DealLawyers.com Blog

In his “Delaware Corporate & Commercial Litigation” Blog, Francis Pileggi notes that Delaware Chancellor William Chandler has retired before the completion of his term and explains the process by which a replacement will be chosen. Francis also notes the importance of not having a full bench of five members of the Delaware Court of Chancery.

Here’s news culled from this memo by Edward Herlihy and David Shapiro of Wachtell Lipton:

On March 30th, the California Court of Appeals affirmed a long standing principle of California law that boards of directors of California companies can lawfully bind themselves to complete an extra-ordinary corporate transaction such as a merger or recapitalization without the need for a “fiduciary out” and without an independent shareholder vote. Monty v. Leis, No. B225646 (Cal. Ct. App. March 30, 2011).

Pacific Capital Bancorp (“PCB”), parent of Pacific Capital Bank, suffered losses in the real estate loan market that resulted in a write-down of its assets and was met with a series of banking regulatory orders which required that PCB raise capital. After seeking additional capital from numerous sources, PCB entered into an exclusive investment agreement with the Ford Financial Fund, LP (“Ford”) a fund affiliated with renowned bank investor Gerald Ford. Ford agreed pursuant to the investment agreement to inject $500 million of capital into the bank to allow it to meet regulatory requirements and grow its business. As a result, Ford would own over 80% of PCB’s common stock. PCB relied on the “financial distress” exception to the NASDAQ shareholder vote requirements to issue common and convertible preferred shares to Ford. After issuance, Ford voted the common shares it held to amend the articles of incorporation to authorize additional shares to be used to satisfy the conversion feature in the preferred stock. Two shareholders filed suit seeking to enjoin the transaction on a number of grounds and the trial court denied the injunction.

After examining the issues raised, the appeals court determined that the investment agreement did not contain improper defensive mechanisms. Specifically, the appeals court rejected the argument that the PCB board breached its duties by failing to include a “fiduciary out” provision enabling PCB to back out of the transaction for a better deal. In doing so, the appeals court specifically declined to follow the Omnicare case, noting that that case had been criticized even by the Delaware courts. Rather, the court opined that a board of directors may lawfully bind itself in a merger or investment agreement from negotiating or accepting competing offers. The Court specifically found that the board had “no duty” to include a “fiduciary out.”

The PCB case is an important recognition of the proper role of a board of directors in a regulated business. In the PCB case, the directors were faced with the immediate and pressing need to raise a significant amount of capital in a short period of time or risk further bank regulatory action. They made an informed and correct decision to commit themselves to a transaction with a sophisticated investor that could provide capital, prevent the company from more aggressive regulatory sanctions and preserve some value for shareholders.

Here’s news culled from this memo by Ted Mirvis, William Savitt and Ryan McLeod of Wachtell Lipton:

That litigation follows in the wake of a deal’s announcement is nothing new. But participants in the M&A markets are still grappling with the increasingly prevalent trend of multiple shareholder actions challenging the same deal in different courts. The Delaware Court of Chancery recently endorsed a pragmatic solution to this endemic problem. In re Allion Healthcare Inc. S’holders Litig., C.A. No. 5022-CC (Del. Ch. Mar. 29, 2011).

The case involved a going-private transaction in which Allion Healthcare’s controlling shareholders, in concert with a private investment firm, bought out the company’s unaffiliated shareholders. As has become customary, multiple lawsuits challenging the deal were filed in Delaware (Allion’s state of incorporation) and New York (Allion’s principal place of business). The various plaintiffs declined to coordinate their efforts and the actions proceeded in both jurisdictions. Preliminary injunction proceedings were scheduled in both jurisdictions and then resolved through supplemental disclosures in Allion’s proxy statement. Following the close of the transaction, both sets of plaintiffs filed amended complaints and the defendants engaged in settlement discussions with the Delaware plaintiffs, which ultimately yielded a settlement based on an increase in the merger consideration. The settlement, including an award of fees for the plaintiffs’ lawyers, was then approved in the Delaware court over the objection of the New York plaintiffs. When the Delaware and New York plaintiffs’ groups were unable to agree on an allocation of fees, the Court was forced to resolve the issue.

