Poison Pill Usage Continues to Decline

Here is something from Kevin Wells of RiskMetrics' U.S. Research Team (as originally noted in RiskMetrics' blog):

Though not as prevalent as they once were, shareholder rights plans, commonly referred to as "poison pills," remain a fixture of the corporate governance landscape, according to a new report from RiskMetrics Group (available for purchase in RMG's bookstore).

As the global economic crisis took a toll across U.S. and international capital markets over the past year, companies continued to adopt pills, albeit with more shareholder-friendly provisions. Indeed, an analysis of regulatory filings, proxy voting trends, and other data finds that companies are incorporating more shareholder-friendly provisions into their pills; moreover, companies are putting such plans to a shareholder vote in greater numbers than ever before.

Perhaps as a consequence of increased management votes to ratify or adopt pills, shareholder activism, as measured by filings of shareholder proposals to terminate or allow shareholders to vote on pills, has declined. However, those shareholder proposals appearing on ballots generally received high levels of support in 2009, winning majority support at Yum Brands and two other firms.

Amid the recent economic turmoil, 2009 has also seen the emergence of NOL (net operating loss) poison pills, which are meant to protect companies' tax assets rather than to deter acquisition offers. It was an NOL pill, in fact, that became the subject of controversy in Selectica v. Versata, pending in Delaware Chancery Court, which may significantly affect future uses of pills by Delaware-incorporated companies.

Select key findings from the report include:

- Thirty-three S&P 1,500 companies enacted pills between July 1, 2008, and July 1, 2009. Their average term was 7.6 years, and 10 were for terms of three years or less. Four of those were enacted for a period of 12 months or less.
- The number of S&P 1,500 companies that maintained a pill declined again, falling from 34.5 percent in 2008 to 27.5 percent in 2009. In 2007, 42.5 percent of companies maintained a pill.
- In 2009, 69.2 percent of the S&P 1,500 companies that maintained a pill employed a 15 percent trigger. Another 19.6 percent employed a 20 percent trigger, while 7.9 percent employed a 10 percent trigger.

More on Broker Nonvote Math

Last week, Tom Ball gave us the basics in broker nonvote math. In this podcast, David Drake and Rhonda Brauer dig further into the math of revised NYSE Rule 452 - here the worksheet you should print out to follow along - and help you explore some possible ways to get out those otherwise lost retail votes.

Baker v. Goldman Sachs: The Hazards of Advising a Private Company

- by John Jenkins, Calfee Halter & Griswold

Investment banks spend a lot of time tailoring their M&A engagement letters to address the perceived risks involved in advising widely-held public companies. Those engagements are often perceived as presenting greater liability risks than M&A advisory engagements for private companies, and that's probably true most of the time, but a recent Massachusetts federal court decision provides a sobering reminder to investment banks that this isn't always the case.

What's more, the Baker v. Goldman Sachs case - here is the opinion - also shows how some of the provisions of an engagement letter designed to protect bankers in public company deals can under certain circumstances have the opposite effect in a private company transaction.

The Baker case arose out of Goldman's service as a financial advisor to Dragon Systems, Inc. in connection with its ill-fated sale to Lernout & Hauspie Speech Products, a Nasdaq-listed Belgian company that collapsed in the aftermath of an accounting scandal that surfaced shortly after the deal was completed. L&H acquired Dragon in an all stock deal, and the buyer's subsequent collapse resulted in a loss to Dragon's controlling shareholders of approximately $300 million.

Dragon's two controlling shareholders filed a lawsuit against Goldman Sachs and related entities. The plaintiffs alleged that Goldman Sachs negligently advised Dragon to merge with L & H without adequately investigating the buyer's value. The plaintiffs made a variety of contractual and other common law claims, including breach of fiduciary duty and negligent misrepresentation, and also alleged that Goldman's conduct violated the Massachusetts Unfair Trade Practices statute.

With the exception of the novel statutory claim, most of the plaintiffs' claims were consistent with what you typically see in investment banker liability cases. The most common legal theories used to sue bankers are the tort of negligent misrepresentation, and breach of contract claims premised on agency or third-party beneficiary principles. More recently, breach of fiduciary duty claims have become more prominently featured as well. With some high profile exceptions, investment bankers have generally been pretty successful in defending against these claims.

Plaintiffs relying on negligent misrepresentation or contract law principles premise their claims on allegations that they were intended beneficiaries of the contractual relationship between the banker and the company, and were thus entitled to rely upon the banker's efforts. Since these claims depend on the contractual relationship between the bank and its client, investment bankers' engagement letters have played a prominent role in their efforts to fend off such claims. Those letters typically include very specific statements about the parties to whom the investment bank is providing its services, together with broad disclaimers of liability to corporate shareholders or other third parties.

