This May-June Issue of the Deal Lawyers print newsletter includes:

– Prospective Bidders: Will the Pershing Square/Valeant Accumulation of Allergan Lead to Regulatory Reform?
– Proposed Amendments to the Delaware General Corporation Law: Section 251(h) Mergers & More
– The Evolving Face of Deal Litigation
– Rural Metro: Potential Practice Implications Going Forward
– New Urgency for Corporate Inversion Transactions

If you’re not yet a subscriber, try a Half-Price for Rest of ’14 no-risk trial to get a non-blurred version of this issue on a complimentary basis.

Over on TheCorporateCounsel.net, I recently blogged about how the Delaware Supreme Court found that fee-shifting bylaws are permissible (there are numerous memos posted on that site about this case). As with exclusive venue bylaws, whether many companies decide to adopt these litigation-related bylaws will likely hinge on the reaction of the proxy advisors and major institutional investors. Here’s a nice article by David Marcus of The Deal about this case:

A recent decision from the Delaware Supreme Court has corporate lawyers and litigators pondering a potentially new way to curb shareholder litigation. On May 8, the court unanimously held legal under Delaware law a
corporate bylaw providing that a shareholder who sues the company unsuccessfully must pay it for the costs of defending the suit. Justice Carolyn Berger’s 14-page opinion in ATP Tour Inc. v. Deutscher Tennis Bund answered only the question of whether such bylaws are legal under Delaware statutory law and did not offer guidance on when a corporate board might be able to implement one consistent with its fiduciary duties. Combined with a 2013 decision in which then-Chancellor Leo E. Strine Jr., upheld a corporate bylaw that requires all fiduciary duty litigation against a company to be brought in the Delaware Court of Chancery, the ATP decision could give companies a powerful tool against insurgent shareholders. (Strine is now the chief justice of the state’s Supreme Court.)

Said one New York M&A lawyer, “This decision opens the door to adding these fee-shifting provisions on top of forum-selection bylaws, with the possibility that these fee-shifting provisions will be more effective in deterring
frivolous shareholder litigation altogether with the forum selection bylaws only effective in eliminating duplicative litigation outside Delaware.”

The ATP case originated not in Delaware state court but in federal court. The Deutscher Tennis Bund and the Qatar Tennis Foundation sued the ATP in U.S. District Court in Delaware after the organization downgraded the tournament played in Hamburg, which the DTB and the QTF own and operation. The plaintiffs claimed that the ATP — a Delaware membership corporation to which both entities belong — violated its fiduciary duties and U.S. antitrust laws with the downgrade. The federal district court found for ATP, which moved to recover its legal fees from DTB and QTF based on a provision in its bylaws. The district court certified the question of the bylaw’s legality to the Delaware Supreme Court.

Berger held that fee-shifting bylaws are “facially valid” under Delaware law but cautioned, “Whether the specific ATP fee-shifting bylaw is enforceable, however, depends on the manner in which it was adopted and the circumstances under which it was invoked. Bylaws that may otherwise be facially valid will not be enforced if adopted or used for an inequitable purpose.”

Companies may adopt a fee-shifting bylaw to deter litigation, Berger held, because the intent to do so “is not invariably an improper purpose. Fee-shifting provisions, by their nature, deter litigation. Because fee-shifting provisions are not per se invalid, an intent to deter litigation would not necessarily render the bylaw unenforceable in equity.”

The ruling was greeted with hearty approval by corporate lawyers, several of whom said that the ATP ruling should be applicable to stock corporations even though the decision involved a non-stock or membership organization. But that doesn’t mean corporations will start adopting such bylaws immediately, since proxy advisory firms and some institutional shareholders would likely oppose them vociferously and the bylaw would need to be appropriately tailored to a company’s specific situation. “In appropriate circumstances, such as the commencement of a sale process, the value of the bylaw could outweigh the negative consequences,” the lawyer said.

