– by Steven Haas, Hunton & Williams
The ACS/Xerox $6.4 billion merger has received significant attention lately. Among the interesting issues in the transaction is the right of the controlling stockholder to receive a control premium. Steven Davidoff (aka the “Deal Professor”) has must-read blog posts on the transaction here and here.
The deal has commentators talking particularly about the implications of Chancellor Chandler’s 2005 opinion in In re Telecommunications. There, the Chancellor said that “[r]easonably construing the facts in favor of plaintiffs, if [the controlling stockholder] wished to be fair, then he could have shared some part of the value of his own stock holdings].” I don’t think that statement altered Delaware law on the right of a controlling stockholder to receive a control premium. The Chancellor was responding to the argument that all holders of TCI’s high-vote shares were entitled to a premium, and he seemingly suggested that the controller could have diverted his own consideration to the other holders of high-vote shares. As the Deal Professor surmises, the Chancellor basically was saying “Look, [the controller] could have taken less and avoided this litigation.”
Fortunately, this issue just received some additional clarity: In In re John Q Hammons Hotels Inc. S’holder Litig., decided a few weeks ago, Chancellor Chandler held that the entire fairness standard set forth in Lynch Communication is not automatically triggered whenever a controller receives consideration that is different from that paid to minority stockholders in a third-party merger. Moreover, the Chancellor explained his holding in TCI:
[I]n In re Tele-Communications, Inc. Shareholders Litigation, the evidence suggested that a majority of the board of directors was interested because they received material personal benefits from the transaction they approved. Specifically, the transaction materially benefited a majority of the directors because it allocated a disproportionate amount of the merger consideration to the directors’ class of stock. Moreover, only one of those directors was a controlling stockholder entitled to a control premium.
Thus, the interestedness of a majority of the directors led the Court to apply the entire fairness standard and to conclude that, as in Lynch, the approval of the transaction by the stockholders and a special committee could at most shift the burden of demonstrating entire fairness to plaintiffs. Here, in contrast, [the controller] negotiated with [the buyer] and did not participate in the negotiations between [the buyer] and the special committee. Nothing in In re Tele-Communications mandates the extension of Lynch to this case.
Although Hammons applied entire fairness due to other perceived defects in process, it indicates that TCI hinged largely on the absence of a majority of disinterested directors. Of course, whether the size of a particular premium is appropriate may be a factual issue for a court to determine. But TCI should not be understood as undercutting a controlling stockholder’s basic right to a premium. Since controllers can freely vote down third-party proposals for “whim or caprice,” judicial restraints on paying a control premium will only impede transactions from taking place.
Hammons is also notable for making clear that majority-of-the-minority provisions must be (1) non-waivable and (2) based on a majority of the outstanding minority shares, not a majority of the minority shares actually voted. As to the first point, the court faulted the special committee’s ability to waive the MOM–even thought it didn’t. As to the latter point, Vice Chancellor Strine made a similar observation in 2006 in PNB Holding Co., a decision decided well after the Hammons merger was effected.
We have begun posting memos analyzing this case in our “Minority Shareholders” Practice Area.
Stan Keller of Edwards Angell Palmer & Dodge recently posted this in Harvard Law’s “Corporate Governance Blog” after being run in the Massachusetts Lawyers’ Weekly:
Classified boards, where directors serve staggered terms (typically for three years with one-third of the directors elected each year), has been a recognized corporate governance alternative for a long time. The laws of every state permit corporations to structure their boards in this way. In fact, it is the default rule in Massachusetts for publicly traded companies unless the board of directors or the shareholders elects to opt out.
This should sound familiar because it is the way members of the United States Senate are elected, with Senators serving six-year terms and one third elected in each two-year election cycle. The Constitution’s Framers understood the stabilizing effect of this arrangement, which they believed would ensure continuity and allow Senators to take responsibility for measures over time and make them independent of rapid swings in public opinion. For more than 200 years, this policy has served the nation well. It is a policy that also has served corporations and their investors well when they have chosen to use it.
Yet undoing this corporate governance system is precisely what is now being proposed – ironically, by two Senators. They want to prohibit for stock exchange traded companies the very governance system under which they serve. They claim that classified boards of directors are part of what they call a “widespread failure of corporate governance” that was one of the “central causes of the financial and economic crises that the United States faces.”
