Recently, I announced a “cool deal cube contest” as part of our ongoing “Deal Cube Chronicles.” John Newell of Goodwin Procter takes the prize with this cube. John notes:
Here is an old JPMorgan advertisement from the late ’80s that explains this cube. In a nutshell, it is that the cube/tombstone from the “tombstone of the unknown deal.” I made a joke to a senior guy at Bowne of Boston after a public deal cratered and he made a couple of these babies.
Recently, I also received this story from a member:
During a drafting session for a follow-on offering in which we were underwriters’ counsel, we commented that the CFO was referred to in his bio as a certified pubic accountant. Company counsel expressed surprise because they had copied the language verbatim from the original IPO prospectus. There followed 1-1/2 seconds of uncomfortable silence, after which we flipped through a copy of the IPO prospectus and confirmed the worst.
There is some consolation in the fact that a search of the term “certified pubic” on EDGAR yields 142 hits (and counting).
As the proxy season gets underway in Japan – where the majority of companies hold their meetings during the last two weeks of June – defensive measures are the hot topic once again this year. This report is from the RiskMetrics Group:
The most controversial issue of the 2009 Japanese proxy season will continue to be the introduction and renewal of “poison pills” and other types of takeover defenses. In the wake of attempts to take over companies including Hokuetsu Paper, Bull-Dog Sauce, and Sapporo Holdings – as well as the successful proxy challenge at Aderans Holdings – many companies have introduced defensive measures because of fears of being acquired.
However, these fears may be overblown because the difficulties of successfully managing a company after a hostile acquisition will help to ensure that the number of such cases will be limited. Nevertheless, several hundred companies will introduce or renew a poison pill this year. More than one in seven Japanese issuers already have a pill in place as of May 1, according to RiskMetrics data.
Notwithstanding investors’ skepticism toward takeover defenses, companies that have put their pills to a vote usually have had no difficulties in winning approval, thanks to the support of cross-shareholders and other management-friendly parties. One exception is Works Applications, which was forced to withdraw a pill proposal after the company could not garner enough shareholder support.
According to RiskMetrics data, about 30 companies have removed poison pills to date. However, this includes companies where pills became unnecessary due to organizational changes such as becoming listed subsidiaries of larger companies; RiskMetrics data shows that only about 10 companies, including Shiseido, Nissen Holdings, and Rohm, removed pills because they came to believe that the defenses were not in the best interests of shareholders.
Most poison pills introduced in 2005 were so-called “trust-type” plans, where warrants are issued to a trust bank, to be transferred to all shareholders (other than a would-be acquirer) in the event the pill is triggered. These plans require a shareholder vote under Japanese law. Since 2006, the vast majority of poison pills have been so called “advance warning-type” or “advance notice-type” plans. In these cases, the board announces a set of disclosure requirements it expects any bidder to comply with, as well as a waiting period between the submission of this information and the launch of the bid. As long as the bidder complies with these rules, the company “in principle” will take no action to block the bid and allow shareholders to decide. The exceptions are where the bid is judged to be clearly detrimental to shareholders, such as in cases of greenmail, asset stripping, and coercive two-tier offers. Usually, such judgments are made by a “special committee” or “independent committee,” but the committee’s decision is usually subject to being overruled by the board. At some companies, the decisions are made by the board with no committee input at all.
Advance warning-type defenses do not require shareholder approval, although in most cases, companies are choosing to put them to a shareholder vote, as it is believed that doing so will put the company in a stronger position in the event of a lawsuit. However, the primary problem is not the terms of the poison pills themselves – these are often superior to those of U.S. companies due to relatively high trigger thresholds, clear sunset provisions, and an absence of “dead hand” provisions. Rather, the main problem is with Japanese companies’ insider-dominated boards and insufficient disclosure. The presence of a critical mass of independent directors is essential to ensure that a takeover defense is used not merely to entrench management, but contributes to the enhancement of shareholder value.
Notwithstanding management fears, some of the companies implementing pills are in fact not especially vulnerable, because founding families, business partners, or other insiders own more than a third of outstanding shares. This is enough to veto any special resolution, such as an article amendment or a merger, meaning that even if a hostile bidder is able to accumulate a sizable stake in such a company, that bidder will be unable to force any major restructuring moves opposed by the insiders. It is difficult to see what shareholders of such a company stand to gain from a poison pill.
Many of the poison pills introduced in the past few years will be up for renewal in 2009. In evaluating these renewals, investors should examine the company’s share price performance, relative to its peers, since the pill was first put in place. Where the company has underperformed the market, it will be difficult to argue that shareholders have benefited from the pill.
