I think we are gonna hear about more and more about this type of thing, shareholders complaining – and eventually litigating – over how votes are counted at shareholders’ meetings. In the hotly contested deal involving CSX Corp. and The Children’s Investment Fund (TCI) – which resulted in a big Delaware court decision last month – there continues to be fighting over the vote count. Here is an entry from the WSJ Deal Journal:
Remember the 2000 election? The vote recounts. The hanging chads. The bitter opponents and bad feelings that lasted for years? Here is your chance to relive it all–at least, if you’re a merger wonk.
The playing field this time is the continuing battle between railroad CSX and activist hedge fund The Children’s Investment Fund. TCI, you might remember, earned a mixed win in its battle for five CSX board seats: it appeared to win four seats, but a court found that TCI and its ally 3G Capital Partners broke SEC rules by failing to disclose their intentions while amassing a 19% stake in the company, 12% of which was through complex derivatives known as total return swaps.
The current slapfight comes down to those four board seats: CSX still is counting the ballots from the June 25 voting. Several hundred million votes have been cast and, according the company, CSX’s independent vote supervisor has found fault with votes cast electronically. (So they aren’t literal hanging chads, but metaphorical ones). People familiar with the company say the miscounted votes put TCI nominee Chris Hohn a little more than 800,000 votes ahead–a margin of around one-third of 1%.
So the company is pressing on with the vote recounts, while TCI is criticizing CSX for dragging its feet and maintains that the recount won’t change the totals. CSX had said it would announce the final results by this Friday; that looks very unlikely. At the same time, CSX has a lawsuit pending before the U.S. Court of Appeals for the Second Circuit to “sterilize” some of the votes and depose the TCI-nominated directors; the court’s decision is expected Aug. 25.
Now RiskMetrics–the former ISS–has jumped into the fray. The shareholder advisory firm previously supported four of TCI’s slate of five nominees and today released a statement blasting what it called “a poorly conceived ’scorched earth’ defense strategy” by CSX.
The statement is of a piece with the continuing war between CSX and RiskMetrics. When RiskMetrics supported the board nominees, CSX complained that the proxy firm made an “attempt to dismiss the opinion of the federal court” and “substituted its own uninformed judgment for the court’s conclusions.” RiskMetrics fired back that it would question the integrity of the hedge funds’ nominees only if they faced criminal charges for perjury. CSX shot back that it was “a low standard” for membership on the board of a publicly traded company.
The timing of RiskMetrics’ latest volley is peculiar since it appears to have a dissenting voice in its own house: former Securities and Exchange Commissioner Arthur Levitt. Levitt sits on the board of RiskMetrics. On July 18, he also joined several other former SEC chairmen in filing a friend-of-the court brief supporting CSX in the lawsuit against TCI.
This recent article from The Deal Newsweekly provides some insight into how private equity shops are pushing for language in their merger agreements that clearly state the target has no right to specific performance. And that the time between signing and closing is growing shorter and shorter…
- Distressed Debt Transactions: “Soup to Nuts”
- The SEC’s Cross-Border Proposal: Top Four Ways Deals Would Change
- The SEC’s New Cross-Border Guidance: Four “Don’ts” for Structuring Cross-Border Deals
- Follow-Up: How to Do a Deal Without Shareholder Approval: The Financial Viability Exception”
- Hedge Fund Attacks: Eight Lessons Learned from the In-House Perspective
- Jumping Through Standstills
- The Shareholder Activist Corner: Spotlight on Shamrock Activist Value Fund
- The Implications of CSX: Beneficial Ownership Reporting Through Total Return Swaps
Some pretty fine analysis – and quick – from Travis Laster: Yesterday, the Delaware Supreme Court issued its much anticipated decision in CA, Inc. v. AFSCME Employees Pension Plan, No. 329, 2008 (Del. July 17, 2008), which resolved two questions of law certified to the Court by the SEC. AFSCME proposed for inclusion on CA’s proxy statement a bylaw that would require the CA board of directors to reimburse the reasonable fees of any stockholder that sought to elect less than 50% of the board (i.e. a short slate) and succeeded in electing at least one director. Here is the court opinion and the related Corp Fin no-action response.