Such a claim ought to be accompanied by hard evidence – but it is not, and with good reason. There is no evidence suggesting that classified boards were in any way a contributing factor to the ongoing economic crisis. To the contrary, companies involved in recent financial meltdowns whose boards were not classified include AIG, Washington Mutual, Bear Stearns, Citigroup, Bank of America, Lehman Brothers and General Motors. Going back to the 2001-era financial frauds, Enron, WorldCom, Tyco and HealthSouth all had unclassified boards. If anything, then, good policy and common sense suggest that we would want to retain the alternative of classified boards, not prohibit them.
As is the case with the U.S. Senate, too-frequent elections, rather than staggered terms of office, are what can undermine desired continuity and the ability to govern for the long term.
The key point is that we should not have a one-size fits all mandate for corporate governance. Rather, investor choice ought to be retained, not discarded. Certainly, corporations and their shareholders should be free to decide whether or not they want a classified board and whether the governance structure that is fine for the United States Senate works for them. Indeed, the current system is working as we would want it to, with individual choice at individual companies exercised freely – less than 40% of the S&P 500 companies have classified boards and, during the last six years, more than 200 companies have successfully put to a shareholder vote proposals to declassify their boards of directors.
In short, there is simply no evidence that classified boards bear any of the blame for the recent economic crisis. The laws of all states allow for classified boards, with Massachusetts mandating it, and there is the ability for investors to make a choice on the matter. In these circumstances, the current legislative proposal to preempt state laws and do away with classified boards is an inadvisable step back from investor choice, and toward the imposition of an unjustified one size fits all federal governance rule that will do nothing to prevent future financial breakdowns.
– by Brad Aronstam of Connolly Bove Lodge & Hutz:
Last week, Delaware Vice Chancellor Noble – in In re NYMEX S’holder Litig. (C.A. No. 3621-VCN) and Greene v. New York Mercantile Exchange, Inc. et al. (C.A. No. 3835-VCN) – reflects the Court of Chancery’s latest post-Lyondell decision reinforcing the significant deference afforded under Delaware law to independent boards in the change of control context.
This consolidated action arose out of NYMEX’s August 2008 merger with CME. The plaintiffs alleged numerous breaches of fiduciary duty by NYMEX’s directors that purportedly resulted in NYMEX’s shareholders not receiving fair value for their shares. Specifically, the plaintiffs alleged that NYMEX’s fourteen member Board was dominated and controlled by its then Chairman, Richard Schaeffer, “and that the Board agreed to sell NYMEX through an unfair process at an inadequate price in order for Shaffer and NYMEX Chief Executive Officer and President James Newsome to obtain nearly $60 million in severance payments.”
In rejecting these – and numerous other – shopworn allegations, the Court touched upon a number of noteworthy and evolving principles of Delaware corporate law. Below are some of the highlights:
– Conclusory Allegations of Control Fall Far Short of the Requisite Inference of Domination or Bad Faith – Having determined summarily that twelve of the Board’s fourteen directors were “unquestionably independent,” the Court rejected plaintiffs’ conclusory allegations that mere facially questionable actions by the Board — e.g., actions in which the Board, among other things, (i) approved the above referenced change of control severance plan, (ii) accepted CME’s first offer, (iii) failed to utilize a strategic initiatives committee (the “SIC”) previously formed to consider, negotiate and recommend any significant company transactions, and (iv) failed to obtain a “collar” on the stock portion of the merger consideration — alone failed to support the requisite “dominance such that the independence or good faith of the board may be fairly questioned.” As explained by the Court, the fact “[t]hat directors acquiesce in, or endorse actions by, a chairman of the board — actions that from an outsider’s perspective might seem questionable — does not, without more, support an inference of domination by the chairman or the absence of directorial will.”
– No Single Blueprint for the Fulfillment of Fiduciary Duties – Having rejected plaintiffs’ above allegations as “too conclusory” to support an inference of domination, the Court turned to plaintiffs’ averments concerning the allegedly flawed merger negotiation process. Noting the well established principle in Delaware that “there is no single blueprint that a board must follow to fulfill its duties,” the Court held that “claims of flawed process are properly brought as duty of care, not loyalty, claims and [that such] claims [we]re [accordingly] barred by the exculpatory clause of NYMEX’s Certificate of Incorporation.”
