Delaware Court Hears Pension Funds' Motion To Enjoin JP Morgan – Bear Stearns Merger

Last week a Delaware Chancery court heard the motion of two pension funds to prevent the JP Morgan – Bear Stearns merger from going forward. As reported by Reuters (here), the court took no action at the hearing. The funds' motion seeks to prevent the sale of 98 million new, non-trading shares of Bear Stearns stock to JP Morgan, which would give JP Morgan a 39.5% interest in the company. JP Morgan would then only need another 10% of shareholders to vote in favor of the merger for the deal to go through.

The court indicated it intended to issue a written decision in the subsequent days, but no opinion has been handed down yet. At the hearing, lawyers for JP Morgan and Bear Stearns asked the court to defer ruling on the case so that a similar proceeding in a shareholder class action would govern the case, a hearing that is set for May 8. The plaintiffs argued the Delaware court is the proper place because the case involves unique and novel issues of Delaware corporate law.

The Delaware court is in a difficult position. The stock sale is set to close on April 8, and the record date for the stockholder vote on the merger is to be set three days after the share issuance according to the merger agreement (available here). So if it decides to defer to the federal court in New York, it will be essentially denying the funds' motion although not reaching the merits of the corporate law issues. Otherwise, the court will need to keep the case and address the issues raised by the funds' motion.

The share issuance was not present in the original merger agreement, which provided that JP Morgan would pay $2 per share to acquire Bear Stearns. After the announcement of the proposed merger, Bear Stearns stock traded significantly higher than the $2 share price, large shareholders expressed disapproval of the merger, and Bear Stearns employees (which owned 30% of the company through an ESOP program) also expressed disagreement with the merger consideration.

On March 24, JP Morgan and Bear Stearns announced the amended merger agreement, which increased the acquisition price to $10 per share and which also included a number of other modifications, including the provision for JP Morgan purchasing 39.5% of Bear Stearns prior to the merger and significant modifications to JP Morgan's and the Federal Reserve's guarantee of Bear Stearns securitized mortgage liabilities (other blogs have provided astute analysis of the changes to the merger agreement, here and here).

While the funds' complaint takes issue with various aspects of the terms of the amended merger agreement, the focus of the injunction proceedings is the share issuance to JP Morgan, which the funds claim "is designed primarily, if not solely, to eviscerate the voting franchise of the current Bear Stearns stockholders" on whether to approve the merger.

The funds' primary argument, relying on Commonwealth Associates v. Providence Health Care, Inc., 1993 WL 432779, (Del. Ch. 1993), is that because the share issuance appears to be for the purpose of impeding the vote of the original Bear Stearns shareholders on the merger, it should be viewed as suspect and only a significant and compelling justification can overcome the presumption that it is improper.

JP Morgan and Bear Stearns no doubt will argue that there was and is compelling justification for the allegedly suspect provisions of the merger agreement. In fact, they have already had to rely on this notion, by invoking NYSE rules that require shareholder approval of any stock issuance over 20% unless "the delay in securing stockholder approval would seriously jeopardize the financial viability of the enterprise." Also, the extraordinary actions of the Federal Reserve – which JP Morgan executives, Bear Stearns executives and government officials defended before Congress Thursday – in providing a $30 billion guarantee of Bear Stearns liabilities as part of the merger would appear to support an argument that there is a compelling need for the share issuance.