In so doing, Chancellor Chandler observed the “increasingly problematic” “fallout” of multi-forum deal litigation–a trend we have warned of before. The Chancellor recognized the unfairness of forcing defendants “to litigate the same case–often identical claims–in multiple courts,” noted the resulting waste of judicial resources, and cautioned of the potential confusion and full faith and credit problems that could stem from different outcomes in different jurisdictions. The Chancellor made clear that his “preferred approach” is an innovation this Firm developed several years ago in response to the multi-forum litigation problem: identical motions simultaneously filed in each venue “asking the judges in each jurisdiction to confer with one another and agree upon where the case should go forward.” The Chancellor explained that this method “has worked for [him] in every instance when it was tried.”

In Allion, the Chancellor awarded the New York plaintiffs half the fees associated with the supplemental disclosures, but no fees in connection with the price bump obtained in the settlement, signaling his view that obstructionist behavior will not be rewarded. More broadly, Allion indicates that the Delaware courts will apply their practical wisdom to combat the untenable burdens imposed by multi-forum deal litigation and remain receptive to new approaches to harmonize conflicting and duplicative merger litigation.

From this memo by Marty Lipton of Wachtell Lipton:

In a speech to the Council of Institutional Investors last Monday, Nelson Peltz, one of the most successful of the activist investors, said the recent changes in corporate governance would enable him to make investments in the heretofore “untouchables”–companies with market capitalizations over $50 billion. Mr. Peltz noted that the new governance rules give activists more tools with which to pressure companies, noting that larger companies provide bigger profit opportunities than smaller companies.

Activist investors with significant records of success will be able to use the new governance rules to convince institutional investors, like the members of the Council of Institutional Investors, to join them in pressuring companies to change their business strategies to those advocated by the activists, whether or not they are in the best interests of the long-term success of the companies and their long-term investors.

There has been a notable increase in hostile takeover and activist investor activity this year. If the present favorable market conditions for this activity continue, there will be a further increase. There is also little doubt that Mr. Peltz’s prediction that the targets will be among the largest companies is also correct.

All companies, even the very largest, should have up-to-date plans for dealing with activists and strategies to avoid inviting the notice of activists.

Here’s news culled from this Troutman Sanders memo:

On March 14th, the Public Company Accounting Oversight Board issued a Research Note focusing on the audits of reverse merger companies from the China region. The Research Note, titled “Activity Summary and Audit Implications for Reverse Mergers Involving Companies from the China Region: January 1, 2007 through March 31, 2010,” is the first such paper to be issued by the PCAOB, and follows its July 2010 Staff Audit Practice Alert No. 6 which raised concerns about compliance with standards for audits of companies with substantially all their operations outside the U.S. These two pronouncements show that the PCAOB is highly concerned about practices in this area, has narrowed its scope to focus on audits of companies from the China region, and may investigate and impose sanctions against accounting firms to raise awareness of these issues.

As context for the PCAOB’s concern regarding the audits of Chinese reverse merger companies (CRMs), the Research Note includes certain statistics: 159 CRMs accessed the U.S. capital markets during the period from January 2007 to March 2010; during that period private operating companies from the China region accessed U.S. capital markets more frequently by CRM transactions than by IPOs; CRMs tend to have relatively lower levels of revenue, assets and market capitalization; and the auditors of many CRMs are “triennial firms,” that is, firms inspected by the PCAOB once every three years (as opposed to annually) because they audit fewer than 100 public companies.
In both the Research Note and Practice Alert No. 6, the PCAOB identified factors that may have a negative effect on the audits of CRMs: language differences; use of third parties to perform audit work; added travel time and expense; and understanding of local business conditions.

The second factor – the use of third parties – appears to be of greatest concern to the PCAOB. In Practice Alert No. 6, the PCAOB cited examples of improper reliance on or coordination with third parties, including one case where a U.S. firm signed an audit report after using a China-based third party firm to perform substantially all the audit procedures on the issuer’s financial statements.

Accounting firms that audit U.S. public companies must comply with PCAOB standards, which include the AICPA’s Statement of Auditing Standards No. 1, Section 543, “Part of Audit Performed by Other Independent Auditors” (“AU 543”). AU 543 requires accountants to decide whether their participation in an audit is sufficient to justify serving as the principal auditor and author of the report on the financial statements. This decision becomes more difficult as more audit work is delegated to a third party, and AU 543 requires an accounting firm to consider various factors in this regard.
Reverse merger companies and their independent registered accounting firms should ensure that future audits are planned and performed in compliance with AU 543.

In addition, companies and accounting firms may want to assess whether prior audits have been conducted in compliance with AU 543, and whether documentation of such compliance exists in order to permit prompt cooperation with any PCAOB investigation. In planning future audits, or assessing prior audits, companies and accounting firms should involve legal counsel with relevant knowledge and experience.

