CAREMARK: DELAWARE COURT ADDRESSES SEVERAL IMPORTANT M&A ISSUES,

FROM APPRAISAL RIGHTS TO CONTRACTUAL DEAL PROTECTIONS

The Delaware Chancery recently issued a preliminary injunction1 postponing for at least
20 days a stockholders meeting at which Caremark Rx stockholders are to consider and vote on the
proposed merger of equals with CVS Corporation. In its ruling, the Court addressed several
important Delaware corporate law issues, most notably the availability of appraisal rights and the
appropriateness of contractual deal protections. To say the least, some of the Courts statements
come as a bit of a surprise. While the unique facts and circumstances of this case undoubtedly
contributed to the Courts decision and may limit its precedential value to some extent, deal-
makers and practitioners should nevertheless pay close attention to this decisions potential impact
on deal structuring and public disclosure requirements.

The original merger agreement between Caremark and CVS provided for Caremark
stockholders to exchange their shares solely for CVS shares. In response to a competing bid from
Express Scripts, Inc., the merger agreement was modified to permit Caremark to declare a special
cash dividend2 prior to the stockholders meeting. However, this dividend is conditioned on, and not
payable until, the closing of the merger. The Caremark board has determined that
Express Scripts competing offer does not constitute a superior proposal and therefore continues
to recommend that stockholders approve the proposed merger with CVS.

The Courts decision touches on several topics that are important to the structuring of M&A
transactions, including:

Appraisal Rights: Under Delaware law, stockholders of a public company are

entitled to assert appraisal rights in any merger transaction requiring them to accept
any consideration other than publicly-traded stock (plus cash in lieu of fractional
shares). However, because the special cash dividend is to be paid to Caremark
stockholders only upon consummation of the merger with CVS, the Court
determined that the dividend is fundamentally cash consideration paid to Caremark
shareholders on behalf of CVS as part of the merger consideration, and as a result,
Caremark stockholders will be entitled to seek appraisal rights if the merger is
completed. In so ruling, the Court declined to apply the well-settled doctrine of
independent legal significance,3 and instead elected to treat the dividend and
merger as an integrated transaction, harshly noting that [in] this case, the label
special dividend is simply cash consideration dressed up in a none-too-convincing

1
See Louisiana Municipal Police Employees Retirement System v. Crawford (Del. Ch. Feb. 23, 2007).
2
The size of this dividend has been increased several times in response to counter-bids from Express Scripts.
3
This legal doctrine would view the special dividend and proposed merger as separate transactions because
each is authorized under separate provisions of the Delaware General Corporation Law.
 disguise . . . So long as payment of the special dividend remains conditioned upon
shareholder approval of the merger, Caremark shareholders should not be denied
their appraisal rights simply because their directors are willing to collude with a
favored bidder to launder a cash payment. As a result, the Court ordered
Caremark to postpone the stockholders meeting for at least 20 days, the minimum
period required under Delaware law to give notice of appraisal rights to stockholders.

Deal Protections: The merger agreement contains a full complement of deal-

protection devices that Caremark and CVS no doubt believed to be customary,
including a force the vote provision4, a no shop provision5, and a last look
provision6. In addition, either company will have to pay the other a $675 million7
break-up fee if its board withdraws or changes its recommendation in favor of the
merger, or if its stockholders reject the merger agreement and accept any other
merger proposal within 12 months thereafter. In a lengthy footnote, the Court made
clear its view that so-called customary deal protection devices cannot be presumed to
be reasonable (and therefore permissible) solely based on past practice. Using the
3% break-up fee as an example, the Court stated that while a 3% rule for
termination fees might be convenient for transaction planners, it is simply too blunt
an instrument, too subject to abuse, for this Court to bless as a blanket rule. Instead,
when analyzing the reasonableness of deal protection devices, the Court indicates
that it will conduct a fact-intensive inquiry and consider a number of factors8 taken
as a whole.

Accelerating Options and D&O Indemnification: The Court rebuked the Caremark
directors and executive officers who stand to benefit handsomely from the
transaction. Because the proposed merger constitutes a change of control for
purposes of accelerating executive stock options and payments under deferred
compensation plans for directors, the Court seemed particularly troubled that the
Caremark directors were arguing that the proposed merger does not constitute a
corporate change of control that triggers an enhanced level of judicial scrutiny under

4
The force the vote provision requires each of the Caremark and CVS boards to submit the merger to its
respective stockholders for a vote, even if such board determines to recommend against the proposed merger.
5
The no-shop provision prohibits each of the Caremark and CVS boards from discussing an alternative
transaction with a competing bidder unless such board concludes, after examining the competing offer, that it
is a superior proposal, or is likely to lead to one.
6
The last look provision requires the target board to disclose the terms of a competing offer determined to
be a superior proposal and then permit the other party to the merger agreement to match such competing
bid during a five-day window period.
7
Representing approximately 3% of the equity value of the proposed merger.
8
The Court listed, without limitation, the following factors: (i) the overall size of the termination fee, as well
as its percentage value; (ii) the benefit to stockholders, including a premium (if any) that directors seek to
protect; (iii) the total size of the transaction and the relative size of the parties to the merger; (iv) the degree
to which a third party found such deal protections to be crucial to the deal, bearing in mind the differences in
bargaining power; and (v) the preclusive or coercive power of all of the transactions deal protections, taken
as a whole.

