The Focus on Contractual Clarity

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...

July-August Issue: Deal Lawyers Print Newsletter

This July-August issue includes articles on:

- 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

Try a "Half Price for Rest of '08" no-risk trial to get a non-blurred version of this issue for free.

CA v. AFSCME: The Delaware Supreme Court Giveth and the Supreme Court Taketh Away

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.

Mars-Wrigley Pending Acquisition: Are the "Strategics" Now Emulating the "Financials"?

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...

How to Handle Hedge Fund Activism

Catch this webcast tomorrow - “How to Handle Hedge Fund Activism” - featuring:

- Joele Frank, Founding Partner, Joele Frank Wilkinson Brimmer Katcher
- David Katz, Partner, Wachtell Lipton Rosen & Katz
- Christopher Young, Director of M&A Research, RiskMetrics Group
- Veronica Rendon, Partner, Arnold & Porter LLP

The Delaware Supreme Court's AFSCME/CA Hearing: All the News Fit to Post

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:

Background

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)."

My essay on this issue - published in the March edition of the Corporate Governance Advisor - predicted that the SEC would certify the bylaw question to Delaware soon. Broc and I also had an interesting discussion during a podcast regarding this question back in February. For more on the growing trend of shareholder democracy behind this challenge, see my article "Pandora's Ballot Box, or a Proxy with Moxie: Majority Voting, Corporate Ballot Access, and the Legend of Martin Lipton Re-Examined."

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?

The Briefing

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.

AFSCME's argument:

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.

Here is CA's brief - and here is AFSCME's brief (and appendix).

Oral Argument

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?

Conclusion

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...

Activists, Swaps & the SEC: A CSX Update

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.

Delaware Supreme Court: CA/AFSCME Certification Accepted and on Fast Track

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.

We have posted the Supreme Court's order in the "Shareholder Proposal" Practice Area on TheCorporateCounsel.net.

Corp Fin No-Action Relief for Busted Merger/Reorganization

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.

Duty Of Disclosure: Delaware Chancellor Further Limits Availability of Damages

From Travis Laster: Last week, Delaware Chancellor Chandler - in In re Transkaryotic Therapies, Inc. - granted summary judgment in favor of three directors who were alleged to have breached their fiduciary duties by supporting and voting in favor of the acquisition of Transkaryotic Therapies by Shire Pharmaceuticals. Here is a copy of the opinion.

Much of the opinion consists of the Chancellor's rulings on the plaintiffs' allegations of bad faith and disloyalty. From a doctrinal and practitioner perspective, the more important discussion focuses on the duty of disclosure (pages 17-28).

In summary, the Chancellor characterizes the duty of disclosure as a doctrine designed for pre-vote adjudication, leaving very little room for any post-closing remedy. In his words, "the Court grants injunctive relief to prevent a vote from taking place where there is a credible threat that shareholders will be asked to vote without such complete and accurate information. The corollary to this point, however, is that once this irreparable harm has occurred --i.e. when shareholders have voted without complete and accurate information--it is, by definition, too late to remedy the harm" (page 25).

Based on this principle, the Chancellor granted summary judgment for the defendant directors: "I hold that this Court cannot grant monetary or injunctive relief for disclosure violations in connection with a proxy solicitation in favor of a merger three years after that merger has been consummated and where there is no evidence of a breach of the duty of loyalty or good faith by the directors who authorized the disclosures" (page 27).

As a practical matter, the Transkaryotic decision obviously favors defendant directors, and it should increase their settlement leverage in cases where plaintiffs primarily assert disclosure claims but do not pursue injunctive relief. In other words, the cost of a post-deal clean-up settlement involving disclosure claims should go down. The logical response from the plaintiffs' bar, however, should be to pursue more pre-closing disclosure-based injunction applications, since that is now the only real avenue available for a meaningful disclosure remedy and a commensurate fee award. In the long run, therefore, the Transkaryotic decision may result in more injunction applications and more disclosure litigation.

Two other points deserve brief mention. First, the Chancellor granted summary judgment on the claim that a director breached his fiduciary duties by soliciting so-called "empty votes" from stockholders who owned shares on the record date then sold them. The Court found that the director's efforts to support the merger was "consistent with - rather than at odds with - his fiduciary duties" (page 39).