Some companies, while not putting a poison pill on the ballot, will seek to pave the way for the eventual introduction of a pill through measures such as increasing authorized capital. Investors should expect to see other article amendments designed to ward off hostile takeovers, such as the elimination of vacant board seats that could be filled by shareholder nominees, and the tightening of procedures for removing a director.
During this podcast, Mary Beth Kissane of Walek Associates analyzes how companies should be monitoring shareholder activist activity, including:
– How do hedge funds have such a solid activism record?
– What should companies do to prepare for an activist attack?
– Who within the company owns the “monitoring activists” task?
– Who within the company should be dealing with the financial press?
– Who is the “financial press” these days? Bloggers included? Social media?
I want to expand on John Jenkins’ recent blog on first drafts to capture a broader – and perhaps more important – point: The initial draft of the acquisition agreement should reflect the ongoing substantive discussions among members of the acquiror’s transaction team regarding risk allocation, purchase price considerations and the overall negotiating strategy.
Perhaps the purchase price is so “good” and any significant risks deemed to be so remote (or containable) that a “seller-friendly” (or “middle-of-the road”) draft is appropriate; on the other hand, perhaps the target has certain significant, uncontainable risks and/or the acquiror perceives it is paying a full purchase price, that the agreement should be aggressively drafted, with broad representations and warranties and indemnification obligations (assuming it is a private deal).
In short, every deal is different, and the role the acquiror’s counsel plays is critical: he must ensure that his client is making an informed judgment with respect to price and terms.
Webster’s Dictionary defines the term “sandbagging” to mean “to conceal or misrepresent one’s true position, potential, or intent especially in order to take advantage of…to hide the truth about oneself so as to gain an advantage over another.” In the world of M&A, the term sandbagging generally refers to the ability of the beneficiary of a representation and warranty to rely on that rep – and sue for its breach – notwithstanding the fact that the beneficiary knew that it was untrue when it was made.
Many buyers will assert that they ought to be able to rely on a representation despite knowing that it was incorrect when made. The justification for pro-sandbagging position is that representations and warranties serve a risk allocation function in M&A, and the parties have a right to bargain to allocate that risk as they see fit.
If that’s your argument, and your agreement is governed by Delaware law, then it looks like the law is on your side. In Cobalt Operating LLC v. James Crystal Enterprises LLC, No. Civ.A. 714-VCS (Del. Ch.; 7/20/07), Vice Chancellor Strine held that a breach of contract claim arising out of an acquisition agreement does not depend on the buyer establishing justifiable reliance:
Due diligence is expensive and parties to contracts in the mergers and acquisitions arena often negotiate for contractual representations that minimize a buyer’s need to verify every minute aspect of a seller’s business. In other words, representations like the ones made in the Asset Purchase Agreement serve an important risk allocation function. By obtaining the representations it did, Cobalt placed the risk that WRMF’s financial statements were false and that WRMF was operating in an illegal manner on Crystal.
So sandbag away, right?
Not so fast. It isn’t entirely clear that Vice Chancellor Strine’s position in Cobalt Operating is the last word on this issue under Delaware law. The Delaware Supreme Court affirmed the Vice Chancellor’s decision last year, but it did so in summary fashion, and it didn’t address a long line of cases from Delaware and other jurisdictions holding that “according to sound Delaware law, a plaintiff must establish reliance as a prerequisite to a breach of warranty claim.” Kelly v. McKesson HBOC, Inc., C.A. No. 99C-09-265 WCC (Del Super.; 1/17/02).
Perhaps it’s fitting that the Delaware courts leave us scratching our heads a bit on this issue, because frankly, the case law in this area is a bit of a mess across the country. The trend seems to be toward the kind of position enunciated by Vice Chancellor Strine, and the leading case is probably the New York Court of Appeal’s decision in CBS, Inc. v. Ziff-Davis Publishing Co., 553 N.E.2d 997 (NY 1990). (Here is a survey of the state of the law on this issue in various jurisdictions, as of 2002.)
Still, courts are still pretty far from giving buyers a license to intentionally sandbag. First of all, not everybody is with the program – some states still have an express reliance requirement. For example, if your agreement is governed by Minnesota law, the Eighth Circuit has held that you’ll need to demonstrate justifiable reliance in order to proceed with a claim for a breach, and you won’t be able to do that if you knew of the inaccuracy when the representation was made. Hendricks v. Callahan, 972 F2d 190 (8th Cir. 1992).
What’s more, cases following the Ziff-Davis line make it clear that the facts count. For instance, it may matter whether the buyer knew of the misrepresentation before signing (see Galli v. Metz, 973 F.2d 145 (2d Cir. 1992)), or whether the information about the inaccuracy of the information came from the seller or from a third party (see Rogath v. Siebenman, 129 F.3d 261 (1997)).
