Many companies resolve potential activist proxy contests by entering into cooperation agreements under which the company agrees to add one or more activist nominees to its board of directors. A recent post on the CLS Blue Sky Blog says that following the Delaware Supreme Court’s decision in Coster v. UIP, (Del.; 6/23), boards should proceed with caution when considering entering into these agreements.
In essence, the blog argues that Coster made it clear that a decision to enter into these agreements should be evaluated under the Unocal standard, which requires the board to establish that it has identified a cognizable threat to the corporation and that its response to that threat is reasonable and proportionate and neither preclusive nor coercive. This excerpt from the blog says that satisfying both prongs of Unocal may prove to be tough sledding for the board:
Post-Coster, the approval of cooperation agreements raises several significant problems for boards. First, Coster imposed a more rigorous definition of a reasonable threat. Many of the concerns that have been historically identified as reasonable threats justifying a defensive response to an activist shareholder may not constitute cognizable threats under Coster, or are, at most, mild threats to the corporation. For example, boards often attempt to justify their opposition to an activist’s proxy fight by arguing that the activist’s focus on short-termism will harm the company. However, that seems to be just another example of a “board knows best” argument, which Coster rejected.
In addition, boards often point to disruptions to the company’s business operations as a threat justifying a cooperation agreement. However, cooperation agreements also cause disruptions. This is especially true when the company has agreed to form a special board committee charged with exploring the activist’s strategic vision, which is often the case. Therefore, any reduction in disruption due to the cessation of the proxy fight must be offset with the disruption due to the cooperation agreement.
In addition, a board will be unlikely to pass the more stringent proportionality prong. Cooperation agreements are “preclusive.” Their sole purpose is to make proxy fights unattainable. The agreements accomplish this goal in two ways. First, the secrecy and speed with which an activist investor’s designated directors assume board seats prior to an annual meeting deprive all other stockholders of a contested vote.
A board might argue that a cooperation agreement is not preclusive because the activist’s designated directors will be subject to a vote at the next annual meeting. However, herein lies the second part of the preclusive effect of cooperation agreements. They ensure that newly appointed board members effectively run as incumbents in uncontested elections at annual meetings. Directors who are nominated in an uncontested election are almost always elected, meaning that the activist’s designated directors are almost certain to get elected.
With some exceptions, Unocal has not been a particularly daunting standard to satisfy in cases involving deal protections and defensive measures such as poison pills. However, boards & their lawyers would be well advised to take this argument about the challenges facing cooperation agreements seriously, particularly since Vice Chancellor Laster flagged this blog on LinkedIn and characterized it as a “good take.”
This Sullivan & Cromwell article discusses Vice Chancellor Laster’s bench ruling last week on a motion to dismiss after oral argument in Clement v. Apollo Global Management, LLC. In this case, the plaintiff alleged a controlling shareholder extracted two unique benefits in the challenged transaction — the conversion of a subordinated loan valued at $27.6 million to equity worth $2.8 million (causing dilution) and a release of any claims that may have existed from the time the controller owned the company — so the entire fairness standard should apply. VC Laster’s ruling provided two points of clarification on the concept of a controller’s receipt of “unique benefits” in a transaction. Here’s an excerpt from the article:
The first is whether the unique benefit received by the controller “has to be at the expense of the minority” shareholders. The court said that “the question really turns on whether we approach fiduciary liability using th[e] concept of compensatory damages” (which focuses on the plaintiff’s loss) or “principles of disgorgement” (which focuses on the defendant’s gain). Because disgorgement is “the dominant paradigm” in “a fiduciary world” where “we’re dealing with equity,” the court stated that, in its view, “it doesn’t make sense to limit the cause of action to one where there’s diversion of consideration.” Therefore, a unique benefit can arise “where the fiduciary takes a benefit, even if it’s not at the expense of the minority stockholders.”
