Recent court decisions of interest: TD Banknorth and LaPoint

November 20, 2007

Proposed settlement of class action relating to minority buyout fails to win the approval of the Delaware Court of Chancery

Exploratory negotiations toward a going private transaction may well have violated a shareholders’ agreement provision barring such discussions unless the Special Committee invited them – ruling suggests that such an invitation may need to be formally issued before negotiations begin, not merely at the point where the price settled on is to be voted on

In re TD Banknorth Shareholders Litigation

Court of Chancery (Delaware)
July 19, 2007 . C.A. No. 2557-VCL
Lamb V.C.

Delaware’s Court of Chancery has refused to approve a proposed settlement of a class action brought by minority shareholders of TD Banknorth, Inc. with respect to majority shareholder Toronto-Dominion Bank’s $3.19 billion acquisition of the shares of the U.S. financial institution that it did not already own. Several TD Banknorth shareholders had balked at the deal, arguing that the representative plaintiffs in the class action had negotiated away “viable contractual and entire fairness claims in return for insubstantial consideration”. The court agreed.


In March 2005, TD Bank acquired a 51% interest in Banknorth in a $3.8 billion cash and stock deal. A stockholders’ agreement was then put in place that restricted any attempt by TD to increase its ownership above 66.7%, as follows:

2.2(b) Until March 1, 2007, TD “shall not.propose or initiate any Going Private Tran¬saction unless invited to do so by a majority of the [Special Committee]. Any Going Private Transaction effected during this period shall also be subject to the requirements of Section 2.2(c).”

2.2(c) March 1, 2007 – March 1, 2010: (i) TD “may initiate and hold discussions regarding a Going Private Transaction with the Board on a confidential basis that would not reasonably be expected to require either [Banknorth or TD] to make any public disclosure thereof [as required by applicable securities laws].. If a majority of the [Special Committee] approves such a transaction, [TD] may publicly announce, commence and effect such Going Private Transaction..”

2.2(d) After March 1, 2010: TD “may propose, initiate or effect a Going Private Transaction, provided that such Going Private Transaction is either approved by a majority of the [Special Committee] or by Unaffiliated Stockholder Approval and further provided that [TD] shall not propose, publicly announce or initiate a Going Private Transaction.without providing prior notice to the [Special Committee] and offering to first discuss and negotiate confidentially the terms [of] such proposed Going Private Transaction with the Special Committee.”

The process

The version of events accepted by Lamb V.C. for the purpose of the order was as follows. In December 2005, the TD board of directors discussed a buyout of Banknorth’s minority shareholders. In January 2006, a meeting of Banknorth’s Strategic Planning Committee was attended by several senior representatives of TD (including two TD directors who were also on Banknorth’s board). One attendee, the COO of Banknorth, met the next day with Banknorth’s Special Committee to discuss a possible going private transaction. The Special Committee appointed its chair, Condron, to study the issue. In April, Condron wrote a letter suggesting that the committee meet in May or June to discuss possible financial and legal advisors.

Before any meeting took place, however, Condron met with Ryan, then the president and CEO of Banknorth and a member of both boards. Ryan raised the possibility of a TD buyout at that meeting and again at a meeting of the Special Committee on May 8. On May 9, Ryan and TD’s president and CEO, Clark, attended a meeting of the Banknorth board’s Executive Committee. Clark was said to have indicated that TD “might be interested in pursuing exploratory discussions if invited to do so” by the Special Committee. Negotiations continued and on November 15, Condron and Clark arrived at a figure of $32.33 per share (all cash).

It was only on November 18 that, following a presentation regarding the offer, the Special Committee formally issued an invitation to TD to submit a proposal according to the negotiated terms. Two days later, both boards had approved the transaction and the deal was publicly announced.

Class actions

Within days, six class action lawsuits had been commenced in Delaware. These were consolidated by court order on November 29. The class plaintiffs agreed to settle for 3 cents per share, some new disclosure and the exclusion of a few officer-owned shares (about 0.1% of those eligible) from the majority of-minority vote.

In a vote held April 18, 2007, almost 95% of the minority investors favoured the deal. But the settlement still had to be approved, and the objecting shareholders continued to press their case before Vice Chancellor Lamb.

Did the process violate s. 2.2(b)?

The plaintiffs and defendants (who were allied in this hearing against the objectors) argued that the process had been completely normal and proper, with a disinterested committee of directors bargaining in an entirely fair way. The 3 cents per share and improved disclosure were evidence of this. Extracting more would have been difficult, because (in their view) s. 2.2(b) had been complied with – in the world of M&A, they claimed, the “initiation” or “proposal” of a transaction occurs only when it is “formally proffered for consideration by the board of directors”. They maintained that s. 2.2(b) was understood by all sides as merely preventing TD from bypassing the Special Committee altogether and making a public tender offer or from attempting the sort of tender/short-form merger offer that was at issue in Pure Resources.1

The court agreed with the objectors that the s. 2.2(b) argument was much stronger than the plaintiffs had concluded. While this hearing was not the place to determine the underlying claim, the plain language of s. 2.2(b) clearly gave substantial support to the objectors’ position:

…a plain reading of section 2.2(b) supports a robust argument that, because there was no preceding invitation from the Special Committee, Toronto-Dominion’s prompting of exploratory negotiations or discussions as to a going private transaction, regardless of how skeletal, amounted to a breach of section 2.2(b)’s prohibition.

