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Private Equity Buyout Frenzy Raises Legal Issues

Judges in Delaware's famed business court are keeping a close eye on legal issues cropping up amid the recent wave of private equity buyouts of public corporations.

In recent rulings, Court of Chancery judges have signaled that Delaware, corporate home to more than half of the Fortune 500, plans to take the lead in disputes arising from the buyouts.

A key issue surrounding the acquisitions is whether managers negotiating deals in which they would keep their jobs after helping take companies private are diligent enough in trying to maximize shareholder value by finding other bidders.

"In a buyout, the shareholder is out completely," noted Charles Elson, director of the University of Delaware's Center for Corporate Governance. "If management stays, the idea is that there will be profits to be had down the road. ... It's the price the shareholder is getting, that's the bottom line."

Vice Chancellor Leo Strine Jr. refused earlier this month to dismiss or stay a consolidated shareholder lawsuit involving a proposed $385 million buyout of baseball card maker Topps by a group that includes former Disney CEO Michael Eisner. A hearing is scheduled for June 11 on a preliminary injunction to halt the deal.

The plaintiffs allege that Topps directors failed to fulfill their fiduciary duties by agreeing to sell the company at a bargain price and by signing off on measures designed to ward off other bidders. They also raise concerns about potential conflicts of interest for Topps officials negotiating the deal.

Strine said the issues surrounding private equity buyouts are too important for him to defer to a New York court where a Topps shareholder filed suit one day before the first of five similar lawsuits were filed in Delaware.

"Although our courts have deferred to clearly first-filed actions in corporation cases involving settled questions of law, ... our courts have long been chary about doing so when a case involves important questions of our law in an emerging area," Strine wrote.

Strine said the going-private transactions raise questions about how to address potential conflicts of interest and balance deal certainty against obtaining price competition "in a very different market dynamic."

"Delaware has an important policy interest in having its courts speak to these emerging issues in the first instance, creating a body of decisional authority that directors and stockholders may confidently rely upon," he wrote.

In March, Strine postponed a shareholder vote to approve the $115 million buyout of business software provider Netsmart Technologies of Great River, N.Y., until the company provided shareholders more information about future cash flow projections and why its board didn't pursue strategic buyers.

"If you don't turn over the strategic buyer stones ... because you're only looking under the private equity rocks, you may be missing out on a better deal," explained Lawrence Hamermesh, professor of corporate and business law at Widener University in Delaware.

In refusing to put the Topps litigation on hold, Strine cited his Netsmart ruling as one of two instances in which Delaware has addressed recent private equity buyouts.

In the other, Vice Chancellor Stephen Lamb refused last year to approve the settlement of a lawsuit involving a buyout of SS&C Technologies of Windsor, Conn., that was instigated by CEO William C. Stone without prior authorization from the board. Lamb took the parties to task for not consulting the court about a planned settlement based on supplemental proxy disclosures, and for not demonstrating that potential claims of shareholder plaintiffs had been adequately investigated.

Among the questions left unanswered, Lamb noted, was whether Stone misused corporate information and resources in hiring an investment banker to help him identify a private equity partner. Lamb also wondered whether Stone's initial dealings with Carlyle Investment Management hampered the ability of a special committee of SS&C directors to objectively consider the buyout, attract competing bids and secure the best price.

"The plaintiffs' submissions, both written and oral, fail to come to grips with the fact that Stone had an array of conflicting interests that made him an unreliable negotiator or that the special committee was placed in a difficult position by Stone's pre-emptive activities," Lamb wrote.

"A manager who has the opportunity to both take $72.6 million in cash from the transaction and roll a portion of his equity into a large equity position in the surviving entity has a different set of motivations than one who does not," he added.

A trial in the SS&C lawsuit is scheduled for July 2008.

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