Interestingly, Goldman's engagement letter with Dragon included customary language intended to accomplish this objective. The letter explicitly stated that "any written or oral advice provided by Goldman Sachs in connection with our engagement is exclusively for the information of the Board of Directors and senior management of the Company." What's even more interesting, however, is that the plaintiffs were able to use this language as the basis for their third party beneficiary and negligent misrepresentation claims.

What the plaintiffs did was to simply point out to the court that one of the two controlling shareholder-plaintiffs was a member of the Board, and was thus within the group entitled to the benefits of the agreement. Goldman argued that in using the quoted language, it was referring to the board in its representative capacity. However, the court looked at some other potentially ambiguous phrasing in the engagement letter, including the fact that the letter was addressed to the shareholder-director and the letter's use of the personal pronoun "you" instead of "the company" in describing the persons to whom it was providing its services, to justify its conclusion that Goldman appreciated that others aside from the board in its representative capacity would benefit from its advice.

The treatment of the plaintiffs' fiduciary duty claim is another area where the Company's closely-held nature appears to have played a significant role in the court's analysis. While the fact that the engagement letter did not include a disclaimer of fiduciary duties played an important role in the court's decision not to dismiss these claims, the close contact that Goldman allegedly had with the plaintiffs throughout the course of the engagement was another important factor in leading the court to conclude that the plaintiffs sufficiently alleged that "special circumstances existed to create a fiduciary relationship apart from the terms of the contract."

It is important to keep in mind that Baker involved a motion to dismiss, so this litigation is at a very preliminary stage and it is inappropriate to draw broad conclusions from it. Nevertheless, the Baker case drives home the point that although the risk profile in engagements involving widely-held public companies may generally be higher than private company engagements, private companies (and public companies with controlling shareholders) present distinct risks of their own that banks may want to take into account in drafting and negotiating engagement letters.

House Hearing on Private Equity and Venture Capital Regulation

In the "Private Equity Law Review" Blog, Steve Vasil has some amusing analysis as he describes the House Financial Services Committee's hearings on regulating hedge funds, venture capital, and private equity earlier this month. Here is Part II of Steve's blogging on this topic.

M&A: Behind the Boom in Unsolicited Bids

In this recent BusinessWeek article, Frank Aquila of Sullivan & Cromwell does a great job of foretelling our future - and explaining our present - in the world of hostile bids. Just like Lois Herzeca did in this podcast a few weeks back...

Wanna Play 20 Questions? DOJ and FTC Seek Merger Guidelines Comments

Recently, the DOJ and FTC issued these 20 questions to solicit comment on how they should reform their horizontal merger guidelines. As I blogged recently, these agencies seek the first major overhaul of these guidelines in quite some time...

Basics of Calculating Impact of Loss of Broker Nonvotes

Helping you to gear up for a difficult proxy season, I have decided to start a weekly proxy solicitor podcast series. Each week, a new podcast with cover a hot topic that you may well face soon - with practical guidance from a proxy solicitor to help you navigate troubled waters. Here is the second installment in our series:

In this podcast, Tom Ball of Morrow & Co. explains the basics of the mechanics of counting broker non-votes and it's implications for companies this proxy season, including:

- What is an example of how the math should be done to determine the impact of the loss of discretionary broker votes on a specific company?
- What type of companies - size, market cap, stock price, industries - may be impacted the most by the loss of broker nonvotes?

Please take a moment to participate in our "Quick Survey on Impact of Loss of Broker Nonvotes for '10 Proxy Season."

"Special Proxy Season" November-December Issue: Deal Lawyers Print Newsletter

With the upcoming proxy season promising to shake things up and possibly place more companies in "play" than ever before, I decided to create a "special" issue of the Deal Lawyers print newsletter and rush it out so that you can begin to prepare now. This "Special" November-December issue of the Deal Lawyers print newsletter was just sent to the printer and includes articles on:

- How to Respond to a Stocklist Demand
- How to Scrub Your Bylaws Ahead of Proxy Access: Considerations for Delaware Corporations
- A Practical Primer: How to Tabulate and Report Voting Results
- "Practice Points" on Reporting Voting Results
- An Insider's Perspective: How to Avoid a Yahoo-Like Tabulation Nightmare
- The Growing Importance of "Just Vote No" Campaigns: Analysis and Takeaways

If you're not yet a subscriber, try a "no-risk trial to get a non-blurred version of this issue on a complimentary basis. Current subscribers should renew now as this is the last issue since all subscriptions expire at year-end.

Please take a moment to participate in our "Quick Survey on Impact of Loss of Broker Nonvotes for '10 Proxy Season."

The ACS/Xerox Merger: The Relative Fairness and ConEd Issues

Following up on Steven Haas' blog last week, Kevin Miller of Alston & Bird gives these further thoughts on the transaction:

1. The Relative Fairness Issue - The NY Times' DealProfessor has suggested that, in order to address the relative fairness issues raised in Chancellor Chandler's decision in TCI, the special committee of the board of directors of ACS most likely obtained a relative fairness opinion - i.e., with respect to whether the consideration received by the low-vote Class A shareholders was fair to them relative to what the high-vote Class B shareholders received in the merger.