In a memorandum to clients, Wilson, Sonsini, Goodrich & Rosati PC said that boards of Delaware companies should “seriously consider” adopting such bylaws. The best time to do so would be “on a ‘clear day,’ when a board is not facing threatened or pending derivative litigation.” The optimal clear day might even be before a company goes public. The Wilson memo noted several caveats to the adoption of a fee-shifting bylaw. First, shareholders always retain the right to amend corporate bylaws and might well try to amend one that provides for fee shifting of litigation costs. Second, as Berger noted in the opinion, a Delaware court might hold that the board use of such a bylaw in a given situation might constitute a breach of fiduciary duties. Finally, the memo noted, other states might not honor fee-shifting bylaws. “The issue will likely be the subject of a lot of debate in the boardroom in the coming months as the recent Delaware decisions signal that companies may consider a variety of ways to control or limit the costs of frivolous litigation,” said Katherine Henderson, a partner in Wilson’s San Francisco office.

A. Thompson Bayliss, a partner at Abrams & Bayliss LLP in Wilmington, said that the ATP decision could encourage other kinds of bylaws designed to curb stockholder litigation. He suggested a bylaw that would opt out of the so-called corporate benefit doctrine, which allows stockholders to recover attorneys’ fees from the corporation if they confer a benefit on the corporation. At least in some instances, that type of bylaw would require suing stockholders to bear the costs of the litigation they bring, rather than imposing the costs on the corporation (and indirectly on the entire stockholder base). That could have a chilling effect on stockholder strike suits, but the widespread adoption of such bylaws remains a long way off, Bayliss said.

Here’s news from Davis Polk:

As expected, Senator Carl Levin and thirteen other Democratic Senators yesterday introduced a bill that would significantly limit, for a two-year period, the ability of U.S. corporations to engage in the type of acquisitive “inversion” transactions that have been increasingly completed or proposed by many U.S. corporations, particularly in the pharmaceutical sector.1

The typical acquisitive inversion transaction involves (i) putting a newly-formed non-U.S. holding company on top of the existing U.S. corporation, with the shareholders of the U.S. corporation becoming shareholders of the non-U.S. holding company, in conjunction with (ii) the acquisition by the non-U.S. holding company of a foreign target corporation, in a transaction in which the former shareholders of the foreign target corporation receive more than 20% of the stock of the non-U.S. holding company. The transaction avoids the most detrimental aspects of current U.S. “anti-inversion” rules (Section 7874 of the Internal Revenue Code), which would otherwise generally treat the non-U.S. holding company as a U.S. tax resident corporation if the former shareholders of the existing U.S. corporation received 80% or more of the stock of the non-U.S. holding company in the transaction. In many of these transactions, the executive officers and senior management of the existing U.S. corporation became the executive officers and senior management of the non-U.S. holding company and remained located substantially in the United States, a fact that is not relevant for purposes of the current anti-inversion rules.

Effective for acquisitions completed after May 8, 2014 and before May 9, 2016, the Levin bill would amend Section 7874 as follows:2

– The required stock ownership of the non-U.S. holding company by the former shareholders of the foreign target corporation would be increased from more than 20% to at least 50%.
– Even if the stock ownership requirement is met, the non-U.S. holding company would still be treated as U.S. tax resident corporation if (i) “management and control” of the non-U.S. holding company group occurs, directly or indirectly, primarily within the United States, and (ii) the group has significant U.S. business activities.3
– At a minimum, management and control of the group would be treated as occurring, directly or indirectly, within the United States if “substantially all” of the executive officers and senior management of the group (regardless of title) who exercise “day-to-day” responsibility for making decisions involving “strategic, financial and operational policies” of the group are based or primarily located in the United States.
– A group would have significant U.S. business activities if at least 25% (or such lower percentage as may be specified in regulations) of the group’s employees (by headcount or compensation), assets or income is located or derived in the United States, as determined by reference to existing regulations under Section 7874.
– If the bill is enacted, and a U.S. corporation undergoes an inversion transaction that meets the new ownership requirement but would otherwise be caught by this new management and control test, the bill may have the effect of forcing a substantial portion of the executive officers and senior management of an inverting U.S. corporation to relocate outside the United States.

