On the heels of the SEC’s February roundtable on universal proxy ballots, CII sent this letter last week pressing the SEC to propose rules regarding universal proxies in contested director elections. This follows a January 2014 rulemaking petition from the SEC on the same topic. The new letter argues:
– The inability of investors to choose from among all individuals nominated from all parties limits shareowner choice and diminishes director accountability by precluding shareowners from choosing the best candidates amongst all of those who have been duly nominated. This limitation weakens the overall quality of corporate governance in the United States.
– Universal proxies would lessen investor confusion. The current proxy rules are the real source of complexity. The commission’s complex explanation of the steps a shareholder must take to vote for management nominees using a shareholder proponent’s proxy in a contest for a minority of the board proves this.
– Universal proxies would lower the substantial costs that investors currently face if they wish to exercise their full voting rights by picking and choosing among all the candidates who are duly nominated in a proxy contest. As for the costs to companies, experience in Canada shows that implementation of a universal ballot regime is cost effective.
– Whether universal proxies would favor shareowner-proponent nominees over company-nominees should be irrelevant. The more relevant question for the commission is whether universal proxies would provide investors, its primary constituents, with the ability to more fully exercise their fundamental right to vote for the election of directors in a proxy contest.
Meanwhile, in this letter, DuPont rejected Trian’s request to use a universal ballot. And check out this blog for some examples of what a universal ballot looks like…
Here’s news from Kevin Miller of Alston & Bird:
As some of you will recall, in OTK v Friedman (aka Morgans Hotel), C.A. No. 8447-VCL (Del. Ch. April 17, 2013)(Letter Ruling on Motion to Compel), Delaware Vice Chancellor Laster held that where a stockholder has the right to appoint a person to the board of a company, that right gives the stockholder the right to board-level information about the company (“When a director serves as the designee of a stockholder on the board, and when it is understood that the director acts as the stockholder’s representative, then the stockholder is generally entitled to the same information as the director”).
Following the Morgans Hotel ruling and subsequent public comments reiterating that approach, a number of commentators questioned that interpretation of Delaware law and expressed the view that a more appropriate and consistent approach would be that a so-called blockholder does not generally have any right to the information provided to the director serving as the designee of such blockholder except and to the extent such rights are set forth in an agreement between the blockholder and the company giving the blockholder the right to appoint its designee as a director (e.g., in the investment agreement pursuant to which the blockholder makes a significant investment in the company and obtains the right to appoint one or more directors).
Such a default approach gives the company the opportunity to insist on confidentiality and use restrictions in exchange for access to such information and the ability to seek injunctive relief and damages for breaches of the confidentiality and use restrictions. In the absence of such an agreement, the director representative of the blockholder shares board-level information with the blockholder at its and the blockholder’s peril in the event that the company believes it has been damaged by the actions of the director (i.e., a breach of fiduciary duty) or the blockholder (i.e., aiding and abetting a breach of fiduciary duty).
The fact that the a blockholder director might often share information with the blockholder without damage to the company and that, in the absence of harm to the company, the company might turn a blind eye to such sharing of information would not impair the ability of the company to seek appropriate relief in the event it determined it had been harmed just as the failure of the police to ticket every driver exceeding the speed limit does not impair the ability of the police to ticket drivers dangerously exceeding the speed limit.
One of the principal concerns with the Morgans Hotel approach raised by some commentators was the potential lack of any remedy against the blockholder for using board-level information in a manner detrimental to the company. In the absence of an independent fiduciary or contractual duty to the company with respect to the use of such information, the company might be limited to a breach of fiduciary duty claim against the director representative of the blockholder if the director knew the information would be misused by the blockholder to whom the information was provided – a problematic remedy to the extent that the company would be required to prove “knowledge” by the director and the director does not have adequate financial resources to pay any resulting damages.
Nevertheless, VC Laster has reiterated his view in a recent article he co-authored in “The Business Lawyer.” In the article, the authors address the concerns regarding the availability of remedies against the blockholder head-on, though I suspect in a manner that will come as a surprise to many private equity investors and other large stockholders with the ability to appoint one or more directors (but less than a majority). According to the article, the director’s sharing of board-level information with the blockholder results in the blockholder being deemed a constructive insider who can be held accountable through a common law claim under Brophy if the stockholder uses the information for the stockholder’s private benefit even if there is no harm to the company. Harm to the company is not an essential element and under Kahn v KKR disgorgement is an available remedy.