The court also addressed a seeming divergence in views with Vice Chancellor Glasscock with respect to the framework for analyzing challenges to a merger where the claimed benefit is the elimination of litigation exposure. In In re Primedia, Inc. Shareholders Litigation, Vice Chancellor Laster had analyzed the issue through the lens of standing, whereas Vice Chancellor Glasscock’s decisions “jump over the concept of standing to address the merits of a challenge to an interested transaction.” The court stated that “when you have a controller that is a controller at the time of the merger . . . it really doesn’t matter” which framework is used because “it’s the same analysis for both” that all “coalesces into one thing”: “[t]here has to be an inference of something material that results in a conflict.” …
With respect to the loan conversion, the court held that the controller’s receiving 10 cents on the dollar for the loan was a “unique detriment,” not a “unique benefit.” With respect to the release, the court held that plaintiff failed to plead that the release covered any “viable claim[s]” that could survive a motion to dismiss, and thus the controller was not shown to have received a material unique benefit.
Earlier this week, the OCC and FDIC both finalized their previously proposed changes to rules regarding business combinations involving national banks and federal savings associations. The DOJ simultaneously announced that it is withdrawing from the 1995 Bank Merger Guidelines. Its 2023 Merger Guidelines are its “sole and authoritative statement across all industries.” To that end, it released the 2024 Banking Addendum to 2023 Merger Guidelines, which includes commentary explaining the application of the guidelines to bank mergers.
This Simpson Thacher memo says “the DOJ and FDIC policy statements in particular represent significant changes from current practice in assessing bank merger transactions and the combined effect could result in significantly more burdensome application requirements and continue the current trend of very long processing periods.” It goes on to describe the changes in detail. The memo notes:
Unlike the FDIC and the OCC, the Federal Reserve has not issued any policy statement outlining changes to its standards for bank merger reviews. In April 2024, Federal Reserve Vice Chair for Supervision Michael Barr confirmed his view that the Federal Reserve’s current review frameworks is “pretty robust” and that no such policy statement is likely forthcoming. …
[T]he Federal Reserve continues to work with the other federal banking agencies and the DOJ to possibly update the 1995 Bank Merger Guidelines with respect to the antitrust analysis of bank mergers. He stated that the Federal Reserve is “thinking about that on an interagency basis rather than just us doing something [alone].”
This recent HLS Blog from Kai H. E. Liekefett and Derek Zaba of Sidley Austin addresses what they characterize as an uptick in “half-truths and outright lies in proxy contests” by dissident shareholders. They at least partially attribute this issue to the fact that the proxy rules were “adopted decades ago and long before the advent of the digital age” and are “increasingly under stress.” Specifically, it says the application of 14a-9 has often “failed to rein in even clearly problematic behaviour in proxy contests” such as inaccurate “statements about proxy tallies prior to the closing of the polls.”
For instance, in one court case, an activist announced preliminary proxy voting results several weeks prior to the shareholder meeting, claiming that it was clearly leading with 80% of the shares voted. These numbers turned out to be false (only 55% of the shares had been voted). However, the court declined to issue a preliminary injunction, and the dissident proceeded to succeed in its proxy contest.
When a company is faced with this issue in a proxy contest, what can it do? The blog says, unfortunately, not much. As the blog explains, SEC review and litigation offer limited relief.
SEC Review. In the past, the SEC staff in the Division of Corporation Finance, through the comment letter process, strove to enhance compliance with these proxy rules. Whenever a party overstepped boundaries, the other party would send a private and confidential letter to the SEC, noting the violations. To the extent its staff agreed, the SEC would often react promptly to those letters by issuing comments to the offending party. …
In recent years, practitioners have observed a decline in the number and breadth of SEC comments in proxy contests. … The SEC’s packed agenda and limited resources have likely shifted attention towards other pressing matters.
Moreover, the SEC’s authority under the proxy rules has always been limited. The Division of Corporation Finance can only provide comments. If proxy rule violators do not comply with those comments, their staff can only refer a matter to the SEC’s Division of Enforcement. However, we are not aware of any enforcement action prior to a shareholder meeting in recent years.