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 the Courts Revlon doctrine9. According to the Court [i]t is an unfortunate and
disappointing spectacle to watch a board of directors insist that it simultaneously
deserves the protection of the business judgment rule because the company is not
changing hands, while a massive personal windfall is bestowed because it is. The
Court also criticized the Caremark directors for the significant benefits contained in
the merger agreements post-closing indemnification provisions. In short, these
provisions provide protection to Caremark directors post-merger that potentially
could exceed the indemnification rights available to such directors pre-merger in
connection with pending litigation involving alleged stock option backdating10.

Disclosure Issues: The Caremark decision also focuses on important state law
disclosure issues. For instance, in a prior related decision, the Court enjoined
Caremark from holding its stockholders meeting on February 20, 2007, only eight
days after CVS and Caremark first announced the special cash dividend. The Court
considered this to be an insufficient period of time for Caremark stockholders to
consider the new disclosure, and ordered that the meeting be delayed until at least
March 9, 2007. In the most recent decision, the Court noted that the disclosure
regarding the fees payable to the investment bankers (who also provided fairness
opinions), while technically true, was misleading by omission because it failed
to disclose the initial requirement that the bankers had to satisfy in order to receive
their fees. Commenting in general about disclosure regarding investment banking
fees, the Court noted that the contingent nature of an investment bankers fees can
be material and have actual significance to a shareholder relying on the bankers
stated opinion. . . Knowledge of such financial incentives on the part of bankers is
material to shareholder deliberations. Accordingly, the Court ordered enhanced
disclosure concerning the investment banking fees.

It is important to note that while the Court criticized both the substance and process
underlying the proposed Caremark-CVS merger in several important regards, the ruling to enjoin
the Caremark stockholders meeting for an additional 20 days was based solely on the Courts
holding with respect to appraisal rights and inadequate disclosure regarding investment banking
fees. The Court did not find it necessary to intervene further (such as by enjoining the stockholders
meeting altogether as requested by the plaintiffs) because stockholders would still have the
opportunity to consider the additional disclosure, vote on the proposed merger and assert appraisal
rights if they are not satisfied with its terms. On this basis, the Court concluded that Caremark

9
See Revlon Inc. v. MacAndrews & Forbes Holdings, Inc., 506 A.2d 173 (Del. 1986), which, in a change of
control situation, shifts the judicial standard of review of board actions from the deferential business
judgment rule to a heightened level of scrutiny.
10
Two recent Delaware decisions held that the intentional backdating of options may constitute a breach of a
directors fiduciary duties of loyalty or good faith and, as a result, could subject the director to personal
liability because a Delaware corporation is prohibited by statute from exculpating its own directors for
actions that constitute a breach of either of those duties. For a description of these recent rulings, see our
prior Client Alert entitled Delaware Chancery Court Takes On Stock Option Backdating And Spring-
Loading dated February 28, 2007. According to the Court in Caremark, because the merger agreement
calls upon the surviving entity in the merger to provide indemnity post-merger to the current Caremark
directors, the directors protection would be contractual in nature and not subject to the statutory limitations
that are imposed upon a corporation seeking to indemnify its own directors.

3
stockholders would not be irreparably harmed if Caremark were allowed to go forward with the
stockholders meeting11. Despite this limited ruling, however, the harsh tone adopted by the Court
with respect to a number of significant issues warrants attention, and sends a cautionary note to
transaction planners and their clients to consider the potential impacts that the decision could have
on future M&A transactions.

* * *

Please feel free to discuss any aspect of this Client Alert with your regular Milbank contacts
or with any of the members of our Corporate Governance Group, whose names and contact
information are provided below.

Phone E-Mail
New York Scott Edelman 212-530-5149 sedelman@milbank.com
Roland Hlawaty 212-530-5735 rhlawaty@milbank.com
Thomas Janson 212-530-5921 tjanson@milbank.com
Robert Reder 212-530-5680 rreder@milbank.com
Douglas Tanner 212-530-5505 dtanner@milbank.com

Los Angeles Ken Baronsky 213-892-4333 kbaronsky@milbank.com

Michael Diamond 213-892-4500 mdiamond@milbank.com
Melainie Mansfield 213-892-4611 mmansfield@milbank.com

Hong Kong Anthony Root 852-2971-4842 aroot@milbank.com

Beijing Edward Sun 8610-5123-5120 esun@milbank.com

In addition, if you would like copies of our other Client Alerts or any of the Court decisions
discussed herein, please contact any of the attorneys listed above. You can also obtain this and
our other Client Alerts by visiting our website at http://www.milbank.com and choosing the
Client Alerts & Newsletters link under Newsroom / Events.

March 16, 2007

This Client Alert is a source of general information for clients and friends of Milbank, Tweed, Hadley & McCloy LLP.
Its content should not be construed as legal advice, and readers should not act upon the information in this Client Alert
without consulting counsel. Copyright 2007, Milbank, Tweed, Hadley & McCloy LLP. All rights reserved.

NY1:#3445951

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The Court warned, however, that its limited ruling should not be read to mean that the Court was somehow
excusing potential violations of fiduciary duties by the Caremark directors, thereby holding the door open to
future stockholder litigation.
4
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