Second, the Chancellor permitted the plaintiffs to proceed with a challenge to the statutory validity of the merger, based on their assertion that the merger had not received sufficient votes. This challenge rested in part on testimony to the effect that the inspectors of election tallied the vote very quickly, yet the plaintiffs produced evidence of over-vote situations that would have taken additional time to resolve. Notwithstanding the passage of three years since the merger closed, the Court permitted the challenge to go forward. This holding emphasizes the need for care when tallying merger votes and counsels in favor of hiring a reputable outside firm, such as IVS, to act as the inspector for close votes.

I've been saying that companies should hire independent inspectors for a long time - and since you sometimes don't know if your vote will be close until the last minute - you need to line up the inspector well in advance because they are in short supply!

Shareholder Rights Plans: Adding Derivatives to "Beneficial Ownership"

As noted in this WSJ article, at least two companies - Louisiana-Pacific Corp. (see related Form 8-K) and Micrel Inc. (see related Form 8-K) - have changed their shareholder-rights plans in recent months to include derivatives when calculating levels of "beneficial ownership" that would trigger their poison pill. The companies likely took this action to thwart the use of derivatives in activist plays.

A Different Perspective on CSX/TCI: Should Courts Reject a Private Right of Action Under Section 13(d)?

In the Harvard Law School Corporate Governance Blog, Phillip Goldstein of Bulldog Investors provides a viewpoint different from those coming from management's perspective. It's interesting to read a different viewpoint from the management one.

We have been posting oodles of law firm memos about the case in our "Schedule 13D" Practice Area.

Half of Sovereign-Wealth Fund Deals Involve Majority Stakes

As noted in this recent WSJ article, according to a recent Monitor Group study, half of the investments by sovereign wealth funds since 2000 involved a more than 50% interest. 37% involved stakes between 10% and 50% and only 13% involved investments of less than 10%.

There were 420 deals during this eight-year period - only 14 of them in wealthy nations, worth abut $9.4 billion, involved majority stakes in companies in such politically sensitive areas as energy, utilities, information technology, telecommunications and financial services.

Here is a copy of the study - and here is a quote from this Reuters article: "Heightened national security concerns over strategic investing by sovereign wealth funds appear to be overblown, a new study released on Friday found. The study, conducted by consulting firm Monitor Group, found that the bulk of SWF investing appears to be aimed at furthering the economic development of a host or allied country, not acquiring sensitive strategic or economic assets to advance political aims of a state."

Winning the World Series: Cubs Worth More? Or Less?

Here is a recent WSJ.com interview with an economist about how much more the Chicago Cubs would be worth if they won the World Series this year (they are red hot and it's been 100 years since they last won).

The interview is short and perhaps not complete - but in my opinion, the Cubs would be worth less in the long run if they won. Part of their national mystique is that they are perennial losers. "Maybe next year" is their mantra. As someone who grew up down the street from Wrigley Field at a time when they "had it in the bag" - the late '60s/early '70s - I don't want to see the streak end...

Closing Time: When the Founder is Ready to Sell

We have posted the transcript for the webcast: "Closing Time: When the Founder is Ready to Sell."

Corp Fin's No-Action Letter: Partial Tender Offers Under US and Israeli Law

Here is some analysis from Jim Moloney of Gibson Dunn: This recent no-action letter - Elron Electronics Industries - is unusual in that it relates to a partial tender offer being done under U.S. and Israeli law. Here you have a situation where an Israeli bidder is is making an all-cash tender offer for up to 5% of the outstanding ordinary shares and ADRs in a single offer. It is somewhat more typical to see a dual-offer structure. According to the bidder, a recent record holder list shows a relatively high percentage of shares held by U.S. persons -- approximately 63%. However, the bidder believes the U.S. ownership of the subject company is really closer to 52%.

The Israeli Companies Law requires a 4-day extension of the tender offer period, without a corresponding extension of withdrawal rights (a "subsequent offering period"), once all conditions to the offer have been satisfied. Payment of the tender offer consideration is expected four or more days after the expiration of the subsequent offering period which is apparently permitted under Israeli law.