After May 9, 2016, the amendments made by the Senate bill would no longer be in effect and the current anti-inversion rules would come back into force for transactions occurring after that date. Senator Levin has indicated that the temporary nature of the amendments made by the bill is intended to effectively place a temporary “moratorium” on typical inversion transactions while Congress works on corporate tax reform, and is an attempt to make the bill more palatable to those members of Congress who would prefer corporate tax reform as a permanent solution to the inversion “problem.” However, the fact that the bill has to date attracted only Democratic co-sponsors in the Senate is indicative of the difficulties that proponents of the bill may have in getting the bill passed in both the Senate and the Republican-controlled House of Representatives.

1. Representative Sander Levin introduced a substantially identical bill in the House of Representatives, with nine other House Democrats, although the House bill did not contain the two-year sunset provision.
2. The following discusses only the provisions of the bill that relate to the types of inversion transactions described above. The bill would also make other, more technical changes to the existing anti-inversion rules that could affect other types of transactions.
3. This amendment to Section 7874 would generally apply to any non-U.S. corporation that acquires, directly or indirectly, substantially all of a U.S. corporation or a domestic partnership of any size or in any type of transaction, including an all-cash acquisition. This provision could apply, for example, to a foreign corporation that was the result of a prior inversion transaction that subsequently acquires another U.S. corporation, or even a foreign corporation, if the foreign target had a U.S. subsidiary.

As I blogged last month, William Ackman’s Pershing Square Capital has teamed up with Valeant to make a hostile bid for Allergan as part of a new paradigm of a hedgie and corporate teaming up. Allergan has formally rejected any overtures so far.

Last week, Pershing Square Capital filed this preliminary proxy statement so that Allergan shareholders could attend a “meeting” of sorts (in person or by proxy) solely to cast a non-binding vote on whether Allergan should negotiate with Valeant on a deal. This straw poll is another novelty of this deal. Here’s some articles about this tactic:

– Reuter’s “No downside in Allergan ‘meeting'”
– The Activist Investor’s “A Shareholder ‘Get Together'”
– WSJ’s “Pershing Square Wants Allergan Holders to Push for Merger Talks”

Here’s news from Lisa Stark of Berger Harris:

In Southern Pennsylvania Transportation Authority (“SEPTA”) v. Volgenau, C.A. No. 461, 2013 (Del. May 13, 2014), the Delaware Supreme Court affirmed a Chancery Court decision holding that a sale of a controlled corporation to an unaffiliated third party, in which a controller (while not on both sides of the transaction) was alleged to have used his position to compete with the minority for merger consideration, would be reviewed under the deferential business judgment standard of review if the transaction is (1) recommended by a disinterested and independent special committee and (2) approved by stockholders pursuant to a non-waivable vote of the majority of all the minority stockholders.

Sales of Controlled Corporations to Unaffiliated Third Parties

The Delaware Supreme Court did not issue a written opinion in connection with this en banc ruling. However, the decision to affirm the Chancery Court decision in SEPTA is significant because it confirms the standard of review applicable to transactions in which the controller is alleged to have used its power to disproportionally divert portions of the merger consideration to be paid by an unaffiliated, third-party acquirer to the minority if the controlled target deploys robust procedural protections. In the 2009 Chancery Court decision in In re John Q. Hammons Hotels Inc. Shareholder Litig., the Court of Chancery held that the business judgment rule would apply to such a situation only if the merger was subject to (1) a non-waivable vote of a majority of the minority stockholders, and (2) a recommendation by a disinterested and independent special committee. In In re John Q. Hammons Hotels Inc. Shareholder Litig., the Court found the transaction at issue to be subject to entire fairness review because, although the transaction was subject to a majority of the minority vote, the special committee could waive the condition and the vote only required a majority of the minority voting on the matter, not a majority of the outstanding minority stockholders.