Here is analysis from ISS’s Ted Allen:

During the 2011 U.S. proxy season, investors again will see a significant number of shareholder proposals that address corporate takeover defenses, such as supermajority voting requirements, classified boards, and limits on shareholder-called special meetings.

Once again, most of these resolutions have been submitted by California shareholder activist John Chevedden and other affiliated investors. So far, shareholders have filed 166 proposals that target takeover defenses, which account for 43 percent of the 386 governance proposals tracked by ISS this year. By contrast, investors have submitted 120 proposals on board issues (such as majority voting and independent chairs), and just 55 resolutions on compensation topics.

So far, investors have filed 48 proposals that urge companies to allow investors holding a certain minimum stake (such as 10 percent) to call a special meeting. However, 12 companies have obtained permission from the Securities and Exchange Commission under Rule 14a-8(i)(9) to omit these proposals by offering their own management proposals with higher ownership thresholds (such as 25 or 40 percent) and other limits on special meetings. Allstate, FirstEnergy, and YUM! Brands are among the issuers that have successfully argued that shareholder proposals would conflict with their management resolutions. In addition, Mattel and Waste Management have told the SEC that they plan to add one-year net-long position requirements to their management proposals.

These companies assert that a higher ownership hurdle is necessary given the expense and distraction of holding a special meeting. While activists would prefer lower thresholds, 53.8 percent of S&P 500 firms do not provide the right to call special meetings, according to ISS GRId data. Another 14.4 percent have ownership thresholds under 25 percent, 14.8 percent require between a 25 and 49 percent stake, and 17 percent have a 50 percent or greater standard.

So far, special meeting proposals have survived no-action challenges on eligibility or other grounds at Honeywell, General Dynamics, AT&T, American Express, and Verizon Communications. As of March 9, 31 proposals on this topic were still pending. It remains to be seen whether these proposals will fare better than last year, when the average support fell to 43 percent, down from 50.1 percent in 2009.

Meanwhile, Chevedden and other retail investors again are filing a greater number of resolutions that urge companies to allow a majority of investors to act by written consent. ISS is tracking 40 proposals this year, up from 29 in 2010. So far this season, 16 companies have asked the SEC for permission to exclude these proposals, but just one request (from Bank of America) has been granted.

Last year, written consent proposals, which appeared on 2010 proxy statements after more than a decade absence, averaged a surprising 54 percent support, but these resolutions may not fare as well this season as some institutional investors have revised their voting guidelines to consider other governance factors, such as a company’s threshold for calling special meetings. About 30 percent of S&P 500 firms now allow investors to act by written consent, ISS data shows.

Supermajority Voting Rules

Investors also will see a significant number of proposals from retail activists that seek to repeal the supermajority (such as 80 or 66 percent) voting rules that some companies have for bylaws or other agenda items. ISS is tracking 35 of these proposals this year; but 20 face no-action challenges. This topic averaged more than 73 percent support, the highest support level for a shareholder measure in 2010, and had 70.5 percent approval in 2009. Notwithstanding these votes, supermajority rules remain common; 55 percent of S&P 500 companies have such rules, according to ISS GRId data.

In a new development since last spring, companies are successfully using Rule 14a-8(i)(9) to exclude these proposals. In most cases, management seeks to propose a majority-of shares-outstanding threshold, while the activists are asking the companies to adopt a majority-of-votes-cast standard. Del Monte Foods successfully used this argument to omit a supermajority proposal filed for its September 2010 meeting. Since then, Alcoa, Medco Health Solutions, Fluor, and three other issuers have used this approach to exclude 2011 proposals on this topic. Four other proposals have been omitted on other grounds. Prudential Financial sought to exclude this resolution based on insufficient proof of ownership, but was turned down. Twenty-two proposals remain pending.

Board Declassification

Another widely supported reform is board declassification, which averaged 58 percent support in 2010. So far, ISS is tracking 34 proposals for 2011. The Nathan Cummings Foundation has filed at least 11 of these resolutions that seek annual elections for all directors. Other proponents include the American Federation of State, County, and Municipal Employees (AFSCME); the Florida State Board of Administration; New York City’s pension funds; and retail investors affiliated with Chevedden.

So far, Allergan, Dun & Bradstreet, DirecTV, and three other issuers have obtained permission to exclude these resolutions by arguing that they had substantially implemented them. The Nathan Cummings Foundation has withdrawn five proposals, typically after the companies agreed to declassify. Meanwhile, KBR has sued Chevedden in federal court over a declassification proposal and contends that he failed to provide sufficient proof of ownership.