– Heavy Deference to Independent Directors in Assessing Lack of “Good Faith” – In regards to any claims that the Board acted in “bad faith” and thus fell outside the protections of NYMEX’s aforementioned exculpatory clause, the Court found that it could not “be said that the Board intentionally failed to act in the face of a known duty to act, demonstrating a conscious disregard for its duties.” The Court quoted Lyondell and Chancellor Chandler’s recent decision in Wayne County Employees’ Ret. Sys. v. Corti (C.A. No. 3534-CC) in support of the proposition that the Complaint must be dismissed given plaintiffs’ failure to allege “that the Board ‘utterly failed to obtain the best sale price.'” This high standard set forth by the Delaware Supreme Court in Lyondell, as evidenced by recent decisions of the Delaware Court of Chancery, thus poses a substantial obstacle to plaintiffs that are unable to allege violations of the duty of loyalty (e.g., self-dealing transactions involving controlling shareholders or insiders standing on both sides of a challenged deal).
– No Breach of Fiduciary Duties for Chairman and CEO Serving as Sole Negotiators of the Deal – The Court also rejected plaintiffs’ claim that “Schaeffer and Newsome breached their fiduciary duties by being the sole negotiators with CME and not involving the SIC in the consideration or negotiation of the acquisition.” The Court explained that “[i]t was well within the business judgment of the Board to determine how merger negotiations will be conducted, and to delegate the task of negotiating to the Chairman and the Chief Executive Officer.” Important to the Court in reaching this conclusion was its finding “that the Board was clearly independent” and, thus, “there was no requirement to involve an independent committee in negotiations.” Also interesting was the Court’s statement that the “the presence of such a committee [i.e., the SIC] [did not] mandate its use.”
– Continuing Uncertainty Regarding the Applicability of Revlon in Mixed Cash/Stock Deals – While the Court’s holding that NYMEX’s exculpatory provision – and plaintiffs’ failure to allege sufficient facts circumventing the protections of that provision – obviated the need for the Court to specifically decide the issue, the Court noted the continuing uncertainty regarding the applicability of Revlon vis-a-vis transactions involving mixed merger consideration of cash and stock.
Specifically, the Court noted that although “[a] fundamental change of control does not occur for purposes of Revlon where control of the corporation remains, post-merger, in a large, fluid market,” the Delaware Supreme Court “‘has not set out a black line rule explaining what percentage of the consideration can be cash without triggering Revlon.'” Indeed, the consideration paid to NYMEX’s shareholders was 56% CME stock and 44% cash and thus fell between the Supreme Court’s Santa Fe decision (holding that merger transaction involving consideration of 33% cash and 67% stock did not trigger Revlon) and the Court of Chancery’s Lukens decision (holding that a merger transaction involving consideration of 60% cash and 40% stock likely triggered Revlon).
–The Continued Narrow Interpretation of the Parnes Direct/Derivative Exception – Also noteworthy was the Court’s detailed discussion of the direct/derivative inquiry in the merger context and, specifically, the Court’s reaffirmation that the so-called “Parnes exception” for direct challenges to the validity of a merger itself has properly been interpreted “very narrowly.” In short “there must be a causal link between the breach complained of and the ultimate unfairness of the merger” for purposes of pleading a direct claim and overcoming the loss of derivative standing typically accomplished by virtue of the transaction.
The NYMEX decision, when read in concert with the Chancellor’s recent Wayne County decision upon which NYMEX expressly relied, further evidences the weighty deference shown by Delaware courts to independent boards in the change of control context. The decision thus warrants careful review and consideration by M&A practitioners and those who advise them.
If you are among the many practioners who spend most of their lives doing small private company M&A deals with escrows rather than large cap public company M&A, you many be interested in a new JPMorgan study relating to holdback escrow accounts used in deals. In addition to analyzing various factors in the claims process and to provide information on year-over-year trends, the report looks at the percentage of escrows that have claims filed against the account; the types of claims; the average life span of the escrows and more.
Key findings in the report include:
– Of the deals analyzed, 40% had claims filed against the escrow.
