I was excited to see a new blog from The Deal: Corporate Dealmaker Forum. In addition, you might want to check out the May-June issue of the Corporate Dealmaker, which has a deal-lawyer theme – it is pretty feature-y (i.e. doesn’t teach lawyers about the law) but you might be interested in the descriptions of how lawyers function as members of deal-teams in corporate settings. Among other things, it has a profile of the legal team at Thomson Corp., and a Q&A with Ben Heineman, late of General Electric.
We have posted the transcript from the popular webcast: “How to Handle Hedge Fund Activism.”
Congress Extends Reduced Rates and Modifies Spin-Off Rules
From this Wachtell Lipton memo in our “Spin-Offs” Practice Area: “Last week, the President signed the Tax Increase Prevention and Reconciliation Act of 2005 (the “Act”). The Act extends reduced tax rates for capital gains and qualified dividend income that would have otherwise expired and includes provisions that directly impact tax-free spin-offs.
1. Extension of Reduced Rates on Capital Gains and Qualified Dividends
Under prior law, individuals were generally taxed on any “qualified dividend income” received and long-term capital gains recognized prior to January 1, 2009 at a maximum rate of 15%. The Act extends the application of the 15% maximum rate to any qualified dividends received and long-term capital gains recognized prior to January 1, 2011.
2. Changes to the Rules Governing Tax-Free Spin-Offs
The Act significantly simplifies the “active business” test that applies to tax-free spin-offs. That test requires each of the distributing corporation and the distributed subsidiary to be engaged in an active trade or business immediately after the distribution. Under prior law, a business conducted by a subsidiary was not automatically attributed to its parent. Consequently, most spin-offs required significant internal restructuring to meet this test. The Act simplifies the active business test by treating the entire affiliated group of the distributing corporation and of the distributed subsidiary, respectively, as a single corporation for purposes of determining whether the requirement is met. This new provision expires on December 31, 2010.
Separately, the Act also curtails “cash rich” split-off transactions, which had been used to repurchase blocks of stock from significant corporate holders on a tax-free basis. The Act now denies tax-free treatment to distributions where either the distributing corporation or the distributed subsidiary is a “disqualified investment corporation” and any person owns a 50% or greater interest in the disqualified investment corporation as a result of the distribution. A corporation is a disqualified investment corporation under the Act if it holds investment assets (such as cash or securities, whether or not liquid) in excess of certain thresholds (75% or more of the value of the corporation’s total assets during the first year after enactment and 662/3% thereafter), and the Act contains look-through rules for purposes of making this determination. The Act also contains a transition rule exempting transactions that were made pursuant to agreements that were binding on the date of enactment or described in a ruling request, public announcement or public filing with the Securities and Exchange Commission on or before the date of enactment.
From ISS’ “Corporate Governance” Blog: A labor union proposal regarding takeover defenses at Hilton Hotels has the potential to establish a legal precedent that could help clarify issues surrounding “binding bylaw” proposals. The proposal by Unite Here’s pension fund would amend Hilton’s bylaws to state the “corporation shall not maintain a shareholder rights plan, rights agreement or any other form of ‘poison pill’ making it more difficult or expensive to acquire large holdings of the corporation’s stock, unless such plan is first approved by a majority shareholder vote.”
The bylaw proposal also states that a “majority of shares voted shall suffice to approve such a plan.” The proposal calls on Hilton to “redeem any such rights now in effect,” and states, “notwithstanding any other bylaw, the Board may not amend the above without shareholder ratification.” If the binding proposal is approved, Delaware-incorporated Hilton has said that it would refuse to recognize the bylaw change, arguing that the proposal is contrary to basic principles of Delaware law giving boards of directors the power to manage the business and affairs of a corporation.
Hilton has obtained a legal opinion from Richards Layton & Finger, a Delaware law firm, in support of this position. The company did not ask the U.S. Securities and Exchange Commission (SEC) for permission to exclude the proposal from its proxy statement. A paucity of legal decisions on the issue of binding bylaw proposals cloud the issues related to the Unite Here proposal, but the resolution could lead to new precedent clarifying some of these issues. While Delaware courts have not addressed the issue, two other courts have done so.