To reiterate, the ability of a blockholder director to convey information to the stockholder that placed him on the board does not mean that the fund or investor obtains the unfettered right to use the information in whatever manner it sees fit. Given the affiliation between the blockholder director and the stockholder and the understanding that information will flow from the blockholder director to the stockholder, the stockholder will be treated as a constructive insider for the purpose of the common law limitations on insider trading. [Citing Brophy v. Cities Serv. Co., 70 A.2d 5 (Del. Ch. 1949)] The corporation also could have a cause of action against the stockholder for any further disclosure of confidential information that inflicted harm on the corporation. In other words, the director can share with his stockholder affiliate, but the ability to share within the silo does not permit sharing outside of the silo ”
According to the article:
The Court of Chancery first recognized a fiduciary duty claim for insider trading in a case called Brophy v. Cities Service Co., 70 A.2d 5 (Del. Ch. 1949). In that case, a stockholder brought a derivative action against the directors of Cities Service Company and Thomas Kennedy, described as a “confidential secretary” to a director and officer of the company. The plaintiff stockholder alleged that, during the course of his employment, Kennedy had obtained knowledge of non-public information regarding the company’s plans to buy back its own shares. The plaintiff stockholder also alleged that Kennedy took advantage of that non-public information and bought a large block of the company’s shares in the market. After the corporation’s planned purchases raised the market price of its stock, Kennedy resold his recently acquired shares to the corporation at a profit. Kennedy moved to dismiss the complaint, contending that no cause of action could be stated against him because he was not a fiduciary to the corporation and the corporation had not suffered any actual harm.
The court disagreed and held the complaint stated a valid derivative claim for breach of the fiduciary duty of loyalty against Kennedy based upon his alleged purchase and sale of company stock. The court’s holding was based on the Delaware public policy, announced most famously 10 years earlier by the Delaware Supreme Court in the seminal case of Guth v. Loft, that “corporate officers and directors are not permitted to use their position of trust and confidence to further their private interests.” Thus, despite not being an officer or director of the corporation, the court found Kennedy occupied a position of trust and confidence within the corporation and deemed his position to be analogous to that of a fiduciary. With respect to Kennedy’s argument that the corporation had suffered no harm, the court held that as a matter of equity, where the claim is that a fiduciary abused a position of trust for personal gain, actual harm to the corporation is not required. “
[. . . ]
“Pfeiffer’s near-elimination of disgorgement as a remedy pursuant to a Brophy claim was soundly rejected by the Delaware Supreme Court in Kahn v. Kolberg Kravis Roberts & Co., L.P., 23 A.3d 831 (Del. 2011). In Kahn, the state supreme court considered the appeal of the Court of Chancery’s decision regarding the viability of a Brophy claim against defendant Kolberg Kravis and Roberts & Co., L.P. (KKR). KKR was the majority stockholder of nominal defendant, Primedia, Inc. The Primedia stockholder plaintiffs alleged, among other things, that KKR obtained non-public company information through its board designees and used that information to purchase company preferred stock it later sold at a substantial profit. During the pendency of the case in the Court of Chancery, Primedia formed a special litigation committee that investigated and ultimately sought the dismissal of the plaintiffs’ claims, including the Brophy claim. In the proceedings below, the Court of Chancery found that while the Brophy claim stated a valid cause of action, the potential damages available to the company – which would not include disgorgement per Pfeiffer – were insubstantial and the special litigation committee was thus justified in seeking to dismiss this claim rather than recommending that the company pursue it.
Plaintiffs appealed the Primedia court’s decision to the Delaware Supreme Court. While reciting with approval the Pfeiffer court’s holding that Brophy remained good law, the Delaware Supreme Court, relying on Guth, overruled Pfeiffer’s holding that disgorgement was generally not a permissible remedy in the Brophy context except in limited circumstances. Rather, the Supreme Court found “no reasonable policy ground to restrict the scope of disgorgement remedy in Brophy cases – irrespective of arguably parallel remedies grounded in federal securities laws.” The Supreme Court also took the occasion to overrule Pfeiffer’s holding that a Brophy claim exists to remedy harm to the corporation and specifically held that harm to the corporation is not a required element to pleading a Brophy claim.