Subsequent Chancery Court decisions, such as Frank v. Elgamal, reaffirmed that, absent the procedural protections of a special committee and a majority of the minority vote, the Court of Chancery would apply the entire fairness standard of review to mergers of controlled corporations to an unaffiliated third party if the controller is alleged to have used its power to unfairly extract merger consideration from the minority or otherwise to have dictated certain aspects of the negotiations contrary to the interests of the minority.

SEPTA v. Volgenau

Unlike MFW, which involved a controlling stockholder on both sides of the transaction, SEPTA involved a merger between a third-party and a company with a controlling stockholder. Specifically, this action involved claims arising from the buy-out of defendant SRA International, Inc. (“SRA”) by Defendants Providence Equity Partners LLC  and its related entities. See SEPTA. v. Volgenau, C.A. No. 6354-VCN (Del. Ch. Aug. 31, 2012). As a public company, SRA had two classes of common stock: Class A and Class B. Holders of Class A stock were entitled to one vote per share, while holders of Class B stock were entitled to ten votes per share. However, SRA’s certificate of incorporation required the Class A and Class B common stock be treated equally in the event of a merger. As part of the transaction, SRA’s founder, Ernst Volgenau, who controlled SRA through his ownership of Class B shares, received a minority interest in the merged entity, a non-recourse note, a continuing role in the merged entity, and, in exchange for fifty-nine percent of his Class B shares, $31.25 per share in cash. Minority stockholders, who held Class A Shares, received $31.25 per share.

In this action, plaintiff contended that Volgenau received greater consideration in the merger than did the minority stockholders and that the board breached its fiduciary duties by failing to attempt to adhere to the charter’s equal treatment provision. However, because the transaction had been approved by a special committee comprised of independent and disinterested directors, and a fully informed, non-waivable majority of the minority vote, the Court reviewed the allegations under the deferential business judgment standard of review.

The decision to uphold the application of the business judgment rule to sales of controlled corporations to unaffiliated third parties where the transactions are subject to the same procedural protections at issue in MFW makes sense. In theory, transactions in which the controller is not on both sides of the deal present less potential for the controller to exert influence to the detriment of the minority stockholders.

Here’s news from ISS’ Chris Cernich:

On Friday, May 9, TIG Investors, a 9.5 percent holder of Zale Corp, filed preliminary soliciting materials and an investor presentation urging other shareholders to resist what it called an “undervalued” sale of the company. TIG points out that, while Zale shareholders are getting almost $300 million in premium – that’s 40 percent – the buyer’s shareholders got a $1.4 billion premium from the market when the deal was announced. This indicates that the value being created by the combination is not being appropriately shared between buyer and seller. TIG proposes that the company renegotiate to include a stock component as well as cash – its proposal would be worth about $28.50, versus the current $21 per share cash offer – which would allow Zale shareholders to participate in the upside of the combined company.

There are signs of growing support among other Zale shareholders, including about a 5 percent rise in Zales share prices, to $22, though no other shareholders have yet gone public. The Zale meeting will be held May 29.

There has also been progress, of a sort, in the Pershing Square/Valeant Pharmaceuticals unsolicited bid for Allergan. As expected, the Allergan board on Monday turned down the bid as undervalued. And, also as expected, Pershing Square and Valeant began taking their case directly to shareholders.

What wasn’t expected, however, was the tactic; Pershing Square is calling a sort of town hall, in lieu of an actual Special Meeting of shareholders, to create a referendum on whether the Allergan board should negotiate with Valeant in good faith. It’s not as strong a move as proposing a dissident slate of directors; but, since Allergan’s bylaws don’t allow for proposals at a special meeting which repeat business on which shareholders have already voted in the past year, it seems unlikely Pershing Square and Valeant can actually run a contest for board seats before May of 2015. As this plebiscite tactic is not an official corporate meeting, it is unclear whether “voting” would be required under ERISA.