In Int’l Brotherhood of Teamsters Gen. Fund v. Fleming Cos. (1999), the Oklahoma Supreme Court upheld a binding bylaw on poison pills, interpreting an Oklahoma statute that closely resembles Delaware’s. However, in Invacare Corp. v. Healthdyne Technologies Inc. (1997), a federal judge in Georgia declared invalid a binding bylaw amendment to require a company to remove “dead-hand” pill features, which typically permit a pill to be redeemed only by “continuing directors.” The court in that case relied heavily on the existence of “continuing director” provisions in Georgia corporate law that are not found in Delaware corporate law.
In addition, the lack of settled law on binding bylaw proposals has led the SEC to adopt a “hands off” approach on no-action requests by companies seeking to exclude binding poison-pill proposals from their proxy statements. (Under federal proxy rules, a company may omit a shareholder proposal that would violate state law.)
The SEC has held this position since its 1997 no-action ruling at PLM International. After PLM sought to exclude a binding bylaw proposal setting a time limit on the company’s use of a poison pill without shareholder approval, the SEC held that, “whether the proposal is an appropriate matter for shareholder action appears to be an unsettled point of Delaware law…[and thus there is not a] basis for excluding the proposal from the company’s proxy materials.” Since this ruling, the SEC generally has made it a practice not to take positions on unsettled questions of state corporation law relating to poison pill bylaws.
In their opinion, Hilton’s Delaware lawyers argue that “Absent an express provision in a corporation’s certificate of incorporation to the contrary, [Delaware General Corporation Law (DGCL) Section 141(a)] vests in the board of directors the authority to manage the corporate enterprise. Among the powers conferred upon directors under Section 141(a) is the power to adopt and maintain defensive measures prior to or in response to a takeover proposal.” The lawyers also argue that, “adopting a stockholder rights plan is a function specifically assigned” to the board by Section 157 of the DGCL. “Absent a provision in the corporation’s certificate of incorporation to the contrary, a board . . . cannot be directed by a stockholder-adopted bylaw to exercise such authority in a particular way or delegate to stockholders or others the authority to exercise such power,” the Hilton lawyers argue.
However, many companies, including Hilton, provide concurrent power to both directors and shareholders to amend bylaws. Hilton’s view of Delaware law carries the risk that any shareholder-promulgated bylaw amendment could be seen as infringing on a board’s authority. This, however, would lead to a result–that all shareholder adopted bylaw amendments are invalid–that is contrary to the express authority set forth in Delaware law for shareholders to amend bylaws. Also, it is not clear that Hilton has the legal authority to deny that its bylaws have been amended. Alternatively, the company could ask a judge to rule that the proposal is invalid. If the bylaw proposal is approved, Unite Here may have to go to court to ensure that the company complies with the bylaw change and to confirm that it does not violate Delaware law.
There is a definite possibility that Unite Here may be able to obtain shareholder approval of its proposal, as Hilton does not have any supermajority voting rules for bylaw amendments that would make shareholder approval of the proposal unrealistic to obtain. The Unite Here proposal would require approval by a majority of the company’s outstanding shares.
Investors generally vote in favor of shareholder proposals regarding poison pills. In 2005, the average level of support for those proposals was 60.1 percent of votes cast. Given that many shareholders fail to vote at annual meetings, the labor pension fund likely will have to obtain significantly more than a majority of votes cast to constitute a majority of Hilton’s outstanding stock. If that happens and Unite Here and Hilton end up in court, investors and companies should watch closely.
A few weeks back, the NYSE submitted a proposal to the SEC that would eliminate the “treasury share exception” from the requirement for shareholder approval under Section 312.03 of the NYSE Listed Company Manual. From reading this blog, it’s clear what the history is on this. The proposal has not yet been published for comment by the SEC and could still be changed.
Although Section 312.03 requires that companies obtain shareholder approval before issuing stock in certain situations or in significant amounts, the calculation of whether the amount of shares issued triggers the shareholder approval requirement doesn’t apply to the reissuance of treasury stock in some cases (i.e., previously issued and listed shares that previously were reacquired by the company). In particular, the NYSE proposal would:
– Eliminate the treasury share exception entirely
– Require that companies notify the NYSE regarding issuances of treasury shares; and
– Clarify that the shareholder approval requirements for issuances to related parties cover a “series of related transactions”
In its proposal, the NYSE clarifies that companies may continue to rely on the treasury share exception until the SEC approves the rule change. But note on page 5 of the proposal: “Issuances effective on or after that date will be unable to utilize the treasury share exception, even if the issuer had contracted for the issuance prior to that effective date.” In other words, the NYSE states that once the SEC approves the rule change, the treasury share exception is not available for any transaction – even if contracted for prior to the rule change.