For reasons not clearly articulated in the letter, the "subsequent offer period" that is permitted under U.S. law (Rule 14d-11) does not work here. Presumably that is because the offer is "partial" and Rule 14d-11 requires that the offer be for "all outstanding" securities of the class sought and the bidder must "accept and promptly pay for all securities" tendered during the initial offering period upon the close of the initial offering period. Therefore, the bidder requested relief from the prompt payment rule (Rule 14e-1(c)) and the rule requiring withdrawal rights (Rule 14d-7(a)(1)), which the staff granted.

The CSX Opinion is In!

Yesterday, in CSX Corp. v. The Children's Investment Fund Management, Judge Lewis Kaplan of US District Court (SDNY) delivered his anxiously awaited opinion finding that the two plaintiff activist funds violated the securities laws by not disclosing their positions and intentions many months before they did.

However, Judge Kaplan also ruled that there was nothing effective that he could do and he didn't bar the funds from voting their shares at CSX's upcoming annual meeting. And in his fine analysis, Professor Steven Davidoff notes that its unlikely the SEC will pursue an enforcement action given the letter submitted to the court from Corp Fin. Here is a NY Times article - and here is a WSJ article.

Here is an additional tidbit - the NY Times' Andrew Ross Sorkin wrote his column Tuesday about how CSX is a case study in how not to respond to a proxy fight...

Disclosure of Internal Financial Projections

From guest blogger Steve Haas of Hunton & Williams:

A hot M&A issue of late has been the need to disclose internal financial projections under Delaware law. In 2002, the Court of Chancery in Pure Resources directed a target corporation to disclose substantive portions of its investment banker's work in responding to a controlling stockholder's tender offer. Many practitioners assumed that Pure Resources was distinguishable from third-party negotiated transactions because, as that court observed, the transaction involved a controlling stockholder who presumably had more knowledge about the company than did the minority stockholders.

But that rationale was implicitly called into question last year in Netsmart, where the court ordered disclosure of management's financial projections in connection with a go-private deal with a private equity fund. Subsequent Delaware decisions, however, including CheckFree and Globis Partners, made clear that there is no bright-line common law rule requiring disclosure of management's projections.

It's not clear how to reconcile all of these decisions, and practitioners are left with generalized standards that require disclosure of all "material information" and a "fair summary" of the target's financial analysis, but the required disclosures do not need to enable stockholders to perform their own independent valuation. In assessing these disclosure obligations, the accuracy and reliability of the projections and the extent to which they were relied upon by the target board and its investment bankers seem to be the most important factors.

One Delaware jurist also suggested recently that the presence of target insiders on the buy-side would help tilt the court's analysis in favor of disclosure, since those insiders likely prepared the projections and understand their utility. That rationale supports the positions taken in Pure Resources and Netsmart. Mike Tumas and Michael Reilly at Potter, Anderson & Corroon recently put together a very helpful analysis of these issues in this memo, which originally appeared in Deal Points.

Unsealed: Yahoo's Tin Parachute

The media has had a field day ever since Delaware Chancery Court's Chancellor Chandler unsealed this amended complaint filed against Yahoo, particularly because Carl Icahn is involved as he pressures Yahoo to sell; see this DealBook post which includes Icahn's latest demand letter. The lawsuit charges that Yahoo's directors breached their fiduciary duties by their actions, including failing to negotiate a deal with Microsoft and enacting a broad employee severance plan.

Professor Steven Davidoff describes the tin parachute plan in quite some detail - and analyzes the arrangement, plus links to two other blogs that do the same - in his "DealBook" blog. Here is an excerpt from his blog:

The plan provides that if an employee with Yahoo is terminated by Yahoo without “cause” or by the employee for “good reason” within two years after Microsoft acquires a controlling interest in Yahoo, the employee will receive (among other things):

(1) his or her annual base salary over a designated number of months ranging from four months to 24 months, depending on the employee’s job level; and

(2) accelerated vesting of all stock options, restricted stock units and any other equity-based awards previously granted.

Under the plan, good reason means any “substantial adverse alteration” in an employee’s duties or responsibilities during the two years following the change of control.