In a later, related proceeding, In re Primedia, Inc. Shareholders Litigation, 67 A.3d 455 (Del. Ch. 2013), the Court of Chancery again considered the merits of the Brophy claim against KKR. The court again found that the Brophy claim was a viable cause of action and would survive a motion to dismiss. The court also explained that, even though the value of the claim was no longer relevant to its analysis, had it considered full disgorgement of KKR’s gains as a potential remedy, it would have denied the special litigation committee’s motion to dismiss as the potential recovery would have risen from approximately $1.5 million to $150 million.”
Query: Suppose you learn through your director representative on the Six Flags board that Six Flags is going to build a new theme park on land Six Flags owns in Texas and you buy a privately owned hotel nearby that Six Flags has no interest in buying but whose value quadruples when Six Flags announces its theme park plans. Under Brophy, it appears Six Flags (or a stockholder derivatively on its behalf) could sue you for disgorgement of the private benefit you obtained from investing in the hotel based on inside information and the hotel quadrupling in value – disgorgement is an available remedy. Under Brophy, no proof of damages to Six Flags is required and even if Six Flags decided not to pursue such claim, stockholders might allege demand futility and seek to pursue the claim derivatively.
Takeaway: Under the Morgans Hotel approach, there would likely be numerous opportunities for Brophy claims alleging that a blockholder was deriving private benefits from its access to board-level information and the company might find itself frequently having to address such claims through special litigation committees or otherwise. On the other hand, the alternative default approach advocated by some commentators would limit claims by the company or by stockholders derivatively on its behalf to those circumstances in which the company or stockholders suing on its behalf could demonstrate that the contractual restrictions on disclosure and use had been breached and actual damages to the company had resulted.
While many private equity and large stockholders with the ability to appoint directors may have initially applauded the holding in Morgans Hotel, they may now find that potentially having to face serial Brophy claims makes the alternative default approach advocated by some commentators more appealing.
[Note: Prior to the Morgans Hotel ruling and absent the Business Lawyer article, a blockholder would not necessarily have a common law right to board level information or be deemed a constructive insider for Brophy claim purposes. In Primedia, KKR was a majority stockholder and in Brophy, Kennedy was a confidential secretary to a director.]
Here’s news from Cliff Neimeth of Greenberg Traurig:
With these proposed amendments, the Delaware legislature is prepared to act over organic fee-shifting and exclusive venue provisions and to consider amending Delaware’s appraisal statute. The proposed amendments – new DGCL Sections 102(f) and 109(b) – would, if adopted, preclude the adoption of fee-shifting bylaws and C-of-I provisions in the case of Delaware stock corporations.
As you recall, the ATP decision involved a non-stock association and its purported (broader) application outside that context has been vehemently criticized by numerous constituents. Several public companies have adopted such bylaws in the wake of the ATP decision and were forced (with considerable embarrassment) to reverse such adoption when they realized that their reading of ATP was a stretch or at least premature, and also due to institutional stockholder backlash and proxy advisor “withhold vote” policies effectively opposing such provisions implemented by unilateral board action.
Here are a few random thoughts on the proposed amendments:
– In the case of exclusive venue bylaws (now commonplace for hundreds of public companies in Delaware and in at least four other jurisdictions), the proposed amendments – DGCL Section 115 – would statutorily validate such provisions on a facial basis. Meaning, they still can be subject to challenge “as applied” given a particular set of facts and circumstances (e.g., adoption after the commencement of subject litigation or in some other context constituting a breach of fiduciary duty).
– The Delaware Court of Chancery recently upheld the adoption by a Delaware corporation of bylaws selecting North Carolina as the exclusive venue for intra-corporate disputes. The proposed amendments to the DGCL would permit such foreign jurisdiction selection so long as the organic language does not 100% foreclose such actions in Delaware courts.
– Under the proposed amendments, stockholder agreements containing such provisions that bind the contracting parties would, however, remain permissible.
– The personal jurisdiction issue raised in the commentary is easily addressed by adding consent to jurisdiction and other language in the relevant bylaw or charter provision. These provisions also are written subject to waiver by the corporation so that there is a “fiduciary out” in the case of a potential “as applied” challenge.
– The initiative to amend Section 262 is in response to the increasing practice of merger arbs and hedge funds to purchase shares post-record date (for the vote on the merger agreement) and assert appraisal rights so long as it can be demonstrated that the record date holder (e.g, CEDE & Co.) holds more shares that were not voted for the merger agreement than the number of shares for which the beneficial owner (the fund) is seeking appraisal. Because Cede & Co. holds shares in fungible bulk for its participant and customer accounts, that condition can be readily satisfied.