The Delaware Supreme Court split the baby on the two certified questions. Answering the first in the affirmative, the Court held that the bylaw was a proper subject for stockholder action. Answering the second in the negative, the Court held that if adopted the bylaw would violate state law. The net result is that the bylaw can be excluded from CA’s proxy statement under SEC Rule 14a-8(i)(2).
This is a very significant decision that will prompt much practitioner commentary and scholarly discussion. It is also a decision with implications that will take time and future decisions to work out. Here are some highlights:
As a threshold matter, the Supreme Court cut the recursive loop between Section 109 and Section 141(a) of the DGCL. Section 109(a) gives stockholders the statutory right to adopt bylaws, and Section 109(b) provides that the bylaws may contain “any provision, not inconsistent with law or with the certificate of incorporation, relating to the business of the corporation, the conduct of its affairs, and its rights or powers or the rights or powers of its stockholders, directors, officers or employees.” Section 141(a) vests the power to manage the business and affairs of every corporation in the board of directors, except as otherwise provided in the DGCL or in the certificate of incorporation. This has led to a running debate as to whether a bylaw under Section 109(b) can limit a board’s power under Section 141(a).
Consistent with Delaware’s historic model of director-centric governance, the Supreme Court makes clear that Section 141(a) has primacy over Section 109(b). After quoting Section 141(a), the Supreme Court notes that “[n]o such broad management power is statutorily allocated to the shareholders.” (p. 7).
The Court then holds “[t]herefore, the shareholders’ statutory power to adopt, amend or repeal bylaws is not coextensive with the board’s concurrent power and is limited by the board’s management prerogatives under Section 141(a).” (p. 7). In footnote 7, the Court addresses the statutory language of Sections 109 and 141(a), stating that Section 109 is not an “except[ion] … otherwise specified in th[e] [DGCL]” to Section 141(a). “Rather, the shareholders’ statutory power to adopt, amend or repeal bylaws under Section 109 cannot be ‘inconsistent with the law,’ including Section 141(a).”
In addressing the first certified question (whether the bylaw was a proper subject for stockholder action), the Supreme Court established an initial test for bylaw validity: “whether the Bylaw is one that establishes or regulates a process for substantive director decision-making, or one that mandates the decision itself.” The Court recognized that a bylaw that is appropriately process oriented can have some implications for board decision-making and the expenditure of corporate funds, giving as an example a bylaw that would require that all board meetings take place at the corporation’s headquarters and thereby necessitate expenditures for travel. (p. 16). Applying this test, the Court found that the primary function of reimbursement bylaw was process oriented. Although it called for the expenditure of funds, it sought to regulate “the process for electing directors –a subject in which shareholders of Delaware corporations have a legitimate and protected interest.” Based on this analysis, the Court held that the bylaw was a proper subject for stockholder action, thus answering the first questioning the affirmative.
In addressing the second certified question, the Supreme Court held that the mandatory reimbursement bylaw as drafted by AFSCME was facially invalid because it could require a board to reimburse expenses in a situation where it could breach the board’s fiduciary duties to do so. Citing its QVC and Quickturn precedents, the Court held that a bylaw could not require the Board to breach its fiduciary duties. Despite the fact that the reimbursement bylaw permitted the board to determine what expenses were “reasonable,” the Court held that that language “does not go far enough, because the Bylaw contains no language or provision that would reserve to CA’s directors their full power” to deny all expenses. (p. 23). In other words, because there were hypothetical situations in which the bylaw could require a board to breach its fiduciary duties, the Court held the bylaw facially invalid.
Each of these holdings potentially has big implications for the future. Although many will likely view this as a loss for stockholders, I believe they should view the case as a significant win. Yes, the director-reimbursement bylaw was held invalid, but the Court held that the election process was a proper subject for stockholder action. A bylaw mandating the inclusion of stockholder nominees on the company’s proxy statement should fare much better under a CA analysis.
Outside the election process, the case is generally negative for stockholder-adopted bylaws. For example, the strong QVC/Quickturn analysis should doom any substantive component to a pill redemption bylaw, such as a requirement that directors not adopt or renew any pill that could be in place longer than a year.