As a measure of the market, the argument that this plan is “egregious” seems primarily related to the cash severance component, not the equity acceleration. The latter feature is quite common even on a single-trigger basis (in which the equity is accelerated immediately upon a change of control or on a modified basis, permitting the executive to leave the company after one year and benefit from this provision).

But single-trigger provisions are becoming much less common. And under the Yahoo plan, both these payments have a double trigger: There must be an acquisition by Microsoft and then a subsequent termination of the employee. This is what you would expect for a tin parachute — slang for a change-in-control plan that covers all employees.

Still, it is less common to permit rank-and-file employees to benefit under the plan if they decide to leave the company for “good reason.” Typically, they only get a benefit if they are terminated without “cause.” But here, the definition of “good reason” is narrower than you would typically see for a corporate executive, though it still gives some rights to the employees to walk away. This is the part of the plan that is most aggressive. And the complaint is right that the definition of good reason could provide substantial leeway for Yahoo’s employees to walk.

Disclosing Swaps: SEC Staff Takes a Position in CSX Lawsuit

As the conclusion of one of the more closely-watched cases in recent years in the M&A area draws near (see this IR Magazine article for background), a number of amicus curiae filings were made available last week, including a letter from Corp Fin Deputy Director Brian Breheny (as transmitted by the SEC's General Counsel; this is not a Commission amicus brief). We have posted them in the "M&A Litigation Portal" on DealLawyers.com, as follows:

- SEC General Counsel's Brian Cartwright Transmittal Letter
- SEC Corp Fin Deputy Director's Brian Breheny Letter
- Prof. Bernard Black's Response to SEC Staff Letter
- ISDA/SIFMA Amicus Curiae Brief

Here is some analysis from Cliff Neimeth of Greenberg Traurig: In a pending litigation being watched closely by the public M&A bar, institutional activists and target issuers alike, this past Wednesday, in correspondence submitted by Corp Fin Deputy Director Brian Breheny to U.S. District Court (SDNY) Judge Lewis Kaplan, Brian endorsed the view of activist hedge funds - The Children's Investment Fund ("TCIF") and 3G Capital Partners ("3G") - that they were not required under Regulations 13G or 14A to disclose their approximate 12% economic stake in Jacksonville, Florida-based railroad operator CSX Corp. until months after they entered into these arrangements. The hedge fund defendants previously announced their intention and presently intend to elect a short-slate of their five nominees at CSX' annual meeting scheduled for later this month.

At issue, among many other aspects of the litigation, is the fact that TCIF and 3G were parties to elaborate "swap" and cash-settle derivative arrangements with investment bank counterparties, and that the nature of these contracts did (and do) not confer upon TCIF and 3G any shared or sole voting power over the underlying equity securities. Accordingly, in their view, such arrangements fall outside of the ambit of Section 13(d) and Regulation 13D thereunder until such time as these arrangements are converted into beneficial voting positions.

Although TCIF and 3G, on numerous occassions, announced to the investment community and to CSX directly that they were parties to the swaps and, in fact, made H-S-R (pre-merger notification) filings with the FTC, the absence of a detailed Schedule 13D filing (and subsequent amendments) allegedly enabled them to conduct (over a period of months) a broad range of "coordinating activities" with other institutional holders of CSX, to execute various plans, arrangements and understandings relating to control of CSX, and to otherwise engage in undisclosed "group" activities.

Brian Breheny (expressing the Staff's position of the appropriate interpretive legal standard and not the position of the SEC's Commissioners) stated in his letter to Judge Kaplan that "the presence of economic or business incentives that the [swap counterparty] may have to vote the shares as the other party wishes" is insufficient to create the beneficial acquisition of voting power in respect of such shares.

If Judge Kaplan agrees with TCIF's and 3G's (and indirectly, Breheny's amicus) interpretation of the legal standard for disclosure, this would have significant implications for hedge fund activist transaction planners and target companies. If he rules in this direction, it is not unlikely that this may prompt the SEC to accelerate its current assesment of whether Regulation 13D should be amended to broaden its reach to cover these cash-settled (synthetic) arrangements that have become more commonplace over the past several years.