Such opinions are extremely rare. See e.g., definitive proxy statement relating to the acquisition of Penton Media, Inc. by Prism Business Media Holdings. In that transaction, which frankly was not analogous to the ACS/Xerox merger, Allen & Company LLC rendered an opinion that:

"Based upon and subject to the foregoing, it is our opinion as of the date hereof that the Common Stock Per Share Merger Consideration to be paid in connection with the Transaction is fair from a financial point of view to the holders of Company Common Stock, including in relation to the holders of Preferred Stock." (emphasis added)

See also the merger proxy relating to the acquisition of Hallwood Realty:

"Based upon and subject to the foregoing, we are of the opinion as of the date hereof that, the allocation of the total consideration to be paid by HRPT in the Proposed Transaction between the General Partner and its affiliates, on the one hand, and the Unitholders (other than the General Partner and its affiliates), on the other hand, is reasonable to the Unitholders (other than the General Partner and its affiliates)."

And the merger proxy related to the acquisition of John Q. Hammons Hotels:

" Based upon and subject to the foregoing, we are of the opinion as of the date hereof that, from a financial point of view and from the point of view of the Unaffiliated Stockholders, the allocation of the consideration offered by JQH Acquisition in the Proposed Transaction between the JQH Stockholders, on the one hand, and the Unaffiliated Stockholders, on the other hand, is reasonable to the Unaffiliated Stockholders."

Though we will have to wait until the ACS merger proxy is filed, it is not clear that the special committee of the board of directors of ACS got a relative fairness opinion from Evercore, the special committee's financial advisor or that the board of ACS got a relative fairness opinion from Citigroup, the company's financial advisor. The description of the opinions in the merger agreement appears to indicate that they didn't:

"(v) Opinion of Financial Advisors. The Special Committee has received the opinion of Evercore Group L.L.C., dated as of the date of this Agreement, to the effect that, as of such date, the Class A Merger Consideration is fair, from a financial point of view, to the holders of the shares of Company Class A Common Stock (other than those holders who also hold shares of Company Class B Common Stock) entitled to receive such Class A Merger Consideration. The Board of Directors of the Company has received the opinion of Citigroup Global Markets Inc., dated as of the date of this Agreement, to the effect that, as of such date, the Class A Merger Consideration is fair, from a financial point of view, to the holders of shares of Company Class A Common Stock (other than those holders who are also holders of Company Class B Common Stock and their Affiliates)."

The recent experience of most practitioners in this area has been that the bulge bracket investment banks have, almost universally, declined to render relative fairness opinions.

For most investment banks the concern is that such opinions require normative judgments that are difficult to support based on traditional financial analyses - e.g., just because many controlling stockholders have declined to seek a control premium for themselves in order to avoid litigation, does not mean that such premiums are inappropriate. Furthermore, comparisons of control premiums on a per share basis are often misleading as it is the aggregate premium that is relevant, not whether it is allocated over a million shares with 10 votes per share or ten shares with a million votes per share.

Turn the situation around and ask yourself how a board of directors gets comfortable concluding that the failure to extract a control premium for the holders of high vote stock is fair to the holders of the high vote stock unless such holders voluntarily determine not to extract such a premium for themselves.

Finally, it is most likely an overstatement to suggest that such opinions are required under Delaware law:

"6. Specific Impact and Relative Fairness. The Delaware Supreme Court's decision rendered in connection with a proposed recapitalization of The Reader's Digest Association, Inc. required the TCI special committee to examine the specific impact on the holders of low-vote stock of the premium paid for the high-vote stock. The TCI court interpreted that to mean the TCI special committee was required to examine the fairness of the premium paid for the high-vote stock relative to the value of the consideration received by the holders of low-vote stock, apparently by obtaining an opinion from a financial advisor as to the fairness of the high-vote premium to the holders of the low-vote stock...

4. Relative Fairness Opinions. The TCI court's interpretation of the Reader's Digest decision to apparently require the TCI special committee to obtain a fairness opinion was particularly surprising as no Delaware court had previously held that a board or special committee was required to obtain a fairness opinion, much less a so-called "relative fairness" opinion. In fact, many financial advisors believe that such normative judgments are beyond the scope of a professional opinion, particularly an opinion expressed "from a financial point of view," that typically focuses on the absolute or relative value of businesses and the consideration being paid or received in exchange therefore.

Relative fairness opinions require normative judgments generally not susceptible to the types of valuation and other financial analyses performed by financial advisors. Financial advisors render fairness opinions based on analyses with respect to the value of a business taken as a whole and almost always avoid rendering judgments with respect to the appropriate allocation of the aggregate consideration among multiple equity constituencies with competing claims. They can (as TCI's financial advisors did), when pressed, separately analyze the intrinsic value of a class of capital stock and express an appropriately qualified opinion with respect to the fairness of the consideration to be received by holders of that class in exchange for their capital stock independent of the consideration to be received by holders of any other class of capital stock, but most opinion providers will include express language in their opinions to the effect that their opinions do not address the allocation of the aggregate consideration among competing equity classes. What financial advisors can and should do is provide special committees with all of the relevant financial analyses and information special committees need to make required normative determinations. After all, the views of financial advisors with respect to the financial aspects of transactions have never been viewed as a substitute for the judgment directors must apply in determining whether a transaction is advisable and in the best interests of shareholders.