This could hurt those companies that may have contacted the NYSE and obtained their blessing that shareholder approval isn’t necessary, contracted for the arrangement, and then the arrangement is effected after the SEC approves the rule proposal; in this situation, shareholder approval would still be necessary despite the NYSE’s prior acquiescence.
From ISS’ “Friday Report“: While more large U.S. companies are dropping “poison pills” and investor support for mandating a shareholder vote on such takeover defenses remains strong, the number of shareholder proposals on this topic has declined significantly, according to a recent ISS report.
However, that trend may change next year. A recent Securities and Exchange Commission (SEC) ruling may prompt more shareholders next year to seek bylaw amendments to require an investor vote on pills. In addition, a Delaware court ruling may inspire some investors to press again to encourage companies to seek shareholder approval before adopting a poison pill. Among S&P 500 companies, 46 percent had a poison pill defense at the end of 2005, down from 53.8 percent in 2004, according to the 2006 Background Report on Poison Pills at U.S. Companies by ISS’ Governance Research Service. Among the prominent firms that abandoned their pills last year were the Bank of New York, Caterpillar, McGraw-Hill, and Sempra Energy. The percentage of S&P 500 companies with such plans has declined steadily since 2002, when 60 percent had pills.
In 2005, voting support remained high for shareholder proposals concerning poison pills. (Typically, such proposals request that a company’s poison pill be redeemed or submitted for shareholder approval.) Seventeen of the 25 pill proposals that appeared on company ballots received majority support. Those 25 proposals received an average of 59.4 percent support, a slight decrease from the 61.1 percent average in 2004.
Despite this strong support, there has been a significant drop-off in the number of proposals filed. In 2004, 101 shareholder proposals were submitted (of which 52 came to a vote). Last year, 51 proposals were submitted (of which 25 came to a vote). ISS is currently tracking 29 proposal filings for 2006, of which 17 have either come to a vote or are expected to come to a vote.
SEC No-Action Rulings
The trend toward fewer proposals on poison pill issues may stem from SEC staff rulings in 2004 on “no-action” requests to omit proposals by companies that already have poison pill policies in place. Typically, such policies state that the company will obtain shareholder approval prior to the adoption of a poison pill or, in the event the company adopts a pill without shareholder approval, that the company will seek such approval within 12 months or at the next annual meeting. Nevertheless, investor opponents of poison pills argue that such policies allow companies the same discretion to adopt a pill without prior shareholder approval that the company had before the adoption of the policy.
In 2004, the SEC’s Division of Corporation Finance granted no-action relief to a number of companies that did not have a poison pill in place but that did have a policy on poison pills. The SEC typically concluded that the company had “substantially implemented” the shareholder proposal because of the existence of the company’s policy on poison pills. As a result, the SEC in 2004 allowed companies to exclude 24 of the 101 poison pill proposals filed by investors. The combination of these SEC rulings in 2004 and the decline in pill proposals in 2005 and 2006 suggests that shareholders may have viewed proposals at certain companies as futile efforts.
In early 2006, however, the SEC staff denied no-action relief to Electronic Data Systems (EDS) and a number of companies that have poison pill policies. At several of these companies, the SEC had permitted exclusion of pill proposals in 2005. The 2006 proposals differed from earlier proposals in that they included a request that the company amend its charter or bylaws to incorporate the proposal “if practicable.” In early March, the SEC reportedly reversed its position after several companies requested reconsideration. In the case of EDS, it was reported that the SEC ruled, “We note that there is a substantive distinction between a proposal that seeks a policy and a proposal that seeks a bylaw or charter amendment. In this regard, however, we further note that the action contemplated by the subject proposal is qualified by the phrase ‘if practicable’ and that the company has otherwise substantially implemented the proposal.”
Thus, while such proposals were excluded this year, the SEC staff rulings suggest that a future poison pill proposal that requests a charter or bylaw amendment likely would not be excluded, as long as the proponent does not use the objectionable phrase “if practicable.” Cornish Hitchcock, a lawyer who represents shareholder proponents including union pension funds and other institutional investors, said he was “surprised the SEC took that position on the ‘if practicable’ language but that this is something that should be addressed by proponents next year.”
Significant Delaware Court Ruling
Another important development regarding poison pills was the December 2005 ruling by Chancellor William Chandler of the Delaware Court of Chancery in the Unisuper Ltd. v. News Corp. litigation. The court ruled that Delaware law does not require that a poison pill policy contain a “fiduciary out.”
