Delaware Court of Chancery Holds That Common Practice of Boards Approving Draft Merger Agreements “Needs to Check Itself”

Background

On January 17, 2022, the board of Activision, a leading video game company, met and approved a draft agreement for the company’s acquisition by Microsoft. The draft merger agreement allegedly did not include the price term, company disclosure letter, disclosure schedules, charter for the surviving corporation, or a provision addressing the “open issue” of what dividends Activision could pay out while the merger was pending.³ However, Activision and Microsoft had settled on the final deal price in December, and in advance of the January approval, Activision’s board had met several times with its financial and legal advisors and received briefings on key provisions, one of which was undoubtedly the price. Thereafter, Activision’s stockholders almost unanimously approved the merger, and after overcoming antitrust scrutiny, the parties closed the approximately $70 billion transaction in October 2023 (yielding a 45 percent premium to Activision’s stockholders, based on the pre-announcement market price).

Nevertheless, an Activision stockholder sued, claiming that the board’s approval process violated DGCL §§ 141 and 251. Section 141(c)(2) provides that no board “committee shall have the power or authority” to approve any action “expressly required by this chapter to be submitted to stockholders for approval,” which includes approving a merger. Section 251(b) requires that the board of each company to a merger “shall adopt a resolution approving an agreement of merger” which “shall state” several categories of relevant information—the terms and conditions of the merger and mode of carrying it into effect, the charter of the surviving or resulting company, the manner of converting shares, and other details “deemed desirable.” The plaintiff argued that the statute requires a board to approve the execution version of the merger agreement, which the court described as the “execution-version interpretation” (the “Execution-Complete Interpretation”) of Section 251(b). Activision’s directors responded that the plaintiff’s interpretation goes against the “norms of market practice” and would create general uncertainty about the validity of mergers and for third parties doing business with Delaware corporations.⁴

Court’s Analysis

The court reasoned that the Execution-Version Interpretation advanced by the plaintiff found support in the plain text of Section 251(b) and in the “DGCL’s statutory scheme,” which requires “strict compliance” with provisions governing the approval of mergers, given their “unique status.”⁵ However, the court seemed somewhat receptive to the practical problems warned of by Activision’s directors. The court acknowledged that it was “undoubtedly true” that attorneys negotiate disclosure schedules up to (if not beyond) deal signing and that “it is hard to square this reality” with the plaintiff’s interpretation of § 251(b).⁶ The court, however, held that it did not need to resolve this tension under the Execution-Version Interpretation because “[a]t bare minimum, Section 251(b) requires a board to approve an essentially complete version of the merger agreement” (the “Essentially-Complete Interpretation”).⁷ The court rejected the defendants’ argument that the Essentially-Complete Interpretation would pose practical problems, and it indicated that approving anything less than an “essentially complete” version of a merger agreement could not be squared with the language of Section 251(b) or basic principles of good governance and fiduciary duties.

What does an “essentially complete version” include? The court did not provide comprehensive guidance, reasoning that, wherever the line was drawn, it had been crossed by the absence of the price term and the charter. The court explained that, at a minimum, “essentially complete” covers the terms and documents “specifically call[ed] out” by § 251(b).⁸ One of these items is a copy of the surviving company’s charter, and because this item was undeniably missing from the draft agreement approved by Activision’s board, dismissal of the lawsuit was denied. However, several of the other items mandated by §251(b) are subject to interpretation, such as “[t]he terms and conditions of the merger” and “[s]uch other details or provisions as are deemed desirable.” Here, the court analyzed the circumstances to determine the importance of the other missing provisions — such as noting that the missing disclosure letter was referenced 45 times in the draft and that the dividend provision was listed as “a ‘key open’ issue” in Activision’s board minutes.⁹ As to the disclosure schedules, the court concluded that “reasonable minds could reach different conclusions.”¹⁰

The court also refused to dismiss the plaintiff’s § 141 claim, holding that it was reasonably conceivable that the board delegated negotiation and approval of the dividend provision to an ad hoc committee, which exceeds a committee’s authority under § 141(c)(2).

Takeaways

The court’s decision, on a topic it acknowledged had “not a lot of case law” and whose outcome called into question common market practices, is bound to have both backward-looking and forward-looking effects on merging companies and their boards.

Looking backward, it is likely that many parties to recent mergers will be confronted with books and records demands by stockholders seeking to investigate whether the board’s approval complied with the DGCL in light of AP-Fonden. Companies whose mergers are in the post-signing, pre-closing phase, should speak to your legal advisors about the potential desirability of the board ratifying its earlier approval (this time with the final merger agreement) — although this remedy could itself pose complications under the DGCL and the parties’ agreement. While the horse is out of the barn as to the approval process for closed transactions, companies should be mindful of how their document productions in response to such a demand, whether pre-closing or post-closing, can best position their directors in any lawsuit by demonstrating the steps that were taken.

For post-closing lawsuits, it also remains to be seen what, if any, damages or other relief a stockholder could plausibly seek. In AP-Fonden, for instance, it is unclear how the plaintiff could claim that Activision stockholders were harmed either by the merger (again, at a large premium) or by the board’s alleged statutory violations in approving it, or how plaintiff could claim that its efforts conferred some benefit on stockholders warranting an award of attorney fees.

Looking forward, the only way to remove all risk in light of AP-Fonden would be to approve a final version of the agreement and ancillary documents, given that the court (i) left open the door to the Execution-Version Interpretation, and (ii) even under the Essentially-Complete Interpretation, left uncertainty about what terms would be required, potentially making it difficult to obtain dismissal of a stockholder challenge.

But, as the court acknowledged, it may sometimes simply not be practicable for a board to wait for every provision and detail to be finalized before approving an agreement. In such circumstances, boards and their advisors should ensure that, at minimum, they are seeking to satisfy the “essentially complete” standard by approving a merger agreement that includes price, any other terms that the parties consider material (e.g., the dividend provision in the Activision agreement), and other provisions “specifically called out” in § 251(b) — i.e., the mode of carrying the merger into effect, charter of the surviving or resulting company, and manner of converting shares. As to the more general provisions of § 251(b) (i.e., the “terms and conditions” of the merger and other details “deemed desirable”), best practice is to obtain board approval as close to execution as possible, at least until the case law develops to provide companies and boards more concrete guidance in this area.

¹ C.A. No. 2022-1001, 2024 WL 863290 (Del. Ch. Feb. 29, 2024).

² Id. at *6.

³ Id. at *1.

⁴ Id. at *5.

⁵ Id. at *4.

⁶ Id. at *6.

⁷ Id. at *7.

⁸ Id.

⁹ Id. at *8.

¹⁰ Id. The court also allowed the plaintiff’s § 251(c) claim to move forward. Id. at *9. The court held that § 251(c), which requires the notice of the stockholder meeting for the merger vote to include either the merger “agreement required by [Section 251(b)]” or a summary, was not satisfied by attaching the merger agreement because it lacked one of the requirements of § 251(b) — the surviving company’s charter. Id. at *8.