In this podcast, Tony Hill, the Director of DealNexus at Intralinks, explains DealNexus – a social dealmaking tool specifically designed for M&A, including:

– How does DealNexus work?
– How does it differ from AngelList and other online connectors?
– What’s new in the DealNexus 3.0 update?
– Any surprises since you launched?

According to this Cornerstone Research study, only 2% of lawsuits filed in connection with M&A deals that settled in 2013 produced monetary returns for shareholders. Here are other findings:

– Supplemental disclosures remained the only shareholder consideration in the majority of 2013 settlements.
– Over 90% of the known 2013 settlements were reached before the merger was closed.
– Average fees requested by plaintiff attorneys in 2013 declined to $1.1 million from $1.4 million in 2011 and 2012.
– Between 2007 and 2013, plaintiff attorney fee awards in M&A deals were higher in settlements with monetary consideration (by an average of 22% of the settlement fund) and with reduced termination fees (by an average of $260,000 for a 10% reduction).
– Fee awards between 2007 and 2013 also were higher in settlements with a larger-than-average number of lawsuits, and in cases where settlements took longer than average to reach.

Tune in tomorrow for the webcast – “Appraisal Rights: A Changing World” – during which Morris Nichols’ John DiTomo, Morris Nichols’ Eric Klinger-Wilensky and Berger Harris’ Lisa Stark will analyze how appraisal rights work in a changing world, how to overcome common problems, and more.

Here’s news from Chris Cernich, ISS’ Head of M&A and Proxy Contest Research, and Juan Bonifacino, ISS Analyst, M&A and Proxy Contest Research:

Proxy contests for board seats are usually the story during the U.S. proxy season–but now it looks like mergers are becoming the bigger story. In some ways they’re a more beguiling story, as they change every day. Four weeks ago, the biggest contest was likely to be Charter Communications challenging the merger vote between Comcast and Time Warner Cable, as a way of getting Charter’s own bid back into the running. Now, however, the companies have announced a three-way deal in which Comcast would buy a number of subscribers the other two are shedding as part of the regulatory requirements of the merger.

There’s a vote coming up at Zales, on the sale to Signet, on May 29. No Zales holders have yet come out against the deal–it does carry a 41 percent premium over the unaffected price. But the deal is only worth $950 million, and the total premium Signet will pay, in dollars, is $275 million. When the deal was announced, by contrast, Signet’s own market cap, instead of falling, rose by $1.5 billion–one-and-a-half times the total purchase prices for Zales, and more than 5 times the “premium” Zales shareholders will get.

Bill Ackman’s Pershing Square recently announced it had purchased 10 percent beneficial ownership of Allergan in support of a bid–which had not yet been announced–by Canada’s Valeant Pharmaceuticals. It’s more complex than the press headlines, but, at a high level, Valeant is offering $48 in cash and 0.83 Valeant shares for every Allergan share held–nearly $46 billion on the date of announcement. The offer represented something like a 30 percent premium to share prices before Pershing Square began its rapid accumulation program in Allergan shares.

Allergan, which just held its annual meeting May 6, hasn’t said anything about the offer yet. Given the unsolicited bid, made publicly and with what seems to be very hard sell tactics, a good board of directors will take some time considering the options for the company. Allergan has also adopted a poison pill, which isn’t unusual. Most companies have one on the shelf for just this reason: to keep an unsolicited bidder and its allies from accumulating a control position while the board is trying to negotiate the best offer. And a pill allows a well-functioning, well-intentioned board time to find other potential bidders who might be willing to pay more.

The thing Allergan shareholders will want to watch is what the board does while it has the pill in place. Sometimes boards do nothing, because the pill itself removes the direct need to take decisive action. Sometimes, though, they use the time afforded by the poison pill very well, and shareholders benefit enormously. Once patent protection on a drug runs out, the pricing power of the branded drug falls off significantly, and generics take its market share. Valeant’s business model, which has been very successful, is to acquire products with dwindling patent protection and milk their remaining patent life even as it positions them to compete more effectively with generics once they’re off patent. The company spends very little on things, like Research and Development, that don’t contribute to that business model.

