The board of directors of any Delaware corporation proposing to merge is required under Delaware law to adopt a resolution approving the merger agreement. In the real world of M&A practice, however, the version of the merger agreement presented to and approved by the board is typically still in draft or nearly-final draft form but not yet final. Does this practice violate Delaware law?
A recent amendment to the Delaware General Corporation Law (“DGCL”) provides that any agreement that must be approved by the board under Delaware law must be in “final or substantially final” form when approved. The DGCL amendment was adopted in reaction to an earlier Delaware Chancery Court ruling in favor of a stockholder that claimed that the board violated Delaware law when it approved only a draft version of the merger agreement. These developments underscore the need for boards to consider whether a merger agreement draft submitted for approval is substantially final before approving it.
Statutory and Practice Background
DGCL Section 251(b) provides that the board of directors of each corporation that desires to merge must adopt a resolution approving an agreement of merger and declaring its advisability. It also specifies certain provisions that must be included in the merger agreement being approved, including the terms and conditions of the merger, the mode of carrying it into effect and the changes in the certificate of incorporation of the surviving corporation proposed to be effected in the merger.
In the normal rhythm of an M&A deal, the target board is asked to approve the merger at some point before the merger agreement is finalized. In most deals, final insertions are made and schedules and exhibits are completed between board approval and execution of the agreement.
The Activision Case
On January 17, 2022, the board of directors of Activision Blizzard, Inc. approved a merger agreement for the merger of Activision with Microsoft Corporation. The version of the merger agreement approved by the board did not include the company disclosure letter, the disclosure schedules or the certificate of incorporation for the surviving corporation. The draft merger agreement also did not state the amount of merger consideration, and included a placeholder (“[●]”) for later identification of the target (Activision).
Also missing from the draft merger agreement was a dividend covenant. The parties knew that it might take years to obtain antitrust clearance which was a condition to closing. The dollar amount of dividends that Activision would be allowed to pay between signing and closing was identified as a “key open issue” to be resolved after the January 17 board meeting, presumably in an ordinary course covenant of the merger agreement which was missing from the draft approved by the board.
The Activision board did not review or approve any version of the merger agreement after January 17, 2022. In final form, the agreement contained several key components missing from the previously approved draft version, including disclosure schedules, exhibits and a dividend covenant.
An Activision stockholder commenced a lawsuit in November 2022 against the Activision directors (as well as against Activision itself, Microsoft and its directors) for, among other claims, violating Section 251(b) of the DGCL by approving a not-yet final draft rather than an execution copy of the merger agreement.
In their motion to dismiss, the defendants argued that requiring the board to approve an execution-version of a merger agreement would run contrary to market practice and would lead to uncertainty; that given the practical realities of negotiating merger agreements, boards commonly adopt resolutions approving a merger agreement in draft or near-final draft form and declaring its advisability before the agreement has been finalized. This is especially true with respect to disclosure schedules and other ancillary documents.
In her Memorandum Opinion ruling on the defendants’ motion to dismiss, Chancellor Kathaleen McCormick determined there was no need to resolve the tension between the plaintiffs’ execution-version approach to Section 251(b) and the defendants’ market practice argument. For the sake of analysis, the court assumed the defendants’ interpretation that Section 251(b) does not require approval of an execution-version of a merger agreement.
So what exactly did Section 251(b) require? At a minimum, the court ruled that Section 251(b) mandates that a board approve a merger agreement that is “essentially complete”. The court reasoned that absent an essentially complete draft, Section 251(b)’s board approval requirement would make no sense inasmuch as board approval of a merger agreement would serve no purpose if the ultimate merger agreement was altered in essential ways, and that a board could not legitimately declare the advisability of the merger absent a review of essential terms. According to the court, the defendants’ market practice argument fails under an “essentially complete” interpretation of Section 251(b). The court further stated that requiring a board to approve an essentially complete merger agreement entails the “basic exercise of fiduciary duties” and “good corporate hygiene”, is not commercially unreasonable and would not lead to uncertainty.
Having ruled that Section 251(b) required that boards approve a substantially complete merger agreement, the court next considered whether the merger agreement approved by the Activision board was in fact “essentially complete”. The court concluded it was reasonably conceivable that the merger agreement that was approved by the Activision board was not essentially complete because it was missing “a lot of important stuff”. The merger consideration was essential. The disclosure letter was referenced 45 times in the merger agreement and contained information that was important to the agreement. Section 251(b) specifically includes the surviving company’s certificate of incorporation in the list of six items a merger agreement must include. The dividend covenant was a “key open” issue. On the issue of the disclosure schedules, however, the court conceded that reasonable minds could differ.
This being a ruling at the pleading stage, the court refused to delve into exactly what missing information was required for an “essentially complete” merger agreement.
Legislative Reaction
In reaction to the Activision case, the Delaware legislature adopted amendments to the DGCL that became effective August 1, 2024. The amendments added a new DGCL Section 147 which provides that any agreement, instrument or document that is statutorily required to be approved by a board must be in “final or substantially final form” when approved. While new Section 147 does not explicitly describe what constitutes “substantially final”, the legislative synopsis indicates that all materials terms of the merger must be either (i) set out in the agreement, instrument or document, or (ii) determinable through other information or materials presented to or known by the board.
Key Takeaways
In light of the Activision case and the DGCL amendment addressing it, it is important that a Delaware board consider whether a merger agreement draft submitted to it for its approval is in substantially final form (including potentially all disclosure schedules and exhibits referenced in the merger agreement) before approving the agreement. If there is any uncertainty as to whether or not the merger agreement is in substantially final form, directors should insist on receiving information or materials from which the material terms of the merger could be determined. Drafters of board resolutions approving a merger agreement should also consider adding self-serving language in recitals preceding the authorizing resolutions to the effect that the directors have determined that the merger agreement in the form presented contains all of the material terms of the merger and is in substantially final form, and/or that the directors have received documents from which to determine the material terms of the merger.
New Section 147 also provides a mechanism for the board to ratify a statutorily required agreement, instrument or document (including a merger agreement) after board approval and up until the time of filing with the Secretary of State. The ratification can serve as evidence that the initially approved agreement, instrument or document was in substantially final form.