The Deal, Unlocked

A controversial Delaware Supreme Court decision knocks down a tactic for sealing a merger agreement.

If there’s anything a dealmaker hates, it’s uncertainty. But thanks to the controversial Delaware Supreme Court decision in Omnicare Inc. v. NCS HealthCare Inc., more uncertainty in mergers and acquisitions may lie ahead.

In a rare 3-2 split decision last April, Delaware’s highest court invalidated a merger agreement between NCS and Genesis Health Ventures that was protected by a shareholder lockup, a commonly used technique for ensuring that a deal will be consummated. Calling the lockup and other deal-protection devices “coercive” and “preclusive,” the court reversed a Delaware Court of Chancery decision that tolerated the lockup—through which Genesis had essentially frozen out Omnicare’s superior offer for NCS.

Not all lockups are designed expressly to seal a negotiated deal. Stock-option lockups, asset lockups, and breakup fees are types of lockups that let suitors claim a consolation prize if their offers are trumped between the signing of a merger agreement and the shareholder vote. In a shareholder lockup, by contrast, an acquirer secures the backing of large or controlling shareholders prior to the actual vote, an approach naturally more common in the pursuit of smaller companies.

The decision in Omnicare doesn’t put an end to shareholder lockups, but it does undercut the effectiveness of the tactic. “Those of us who practice in the area don’t believe, and didn’t before this case, that in normal circumstances you could lock up a deal all the way,” says Frederick S. Green, senior partner and head of the M&A practice at Weil, Gotshal & Manges LLP in New York. “But if there was ever a fact pattern where you might get yourself comfortable that you could do it, it was this one.”

Genesis of the Case

The story behind Omnicare begins in late 1999, when NCS, a Beachwood, Ohio-based provider of pharmacy services to long-term-care institutions, began to suffer from a decline in government and third-party reimbursements. In February 2000, it hired a financial adviser to help find an acquirer or equity investor, but an exhaustive search turned up only one offer, which required filing for bankruptcy and arranging a so-called Section 363 bankruptcy asset sale, for an amount well below its debt.

Unhappy with that option, NCS changed advisers in December 2000 and continued its search for a financial savior. By early 2001, the company was in default on some $350 million in debt. Then, in the summer of that year, NCS began talks with another potential suitor—Omnicare, an 800-pound gorilla in the institutional-pharmacy business, with 2002 sales of $2.6 billion. But Covington, Kentucky-based Omnicare also proposed a 363 sale, conditioned on due diligence, that would pay down more of the debt but, again, leave nothing for shareholders.

As 2002 dawned, NCS’s business began to revive, giving its board renewed hope that a better offer could be found. In January, a committee of NCS creditors began discussions with Genesis, a Kennett Square, Pennsylvania, provider of health-care services for the elderly. Genesis signed a confidentiality agreement with NCS and began due diligence.

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