The central issue in the case, whether a company policy on poison pills may be changed at will by directors, was held over for a trial. The plaintiffs argued that News Corp. made an enforceable promise in the form of its pill policy to persuade shareholders in 2004 to approve the company’s reincorporation from Australia to Delaware. (On April 6, investors announced that they had reached a settlement to the litigation, in which the company agreed to put its pill to a shareholder vote. For more details, see the April 7, 2006, issue of Governance Weekly.)
Prior to the court’s December 2005 decision, many companies had claimed that, under state law, they are prohibited from adopting a policy requiring prior shareholder approval for the adoption of a poison pill. Companies argued that their fiduciary duties required them to retain the option of adopting a pill without shareholder approval. Companies making such arguments relied on earlier case law holding that a current board may not take action that disables a future board from managing the company.
Chancellor Chandler rejected this reasoning in the context of poison pill policies. The court noted that these earlier cases had dealt with “ defensive measures that took power out of the hands of shareholders.” Such defensive measures are different from poison pill policies where “shareholders will make the decision for themselves whether to adopt a defensive measure or leave the corporation susceptible to takeover,” the chancellor noted. Chandler held that, “It makes no sense to argue that the News Corp. board somehow disabled its fiduciary duties to shareholders by agreeing to let the shareholders vote on whether to keep a poison pill in place.” The court further held that, “Fiduciary duties cannot be used to silence shareholders and prevent them from specifying what the corporate contract is to say. Shareholders should be permitted to fill a particular gap in the corporate contract if they wish to fill it.”
As I noted a while back, the Tulane M&A Conference decided to continue its long-standing tradition despite Hurricane Katrina – the May issue of “Corporate Control Alert” includes an article dissecting part of the Tulane Conference, including:
– Delaware Vice Chancellor Leo Strine downplayed fears that his ruling last year in a case involving the LBO of Toys “R” Us Inc. was meant to discourage stapled financing…”
– “Many lawyers interpreted [Strine’s critical comments in the Toys decision] as a broad comment on the practice of stapled financing generally and discouraged investment banks from offering it when advising a target, or recommended that banks not give the target a fairness opinion when they provide the staple.
– VC Strine said that such a reading “misconstrued” his opinion. Apparently his concern was that the seller’s board initially refused to allow its financial advisor to offer financing to bidders and then changed its mind “for absolutely no purpose. This was not adroit. I could see situations where it would be really good for a seller to offer financing.”
– Apparently VC Strine also add that targets didn’t benefit from having a second bank give a fairness opinion where the primary adviser is offering a staple. “running the auction is in many ways the most important part of the process…” Were he a board member of a company selling itself in an auction, he would be of the belief that, “If [a bank is] going to run the process, they’re going to back it up by giving a fairness opinion.”
– Furthermore, VC Strine expressed the view that to get [a second] opinion, a target must either pay a lot of money to a first-tier firm or get an opinion from a less-distinguished one, which, the judge said “doesn’t give me a lot of comfort. What’s going to impress us about whether you got a good deal is the quality of the market check.” The second opinion is “banker protection,” he said, and does little to benefit target shareholders.
Last month, I blogged about comments from the SEC Staff on fairness opinion disclosures. Here is another example of how the SEC comment process has evolved since the predecessor to Item 1015 of Regulation M-A was adopted: see these SEC comments relating to the merger of Alltel and Western Wireless. The comments start off relatively simple – but gradually become more complex until they ultimately require detailed disclosure to explain analytical judgments (in particular, see comments 31 and 32).
Following the receipt of these responses, the Staff issued further comments. Comments 6 and 7 provide additional examples of the level of detail the Staff may now require under Item 1015. And then the Staff had even more comments. The end result of these comments can be found beginning on page 38 of the Western Wireless proxy.
From TheDeal.com: “Stapled finance has become a favorite product for investment banks auctioning companies. By offering prepackaged financing, they hope to encourage bids and collect a second layer of fees on the deal.
But in a twist, Bally Total Fitness Holding Corp. has turned to Deutsche Bank AG to provide ready-made debt financing in Bally’s auction, sources close to the bank and company said, not J.P. Morgan Chase & Co. and Blackstone Group LP, the banks running the sale of the fitness chain.
