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Court of Chancery Explains Revlon Duties

Posted In M&A

In re Netsmart Technologies, Inc., C.A. No. 2563-VCS, 2007 WL778612 (Del. Ch.).

When a company is to be sold, then the board of directors have so-called Revlon duties that basically come down to getting the best price. There is no set methodology or procedure the board must employ.  However it proceeds, its actions will be subject to a level of increased scrutiny by a reviewing court. In other words, the normal business judgment rules do not apply in such a case. This important decision illustrates what the Court of Chancery expects a board in "Revlon land" to do. 

Here the board was faced with two possible sets of potential buyers for their company: (1) so-called strategic investors who would acquire the company to run it as part of their other business interests and (2) private equity investors who would let current management run the company after taking it private. The board never really explored the possibility of a sale to strategic investors and, apparently, preferred a sale to private equity from the outset. Only one bidder stayed the course and the court was faced with a complaint that the price was not high enough. After finding some disclosure problems with the proxy materials, the Court held that the stockholders should be given an amended disclosure statement that included more financial information and enjoined the meeting until that was done. More importantly, the Court also ordered that the stockholders be told that their board had not really pursued a sale to strategic investors.

There are several fine points that should be noted about this decision. First, the heart of the decision is the Court's search for assurance that the board really did act rationally in choosing alternatives and not out of its self-interest. Note that the Court seemed very skeptical of private equity that offers to keep management in place if only management will go along.

Second, the usual devices designed to carry out a board's Revlon duties may not work in all cases to prevent an adverse ruling. Here, for example, the deal permitted post-announcement shopping and had only a small termination fee. The Court felt those were not enough given the micro-cap status of the company that might have kept it from being noticed.

Third, the decision reflects the highly sophisticated business knowledge of the members of the Court of Chancery. The decision cites to financial literature and somewhat obscure materials on deal making that will be taken into account in reviewing a proposed transaction. In other words, the Court of Chancery may be smarter than the litigants think and that will get them in trouble.



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