Delaware’s “Toys “R” Us Decision: Requirements for Corporate Sale Process

The recent Delaware Court of Chancery decision in Toys “R” Us Inc. Shareholder Lit. (C.A. No. 12-12-N (Del. Ch. June 22, 2005, Strine, V.C.)) is in keeping with the Court’s reluctance to second-guess the business judgment of a Board of Directors in structuring the sale of a company, provided that the Board has thoroughly considered all viable strategic alternatives and carefully educated itself on the value of the company’s business.

The case was brought by a group of Toys “R” Us stockholders seeking to enjoin the pending $6.6 billion sale of the company to a consortium of private equity investors headed by Kohlberg Kravits and Roberts & Co. (KKR). Agreement with KKR was reached after nearly a year were the Board and management conducted a wide-ranging evaluation of the company’s strategic alternatives and obtained detailed information regarding the value of its business and its real estate holdings. Originally having considered only selling individual divisions of the company, the Board finally determined that sale of the entire company was preferable.

In reaching its decision to deny the plaintiff’s motion to enjoin the sale, the court evaluated various aspects of the sale process, including the following:

□ By granting KKR a $247.5 million break-up fee, a right to match a later bid, and a $30 expense reimbursement if Toys “R” Us shareholders voted down the sale, plaintiffs argued that the Board had unreasonably deterred additional, and potentially more lucrative, offers for the company. The court held that the directors decision to protect the KKR deal was not unreasonable, given that KKR’s bid was $300 million higher than the next highest bid, the company had negotiated down the break-up fee from 4% to 3.75%, and in the court’s view the fee would not act “as a serious barrier to any bidder willing to pay materially more.”

□ The court did, however, point out that an “excessive” termination fee that “presents a more than reasonably explicable barrier to a second bidder” would be considered unfavorably and indicated that it would continue to consider break-up fees in a nuanced manner. Therefore, it cautioned that a fee lower than 3% would not by definition be regarded as reasonable.

□ Whereas the company had originally considered selling its divisions individually, after several of the bidders indicated an interest in purchasing the entire company, the Board decided to put the entire company up for sale and limit the auction to the four bidders who had initially conducted due diligence, in order to avoid “losing the birds in the hand”. The upholding the Board’s decision the Court emphasized that no new bidders had emerged even after the Wall Street Journal reported that two of the existing bidders had expressed interest in purchasing the whole company.

□ The Court also indicated its approval of the manner in which management and the Board had disentangled discussions regarding sale of the company with decisions regarding whether the purchaser would retain key managers and the CEO. During the negotiations, the company had in fact required KKR to remove a condition to the contract requiring existing management to run the company post-sale.

Simon Riviles