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Del. Supreme Court Cites Timing of Deal Talks in Reviving Case Over Oil and Gas Merger


Delaware Supreme Court.

The Delaware Supreme Court has revived part of a shareholder derivative lawsuit over Earthstone Energy Inc.'s controller-led acquisition of Texas-based Bold Energy III LLC, ruling that deal negotiations had started before a special committee could establish protections for the oil-and-gas driller's minority investors.

The ruling, published Friday by a three-judge panel of the state high court, applied the justices' 2014 precedent in the case Kahn v. M&F Worldwide to deny business-judgment deference to the Earthstone board and reversed, in part, the Chancery Court's dismissal of the case in its entirety last July.

In MFW, the Supreme Court held that mergers proposed by a controlling stockholder and its corporate subsidiary can only avoid Delaware's rigorous "entire fairness" review when conditioned from the beginning on the approval of a strong, independent special committee and the uncoerced and informed vote of a majority-of-the-minority of stockholders.

The high court later clarified that MFW's timing requirement meant those minority protections must be in place prior to any substantive economic negotiations with the target.

Earthstone investor Nicholas Olenik seized on those two rulings to challenge a tie-up between Earthstone and a cash-strapped Bold, which is controlled by EnCap Investments, a private equity firm that until recently held a majority stake in Earthstone. In his June 2017 complaint, Olenik argued that merger negotiations started eight months before Earthstone's independent directors formed a panel to evaluate the deal, resulting in an unfair deal that favored EnCap over Earthstone's public stockholders.

Vice Chancellor Joseph R. Slights III, however, granted the defendants' motion to dismiss the case on business-judgment grounds, saying that the lengthy talks "never rose to the level of bargaining" and were only exploratory in nature.

On Friday, Justice Collins J. Seitz Jr. noted that Slight's ruling last July came before the high court decided Synutra. Still, he said, Earthstone, EnCap and Bold had clearly held back-and-forth conversations well before Earthstone had tried to bring the process in line with MFW.

"While some of the early interactions between Earthstone and EnCap could be fairly described as preliminary discussions outside of MFW’s 'from the beginning' requirement, the well-pled facts in the complaint support a pleading stage inference that the preliminary discussions transitioned to substantive economic negotiations when the parties engaged in a joint exercise to value Earthstone and Bold," Seitz wrote on behalf of the panel.

"Based on these facts, it is reasonable to infer that these valuations set the field of play for the economic negotiations to come by fixing the range in which offers and counteroffers might be made," he said.

He was joined in the opinion by Justices Leo E. Strine Jr. and Karen L. Valihura.

The ruling, however, revived only part of Olenik's case against the board. Seitz held that claims over an allegedly misleading proxy accompanying the merger's announcement had not cited specific information that would have affected how a reasonable investor would vote on the deal.

According to court papers, shareholders approved the merger in May 2017, with more than 99 percent voting in favor of the transaction.

An attorney for Olenik on Monday declined to comment on the ruling. Counsel for Bold, Earthstone and the company's directors did not immediately return a call seeking comment on the decision.

Olenik is represented by Jeremy S. Friedman, Spencer Oster and David F.E. Tejtel of Friedman Oster & Tejtel in New York; Ned Weinberger and Thomas Curry of Labaton Sucharow and Peter B. Andrews, Craig J. Springer and David Sborz of Andrews & Springer, both in Wilmington. Weinburger, of Labaton, argued the appeal.

Bold, Earthstone and its board are represented by Kenneth J. Nachbar, D. McKinley Measley and Lauren Neal Bennett of Morris, Nichols, Arsht & Tunnell in Wilmington; Gerard G. Pecht of Norton Rose Fulbright in Houston and Peter A. Stokes and William Patrick Courtney from the firm's Austin, Texas office.

EnCap and its related entities are represented by Rolin P. Bissell and James M. Yoch Jr. of Young Conaway Stargatt & Taylor in Wilmington and Michael C. Holmes, Craig E. Zieminski, Stephen S. Gilstrap, R. Kent Piacenti and Jeffrey Crough of Vinson & Elkins in Dallas.

The case, now remanded to the Court of Chancery, is captioned Olenik v. Lodzinski.