M & A Law Prof Blog

Editor: Brian JM Quinn
Boston College Law School

Wednesday, May 5, 2010

Triggering Revlon Duties with Convertible Debt

One of the most common search terms to find this site in the past week or so has been "What triggers Revlon duties?"   Now, this has little to do with the business cycle and much more to do with the cycle of law school exams.  It's about this time when students are sitting in the library, looking over their incomprehensible notes, and asking themselves, "What triggers Revlon?"  I know.  I was in that same situation myself.

Almost as if on cue, the Chancery Court hands down decision in Binks v DSL.net dealing with Revlon duties in the context of the issuance of convertible notes (H/T Morris James).  It’s a nice review of the state of the law with a slight twist on the facts.  The case involves a transaction between DSL.net and MegaPath.  DSL was in financial trouble in 2006 and rather than enter bankruptcy entered into a transaction with MegaPath.  MegaPath lent DSL.net $13 million and took convertible notes.  A few months after the transaction, MegaPath converted its notes to equity and ended up with more than 90% of DSL's common stock.  Shortly thereafter MegaPath effected a short form merger to eliminate the minority stockholders.  

Plaintiffs argued at the motion to dismiss stage that issuance of the convertible notes represented a potential "change in control" and that the DSL.net directors had an obligation under Revlon to "obtain the best price reasonably available to shareholders."  The Plaintiff didn't argued that the board should have held an auction or that a successful auction was likely.  Rather, the plaintiff argued the deal the board made with MegaPath essentially permitted MegaPath to loot DSL and that there were a number of other reasonable alternatives that would have left DSL shareholders better off than the issuance of convertible notes (e.g. DSL.net had $50 million in NOLs that could have been used to engineer a transaction).  

First, to the question whether Revlon is the applicable standard in the case at the motion to dismiss stage, the court answers in the affirmative, noting that the issuance of the convertible notes can be interpreted as a change in control:

It is not unreasonable to review the Amended Complaint as alleging that the short-form Merger was an inevitable and foreseeable consequence of the MegaPath Financing Transaction.  As the Supreme Court in QVC pointed out, in determining whether the transaction constitutes a "change of control" for Revlon purposes, "the answer must be sought in the specific circumstances surrounding the transaction."  Inferring that the relevant events should be collapsed for analytical purposes into a single transaction is also consistent with this Court's earlier consideration of the issue:

I assume for purposes of deciding this case, without deciding, that the granting of immediately exercisable warrants, which, if exercised, would give the holder voting control of the corporation, is a transaction of the type that warrants the imposition of the special duties and special standard of [Revlon].

This assumption arose out of the Court's recognition that Revlon duties may arise when a board, as here, "approves a transaction having a change in control effect ( ... specifically ... where a corporate action plays a necessary part in the formation of a control block where one did not previously exist.)

In applying Revlon, the court finds that the plaintiffs did not offer sufficient evidence to support a finding that the board was not independent and disinterested.  The Court also noted that the plaintiff’s complaint was devoid of facts suggesting that the board was not adequately informed.  With all that in place, the court laid out its standard for deciding this case under Revlon:

Where a board is found to be independent, disinterested, and adequately informed, the decision to enter into a change in control transaction should be upheld unless the directors “utterly failed to attempt to obtain the best sale price … ‘Because there can be several reasoned ways to try to maximize value, the court cannot find fault so long as the directors a reasoned course of action.’  Here the board’s conclusion that the Megapath Financing Transaction was preferable to bankruptcy was within its business judgment.

The Court reiterates the basic holding in Lyondell, that good faith claims (essentially a claim that attempts to convert a care violation into a loyalty violation) are very hard to win and require extreme facts – facts that suggest “utter failure”.  These days when even the last kid on the bench of the last place team gets a trophy, it’s hard to imagine what “utter failure” might look like in the corporate context.



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