Deutsche is offering about $700 million in financing, sources said, made up of senior bank debt and subordinated debt. The choice of an independent debt source was made by a special strategic alternatives committee of Bally’s board comprising management-backed directors plus Don Kornstein, who was installed on Bally’s board by hedge fund Pardus Capital Management LP after a proxy contest at Bally’s annual meeting in January.
Investment banking sources close to the company said that outside counsel to the committee, Robert Wall of Winston & Strawn LLP, recommended finding a third bank to provide the debt financing to avoid the potential impression of a conflict of interest. Wall declined to comment.
Stapled financing emerged as a result of the slump in financing markets in 2001, when financial sponsors found it hard to obtain the debt financing they needed for LBOs. With a stapled package on offer, bidders know going in that they will be able to obtain financing, and at what price. Even if they choose other lenders, the stapled package could serve as a floor when negotiating alternatives.
There are potential conflicts, however. Some bidders fear the bankers handling a sale may have an incentive to favor a bidder that will take advantage of their bank’s financing. And some bidders are wary of working with a lender whose bankers may share information about the bidder with the bankers handling the sale.
Lining up stapled financing from an independent bank is not unheard of, but is not common, says Charles Elson, director of the John L. Weinberg Center for Corporate Governance at the University of Delaware, but it makes sense, he adds. ‘These days the more free from conflict one can be in these situations the better. From a shareholder perspective, you want the highest possible price.'”
From Francis Pileggi’s “Delaware Corporate & Commerical Litigation” Blog: “Though it is not uncommon for Chancery Court decisions to be in the area of 100-pages long, due to its length, my summary will be longer than usual for the blurbs on this blog. Oliver v. Boston University is 105-pages long and deals with a voluminous set of facts and a multitude of legal issues. I have divided the downloadable opinion into 2 parts for the user’s convenience: Part I and Part II.
Specifically, the case involves a financially troubled biotechnology company by the name of Seragen, Inc., which was controlled by Boston University (“BU”), as well as its friends and affiliates, who on several occasions came to its fiscal rescue in transactions implemented without procedures reasonably designed to protect the interests of minority shareholders.
With Seragen on the precipice of financial doom, a company by the name of Ligand offered merger consideration of approximately $75 million to acquire Seragen, but that amount would not satisfy all of the stakeholders because the claims of many stakeholders asserting rights to priority payment exceeded the amount of Ligand’s offer. A group of minority shareholders brought to trial a series of claims challenging certain transactions before the merger between Seragen and Ligand and the process by which the merger proceeds were allocated. This 105-page decision followed that trial.
The court noted that if the merger did not succeed, bankruptcy was the likely result on a very short timetable and that bankruptcy may have necessarily involved sacrificing the interests of the minority shareholders to placate other stakeholders, and it is within that troubled context that the court addressed the corporate governance issues.
Unlike other similar factual settings, this case did not deal with the issue of possible duties that the directors may have owed to creditors, because it was only the minority shareholders who were complaining that their ox was gored, primarily because they did not receive enough of the allocated proceeds of the merger. Among the legal issues addressed were: equity dilution and voting power dilution; business judgment rule; entire fairness standard; duty of loyalty that majority owes to the minority; duty to disclose material facts in proxy; aiding and abetting breaches of duty; and the difference between derivative and direct claims.”
We have posted our schedule for this summer’s “M&A Boot Camp,” which is free for any member of DealLawyers.com. It includes:
– Conducting Due Diligence: Through the Eyes of the Associate (Monday, June 19th)
Deborah Bentley Herzog and Mike Woodard of McGuire Woods will start us off by teaching us the basics of what you need to know about conducting due diligence, with an emphasis on what issues and traps associates should seek to spot and resolve.
– International Deal Considerations (Monday, June 26th)
Elizabeth (“Libby”) Kitslaar and Phil Stamatakos of Jones Day will walk us through the special issues that you will face in a cross-border deal. Learn the essentials of what an international deal is all about, including how to best work with lawyers from other countries and other practice pointers unique to the international deal.
– The Role of Investment Bankers (Monday, July 10th)
Kevin Miller of Alston & Bird LLP – a former in-house investment banking lawyer – will talk about the role of investment bankers in the M&A process, including tips on how to maximize their effectiveness and minimize disappointments.
– Selling the Venture-Backed Company (Monday, July 17th)
Phil Torrence and David Parsigian of Miller Canfield LLP will teach us about “everything you need to know” to understand the basics of the issues typically present in a sale of a venture backed company with multiple class of stock and varying liquidation preferences.