The court also observed that the plaintiffs’ interpretation left little to distinguish subsection (b) from subsection (c).

The court concluded that the “near-constant series of discussions and negotiations” between Clark and Condron from June to November 2006 – prior the Special Committee’s “invitation” – constituted “substantial evidence to support a claim that the merger agreement is the product of the defendants’ violation of the stockholders’ agreement”.

Entire fairness

Having concluded that there was “substantial evidence” that the going private transaction was “the product of the defendants’ violation of the stockholders’ agreement”, the court turned to the plaintiffs’ argument that the minority had suffered no harm.

The court disagreed with the plaintiffs’ claim that any financial harm was suffered by Banknorth rather than individual shareholders. Moreover, under the “entire fairness” doctrine in Weinberger v. UOP, Inc., 457 A.2d 701 (Del. 1983), a court faced with a minority freeze-out must conclude that there was not only a fair price but fair dealing. That meant that objectors’ claim could not be defeated by showing that the TD offer was within “the range of fairness at the time the merger agreement was executed or completed“. As the italics suggest, an entire fairness analysis would also have had to consider the timing of the offer, since s. 2.2(b) could also be seen as an attempt to prevent the controlling shareholder from making oppor¬tunistic buyout offers during economic downswings etc. A finding that s. 2.2(b) had been breached would therefore lend even more credibility to the argument that the transaction failed the entire fairness test.


The court concluded that:

…the plaintiffs unreasonably chose not to pursue viable claims based upon a violation of section 2.2(b) of the stockholders’ agreement and any resultant inequitable timing of the transaction. While expressing no opinion as to the ultimate merits of these causes of action, the court must conclude that, according to established principles of contract interpretation and Delaware case law, these claims have some substantial strength. A reasonable class representative in the plaintiffs’ position certainly would have tried to extract substantial consideration for the settlement of these claims. That plainly did not happen here.

Even though the court did not decide the underlying issues here, the lesson of the case is to consider the risk that a court would hold that exploratory discussions about the possibility of a going private transaction constitute the “initiation” or “proposal” of such a transaction, and that if there are restrictions on the initiation of such transactions they may need to be dealt with at a very early stage rather than when the deal is essentially done. While this was an application for the approval of a settlement, Lamb V.C. quite clearly considered the process to have been flawed, even though both TD and Banknorth had evidently made conscientious efforts to live up to the terms of s. 2.2(b).

1In re Pure Resources, Inc., Shareholders Litigation, 808 A.2d 421 (Del. Ch. 2002).


Acquiror pays a heavy price for poorly drafted earn-out when its relationship with its new subsidiary quickly degenerates post-closing
Acquiror fails to live up to commitment to “actively and exclusively” promote target’s products after merger, in violation of key earn-out commitment; also found to have miscalculated the earn-out

LaPoint v. AmerisourceBergen Corp.

Court of Chancery (Delaware)
September 4, 2007 . Civil Action No. 327-CC
Chancellor Chandler

While earn-out arrangements can help get deals done, they often create “enforcement” issues after the merger. Ideally, earn-outs would be structured so that the new owner can’t avoid the payments by artificially suppressing the business but at the same time is able to make ordinary business decisions even if they might reduce the value of the earn out. This Delaware decision shows some of the pitfalls of a poorly drafted earn-out.

Chancellor Chandler described the case as falling “into an archetypal pattern of doomed corporate romances”. AmerisourceBergen Corp. (“ABC”) merged with Bridge Medical, Inc., a start-up that had not yet turned a profit. An earn-out seemed a good way of compensating the selling shareholders fairly in the event that Bridge’s business finally took off in the two-year period post-closing. The deal was accordingly structured as a $27 million up-front payment and an earn-out of anything from nothing to $55 million, based on EBITA.

The key provisions

Two provisions were central to the case:

[ABC] agrees to (and shall cause each of its subsidiaries to) exclusively and actively promote [Bridge’s] current line of products and services for point of care medication safety. [ABC] shall not (and shall cause each of its subsidiaries to not) promote, market or acquire any products, services or companies that compete either directly or indirectly with [Bridge’s] current line of products and services.

[ABC] will act in good faith during the Earnout Period and will not undertake any actions during the Earnout Period any purpose of which is to impede the ability of the [Bridge] Stockholders to earn the Earnout Payments.

Unimpressed with this type of drafting, the court condemned the agreement’s “gossamer definitions” and “aspirational statements” as “too fragile to prevent the parties from devolving into the present dispute”.