Coupled with the SEC's e-proxy regime, the current slowdown in traditional economic M&A activity, and the recent Delaware Supreme Court and Delaware Chancery Court decisions in Openwave-Harbinger Capital, Jana Partners-CNET, Levitt Corp.-Office Depot and TravelCenters-Brog (with respect to the efficacy of the advance notice by-laws in those cases), this continues to help fuel an unprecedented level of institutional activism and control contest activity for the forseeable future. This also underscores the need for corporate issuers to examine their "shark repellents" and defensive arsenal.

Obama's "Incorporation Transparency Act" and The Shape of Things to Come

From guest blogger J.W. Verret, Assistant Professor, George Mason University School of Law:

The Senate Permanent Investigations Subcommittee is considering a bill introduced a few weeks ago by Senators Barack Obama, Norm Coleman, and Carl Levin, the "Incorporation Transparency and Law Enforcement Assistance Act," requiring states to determine the beneficial ownership of business entities formed under their jurisdiction and make that information available to their the federal government through subpoena.

In support of this bill, the Senators cite a handful of cases investigated by federal agencies that were later dropped because of difficulty determining beneficial ownership in the investigated entities. A proper analysis of the effects, costs, and likely constitutional challenges facing this bill reveals it as little more than a red herring - an empty gesture by a Presidential aspirant and Senators from contested districts meant to generate the appearance of being tough on corporate crime.

Other Alternatives

Legitimate prosecution of business entities engaging in activities that represent a threat to national security or violate tax, banking, or securities laws is a vital element of the federal government's law enforcement mandate. This does not mean that the state governments should be enlisted as subsidiaries of the Department of Justice merely because federal prosecutors find their work difficult or expensive.

There are other ways for the DOJ to determine the beneficial ownership of corporations. For instance, in Delaware, the home to more than half of all business entities, and 60% of the Fortune 500, nearly 2,000 cases are filed annually in Delaware's Court of Chancery against business entities. Delaware's plaintiffs bar skillfully uses the legal discovery process to determine beneficial ownership of those defendants.

Learning from Delaware - and the Costs

Perhaps federal prosecutors could learn something from Delaware lawyers in that regard. Legal discovery is an expensive and difficult process, but the fact that a handful of federal prosecutions have not resulted in successful convictions does not justify the federal government drafting the states into the service of federal agencies.

Indeed, the Constitution prohibits such an approach. In Printz v. U.S., the U.S. Supreme Court invalidated provisions of the Brady Bill that imposed mandatory regulatory requirements on local law enforcement. Justice Scalia articulated the Court's interpretation of state sovereignty succinctly: "The Federal Government may not compel the States to enact or administer a federal regulatory program."

The realities of business ownership, with its complex holding arrangements, make the costs of this bill prohibitive. Holdings are often structured with a network of ownership using flow through entities as well as powerful contractual rights held by non-shareholders. This is done for legitimate tax efficiency planning purposes as well as to sell specific interests to groups of investors or secure specific assets to interested creditors. The ownership structure of the Carlyle group or a typical grocery store franchise share that quality. This bill holds criminally liable any business failing to keep an accurate listing of its "beneficial owners" with the state in which it is registered, thus subjecting the two million businesses that form every year to unreasonable liability for a number of open questions of what being a "beneficial owner" really means in today's business environment.

Impact on Small Business

Professor Bainbridge of UCLA Law School has also observed that this bill will harm the millions of small businesses exempt from SEC registration trading on the pink sheets. Though the bill exempts entities registered with the SEC, recognizing that when shareholders trade in an active market an accurate list of their beneficial owners would be nearly impossible to maintain, it ignores that the same issue will be worse for smaller firms exempt from SEC registration.

The overriding drawback to this scheme is that only law-abiding businesses will feel its effects. Registrants of business entities used to cover illicit activities, such as money laundering or terrorism financing, would certainly lie on any form the states send them requesting beneficial ownership information. Unreasonable administrative costs are then imposed on state governments and small businesses with little effect on the exceedingly small percentage of businesses actually engaging in illicit activities.