Litigation. Companies waiting for SEC action can instead bring suit against proxy rule violators in federal court. However, litigation poses significant risks for a company.
… [T]here is typically no insurance available for companies to pursue litigation as plaintiffs. Moreover, proxy advisory firms and investors frequently criticise companies for initiating litigation against shareholders. This is certainly an important consideration in a proxy contest where a company needs to weigh any potential win in court against a loss at the ballot box.
More substantively, there is also the reality of condensed proxy fight timelines and the burden of proof [and …] preliminary injunction is an extraordinary remedy that generally will be granted only in limited circumstances. …
A further complicating factor is that many federal judges are not familiar with the intricacies of proxy contests because such cases are relatively rare. As a result, the case law originating from the federal courts has been uneven and inconsistent.
The post suggests the proxy rules be tweaked to give the SEC more authority to sanction violations, require proxy rule violators to publicly withdraw false statements, enjoin proxy contests and impose severe sanctions on repeat violators. But, for now, this is is still something companies are struggling with and likely will continue to.
Yesterday, I blogged about Corp Fin Director Erik Gerding’s statements at the ABA Business Law Section’s “Dialogue with the Director” last Friday. During the program, he acknowledged that technical EDGAR issues continue with respect to co-registrants but that the SEC is working to update EDGAR.
Well, as it happens, yesterday afternoon the SEC announced the adoption of updates to Volume II of the Filer Manual to reflect, among other things, that EDGAR is being updated to permit SPACs to identify target companies in a de-SPAC as co-registrants on Form DRS and DRS/A. It looks like EDGAR Release 24.3 was rolled out yesterday with the announcement.
At the same time, the SEC updated these FAQs on Voluntary Submission of Draft Registration Statements to revise old question 19 on de-SPACs & co-registrant status, which now reads:
(19) Question:
If a registrant uses the confidential submission process to submit a draft registration statement in connection with a de-SPAC transaction, when should it include any co-registrant’s CIK and related submission information in the EDGAR Filing Interface?
Answer:
In EDGAR Release 24.3, EDGAR was enhanced to allow co-registrants on draft registration statement submissions. See Section 7.2.1 Accessing the EDGARLink Online Submission of the EDGAR Filer Manual. The primary registrant must include the co-registrant’s CIK and related submission information in EDGAR when it submits the draft registration statement. See Section 7.3.3.1 Entering Submission Information of the EDGAR Filer Manual. The draft registration statement must also contain the information required by the applicable registration statement form, including required information about the target company. Co-registrants do not need to separately submit the draft registration statements or related correspondence in EDGAR.
During the ABA Business Law Section’s “Dialogue with the Director” held on Friday, Corp Fin Director Erik Gerding noted that Corp Fin staff has noticed a slight uptick in SPAC IPOs and shared some helpful thoughts on the disclosure review process now that the SPAC disclosure rules are effective. I’ve tried to paraphrase some of the key takeaways below (subject to the SEC’s standard disclaimer — and my own disclaimer that these are summaries based on my notes from Director Gerding’s oral comments):
– The SEC expects DRS submissions to be substantially complete when submitted. Nothing new; just a reminder.
– The filings complying with the new rules are lengthy, which may impact disclosure review timing. Plan accordingly.
– Some filers have elected to voluntarily comply with the new rules even if they don’t apply (for example, when the filing could be governed by the old rules because the filer had submitted filings prior to the effective date of the new rules on July 1). In that case, the Disclosure Review Program staff will treat the filing as if the new rules apply and comment accordingly.
– When dealing with a “SPAC on top” structure, Corp Fin staff may permit the de-SPAC filing to be submitted as a DRS by relying on the co-registrant’s DRS eligibility where the rules require a co-registrant. This is because the de-SPAC is the functional equivalent of the target’s IPO.
Director Gerding also acknowledged that technical EDGAR issues continue with respect to co-registrants but that the SEC is working to update EDGAR.