Pershing Square’s role in all this, which has caught investors’ attention, has even spawned a few law firm notes pointing out that it’s not insider trading; your own plans to make a bid aren’t “insider information” when it comes to buying or selling the target’s shares. And there is a long precedent for things like this–a hostile bidder often buys a “toehold” (2-3 percent of shares, not 10 percent) in advance of its bid for a number of reasons, including that the toehold can help offset the expense it’s going to incur in running a campaign to win over shareholders. Pershing actually raised a new $4 billion fund specifically for this investment, and Valeant agreed to invest in the fund, which gives it some of those same “toehold” advantages.

This action by Pershing Square has felt to many observers like there’s something not altogether aboveboard about it, although it has led to a reconciliation between Ackman and Carl Icahn. The genesis of this reconciliation, apparently, was when Icahn said on CNBC two weeks ago that he didn’t see “anything illegal” in Pershing Square’s actions.

While the Allergan situation appears unlikely to go to a proxy contest at this point, ISS is tracking 18 contests scheduled for May and June, plus three that took place in April:

– At Cracker Barrel, shareholders rejected the proposal by Biglari Holdings to sell the company.

– At Sensient Technologies, it looks like–because strangely the company didn’t put out a press release–none of the four dissident nominees proposed by FrontFour Capital were elected.

– And in the consent solicitation at Darden Restaurants, Starboard got the 50 percent support it needed to call a special meeting. ISS expects to see that meeting–where Starboard will propose a restriction on the sale or spin of the Red Lobster business prior to the Fall annual meeting–within about 60 days.

Commonwealth REIT’s will hold a special meeting on May 23 to elect new directors nominated by shareholders. At the company’s February consent solicitation, Corvex and Related got more than 80 percent of shares to consent to remove the entire board. So far, for the May meeting, only Corvex and Related have proposed candidates, and there is nothing to suggest that these elections will be contested.

Following press reports that the hearing on Sotheby’s poison pill had uncovered emails from one director saying, in effect, that Dan Loeb of Third Point Capital, the dissident, was right, the board was “too chummy” and performance and compensation had become a problem, Sotheby’s and Third Point agreed to a settlement that will see the addition of all 3 dissident nominees to the board. The company adjourned its meeting to a yet-unspecified later date.

Several other proxy contests are on the horizon:

– Morgan’s Hotel Group, where the dissidents cite, amongst other things, some significant failures to follow through on commitments to shareholders.

– Intevac, where the dissidents believe the company’s “venture capital” strategy and capital allocation have driven long-term underperformance.

– Griffin Land & Nurseries, where Mario Gabelli’s GAMCO is seeking two seats and has a proposal to convert the company into a REIT or MLP structure

– Poage Bancshares, where Joe Stilwell’s fund is seeking one of nine board seats;

– GrafTech International, where the largest shareholder, Nathan Milikowski–a former director the board declined to renominate in 2013–is seeking three of seven seats.

There are also be six contests with meeting dates the week of May 19, which is “peak week” for US proxy season:

– Telephone and Data Systems, where GAMCO is seeking two of the four seats electable by non-controlling shareholders. The controlling shareholder elects an additional eight directors;

– Harvard Illinois Bancorp, where Stilwell is also seeking a seat;

– Solera National Bancorp, where two retail investors are separately seeking board seats;

– Anworth Mortgage REIT, where the dissident is seeking one seat; and

Endeavor International, where the dissident wants one of seven seats. Interestingly, the lead dissident at Endeavor is the chair of Morgan’s Hotels, who got there through a proxy contest last year. Now he’s being targeted for removal from the Morgan’s board by a different hedge fund in another proxy contest a week earlier. His uncle, moreover, is one of three directors targeted in the proxy contest at Sotheby’s.