In addition, AFSCME has asked Ball Corp. and Wellpoint to reincorporate to Delaware from Indiana, where a 2009 state law requires staggered board terms unless a company’s board votes to opt out.

Oklahoma-incoporated firms may be a target of similar proposals in the future. In September, a new Oklahoma corporate law took effect that mandates classified boards; to opt out, a company would have to wait until 2015 and then obtain support from a majority of shares outstanding. John Keenan, a strategic analyst with AFSCME, said the union pension fund has no immediate plans to file reincorporation proposals at Oklahoma firms, but noted: “we’ll continue to evaluate the changes and overall corporate governance regime of Oklahoma law.”

Classified boards have received more attention in recent months after a trio of Delaware court decisions upheld poison pills at Airgas, Selectica, and Borders Group, which all had staggered board terms. In a recent Wall Street Journal commentary on the Airgas decision, Harvard Law Professor Lucian Bebchuk observed that a declassified board can be an “antidote” to a poison pill. “Despite the Delaware court’s decision, investors still have recourse–because a poison pill is powerful only as long as the directors supporting it remain in place,” Bebchuk wrote. “If, by contrast, a company’s shareholders could replace a majority of its board more quickly, the board’s power to block a takeover bid would be correspondingly weakened.”

Overall, U.S. companies have responded to shareholder demands for this reform in recent years. Within the S&P 500 index, 61.6 percent of companies now have declassified boards, and another 6.2 percent are in the process of eliminating their staggered board terms, according to ISS GRId data.

Investors also have filed a handful of proposals that address other takeover defenses. Retail investors have asked Ford Motor, Martha Stewart Living Omnimedia, Telephone & Data Systems, Constellation Brands, and Ingles Market to drop their dual-class equity structures, while Comcast was allowed to omit a recapitalization proposal on ownership grounds.

The Amalgamated Bank’s LongView Fund filled a proposal at J.C. Penney that asked for a shareholder vote on its poison pill, but that resolution was withdrawn after the retailer announced new board appointees. While activists no longer submit dozens of pill proposals each season, investors still care about this issue. In 2010, the failure to seek shareholder approval for a poison pill contributed to majority withhold votes against directors at least seven Russell 3000 companies.

We have posted the transcript from our recent webcast: “3rd Annual Public Company M&A Nuggets.”

In what may reflect a new trend following the Del Monte hearing and decision, plaintiffs in this recent complaint allege that a financial advisor aided and abetted breaches of fiduciary duties by their client’s board. Specifically, plaintiffs allege that BofA Merrill Lynch “knew that the Emergency Medical Services Board actually disregarded its fiduciary duty to evaluate what is in the best interest of the company and its shareholders, and determined to pursue a singular strategy – to sell the Company” and that BofA Merrill Lynch aided and abetted the directors’ breach of fiduciary duty by “persuading the Board to accept the negative premium Proposed Transaction, to ensure BAML’s receipt of lucrative advisory and financing fees.”

In the EMS transaction, BofA Merrill Lynch and Goldman Sachs were co-financial advisors. BofA Merrill Lynch, which, at the Board’s request, was offering to provide buyer financing, did not render a fairness opinion. Goldman Sachs, which was not offering to provide buyer financing, rendered a fairness opinion.

Note that the complaint merely reflects plaintiffs’ allegations and not a judicial determination of fact. The disclosure in the proxy statement give some indication of some of the defenses likely to be raised, such as these extracts:

Background of the Merger

In order to enhance the confidentiality of the process by reducing the number of financial institutions involved before the board of directors determined whether to proceed with a formal sale process, the board of directors determined not to allow potential purchasers to disclose information to possible equity or debt financing sources. Rather, the board of directors requested that BofA Merrill Lynch provide potential purchasers with its preliminary views as to the possible financing for an acquisition and, if requested by qualified purchasers, to arrange and/or provide for such financing (however, potential purchasers were advised that they would not be required to use BofA Merrill Lynch financing for any transaction). Subsequent to this meeting, the Company provided its written consent to BofA Merrill Lynch and its affiliates serving as a potential source of debt financing, if requested by qualified purchasers, which consent outlined certain information and communication barriers that would be put in place between BofA Merrill Lynch’s financial advisory team providing services to the Company and the bank’s financing teams that would be established in connection with potential financing to qualified purchasers.