– Of the escrows with claims presented by the buyer, some portion of the claim was paid in virtually all cases.
– The incidence of claims increased significantly from 2007 to 2008, which may be a reflection of the past year’s economic environment.
Deal junkies have been actively following Kraft’s journey in its hostile bid for Cadbury. One of the unique aspects of this deal is that Kraft – a US company – has made an unsolicited bid for a United Kingdom company (last week, the British Panel on Takeovers and Mergers gave Kraft until November 9th to make a bid or sit out for six months). Hostile deals are relatively rare in the UK, particularly when a US bidder is involved.
This is probably why Kraft’s web page that provides information about its proposed offer is replete with a record-number of click-through disclaimers. As the proposed offer is unsolicited, Kraft would not have access to Cadbury’s shareholder lists and thus would not necessarily know which country’s laws it has to comply with – and given that unsolicited bids are relatively rare in the UK, there might be some uncertainty as to what exactly is needed. Hence, there might be some overkill.
Interestingly, even Cadbury’s web page even has a click-through disclaimer for its information. Its lawyers have the advantage of knowing where its shareholders reside.
Note that “agreed-upon” deals in the United Kingdom are often structured as a “scheme of arrangement.” Such deals are typically exempt from registration in the US under Section 3(a)(10) of the ’33 Act. The 3(a)(10) exemption requires that the terms and conditions of the issuance and exchange of securities are approved (after a hearing upon the fairness of such terms and conditions at which all persons to whom the exchange is proposed have the right to appear) by a court or by any official or agency of the US or any state or territorial banking or insurance commission or other governmental authority authorized by law to grant such approval.
In the US, the most common examples are California fairness hearings. While 3(a)(10) does not appear on its face to apply to non US governmental approvals – i.e., UK schemes of arrangement or Canadian plans of arrangement – in practice, the SEC permits them to qualify for the exemption. Note, in addition to judicial approval, UK schemes of arrangement and Canadian plans of arrangement typically require supermajority shareholder approval – a higher percentage than would effect a change in control, but lower than would typically be required to effect a backend squeezeout under UK or Canadian law.
Kevin Wells of RiskMetrics recently blogged this:
Though not as prevalent as they once were, shareholder rights plans, commonly referred to as poison pills, remain a fixture of the corporate governance landscape. As the global economic crisis took a toll across U.S. and international capital markets over the past year, companies continued to adopt pills, albeit with more shareholder-friendly provisions. Indeed, an analysis of regulatory filings, proxy voting trends, and other data finds that companies are incorporating more shareholder-friendly provisions into their pills; moreover, companies are putting such plans to a shareholder vote in greater numbers than ever before.
Perhaps as a consequence of increased management votes to ratify or adopt pills, shareholder activism, as measured by filings of shareholder proposals to terminate or allow shareholders to vote on pills, has declined. However, those shareholder proposals appearing on ballots generally received high levels of support in 2009.
Amid the recent economic turmoil, 2009 has also seen the emergence of NOL poison pills, which are meant to protect companies’ tax assets rather than to deter acquisition offers. It was an NOL pill, in fact, that became the subject of controversy in Selectica v. Versata, pending in Delaware Chancery Court, which may significantly affect future uses of poison pills by Delaware companies.
Select key findings from the report include:
– Newly Enacted Pills: Thirty-three S&P 1,500 Index companies enacted pills between July 1, 2008, and July 1, 2009. Their average term was 7.6 years, and 10 were for terms of three years or less. Four of those were enacted for a period of 12 months or less.
– Pill Usage Among S&P 1,500 Companies Declines for Third Straight Year: The number of S&P 1,500 companies that maintained a poison pill declined for the third straight year in 2009, from 34.5 percent in 2008 to 27.5 percent in 2009. In 2007, 42.5 percent maintained a pill.
– Poison Pill Trigger Thresholds: In 2009, 69.2 percent of the S&P 1,500 companies that maintained a pill employed a 15 percent trigger. Another 19.6 percent employed a 20 percent trigger, and 7.9 percent employed a 10 percent trigger.
RiskMetrics’ clients can contact their account managers to obtain a copy of 2009 Corporate Governance Background Report – Poison Pills. To purchase a copy, please visit our online bookstore.