5. The Reader's Digest Decision. The facts in the Reader's Digest case are distinguishable from the facts of TCI. While Reader's Digest involved a $100 million reduction in the equity value of Reader's Digest to the detriment of holders of Reader's Digest non-voting stock without their consent, TCI involved the allocation of a control premium being paid by a third party to which the holders of TCI low-vote stock were arguably not entitled. In the Reader's Digest decision, the Delaware Supreme Court took issue with the Reader's Digest special committee for its apparent failure to focus on the specific impact upon the holders of low-vote stock of a $100 million payment to holders of high-vote stock, particular given Reader's Digest's tenuous financial condition.

In the case of TCI, nothing was taken away from the holders of TCI low-vote stock. The only question was the extent to which they would be permitted to share in a control premium even though they had little or no ability to control the outcome of the transaction. By voluntarily limiting the high-vote premium to 10 percent and not seeking the full amount of the premium to which a control block may legally be entitled, the holders of TCI high-vote stock permitted the holders of low-vote stock to receive a 37 percent premium upon a change-in-control, a premium that they could not reasonably have expected to receive when they bought shares of low-vote stock in a company controlled by one or a relatively small number of holders of high-vote stock. That would appear pretty generous, particularly given that had the holders of TCI high-vote stock not voluntarily limited the size of their premium, it may have been difficult for the TCI board or special committee to have concluded that a mere 10 percent premium was fair to them. The indirect impact of the high-vote premium on the value received by holders of low-vote stock was negligible.

As noted by the TCI court, "the impact of the [high-vote stock] premium on the holders of [low-vote stock] was not large; effectively, the [high-vote stock] premium only lowered the price paid to the holders of [low-vote stock] by approximately 1.2%, from $67.19 to $66.37." Given the foregoing, it is not surprising that the TCI special committee's principal negotiator viewed a 10 percent premium for shares of high-vote stock as a "pinhole part of the transaction" and worried that belaboring the point could threaten the deal. Such analyses and information would appear much more relevant to a decision whether or not to recommend a transaction involving a premium for high-vote shares than historical trading premium and the number of precedent transactions not involving a premium."

2. The ConEd Issue - In ConEd, the Second Circuit effectively held that, under New York law, an acquiror could not be held liable for target shareholders' lost merger premium if the target shareholders were not intended third-party beneficiaries entitled to such relief. Since ConEd, many practitioners have avoided New York law as the governing law for merger agreements in hopes, partially fueled by dicta or other statements made by certain members of the Delaware Chancery Court, that Delaware courts would reach a different conclusion. Less frequently, parties have addressed ConEd, by including provisions in their merger agreements to address the issue and thereby clarify the intent of the parties. This was the approach taken in the ACS/Xerox merger even though the contract is governed by Delaware law:

"SECTION 8.06. Entire Agreement; Third-Party Beneficiaries. This Agreement (including the Exhibits and Schedules and the Company Disclosure Letter and the Parent Disclosure Letter), the Confidentiality Agreement, the Voting Agreement and any agreements entered into contemporaneously herewith (a) constitute the entire agreement, and supersede all prior agreements and understandings, both written and oral, among the parties with respect to the subject matter hereof and thereof and (b) are not intended to and do not confer upon any person other than the parties hereto any legal or equitable rights or remedies. Notwithstanding the foregoing clause (b):

(i) Following the Effective Time, each holder of Company Common Stock shall be entitled to enforce the provisions of Article II to the extent necessary to receive the consideration to which such holder is entitled pursuant to Article II.

(ii) Prior to the Effective Time, each holder of Company Common Stock shall be a third party beneficiary of this Agreement for the purpose of pursuing claims for damages (including damages based on the loss of the economic benefits of the Merger, including the loss of the premium offered to such holder) under this Agreement in the event of a failure by Parent or Merger Sub to effect the Merger as required by this Agreement or a material breach by Parent or Merger Sub that contributed to a failure of any of the conditions to Closing from being satisfied. The rights granted pursuant to clause (ii) shall be enforceable only by the Company in its sole and absolute discretion, on behalf of the holders of Company Common Stock, and any amounts received by the Company in connection therewith may be retained by the Company."