A recent Grant Thornton survey asked dealmakers about how the US presidential election was affecting their M&A activity. While most expect to see an uptick in deal volume over the next six months, this excerpt notes that a substantial minority are postponing deals until after the election:
Although 67% of M&A professionals say deal volume will increase in the next six months, slightly less than half are hitting the pause button on deals until after the U.S. election in November, according to a Grant Thornton survey.
Forty percent of the 255 M&A professionals surveyed said they’re holding back on their M&A plans until after the election. The respondents included corporate development team members, investment bankers, in-house legal professionals, private equity investment professionals, M&A attorneys and CFOs.
About half of the respondents said the election will have no effect on their deal activities, and 10% said they are speeding up their M&A processes to close before the election. Grant Thornton Transaction Advisory Services Managing Director Vic Sandhu said buy-side and sell-side professionals whose businesses are especially sensitive to regulation and market uncertainty tend to be the ones who are pausing deal activity.
Almost 50% of survey respondents identified the election’s effects on the overall economy as having the largest impact on M&A, while 25% cited its effects on regulatory policy and 22% its implications for tax policy.
In our latest “Understanding Activism with John & J.T.” podcast, my co-host J.T. Ho and I were joined by Dan Scorpio, head of M&A and Activism for H/Advisors Abernathy, to discuss what to do – and not do – when an activist comes knocking. Topics covered during this 22-minute podcast include:
– Why companies need more than good results to respond effectively to activism
– Why management teams shouldn’t assume an activist’s message won’t resonate with shareholders
– Common mistakes companies make in responding to activism and what they should do instead
– How universal proxy has changed proxy fights and overall strategies
– The role of social and digital media in making the case to retail investors
– Strategies for engaging index funds and other “passive” investors
– What makes an effective internal and external team for responding to activism
– The importance of offering solutions instead of attacking activists
Our objective with this podcast series is to share perspectives on key issues and developments in shareholder activism from representatives of both public companies and activists. We’re continuing to record new podcasts, and I think you’ll find them filled with practical and engaging insights from true experts – so stay tuned!
Section 220 of the DGCL gives stockholders the right to inspect “the corporations’ stock ledger, a list of its stockholders, and its other books and records” upon showing a proper purpose. If you’re like me, you may well have used the terms “stockholder list” and “stock ledger” interchangeably – and if you did that, you’d be wrong. This excerpt from a recent Duane Morris blog explains:
A short, letter decision by Chancellor McCormick ruling on motions for summary judgment in the matter of Mitchell Partners, L.P. v. AMFI Corp., et al., C.A. No. 2020-0985-KSJM (July 3, 2024) provides a crisp reminder–both to me and to other professionals advising Delaware corporations–that they are not the same thing given the clear language of Section 219(c) of the DGCL.
The letter decision is a quick-read at eight pages, so I commend it to the reader in its entirety. That said, three lessons emerge from this decision.
First, Section 219(c) is specific in its command that a Delaware corporation keep a stock ledger and enumerates the small list of information required to be including on the ledger. The Chancellor quotes from a 1956 decision of the Delaware Supreme Court noting that a stock ledger is “a continuing record of stockholdings, reflecting entries drawn from the transfer books, and including (in modern times) nonvoting as well as voting stock.”
That leads directly to the second lesson: the Chancellor notes that the stock ledger must record “all issuances and transfers of stock of the corporation” (emphasis in original). This includes non-voting shares of stock. The stock ledger in the matter being decided was found deficient because it excluded a class of stock that had been issued but was nonvoting in nature.
The blog says that the third lesson – the information that a company must include in a compliant stock ledger – was addressed in this footnote to the Chancellor’s opinion:
8 Del. C. § 219(c) defines “stock ledger” as “1 or more records administered by or on behalf of the corporation in which the names of all of the corporation’s stockholders of record, the address and number of shares registered in the name of each such stockholder, and all issuances and transfers of stock of the corporation are recorded in accordance with § 224 of this title.” 8 Del. C. § 219(c).
