In Re Toys R Us, Inc. Shareholder Litigation

Facts

The Iron Workers of Western Pennsylvania Pension and Profit Plans and Jolly Roger Fund LP, are shareholders (P) of defendant Toys 'R' Us, Inc. (D). D's board of directors consists of ten members. Ps concede that nine of those members are independent, non-management directors. The Executive Committee of the board is comprised of four members. D was faced with severe price competition from discount merchandisers. In addition, preferences of children were changing. Televisions and computer games were invading the province of traditional toys. In 2003, domestic toy sales declined nearly 5% over the prior year's holiday period and were flat internationally. D's shares traded below $11 apiece. D was looking for a way out. The board retained an investment banking team from Credit Suisse First Boston ('First Boston') to help it develop and evaluate its options. One of its divisions, Global Toys, owned many of the properties on which its stores operated. Those properties were very valuable in a hot real estate market. The board retained the law firm of Skadden, Arps, Slate, Meagher & Flom to advise them as to their legal and equitable duties in the review process. Best Buy, Home Depot, PETsMART, Staples, and Office Depot each expressed an interest in a portion of Global Toys' real estate portfolio. First Boston recommended making a public offering of the Company's Toys Japan equity interest; 'Monetizing' the value of Babies 'R' Us by spinning or splitting it off to the stockholders; Selling Global Toys and monetizing the Babies 'R' Us division but if Babies 'R' Us was sold first, the tax ramifications to the Company and its stockholders could be substantial; or Retaining Babies 'R' Us as the Company's sole remaining retail division and selling Global Toys. First Boston 'did not believe there was a buyer for the whole company.' The board debated the pros and cons of the various options and discussed the work needed to be done in order to make a decision whether to pursue one of the four options management, and First Boston had urged be their focus. First Boston had briefed the board on its 'sum of the parts' valuation of the Company. The board met a number of times to determine what to do. They even doubled the length of their August 10 meeting and to make themselves available for telephonic meetings earlier if developments warranted. Independent board members indicated that they were leaning towards a total spin-off of Babies 'R' Us as a preferred option if there was to a be a separation of that division. Cerberus Management, L.P., and GS Capital Partners sent the Company a formal expression of interest in purchasing Global Toys for between $2.6 billion and $3.0 billion (between $11 and $13 per share) in cash. Apollo Advisors, also orally expressed interest in buying Global Toys. The board authorized First Boston to inform both Cerberus and Apollo that the Company would be prepared to hold discussions with them after the board's August 10 meeting. The board approved a strategy focused on separating Global Toys and Babies 'R' Us, either by selling Global Toys or by spinning off Babies 'R' Us. Management was authorized to publicize this strategic direction through a press release that the board had reviewed in its executive session. The board authorized First Boston to solicit buyers for Global Toys. First Boston heard from eleven sources that expressed interest in buying the entire Company. It did not report those tentative expressions of interest to the board. First Boston contacted 29 potential buyers for Global Toys who were a 'who's who' of private equity funds. On November 2, 2004, nine bids came in; some of which were consortia bids from private equity firms that had joined together as bidding partners. The Executive Committee met on November 3, 2004, to review the preliminary bids. First Boston indicated that none of the bidders expressed any interest in acquiring the Corporation as a whole. Some of the preliminary bids for Global Toys seemed to be at very attractive levels. The sale of Global Toys, therefore, looked like the option for separation that would deliver the most value for Company stockholders. The Executive Committee decided to put the idea of a Babies 'R' Us spin-off on hold pending the outcome of the sales process. On November 18, the full board met and accepted the recommendation of the Executive Committee to proceed with a sale of Global Toys, and to defer any plan to spin off Babies 'R' Us. After due diligence, four bidders were left -- KKR, Cerberus, Apollo, and the Bain/Vornado group. A final bid was set for February 15. D's results for the 2004 holiday season were improved from the year prior. On January 21, the board met and authorized the Executive Committee to make day-to-day decisions about the sales process, in order to facilitate a timely response to developments as they arose. The Executive Committee met on February 9 to discuss Cerberus's request to First Boston that it be permitted to bid for the entire company, not just Global Toys. Cerberus was given a green