The formation of over two million businesses each year is not something to be maligned by politicians hoping to spin momentary political hay. It is a result of a regulatory environment that has created a business entity formation system envied by developing markets around the world. If economic benefits of small business entities are to be protected, regulatory proposals should be subject to a sincere cost-benefit analysis.

What to Do Now

Most entities are formed in jurisdictions, such as Delaware, that have developed a specialized business court and corporate code to assure directors and officers maintain strict adherence of their fiduciary duty to their shareholders. The Obama/Levin/Coleman Act puts the success of this system in jeopardy.

Corporate counsel involved in the creation of LLC, LLPs, and corporations would be advised to inform their clients about this impending change, as well as the potential liability they face for failing to fully report their "beneficial owners" to the state's that chartered them.

Goldman Sach Cancels a Deal: SPACs in Limbo?

With Goldman Sachs canceling its much-anticipated SPACs offering - through Liberty Lane - it looks like the bloom may be off the SPACs, rose (see this WSJ article from yesterday). Today's WSJ has an article which offers this analysis:

The failure of Goldman Sachs Group Inc.'s first SPAC offering this week has sparked a debate over what brought the deal down and whether any structural changes within the industry could revive this segment of the IPO market.

Expectations for a successful offering had been raised the moment Liberty Lane Acquisition Corp. filed its initial public offering prospectus with the Securities and Exchange Commission in March. As a special purpose acquisition company, or SPAC, Liberty Lane's offering followed a familiar format: The company began life as an empty shell and planned to raise money through an IPO to finance the acquisition of an operating business within two years, or investors would get their money back.

But alterations to the traditional SPAC structure made this deal a departure from the norm -- one that Goldman hoped would draw in a stable base of investors and make potential acquisition targets more amenable to a takeover.

Instead, after two weeks of trying to price, Liberty Lane threw in the towel Wednesday, saying it had decided not to go ahead with the IPO for now. (See related Breakingviews commentary.)

'State of the Market'
"My personal view is it was probably more the state of the market than the structure of the deal" that stymied Liberty Lane's launch, said Michael Littenberg, an attorney who works on SPACs for Schulte Roth & Zabel LLP. "This has not been one of the most robust periods for capital markets."

After a banner year in 2007, in which nearly a quarter of all completed IPOs in the U.S. were SPACs, the demand for these deals in 2008 withered along with the broader IPO market.

Others say Liberty Lane's altered structure wasn't appealing enough to investors. The changes Goldman made were aimed at reducing the dilution that SPAC investors and acquisition targets face due to the large amount of stock normally held by most SPAC management teams. But at the same time, it cut the stake that management took in the company, reduced the percentage of investors' money kept in trust, and trimmed the amount of stock warrants available to investors.

"Obviously, we all know that SPACs in general have not been doing well, but they have had dips before," says Kristin Angelino, an attorney who represents SPAC issuers and underwriters at Gersten Savage LLP. "If Goldman's IPO didn't have such a weak structure, I might say that this reflects a worsening of the market for SPACs."

Through the new structure, Goldman was intent on placing Liberty Lane's shares with "fundamental" investors, such as mutual funds, rather than marketing the deal to the typical SPAC buyers, which are hedge funds. Hedge funds in the past have gravitated to SPACs because the deals are sold as a stock-and-warrant unit that eventually splits, with some funds selling off the warrant portion and others purchasing only the warrants, depending on their investment strategies.

Underwriters and SPAC management have long wanted to shift ownership of the deals toward fundamental buyers who would stick with the SPAC throughout its lifespan and be more likely to approve an acquisition than hedge funds, which sometimes vote a deal down as part of their investment strategy. But fundamental buyers didn't line up as expected.

Citi's Alternative
Coincidentally, as Goldman's deal was floundering last week, Citigroup Inc. filed an amendment to a SPAC it is underwriting that alters the structure in a different manner than Liberty Lane.

The Citigroup deal, HCM Acquisition Co., splits each IPO unit into two parts: One that contains 80% of a share of stock, another that contains 20% of a share of stock and a warrant that is nondetachable until the day after a business combination is approved. If a deal is voted down, the warrants expire worthless.