See also the proxy relating to Entrust's acquisition by Thoma Bravo:

"9.6 Third Party Beneficiaries. This Agreement is not intended to, and shall not, confer upon any other Person any rights or remedies hereunder, except (a) as set forth in or contemplated by the terms and provisions of Section 6.11, (b) prior to the Effective Time, for the right of holders of shares of the Company Common Stock to pursue claims for damages (including damages based on loss of the economic benefits of the transaction to Company Stockholders) and other relief (including equitable relief) for any breach of this Agreement by Newco or Merger Sub, whether or not this Agreement has been validly terminated pursuant to Article VIII, which right is hereby expressly acknowledged and agreed by Newco and Merger Sub, and (c) from and after the Effective Time, the rights of holders of shares of the Company Common Stock to receive the merger consideration set forth in Article II. The rights granted pursuant to clause (b) of this Section 9.6 shall only be enforceable on behalf of Company Stockholders by the Company in its sole and absolute discretion, as agent for the Company Stockholders, it being understood and agreed that any and all interests in such claims shall attach to such shares of the Company Common Stock and subsequently transfer therewith and, consequently, any damages, settlements or other amounts recovered or received by the Company with respect to such claims (net of expenses incurred by the Company in connection therewith) may, in the Company's sole and absolute discretion, be (A) distributed, in whole or in part, by the Company to the holders of shares of Company Common Stock of record as of any date determined by the Company or (B) retained by the Company for the use and benefit of the Company on behalf of its stockholders in any manner the Company deems fit. In addition, the Company hereby agrees that it will only accept the payment of any damages awarded pursuant to claims brought under clause (b) of this Section 9.6 if Newco and Merger Sub are found to be in breach of their respective obligations to consummate the Merger under Article II of this Agreement and a court of competent jurisdiction has declined to specifically enforce the obligations of Newco and Merger Sub to consummate the Merger pursuant to a claim for specific performance brought against Newco and Merger Sub pursuant to Section 9.8(b) and applicable law."

See this article for a more detailed discussion of these types of provisions, complete with drafting suggestions many of which appear to be reflected in the foregoing.

How to Sell a Division: Nuts & Bolts

We have posted the transcript for our recent webcast: "How to Sell a Division: Nuts & Bolts."

The Skinny on Split Voting

Helping you to gear up for a difficult proxy season, I have decided to start a weekly proxy solicitor podcast series. Each week, a new podcast with cover a hot topic that you may well face soon - with practical guidance from a proxy solicitor to help you navigate troubled waters. Here is our first installment in the series:

In this podcast, Scott Winter of Innisfree provides some insight into how to handle split voting (i.e., voting for nominees from opposing proxy cards in a contest) and its intersection with the 14a-4 bona fide nominee rule, including:

- What is split voting?
- How often do we see split voting?
- How do shareholders actually split their votes?
- Are there any ways we could make changes to the system which would make split voting easier?

Please take a moment to participate in our "Quick Survey on Impact of Loss of Broker Nonvotes for '10 Proxy Season."

Controlling Stockholders and Control Premiums

- by Steven Haas, Hunton & Williams

The ACS/Xerox $6.4 billion merger has received significant attention lately. Among the interesting issues in the transaction is the right of the controlling stockholder to receive a control premium. Steven Davidoff (aka the "Deal Professor") has must-read blog posts on the transaction here and here.

The deal has commentators talking particularly about the implications of Chancellor Chandler's 2005 opinion in In re Telecommunications. There, the Chancellor said that "[r]easonably construing the facts in favor of plaintiffs, if [the controlling stockholder] wished to be fair, then he could have shared some part of the value of his own stock holdings]." I don't think that statement altered Delaware law on the right of a controlling stockholder to receive a control premium. The Chancellor was responding to the argument that all holders of TCI's high-vote shares were entitled to a premium, and he seemingly suggested that the controller could have diverted his own consideration to the other holders of high-vote shares. As the Deal Professor surmises, the Chancellor basically was saying "Look, [the controller] could have taken less and avoided this litigation."

Fortunately, this issue just received some additional clarity: In In re John Q Hammons Hotels Inc. S'holder Litig., decided a few weeks ago, Chancellor Chandler held that the entire fairness standard set forth in Lynch Communication is not automatically triggered whenever a controller receives consideration that is different from that paid to minority stockholders in a third-party merger. Moreover, the Chancellor explained his holding in TCI:

[I]n In re Tele-Communications, Inc. Shareholders Litigation, the evidence suggested that a majority of the board of directors was interested because they received material personal benefits from the transaction they approved. Specifically, the transaction materially benefited a majority of the directors because it allocated a disproportionate amount of the merger consideration to the directors' class of stock. Moreover, only one of those directors was a controlling stockholder entitled to a control premium.

Thus, the interestedness of a majority of the directors led the Court to apply the entire fairness standard and to conclude that, as in Lynch, the approval of the transaction by the stockholders and a special committee could at most shift the burden of demonstrating entire fairness to plaintiffs. Here, in contrast, [the controller] negotiated with [the buyer] and did not participate in the negotiations between [the buyer] and the special committee. Nothing in In re Tele-Communications mandates the extension of Lynch to this case.