– Recent Delaware decisions (Ancestry.com and Merion Capital) have confirmed that the beneficial owner does not need to demonstrate that it’s specific shares were not voted for adoption of the merger agreement.
– In that statutory interest for properly perfected appraisal shares is 500 bps above the prevailing federal discount rate, even if the Delaware Court of Chancery were to determine that the fair value of the appraisal shares was the merger deal price (which a couple of recent cases in fact held), the arb still makes a tidy profit because of the statutory interest rate spread.
– Various inconsistencies in DGCL 262 regarding the procedures for beneficial owners and record date holders to perfect appraisal are the subject of potential legislative clarification.
As always, all remains to be seen, but it is expected that the proposed fee-shifting and exclusive venue amendments will be adopted substantially as proposed.
Here’s news from this blog by Steve Quinlivan (also see this memo):
In Halpin et al v. Riverstone National, the Delaware Court of Chancery found that invoking drag-along rights against minority stockholders after a merger did not waive appraisal rights under the facts of the case before the court.
Here, the drag-along right did not include a specific waiver of appraisal rights. It only provided that upon advance notice, minority shareholders would vote in favor of a change-in-control-transaction.
Delaware courts have never addressed whether a common stockholder can waive appraisal rights in advance. The court discussed In re Appraisal of Ford Holdings, Inc. That case found that a preferred stockholder may waive its right to appraisal. According to the case, “[s]ince Section 262 represents a statutorily conferred right, it may be effectively waived in the documents creating the security only when that result is quite clearly set forth when interpreting the relevant document under generally applicable principles of construction,” and ultimately held that the indirect language in the relevant documents was “too frail a base upon which to rest the claim that there has been a contractual relinquishment of rights under Section 262″.
For purposes of the Halpin opinion, the court assumed that common stockholders may waive appraisal rights in advance of a transaction. Here the court found construction of the unambiguous contract provision does not clearly demonstrate that the company is entitled to force a waiver of appraisal. The court found the contract demonstrated the opposite—under the circumstances, the minority stockholders did not breach the stockholders agreement by seeking appraisal.
The court assumed, as argued by the company, that the only purpose of the drag-along was to waive the minority stockholders’ appraisal rights. However, rather than explicitly waiving appraisal rights, the parties opted instead to contract for acts by the minority stockholders that would have the effect of waiving appraisal rights–either a forced tender or vote in favor of a transaction.
But the company’s argument failed because it did not exercise the drag-along rights before the merger. The actual vote on the merger occurred by written consent of the controlling stockholder, before the drag-along rights were exercised. Simply put, the drag-along rights did not require the minority stockholders to consent to a transaction that had already taken place.
The court rejected the notion that the minority stockholders waived their appraisal rights because of the implied covenant of good faith and fair dealing. The company and the minority stockholders were sophisticated parties, and both were charged with knowledge as to the various ways the company could have carried out a merger under Delaware law, including by written consent pursuant to Section 228 of the DGCL. Yet, with full awareness that it could consummate a merger by written consent, without the minority stockholders’ knowledge or involvement, the company agreed to drag-along rights that by their unambiguous terms did not apply to this retrospective scenario.
Here’s an excerpt from this FactSet infographic on poison pills:
An analysis of last year’s U.S. poison pill adoptions reveals that companies continue to primarily adopt them for a specific reason, including in response to unsolicited acquisition offers and activist investors as well as protecting net operating loss (NOL) carryforwards. In 2014, 57 poison pills were adopted by 54 distinct U.S. incorporated companies. Only 13 of the companies adopted what we would categorize as a routine adoption: those adopted before any publicly disclosed threat has emerged or for the specific purpose of protecting tax assets. NOL protective poison pills represented the largest proportion of 2014 adoptions.
The 18 NOL poison pills adopted in 2014 is a three-year high and are tied for the third most such adoptions in any year since 1998, the first year in which we are aware of any U.S. company adopting a poison pill in order to preserve NOLs. Poison pills adopted in response to the company being approached by an activist investor or a rapid share accumulation represented over a quarter of all adoptions.
Tune in tomorrow for the webcast – “Merger Filings with the SEC: Nuts & Bolts” – to hear Dennis Garris of Alston & Bird, Laurie Green of Holland & Knight and Jim Moloney of Gibson Dunn discuss the nuts & bolts of preparing disclosure documents that are filed with the SEC, including practical guidance into what should be disclosed (or not disclosed) to minimize litigation risk – as well as how to handle common Corp Fin comments.