A recent Delaware Chancery Court decision raises the stakes for faulty compliance with Section 13(d) filings, holding that a jilted merger partner in a deal-jump situation may proceed with a common law fraud claim for damages against the topping bidder based on its misleading Schedule 13D disclosures. NACCO Industries, Inc. v. Applica Inc., No. 2541-VCL (Del. Ch. Dec 22, 2009). The decision, which holds that NACCO Industries may proceed with numerous claims arising out of its failed 2006 merger with Applica Incorporated, also serves as a cautionary reminder to both buyers and sellers that failure to comply with a "no-shop" provision in a merger agreement not only exposes the target to damages for breach of contract, but in certain circumstances can also open the topping bidder to claims of tortious interference.
The court, reviewing a motion to dismiss claims arising out of the failed 2006 merger of NACCO Industries and Applica Incorporated, appears heavily influenced by the particularly egregious facts alleged against Applica and the topping bidder, an affiliate of Harbinger Capital Partners. The complaint alleges that Applica management, concerned that their jobs would be at risk if they were acquired in a strategic deal by NACCO's subsidiary, favored an acquisition by a financial buyer such as Harbinger and provided inside information to Harbinger throughout negotiations between Applica and NACCO. According to the complaint, Harbinger used the information to accumulate surreptitiously a nearly 40% stake in Applica, while failing to disclose anything more than "investment intent" in its 13D filings, thereby obtaining a significant advantage over NACCO in the bidding contest.
Common Law Fraud Claim Based on Section 13 Filings. Although a state court does not have jurisdiction over disclosure violations in SEC filings required by federal law, the Delaware court finds that it does have authority to entertain a common law fraud claim arising out of false or misleading statements made in such filings. While not groundbreaking as a legal matter, this ruling underscores that the consequences of faulty 13D disclosure can be far greater than an order of corrective disclosure. Moreover, a 13D filer would not be able to moot the type of claim being asserted by NACCO through "curative" disclosure, as TCI was able to do in the widely-publicized CSX situation.
In order to prevail in its fraud claim, NACCO will have to show both that Harbinger made the filings with an intent to mislead NACCO and that NACCO relied on Harbinger's statements in making decisions about how to proceed in its negotiations with Applica. Even at the pleadings stage, Vice Chancellor Laster calls NACCO's case "close," and it is far from clear that NACCO will ultimately prevail on this point, but investors should heed the court's focus on Schedule 13D disclosures, which have received similar attention from the SEC.
Bidders should note Vice Chancellor Laster's flat-out rejection of Harbinger's contention that "one need not disclose any intent other than an investment intent until one actually makes a bid." The Vice Chancellor's position is consistent both with Regulation 13D and the SEC's long-held guidance that even where a Schedule 13D catalogues a long list of potential options in Item 4, the purpose section, the filing must be amended to disclose accurately once an intention changes. Identifying when that occurs on the continuum between exploring alternatives and having a firm plan is a context-specific inquiry. The Harbinger decision does not settle the question, but illustrates the risks attendant in waiting to disclose until a formal bid submission is real. Note that the 13D in the Harbinger case did not even contain a general list of alternative possibilities in the "purpose" section. Instead, Harbinger reported that it had acquired Applica shares for "investment purposes only" and subsequently amended its filing to drop the word "only," an action which the court deemed a "fig leaf."
Damages Exposure for Breach of Deal Protection Provisions. Assuming the facts as alleged by NACCO to be true for purposes of this ruling, the court had "no difficulty inferring" from the pleadings that Applica failed to meet its obligations under the merger agreement's no-shop, superior proposal and prompt notice provisions. Vice Chancellor Laster emphasized that in the context of a topping bid, "days matter," and that Applica could have been expected to have "regularly picked up the phone." Not surprisingly, the court found that NACCO's receipt of the termination fee does not prevent it from seeking damages against Applica because Applica's right to terminate the merger agreement was predicated on its having complied with the other provisions of the agreement and the agreement's limitation on liability excluded any termination due to willful and material breach.
Tortious Interference Claim Against Topping Bidder. The court's ruling that NACCO may proceed with its tortious interference claim against Harbinger is not novel, or indeed surprising, given the facts alleged. No-shop and other deal protection provisions are carefully drafted to protect the original merger party, and well-advised bidders are careful to observe the procedures and formalities set forth therein. In the present case, by contrast, Harbinger is alleged to have knowingly colluded in contacts and communications with Applica that violated the no-shop and prompt notice clauses in Applica's merger agreement and obtained an unfair advantage over NACCO by accumulating a large stock position in Applica based on false disclosures, thereby interfering with NACCO's expectations of performance under the merger agreement.
See NACCO Industries, Inc. v. Applica Inc., No. 2541-VCL (Del. Ch. Dec 22, 2009).