light to make such a bid. The 'final' bids came in at KKR $13.62 per share; Apollo - $13.21 per share; Cerberus $13.10 per share; Bain/Vornado $12.73 per share. Cerberus also offered to buy the whole Company for $23.25 per share, subject to due diligence on Babies 'R' Us. Bain/Vornado also expressed an interest in buying the entire Company but did not state a price. The Committee was intrigued by Cerberus's $23.25 bid; it did not consider that price to be sufficiently attractive to halt a push towards a sale of Global Toys. First Boston was instructed to extract from the final bidders yet another 'final' bid on Global Toys while signaling if asked, that the board would consider any whole Company offer with an open mind. It is the contention of P's that KKR and others were following the 'rules' laid down at to what was for sale. Also, KKR's bit was contingent on management staying which was attractive to the current CEO. KKR increased its bid, to $15.54 per share. KKR topped Cerberus's bid by a small margin, and the Apollo and Bain/Vornado bids by a greater increment. Cerberus had increased its offer slightly for the whole Company, indicating that it would pay $24 per share with due diligence on Babies 'R' Us, and $23.25 without additional due diligence. The directors began to get gun shy and wondered if the current bidding process had run its course. It decided that if Cerberus was willing to increase the price and closing certainty of its whole Company bid, then the Executive Committee could authorize the other bidders to make a similar bid. Cerberus, improved its whole Company offer to $25.25 per share, without a due diligence condition, and signaled that it might move that bid north. Eyler, agreed that the new Cerberus bid justified taking the risk of asking the final bidders to submit a bid for the whole Company, to be made after a rapid period of due diligence on Babies 'R' Us. Cerberus tried to pressure D into giving it a leg up on the other bidders. It threatened to withdraw if D did not enter into an exclusivity agreement with it. D did not assent and Cerberus backed down. KKR and Bain/Vornado banded together to present a joint bid for the entire Company. Apollo balked at moving quickly. It ventured the possibility of a bid of $24 to $26 if it could have two to three weeks more due diligence. Eyler and First Boston wanted to end the process by March 16. The KKR Group Tops Cerberus By $1.50 Per Share. After lengthy discussions, the board decided to sell the whole Company to the KKR Group. Duff & Phelps presented a range of values for the Company operating as a single entity of between $19.76 and $21.45 per share. A separate range of values was presented for Global Toys and Babies 'R' Us, successfully divided and operating separately, of between $22.23 and $25.33. The board then instructed the Company's legal and financial advisors to try to conclude a merger agreement with the KKR Group promptly. The independent directors met in executive session to consider the effect of a merger with KKR Group on Eyler and other top executives. Eyler's compensation was largely comprised of stock and options, and therefore that 'his interests were closely aligned with that of the shareholders. The board also discussed Eyler's potential severance package, recognizing that the KKR Group might 'decide to terminate his services.' In the event that the merger agreement was terminated simply because D's stockholders voted it down, D offered only to reimburse the KKR Group for a to-be-negotiated sum approximating its documented, out-of-pocket expenses. D included in its proposal a 'no shop' provision that precluded D from continuing to shop itself. D insisted on retaining the right to consider a superior proposal if one came along unsolicited. As finally adopted, the merger agreement contained four deal protection measures: 1) a fixed termination fee of $247.5 million, equal to 3.75% of equity value or 3.25% of enterprise value - payable for the most part only if D terminated the merger agreement in order to sign up another acquisition proposal within a year; 2) an agreement to pay up to $30 million in documented expenses after a naked no vote; 3) a relatively non-restrictive no-shop clause that permitted the consideration of unsolicited bids; and 4) a temporally-limited match right. The board discussed these provisions. Ds also invoked the attorney-client privilege. Of the ten directors, only Eyler is employed by the Company. All of the directors, however, received compensation for their services in the form of stock options. The value of the independent directors' options range broadly from as little as $150,000 to as much as $1.7 million. Eyler, on the other hand, will receive some $65 million for his equity. First Boston stood to receive $7 million more in fees for the sale of the entire Company than it would have received for the sale of Global Toys by itself. Ps filed suit and seek a preliminary injunction against the closing of the merger.

Issues

Rule of Law

Holding and Decision

Legal Analysis

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