Although Hammons applied entire fairness due to other perceived defects in process, it indicates that TCI hinged largely on the absence of a majority of disinterested directors. Of course, whether the size of a particular premium is appropriate may be a factual issue for a court to determine. But TCI should not be understood as undercutting a controlling stockholder's basic right to a premium. Since controllers can freely vote down third-party proposals for "whim or caprice," judicial restraints on paying a control premium will only impede transactions from taking place.

Hammons is also notable for making clear that majority-of-the-minority provisions must be (1) non-waivable and (2) based on a majority of the outstanding minority shares, not a majority of the minority shares actually voted. As to the first point, the court faulted the special committee's ability to waive the MOM--even thought it didn't. As to the latter point, Vice Chancellor Strine made a similar observation in 2006 in PNB Holding Co., a decision decided well after the Hammons merger was effected.

We have begun posting memos analyzing this case in our "Minority Shareholders" Practice Area.

Corporate Governance and the U.S. Senate

Stan Keller of Edwards Angell Palmer & Dodge recently posted this in Harvard Law's "Corporate Governance Blog" after being run in the Massachusetts Lawyers' Weekly:

Classified boards, where directors serve staggered terms (typically for three years with one-third of the directors elected each year), has been a recognized corporate governance alternative for a long time. The laws of every state permit corporations to structure their boards in this way. In fact, it is the default rule in Massachusetts for publicly traded companies unless the board of directors or the shareholders elects to opt out.

This should sound familiar because it is the way members of the United States Senate are elected, with Senators serving six-year terms and one third elected in each two-year election cycle. The Constitution's Framers understood the stabilizing effect of this arrangement, which they believed would ensure continuity and allow Senators to take responsibility for measures over time and make them independent of rapid swings in public opinion. For more than 200 years, this policy has served the nation well. It is a policy that also has served corporations and their investors well when they have chosen to use it.

Yet undoing this corporate governance system is precisely what is now being proposed - ironically, by two Senators. They want to prohibit for stock exchange traded companies the very governance system under which they serve. They claim that classified boards of directors are part of what they call a "widespread failure of corporate governance" that was one of the "central causes of the financial and economic crises that the United States faces."

Such a claim ought to be accompanied by hard evidence - but it is not, and with good reason. There is no evidence suggesting that classified boards were in any way a contributing factor to the ongoing economic crisis. To the contrary, companies involved in recent financial meltdowns whose boards were not classified include AIG, Washington Mutual, Bear Stearns, Citigroup, Bank of America, Lehman Brothers and General Motors. Going back to the 2001-era financial frauds, Enron, WorldCom, Tyco and HealthSouth all had unclassified boards. If anything, then, good policy and common sense suggest that we would want to retain the alternative of classified boards, not prohibit them.

As is the case with the U.S. Senate, too-frequent elections, rather than staggered terms of office, are what can undermine desired continuity and the ability to govern for the long term.

The key point is that we should not have a one-size fits all mandate for corporate governance. Rather, investor choice ought to be retained, not discarded. Certainly, corporations and their shareholders should be free to decide whether or not they want a classified board and whether the governance structure that is fine for the United States Senate works for them. Indeed, the current system is working as we would want it to, with individual choice at individual companies exercised freely - less than 40% of the S&P 500 companies have classified boards and, during the last six years, more than 200 companies have successfully put to a shareholder vote proposals to declassify their boards of directors.

In short, there is simply no evidence that classified boards bear any of the blame for the recent economic crisis. The laws of all states allow for classified boards, with Massachusetts mandating it, and there is the ability for investors to make a choice on the matter. In these circumstances, the current legislative proposal to preempt state laws and do away with classified boards is an inadvisable step back from investor choice, and toward the imposition of an unjustified one size fits all federal governance rule that will do nothing to prevent future financial breakdowns.

Continued Post-Lyondell COC Deference to Independent Directors

- by Brad Aronstam of Connolly Bove Lodge & Hutz:

Last week, Delaware Vice Chancellor Noble - in In re NYMEX S'holder Litig. (C.A. No. 3621-VCN) and Greene v. New York Mercantile Exchange, Inc. et al. (C.A. No. 3835-VCN) - reflects the Court of Chancery's latest post-Lyondell decision reinforcing the significant deference afforded under Delaware law to independent boards in the change of control context.

This consolidated action arose out of NYMEX's August 2008 merger with CME. The plaintiffs alleged numerous breaches of fiduciary duty by NYMEX's directors that purportedly resulted in NYMEX's shareholders not receiving fair value for their shares. Specifically, the plaintiffs alleged that NYMEX's fourteen member Board was dominated and controlled by its then Chairman, Richard Schaeffer, "and that the Board agreed to sell NYMEX through an unfair process at an inadequate price in order for Shaffer and NYMEX Chief Executive Officer and President James Newsome to obtain nearly $60 million in severance payments."

