -- Opinion § V.C
• Omissions about the negotiation of Caremark's special dividend -- Opinion § V.D
• Failure to disclose relevance of backdating investigation -- Opinion § V.E
• Failure to disclose impact of merger on backdating litigation -- Opinion § V.F
• Misleading disclosures about anti-trust risks
  -- Opinion § V.G
• Misleading disclosures about investment banker compensation -- Opinion § V.H

Court dismissed all these disclosure claims except the last

• Court held that Caremarks disclosures regarding the contingent nature of its investment bankers fee arrangement were inadequate because they failed to disclose that the two Caremark advisers collectively would be entitled to fees totaling $35 million upon the conclusion of the CVS transaction or other similar transaction, but that in all events the bankers entitlement to those fees arose only if Caremark first entered into a merger agreement with CVS

Law firms

• Potter Anderson

Delaware General Corporation Law