In the unforeseen consequences department, CA opens the door to the broad use of facial challenges by creating a regime where it is actually easier to make a facial challenge than an as-applied challenge. Under the approach articulated in CA, a facial challenge must be granted and a bylaw stricken if there is any situation in which the bylaw could be held invalid. In contrast, in an as-applied challenge, the CA court noted that a bylaw is presumed valid. Traditionally in a facial challenge, a provision would be upheld if there are circumstances in which it could be valid, such that invalidity can only be tested in an as-applied context. The CA court reverses this approach.
Also in the unforeseen consequences department, directors may find that the CA decision’s broad extension of a fiduciary trump card causes more problems than it solves. Under the CA analysis, mandatory bylaws may no longer be mandatory. They rather appear to be subject to the directors’ overarching fiduciary duties. Directors who take action in reliance on a mandatory bylaw therefore can now be second-guessed on fiduciary duty grounds.
The most obvious circumstance where this can arise is with a bylaw providing for mandatory advancements. The Delaware courts have consistently enforced mandatory advancement bylaws, even if the board of directors believes the recipient of the advancements is a bad actor and that it would be a breach of the board’s duties to provide the advancements. Under CA, a board can argue that a mandatory advancement bylaw cannot trump its fiduciary duties, and therefore it has the discretion not to pay. The converse, however, is also true, and a board that advances funds pursuant to a mandatory advancement bylaw is now open to a claim that their fiduciary duties required them not to advance.
This could be particularly problematic for sitting directors, because a permissive decision to provide advancements is a self-interested transaction subject to entire fairness. While I expect that the Delaware courts will find a way to uphold mandatory advancement bylaws, they will have to distinguish CA to do it.
Similar arguments could arise in less obvious circumstances. For example, a common defensive bylaw eliminates the right of stockholders to call a special meeting. Under CA, if a stockholder asks the board to call a special meeting, it could be argued that the board cannot simply rely on the bylaw and inform the stockholder that it has no right to the call. Because the bylaw cannot trump the board’s fiduciary duties, the board must consider as a matter of fiduciary discretion whether to call the meeting notwithstanding the bylaw.
Here again, I expect that the Delaware courts will support boards who act in accordance with mandatory bylaws. The CA Court was careful to leave itself wiggle room for the future, cautioning that it could not “articulate with doctrinal exactitude a bright line” rule for stockholder-adopted bylaws (p. 12) and stressing that “[w]hat we do hold is case specific” (n.14). In the near term, however, CA may open directors up to fiduciary challenges on decisions that previously were not subject to challenge.
There is not inconsiderable tension between the holding that the reimbursement provision was procedural and thus a proper subject of stockholder action and the holding that the same provision was invalid because it mandated substantive board action without a fiduciary carve out. CA is thus a decision that simultaneously gives and takes away. It gives stockholders the ability to propose bylaws addressing the election process. At the same time, it takes away the ability to adopt mandatory bylaws (or at least those providing mandaotry reimbursements) by holding such bylaws invalid if they could force the board to violate its fiduciary duties. Only future decisions will reveal how this tension plays out.
From Cliff Neimeth of Greenberg Traurig: Here is the merger agreement for the Mar’s pending acquisition of Wrigley. Query whether this is indicative of the new strategic purchaser mindset in mega business combinations – or just a stand-alone deal?
At a minimum, the deal reflected in the attached merger agreement offers an interesting insight into the current (and perhaps offers a more prescient glimpse into the mid-term future?) state of the M&A financing market.
Most uncommonly, the merger agreement providing for Mars’ strategic $23.0 billion acquisition of Wm. Wrigley Jr. Co. contains some of the seller risk allocations and limitations on equitable remedies, financing covenants and reverse break-up fee provisions that sellers tolerated during the 2005-mid-2007 wave (and subsequent “trickle”) of private equity-sponsored buyouts.
Specifically, Wrigley has no general right to seek specific performance of Mars’ performance obligations under the merger agreement; Mars has agreed to pay a $1.0 billion reverse break-up fee to Wrigley (i.e., an absolute cap on its damages, in prescribed circumstances); and a financing covenant that expressly excludes Mars’ obligation to sue its lenders to enforce their commitments. (NB: Warren Buffet’s Berkshire Hathaway is one of Mars’ financing sources).