In rejecting these - and numerous other - shopworn allegations, the Court touched upon a number of noteworthy and evolving principles of Delaware corporate law. Below are some of the highlights:

- Conclusory Allegations of Control Fall Far Short of the Requisite Inference of Domination or Bad Faith - Having determined summarily that twelve of the Board's fourteen directors were "unquestionably independent," the Court rejected plaintiffs' conclusory allegations that mere facially questionable actions by the Board -- e.g., actions in which the Board, among other things, (i) approved the above referenced change of control severance plan, (ii) accepted CME's first offer, (iii) failed to utilize a strategic initiatives committee (the "SIC") previously formed to consider, negotiate and recommend any significant company transactions, and (iv) failed to obtain a "collar" on the stock portion of the merger consideration -- alone failed to support the requisite "dominance such that the independence or good faith of the board may be fairly questioned." As explained by the Court, the fact "[t]hat directors acquiesce in, or endorse actions by, a chairman of the board -- actions that from an outsider's perspective might seem questionable -- does not, without more, support an inference of domination by the chairman or the absence of directorial will."

- No Single Blueprint for the Fulfillment of Fiduciary Duties - Having rejected plaintiffs' above allegations as "too conclusory" to support an inference of domination, the Court turned to plaintiffs' averments concerning the allegedly flawed merger negotiation process. Noting the well established principle in Delaware that "there is no single blueprint that a board must follow to fulfill its duties," the Court held that "claims of flawed process are properly brought as duty of care, not loyalty, claims and [that such] claims [we]re [accordingly] barred by the exculpatory clause of NYMEX's Certificate of Incorporation."

- Heavy Deference to Independent Directors in Assessing Lack of "Good Faith" - In regards to any claims that the Board acted in "bad faith" and thus fell outside the protections of NYMEX's aforementioned exculpatory clause, the Court found that it could not "be said that the Board intentionally failed to act in the face of a known duty to act, demonstrating a conscious disregard for its duties." The Court quoted Lyondell and Chancellor Chandler's recent decision in Wayne County Employees' Ret. Sys. v. Corti (C.A. No. 3534-CC) in support of the proposition that the Complaint must be dismissed given plaintiffs' failure to allege "that the Board 'utterly failed to obtain the best sale price.'" This high standard set forth by the Delaware Supreme Court in Lyondell, as evidenced by recent decisions of the Delaware Court of Chancery, thus poses a substantial obstacle to plaintiffs that are unable to allege violations of the duty of loyalty (e.g., self-dealing transactions involving controlling shareholders or insiders standing on both sides of a challenged deal).

- No Breach of Fiduciary Duties for Chairman and CEO Serving as Sole Negotiators of the Deal - The Court also rejected plaintiffs' claim that "Schaeffer and Newsome breached their fiduciary duties by being the sole negotiators with CME and not involving the SIC in the consideration or negotiation of the acquisition." The Court explained that "[i]t was well within the business judgment of the Board to determine how merger negotiations will be conducted, and to delegate the task of negotiating to the Chairman and the Chief Executive Officer." Important to the Court in reaching this conclusion was its finding "that the Board was clearly independent" and, thus, "there was no requirement to involve an independent committee in negotiations." Also interesting was the Court's statement that the "the presence of such a committee [i.e., the SIC] [did not] mandate its use."

- Continuing Uncertainty Regarding the Applicability of Revlon in Mixed Cash/Stock Deals - While the Court's holding that NYMEX's exculpatory provision - and plaintiffs' failure to allege sufficient facts circumventing the protections of that provision - obviated the need for the Court to specifically decide the issue, the Court noted the continuing uncertainty regarding the applicability of Revlon vis-a-vis transactions involving mixed merger consideration of cash and stock.

Specifically, the Court noted that although "[a] fundamental change of control does not occur for purposes of Revlon where control of the corporation remains, post-merger, in a large, fluid market," the Delaware Supreme Court "'has not set out a black line rule explaining what percentage of the consideration can be cash without triggering Revlon.'" Indeed, the consideration paid to NYMEX's shareholders was 56% CME stock and 44% cash and thus fell between the Supreme Court's Santa Fe decision (holding that merger transaction involving consideration of 33% cash and 67% stock did not trigger Revlon) and the Court of Chancery's Lukens decision (holding that a merger transaction involving consideration of 60% cash and 40% stock likely triggered Revlon).

-The Continued Narrow Interpretation of the Parnes Direct/Derivative Exception - Also noteworthy was the Court's detailed discussion of the direct/derivative inquiry in the merger context and, specifically, the Court's reaffirmation that the so-called "Parnes exception" for direct challenges to the validity of a merger itself has properly been interpreted "very narrowly." In short "there must be a causal link between the breach complained of and the ultimate unfairness of the merger" for purposes of pleading a direct claim and overcoming the loss of derivative standing typically accomplished by virtue of the transaction.

The NYMEX decision, when read in concert with the Chancellor's recent Wayne County decision upon which NYMEX expressly relied, further evidences the weighty deference shown by Delaware courts to independent boards in the change of control context. The decision thus warrants careful review and consideration by M&A practitioners and those who advise them.

