The Costs and Benefits of Precommitment: An Appraisal of Omnicare V. NCS Healthcare

I. INTRODUCTION For almost two decades, the law of mergers and acquisitions has operated according to a set of dichotomies. Two fiduciary duties, the duty of loyalty and the duty of care, guide director conduct.1 Two standards of review-business judgment deference and enhanced scrutiny-are applied by courts.2 The applicable standard is determined by a pair of threshold questions also involving a set of dichotomies. Does the transaction involve a change-of-control or not? And is the transaction hostile or friendly? Although the answers given by a schematic of binary oppositions may seem artificial or overly simplistic-basically, change-of-control transactions trigger enhanced scrutiny, while non-change-of-control deals do not,3 and friendly acquisitions are granted judicial deference while hostile acquisitions are likely to occasion another form of heightened scrutiny4-they provided enough clarity to support a massive wave of merger activity in the 1990s.5 But all ofthat has now changed. Recently, in the case of Omnicare v. NCS Healthcare,6 the Delaware Supreme Court split three justices to two7 in a decision that applied a form of heightened scrutiny to a friendly merger not involving a change-of-control.8 Over the objections of two vigorous dissents, the majority articulated a bright-line rule that requires target boards to preserve effective termination rights between the signing and closing of a merger transaction.9 Because merger agreements must include an escape clause, known as a "fiduciary out,"10 enabling the target's board of directors to abandon the initial agreement should a premium bid arise, transacting parties may no longer include deal protection provisions that provide the initial acquirer with certainty that its transaction will close. By writing this rule into the law of negotiated acquisitions, an area that Delaware courts had previously treated with great deference,11 the Omnicare Court rejects the doctrinal dichotomies that have long shaped merger transactions and reaches for a broad principle to guide the merger process: directors sign up deals, and shareholders accept or reject them.12 Directors cannot commit to a particular deal, the court seems to say, in such a way that competing bidders are effectively precluded, thereby narrowing the choices ultimately available to shareholders. Instead, the possibility that the deal will be renegotiated with a new bidder must remain open until the shareholders have voted. The board may not exert such control in signing the deal that they essentially foreclose options that might otherwise have arisen prior to the shareholder vote. But requiring boards to keep their options open between the signing and closing of a merger agreement effectively circumscribes some of the actions available to directors. If boards must include fiduciary outs in their merger agreements, there is some sense in which they cannot commit to deals at all. It does not mean much, after all, to agree to something that you can easily get out of. And if boards must be able to get out of a potential deal the moment a premium bid appears, targets can no longer offer transactional certainty to would-be acquirers, promising a high level of confidence that the deal will close in exchange for another concession in the bargain, and can no longer follow a "precommitment strategy," committing to sell to a particular bidder at some point in the negotiation process in order to force the hand of the other bidders at the table.13 Because precommitment strategies may be used for the benefit of the target corporation and its shareholders, a rule that takes these away threatens to harm shareholder welfare. The issues raised in Omnicare are thus highly relevant not only to practitioners seeking to protect their clients' deals, but also to academics engaged in a number of corporate law debates. The Omnicare opinion opens questions regarding the appropriate standard of review for takeovers and the relevance of prior doctrinal paradigms. …