[. . . ]

On December 1 and 2, 2010, a first round process letter with invitations for submission of indications of interest was sent to potential purchasers. The letter instructed potential purchasers to base their indications of interest on a financing structure proposed by BofA Merrill Lynch. The letter stated that potential purchasers were not required to use BofA Merrill Lynch financing for an acquisition of the Company and would have the opportunity to work with other sources of financing in preparing final bids.

[. . . ]

On February 4, 2011, bids were received from CD&R and Party B. The CD&R bid proposed a purchase price of $63.00 per share and was accompanied by specific proposed changes to the merger agreement and unitholders agreement, and proposed forms of limited guarantee, equity commitment letter and debt financing commitments. As anticipated and authorized by the board of directors, CD&R’s debt financing commitment letter contemplated the participation of BofA Merrill Lynch and certain of its affiliates in the proposed debt financing for the merger as one of six potential debt financing sources.

Engagement of Merrill Lynch, Pierce, Fenner & Smith Incorporated

As further discussed above (see “–Background of the Merger”), the Company retained BofA Merrill Lynch as one of its financial advisors in connection with the merger. In addition, BofA Merrill Lynch and certain of its affiliates will provide a portion of the debt financing for the merger, subject to specified conditions as set forth under “–Financing of the Merger–Debt Financing.” Given that BofA Merrill Lynch and certain of its affiliates had been requested by the Company to arrange and/or provide, and ultimately participated in, the debt financing for the merger, BofA Merrill Lynch was not requested to, and it did not, deliver an opinion in connection with the merger.

In connection with BofA Merrill Lynch’s services as the Company’s financial advisor, the Company has agreed to pay BofA Merrill Lynch an aggregate fee currently estimated to be approximately $12.95 million, $500,000 of which was payable upon execution of the merger agreement and the balance of which is payable upon completion of the merger. The Company also has agreed to reimburse BofA Merrill Lynch for its reasonable expenses, including fees and disbursements of BofA Merrill Lynch’s counsel, incurred in connection with BofA Merrill Lynch’s engagement and to indemnify BofA Merrill Lynch, any controlling person of BofA Merrill Lynch and each of their respective directors, officers, employees, agents and affiliates against certain liabilities, including liabilities under the federal securities laws, arising out of BofA Merrill Lynch’s engagement. BofA Merrill Lynch and its affiliates comprise a full service securities firm and commercial bank engaged in securities, commodities and derivatives trading, foreign exchange and other brokerage activities, and principal investing as well as providing investment, corporate and private banking, asset and investment management, financing and financial advisory services and other commercial services and products to a wide range of companies, governments and individuals.

In the ordinary course of business, BofA Merrill Lynch and its affiliates may invest on a principal basis or on behalf of customers or manage funds that invest, make or hold long or short positions, finance positions or trade or otherwise effect transactions in equity, debt or other securities or financial instruments (including derivatives, bank loans or other obligations) of the Company, CD&R, Onex and certain of their respective affiliates and/or portfolio companies. BofA Merrill Lynch and its affiliates in the past have provided, currently are providing, and in the future may provide, investment banking, commercial banking and other financial services to the Company, CD&R, Onex and/or certain of their respective affiliates and portfolio companies and have received or in the future may receive compensation for the rendering of these services.

This March-April issue of the Deal Lawyers print newsletter was just sent to the printer and includes articles on:

– Never Say Never, But, You May Have to Wait Two Years: Delaware’s Airgas Decision
– How Process Flaws Can Rewrite Your Merger Agreement:
Process Flaws, Remedies and Del Monte
– The Validity of Stockholders’ Representatives after Aveta
– Tips for PE Firms Participating in Stalking Horse Auctions

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

Here’s news culled from this Davis Polk memo: In mid-February, the U.S. committee charged with examining national security implications of foreign acquisitions of U.S. businesses determined that Huawei Technologies should be required to unwind its recent purchase of certain assets of 3Leaf Systems, a California-based company which provides technology for cloud computing. According to news reports, after conducting a 30-day review and a follow-on 45-day investigation of the acquisition pursuant to the “Exon-Florio” statute, the interagency Committee on Foreign Investment in the United States informed Huawei that it would have to divest the assets or CFIUS would recommend to the U.S. President that the acquisition be unwound. Huawei reportedly decided initially to wait for the President’s decision, required by law to be made within 15 days, but subsequently agreed to divest the assets. Huawei’s decision spared President Obama what might have been a controversial and difficult determination.