Study: M&A Holdback Escrows

If you are among the many practioners who spend most of their lives doing small private company M&A deals with escrows rather than large cap public company M&A, you many be interested in a new JPMorgan study relating to holdback escrow accounts used in deals. In addition to analyzing various factors in the claims process and to provide information on year-over-year trends, the report looks at the percentage of escrows that have claims filed against the account; the types of claims; the average life span of the escrows and more.

Key findings in the report include:

- Of the deals analyzed, 40% had claims filed against the escrow.
- Of the escrows with claims presented by the buyer, some portion of the claim was paid in virtually all cases.
- The incidence of claims increased significantly from 2007 to 2008, which may be a reflection of the past year's economic environment.

Hostile Deals: The Mighty Click-Through Disclaimer

Deal junkies have been actively following Kraft's journey in its hostile bid for Cadbury. One of the unique aspects of this deal is that Kraft - a US company - has made an unsolicited bid for a United Kingdom company (last week, the British Panel on Takeovers and Mergers gave Kraft until November 9th to make a bid or sit out for six months). Hostile deals are relatively rare in the UK, particularly when a US bidder is involved.

This is probably why Kraft's web page that provides information about its proposed offer is replete with a record-number of click-through disclaimers. As the proposed offer is unsolicited, Kraft would not have access to Cadbury's shareholder lists and thus would not necessarily know which country's laws it has to comply with - and given that unsolicited bids are relatively rare in the UK, there might be some uncertainty as to what exactly is needed. Hence, there might be some overkill.

Interestingly, even Cadbury's web page even has a click-through disclaimer for its information. Its lawyers have the advantage of knowing where its shareholders reside.

Note that "agreed-upon" deals in the United Kingdom are often structured as a "scheme of arrangement." Such deals are typically exempt from registration in the US under Section 3(a)(10) of the '33 Act. The 3(a)(10) exemption requires that the terms and conditions of the issuance and exchange of securities are approved (after a hearing upon the fairness of such terms and conditions at which all persons to whom the exchange is proposed have the right to appear) by a court or by any official or agency of the US or any state or territorial banking or insurance commission or other governmental authority authorized by law to grant such approval.

In the US, the most common examples are California fairness hearings. While 3(a)(10) does not appear on its face to apply to non US governmental approvals - i.e., UK schemes of arrangement or Canadian plans of arrangement - in practice, the SEC permits them to qualify for the exemption. Note, in addition to judicial approval, UK schemes of arrangement and Canadian plans of arrangement typically require supermajority shareholder approval - a higher percentage than would effect a change in control, but lower than would typically be required to effect a backend squeezeout under UK or Canadian law.

RiskMetrics Releases '09 Report on Poison Pills

Kevin Wells of RiskMetrics recently blogged this:

Though not as prevalent as they once were, shareholder rights plans, commonly referred to as poison pills, remain a fixture of the corporate governance landscape. As the global economic crisis took a toll across U.S. and international capital markets over the past year, companies continued to adopt pills, albeit with more shareholder-friendly provisions. Indeed, an analysis of regulatory filings, proxy voting trends, and other data finds that companies are incorporating more shareholder-friendly provisions into their pills; moreover, companies are putting such plans to a shareholder vote in greater numbers than ever before.

Perhaps as a consequence of increased management votes to ratify or adopt pills, shareholder activism, as measured by filings of shareholder proposals to terminate or allow shareholders to vote on pills, has declined. However, those shareholder proposals appearing on ballots generally received high levels of support in 2009.

Amid the recent economic turmoil, 2009 has also seen the emergence of NOL poison pills, which are meant to protect companies' tax assets rather than to deter acquisition offers. It was an NOL pill, in fact, that became the subject of controversy in Selectica v. Versata, pending in Delaware Chancery Court, which may significantly affect future uses of poison pills by Delaware companies.

Select key findings from the report include:

- Newly Enacted Pills: Thirty-three S&P 1,500 Index companies enacted pills between July 1, 2008, and July 1, 2009. Their average term was 7.6 years, and 10 were for terms of three years or less. Four of those were enacted for a period of 12 months or less.

- Pill Usage Among S&P 1,500 Companies Declines for Third Straight Year: The number of S&P 1,500 companies that maintained a poison pill declined for the third straight year in 2009, from 34.5 percent in 2008 to 27.5 percent in 2009. In 2007, 42.5 percent maintained a pill.

- Poison Pill Trigger Thresholds: In 2009, 69.2 percent of the S&P 1,500 companies that maintained a pill employed a 15 percent trigger. Another 19.6 percent employed a 20 percent trigger, and 7.9 percent employed a 10 percent trigger.

RiskMetrics' clients can contact their account managers to obtain a copy of 2009 Corporate Governance Background Report - Poison Pills. To purchase a copy, please visit our online bookstore.