By binding the warrant to a portion of stock until an acquisition is completed, HCM is effectively giving warrant holders the ability and incentive to approve a deal. To give HCM a further edge in closing a deal, the company will still go ahead with an acquisition even if up to 40% of the shareholders vote it down - a higher bar than the typical 20% no-vote norm in the SPAC world.

How Companies Can Foil Their Activist Shareholders

I drafted this a while back but forgot to post it - more Tulane Institute notes from the WSJ's Deal Journal:

The promisingly named “Barbarians at the Ballot-Box” panel here at the Tulane University Corporate Law Institute didn’t disappoint: it was full of good stories and disagreement among the panel members, who included Mackenzie Partners CEO Daniel Burch, PR maven Joele Frank, Roy Katzovicz, general counsel at the hedge fund Pershing Square, and Institutional Shareholders Services executive Chris Young.

The panelists don’t exactly come to blows. Still, it is clear Katzovicz and Young will have to take a lot of heat for the frustrations of people who have problems with activist investors. Katzovizc says hedge funds would rather not wage proxy fights and fight for board seats– they would rather focus solely on profitable investing.

Then quickly the panel seems to shift in to “Dear Abby” mode, advising on how to fight off shareholder activists. Here is a look at some of their advice.

Staggered Boards Don’t Work: It turns out that some of the things that companies think protect them from attacks by activists don’t work. Katzovicz, for instance, disputes that staggered boards–where directors are elected in different years, rather than all at once–help fend off activists. Instead, he says, they make his job much easier.

Don’t Be Snotty to Your Activist: Frank warned people to pick up the phone very carefully when they see calls from the (203) area code in Greenwich, in hedge-fund heavy Connecticut, because whatever you say to an activist can and will be used against you in a 13D filing to the SEC. The panelists discuss the sad cautionary tale of Embarcadero Technologies, whose chief financial officer once said to activist Robert Chapman, “F*** You!” That gave Chapman a chance to get justifiably huffy that it was “inappropriate and inadvisable” to use such “blasphemy” to a shareholder who owns 9.3% of your company. We quibble with Chapman’s choice of words — a blasphemy is only when you are insulting a deity –but the point is a good one. Young, of ISS, recounts what he considers a horror story of an unresponsive company: one which wouldn’t even meet with T. Rowe Price. “This isn’t an activist! It’s T. Rowe Price!” he said with wonder.

Do Lots of Hand-Holding: Frank advocated keeping good relationships with the media and guiding CEOs through the process. “Most CEOs aren’t used to opposition,” Frank says. She also advocated a quick response to activists: call them early and often. This can apparently diffuse the activist. Katzovicz recalled a story in which Carl Icahn was on the brink of going on the attack at a company he had invested in. He met with the firm’s executives, who told him, “Carl, whatever it is you want, we’ll do it.” Icahn sold all of shares and left the company alone. Kim Rucker talks about the “headline pressure” as executives face the dread of seeing themselves in the paper every morning. That, and exhaustion, can take a toll on management’s decision making, she and Frank agreed.

Accept that You Can’t Control Your Proxy Firm: Frank, who does a lot of hostile defense work, launched this attack toward the end of the panel: “I believe ISS has never seen a slate it doesn’t like from activists. Frank asked with some annoyance if ISS ever goes against an activist slate in toto. Young said the proxy firm does, about 30% of the time. The question to ask, he suggested, isn’t what ISS approves but why activists are getting traction with shareholders. He noted that a few years ago, the directors suggested by hedge funds were the hedge-fund manager and four of his fraternity brothers who worked for him. The activists have wised up since then and suggested better directors, he said. Rather than saying that ISS tends to approve the majority of hedge fund director suggestions, he instead pointed out that ISS discards some of the activists’ suggestions.

Don’t Get too Comfortable: Burch noted that long-term investors won’t necessarily support what you do against activists. Rucker said that if boards and companies are doing the right things and doing their jobs, they can survive all that.

2008: The Year of the Hedge Fund Activist

We have just posted the transcript for the webcast: "2008: The Year of the Hedge Fund Activist." Catch the companion webcast - "How to Handle Hedge Fund Activism" - on July 15th.