Time will tell whether this becomes more common in large cap strategic deals…
With a hearty thanks to J.W. Verret, our man on the ground during yesterday’s Delaware Supreme Court hearing about the important issue certified from the SEC regarding AFSCME’s “reimbursement of expenses” binding bylaw proposal. J.W. is a rising star and Assistant Professor at George Mason University School of Law. Here is J.W.’s report:
The American Federation of State, County, and Municipal (“AFSCME”) Employees Pension Plan submitted a shareholder proposal for inclusion in CA’s (formerly known as Computer Associates) proxy materials for their annual meeting scheduled to be held on September 9, 2008. That proposal sought to amend CA’s bylaws to require that the company reimburse the reasonable expenses incurred by a dissident nominating a rival slate of directors, provided that at least one nominee from the dissident slate was victorious. CA sought no-action relief from the SEC permitting it to exclude that proposal under Rule 14a-8 as illegal under Delaware law, and the SEC certified the question to the Delaware Supreme Court a few weeks ago (here is Broc’s blog on that development).
Part of the SEC’s submission read ominously: “[N]o-action requests regarding substantially similar proposals have been submitted in the past….The extent to which the Division can expect to receive future requests to exclude proposals similar to the AFSCME Proposal will necessarily be affected by the outcome (of these proceedings).”
Anticipating that the opinion in this difficult case might make use of dicta guidance, see also my article with Chief Justice Steele on the “Delaware Guidance Function.” Also, a shorter posting on this case is available here.
The Overriding Question
Section 109 of the Delaware General Corporation Law grants shareholders the right to adopt bylaws. Section 141(a) reads that “the business and affairs of every corporation…shall be managed by…a board of directors.” To what extent do shareholder-adopted bylaws conflict with the Board’s discretion under 141? And to what extent does this election bylaw limit that discretion? Indeed, is it really an election bylaw at all?
CA argues that:
1. This bylaw mandates a payment of expenses, rather than relates to an election, and control over corporate expenditures is part of the business and affairs of the corporation described in Section 141 and Paramount v. QVC and JANA v. CNET;
2. Any limits on the board’s authority under 141 must be contained in the Certificate of Incorporation. A bylaw in conflict with the certificate of incorporation is a nullity. Since CA has a provision in its Certificate of Incorporation that mirrors 141, a bylaw in conflict with 141 would therefore be a nullity. The practical result of this argument is that, since CA’s certificate of incorporation provides that it may only be amended by the Board, a common provision, the shareholders have no way to mandate proxy reimbursement;
3. CA distinguishes bylaws that regulate the process by which Boards act, which they argue describe the majority of bylaws constraining directors which the Delaware Courts have upheld, from bylaws mandating a specific policy, which CA argues describes the bylaw at issue;
4. CA argues that since Delaware law permits reimbursement of proxy expenses only where contests benefit all shareholders, rather than a mere subset, mandatory reimbursement may cause directors to violate Delaware law and their fiduciary duties. This is especially likely in short slates, because of their assumption that minority interests would be the only aim of the dissident slate, and thus the Board may be constrained from preventing this threat to the other shareholders;
5. An affirmative decision in this case would lead to a host of new contests, and could lead to corporate waste of assets causing directors to violate their fiduciary duties;
6. CA distinguishes cases cited by AFSCME, such as Unisuper, relating to board-approved limitations on board authority as permitting shareholder limitations, by arguing that contractual and equity principles were applied to board action to justify those self-imposed limitations that make them irrelevant to a determination of whether shareholder approved limitations are permissible.