The footnote goes on to point out that Section 224 of the DGCL provides that the stock ledger must be kept so it “(i) can be used to prepare the list of stockholders specified in §§ 219 and 220 of this title, (ii) record the information specified in §§ 156, 159, 217(a) and 218 of this title, and (iii) record transfers of stock as governed by Article 8 of subtitle I of Title 6.”
This may seem like a highly technical issue, and I guess it is – but the directors’ alleged failure to maintain a stock ledger with all the information required by the statute served as a basis for a breach of fiduciary duty claim that Chancellor McCormick refused to dismiss. So, this is another area of Delaware law where it’s important to keep the “t’s crossed & the i’s dotted”.
In December 2022, I blogged about the Delaware Supreme Court’s decision in Boardwalk Pipeline Partners v. Bandera Master Fund, (Del. 12/22). In that case, the Court reversed a 2021 Chancery Court decision which found that the general partner of a Master Limited Partnership (“MLP”) was liable for nearly $700 million in damages as a result of a breach of the partnership agreement involving willful misconduct.
In his 2021 post-trial decision, Vice Chancellor Laster sharply criticized the general partner’s conduct and the process by which its outside counsel rendered a legal opinion required in order to complete the challenged transaction. The Delaware Supreme Court took a much more deferential approach to the general partner’s actions based upon its reading of the operative language of the MLP’s partnership agreement, and in a concurring opinion, Justice Valihura extended that deferential approach to the legal opinion.
The Supreme Court remanded the case to the Chancery Court for further proceedings consistent with its ruling. Yesterday, Vice Chancellor Laster dismissed the case. Under the circumstances, that result isn’t surprising, but the opinion in the case is a bit unusual. The Vice Chancellor’s 117-page opinion offers a spirited apologia for his prior decision and pushes back against the way that Loews Corporation, which controlled Bandera’s general partner, characterized certain aspects of that decision in briefing before the Delaware Supreme Court.
This excerpt from a section of the Vice Chancellor’s opinion responding to Loews’s claim that, in his earlier decision, he “discerned a nefarious conspiracy of top-flight lawyers, somehow bullied into professional malfeasance to the point of delivering ‘whitewash[ed]’ ‘contrivances’ instead of reasoned legal opinions rendered in good faith” gives you a sense of its combative tone:
Loews seems to believe that no one should ever consider that an attorney at a big firm might engage in motivated reasoning or otherwise act improperly. On behalf of elite, big-firm lawyers everywhere, Loews objects to the possibility that elite lawyers could rationalize as right what is personally beneficial. Those claims equate to assertions that big firm lawyers are inhuman. The scholarship on these points goes back over three decades and is no longer subject to meaningful dispute.
Big firm lawyers are subject to the same pressures and cognitive biases as other humans, and perhaps especially so. Professor Donald Langevoort, a leading scholar in this area, explains “that various cognitive (and cultural) biases lead many lawyers—including, and maybe even especially, elite ones—to deflect, normalize, and rationalize actions that are either illegal or unethical without compromising their internal self-image as good, responsible people and good, responsible lawyers.
This is just one of several issues that Vice Chancellor Laster had with arguments raised by Loews on appeal – but why bother addressing them you’re going to dismiss the case? The Vice Chancellor’s answer to that lies in the reasoning behind the Supreme Court’s decision and the possibility of further appeals.
The defendants argued that the legal opinion condition set forth in the partnership agreement had been satisfied, but the Supreme Court’s decision didn’t resolve that issue. Instead, it held that the general partner properly relied on another law firm’s advice that it could reasonably rely on the legal opinion at issue. This meant that, under the partnership agreement, the general partner was entitled to a conclusive presumption of good faith, which effectively exculpated it from damage claims.
The arguments made by Loews with which Vice Chancellor Laster took issue relate to the satisfaction of the legal opinion condition, and he argued that his responses to them could be helpful to the Delaware Supreme Court if the plaintiffs appeal, because Loews likely will argue that the justices should determine that the opinion condition was satisfied and affirm on that alternative ground.