Failure to promote Bridge products

The plaintiffs argued that ABC had not “exclusively and actively” promoted Bridge products to its hospital customers. Particularly damning, in the court’s view, was an email from an ABC vice-president advising an employee that if a certain customer were to insist that it didn’t want the Bridge product, it would then be fine to sell them a rival product that “we want to use”. The employee was then asked to consider whether it “is too risky” to contact “someone at [the customer] and ask them for some assistance”. In addition to this, ABC essentially prohibited the Bridge division from sending out press releases that it had relied on as a form of promotion. And finally, ABC turned down a merger agreement with a third company that would have been very favourable to Bridge.

The court accepted the Bridge shareholders’ version of events as well as its conclusion that ABC had neither exclusively nor actively promoted Bridge. The main exception was the aborted merger – Chancellor Chandler held that ABC was not obliged to proceed with a merger that would not have been profitable because of the earn-out payments it might have triggered (or, more precisely, because of the cost of buying out the earn-out rights of the Bridge shareholders as ABC’s proposed merger partner appears to have required).

Damages of six cents

In spite of its general finding against ABC, the court held that there was no evidence that the ABC’s failure to promote Bridge had made a difference in a market that was moving away from Bridge’s type of product. Damages were thus only nominal, which in Delaware turns out to mean six cents.

The 2003 earn-out

The Bridge shareholders also asked the court to rule that ABC’s calculations relating to the 2003 earn-out had deprived it of millions. The court agreed, finding that ABC’s proposed interpretation of the earn-out amounted to a request for the court to re-draft it. This it would not do, even though Chancellor Chandler agreed that that the plaintiffs were “craftily” taking advantage of some very bad drafting.

R&D expenditures

The first drafting mistake was an R&D clause providing that Bridge must remain within 80% of a projected figure (“X”). When actual R&D expenditures did not meet this target, and in fact fell $1.25 million short of X, ABC deducted that amount from EBITA, affecting the earn-out. The plaintiffs argued, and the court agreed, that nothing in the provision stated that the remedy for an R&D shortfall was an adjustment to EBITA. ABC’s only remedy – which it had not pursued here – would be to sue “appropriate defendants” for the shortfall. Because the earn-out rose exponentially (more or less) as EBITA increased, restoring the $1.25 million to the EBITA increased the potential earn-out by far more than that amount.

Weighted averages

Failing to distinguish between an “average” and a “weighted average” cost ABC even more dearly. The crucial paragraph 34 of Annex I of the merger agreement provided:

When [Bridge’s] products or services are bundled with other products or services of [ABC] or any of [ABC]’s other subsidiaries in a sale to a customer, [Bridge] will receive revenue credit for such bundled sale at [Bridge]’s list price for such products and services (less normal discounting of 20%; provided, however, that where products and services are discounted by more than 20%, the discount to be applied for purposes hereof shall be the average amount of the discount in the last (5) unbundled contracts executed prior to the execution of the subject contract) for determining Adjusted EBITA attainment each year for comparison to the Earnout Payment objectives of each year.

Discount rates in the comparison contracts ranged from 0 to 51.2%. ABC argued that “average” meant “weighted average” – the difference being an increase in the discount from 27.9% (unweighted) to 46.8% (weighted). While Chancellor Chandler agreed that a weighted average might make business sense, he saw no reason that an unweighted average might not also make business sense, as might a time-weighted average (with more recent contracts weighted more heavily) or any number of other conceivable formulas. ABC’s lengthy argument on the “law of averages” – which ranged as far afield as Ty Cobb’s batting average – failed to budge the court from its view that “absent explicit instruction to the contrary, the term ‘average’ implies a simple arithmetic mean”.

Conflict with GAAP

Paragraph 34 of Annex I concluded as follows:

The credit for bundled sales will be added to revenues for determining Adjusted EBITA attainment in the year that the software is delivered to the customer and for services in the year in which the services are provided to the customer.

ABC argued that this had to be taken in the context of paragraph 4 of Annex I, which stated:

The term “Adjusted EBITA” means the earnings of the Surviving Corporation before interest, taxes and amortization, as determined in accordance with GAAP applied on a consistent basis, as adjusted pursuant to and in accordance with this Annex I…

Because GAAP precluded the attribution of the entire bundled sales credit to the year 2003, ABC argued, Adjusted EBITA had to be reduced accordingly. The court disagreed: the words “as adjusted pursuant to and in accordance with this Annex I” made it “perfectly explicit” that the adjustments in the Annex “took precedence over GAAP accounting”. Chancellor Chandler went on to note that, had ABC wished to tie the bundled sales credit to principles of recognition under GAAP, “it would have been easy to draft such a contract”.

The cost of bad drafting

All told, the cost of omitting the word “weighted”, failing to make the sales credit calculation subject to GAAP recognition rules and failing to make R&D expenditure shortfalls count against EBITA was an upward adjustment to Adjusted EBITA of about $7.4 million, giving Bridge a positive Adjusted EBITA for 2003 of about $4.9 million. The earn-out, which ABC’s negative EBITA calculation had set at $0, was accordingly increased by the revised EBITA calculation to the maximum amount the contract envisaged for 2003: $21 million.

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