1. In response to CA, AFSCME argues that the language in 109 which permits shareholder bylaws “not inconsistent with law” would be a redundant phrase if the legislature’s intent were to only permit bylaws authorized by other statutory provisions;
2. The validity of bylaws are not judged based on who adopted them;
3. In response to claims that mandating expenditure of funds would interfere with Director’s authority under Section 141, or may leave the corporation open to payments that flow from fiduciary violations, AFSCME points to prior cases upholding the validity of bylaws requiring indemnification of directors despite the Board’s wish to withhold indemnification. Further, they argue that the mandated payment does not implicate fiduciary concerns precisely because the payment would be mandatory, and thus could not be based on a director or manager’s self-dealing motives;
4. The Blasius, Unitrin, and MM Companies cases also evidence a dim view of attempts to thwart the shareholder franchise, which is the underpinning of the business judgment rule. Also, Harrah’s v. JCC provides that the shareholder franchise includes a meaningful right to nominate an opposing slate, and not simply vote in an election. Thus, AFSCME essentially argues that this amounts to a heightened standard of review, or a presumption in favor of the shareholder, in cases resolving shareholder bylaw validity;
5. AFSCME skillfully leaves a trail for the Court to limit its holding, arguing that even if there is a tension between 141 and 109, and 141 limits the types of bylaws shareholders may adopt (this is the area in which poison pill bylaw fights would come up), that limitation does not extend to election bylaws;
6. They respond to a number of CA’s examples of specific bylaws determined to be inconsistent with the DGCL as irrelevant, because all of them related to Board bylaws, also noting that the Court has never struck down a shareholder adopted bylaw for being inconsistent with the DGCL or restricting the Board’s ability to fulfill their fiduciary duties.
Arguing on behalf of Computer Associates was Robert Guiffra of Sullivan & Cromwell. Arguing on behalf of AFSCME was Michael Barry of Grant & Eisenhofer. The issues from the briefs central to the oral argument were whether this bylaw relates to an election, or control over the corporate treasury, and then whether a mandatory reimbursement requirement could cause directors to violate their fiduciary duties to the company. The mix of questions from the Court during oral argument make any predictions difficult.
The Justices pushed counsel for CA over whether the prospect of reimbursement was inextricably linked to the success of an election, and whether the bylaw would be legal if adopted by the board. The Justices pushed counsel for AFSCME over whether there might be any circumstances under which a bylaw could force inequitable reimbursement and whether the board’s authority to adopt bylaws was co-extensive with that of shareholders.
Interestingly, Justice Berger, when she served as a Vice Chancellor on the Court of Chancery, suggested in dicta that stockholders create a bylaw limiting the board’s power to amend a stockholder adopted by-law in American Int’l Rent a Car, an opinion from 1984, which may indicate her view on whether the right to adopt bylaws is co-extensive. The Court also questioned whether the “reasonable” qualifier in this bylaw left enough room for board discretion not to reimburse wasteful expenses.
One open thread that may not be resolved: If this bylaw is included in the corporation’s proxy, and if it passes, can the board simply amend that bylaw? Meaning the Court could conceivably rule that the bylaw was legal, and thus the SEC would have no basis to allow the company to exclude it, but in a subsequent challenge to the board’s decision to amend the shareholder bylaw would the company get business judgment protection?
This is a particularly controversial and intricate case, and the Delaware Supreme Court has only a week and a half to craft a decision. It is probably best to save substantive practice advice until the opinion is issued. See you then…
In this podcast, Ron Orol, Senior Writer for The Daily Deal, discusses activists, swaps and the SEC in light of the CSX decision, including:
- Can you explain how activist fund managers are attempting to use cash settled swaps to evade SEC reporting?
- How did The Children’s Investment Fund use swaps with respect to CSX and what was the impact?
- Do you expect the CSX decision to have any effect on the SEC’s rules or interpretations?
By the way, Gibson Dunn recently held a webcast on the CSX decision and has posted this archive.
Yesterday, the Delaware Supreme Court accepted the questions certified to it by the SEC relating to the battle between CA and AFSCME over the proponent’s binding bylaw proposal seeking reimbursement for third-party solicitations. The Court sure didn’t lose any time taking the case – and look at the quick briefing and argument schedule they have set (given CA’s mailing date is July 17th, this was necessary): briefs are due on Monday, July 7; oral argument is scheduled for July 9. We will have a guest blogger giving us news live from the hearing.
Last week, Corp Fin posted this no-action letter – Barclays (Netherlands)(available 6/26/08) – which seems to be well within the line of “abandoned offering” 12h-3 letters. Usually they are for a busted IPO, but this one is for a busted merger/reorganization.
In both cases, the facts are pretty much the same – a registration statement goes effective but the offer is never completed. Therefore it make no sense for the registrants to have to file a Form 10-K/20-F to satisfy the Section 15(d) obligation since no one is holding the securities from the originally contemplated IPO/merger.