Since the case law remains somewhat opaque, lawyers often recommend that buyers negotiate for language stating that the seller’s representations and indemnity obligations won’t be affected by the buyer’s due diligence or its knowledge or suspicion that a rep is false. That kind of language puts buyers in a much better position to argue that they bargained for the risk allocation that’s embodied in the agreement.
That’s good advice, and it’s advice that many buyers appear to be taking. The 2006 Deal Points Survey of private company transactions indicates that approximately 50% of private deals contained “pro-sandbag” language, while only 8% contained an “anti-sandbag” clause that would preclude a buyer from making a claim with respect to a rep it knew was false. Still, 41% of the deals surveyed were silent on this issue, and the case law suggests that there may be more risks to this approach than most buyers realize.
That brings up another point. Maybe the most important advice for a buyer is that intentionally sandbagging the other side is a very risky tactic. As one commentator who analyzed the Ziff-Davis line of cases put it: “sandbag at your peril – if you have knowledge of a breach before signing and do not seek a specific indemnity, you risk losing your rights, even if you have attempted to preserve them.” Robert Quaintance, Jr. “Can You Sandbag? When a Buyer Knows Seller’s Reps and Warranties Are Untrue,” 5 The M&A Lawyer 9 (March 2002).
Let’s face it, the optics of strategic sandbagging look pretty bad, and as the case law suggests, there are all sorts of ways for courts to distinguish situations involving what it thinks is unfair behavior from those more benign situations in which general right to allocate risk through representations and warranties has been upheld. So when it comes to strategic sandbagging, caveat emptor – let the buyer beware.
The ghosts of securities law past, present, and future seem to haunt the headlines lately. But proxy access is heralded as the issue most likely to bring a tectonic shift in the balance of power between shareholders and boards – and the boundary between federal and state authority in corporate governance. Many are concerned that the SEC’s access proposal will empower special interests to hijack corporate policy toward objectives threatening long-term wealth maximization. In this article, Marty Lipton outlines his concerns. I have an answer that significantly alters the dynamic.
I call it the Chinese Menu Ballot. I explore the idea briefly in an article entitled “Pandora’s Ballot Box, or a Proxy with Moxie?” The SEC’s proxy access proposal concerns shareholder nominations. It says nothing about procedures to determine the winner of those elections. My method minimizes the ability of a small minority of highly interested, special interest shareholders to influence corporate elections. This danger is caused by the current plurality standard (most votes wins, even if not a majority) for contested elections.
The problem with plurality voting is that as more nominees appear on the ballot, the likelihood increases that a director not supported by a majority of voting shareholders will be able to win. And the number of nominees could be quite high. The SEC proposal limits individual shareholders from nominating more than a quarter of the total board size, but the presence of multiple shareholders nominating candidates could widen the field.
The reason why we don’t currently use majority voting for contested elections is that it may require a runoff, which would necessitate a second round of solicitations and double the expense. But my method alleviates the need for a runoff. A Chinese Menu Ballot would require a shareholder to rank the candidates in order of their preferences. The ballots would clearly state that any ballots that do not rank all candidates will be excluded. Then, any runoffs will be determined using the shareholders preferences to successively eliminate candidates in new vote tallies.
The result is very similar to what would happen if the company had a pure majority vote election with an actual runoff, and the result is significantly different from an election in which there are a large number of candidates and plurality voting is used. In each new round of a vote tally, the vote of a shareholder that voted for an eliminated candidate will be transferred to the next highest ranked candidate. And this transitive property of the Chinese Menu Ballot is the key to its ability to screen out special interest directors. The result is that candidates ranked high by a small number of shareholders, but not ranked within the top echelon by a majority of shareholders, are eliminated from the pool very quickly. Candidates ranked in the top echelon by a majority of shareholders will tend to emerge as winners.
There are a multitude of algorithms to use the shareholders’ rankings to generate an outcome. The appropriate method will depend upon circumstances particular to a company, including whether the board is staggered. The appropriate method will also depend on the demographics of a company’s shareholders, including the balance of institutional vs. retail investors and the type of institutional investors it has.
Consider a simple example: In the first round of vote tallying, each ballot’s vote will count toward the first ranked choice. After the first round of the tally, any seats not filled by a candidate receiving a majority of the votes will be determined by subsequent rounds of tallying. Before starting the second round of the tally, the candidate with the fewest number of votes (the candidate ranked first by the fewest number of shareholders) will be eliminated.
Any ballots that ranked the eliminated candidate first will now be registered as votes for their second ranked choice. This process would continue until the number of candidates remaining equals the number of available seats. There are a wide variety of available implementation methods and further recommendation would require a company-specific analysis.
For a brief analysis of the legality of this method under Delaware Corporate Law, I first note that DGCL 216 provides the plurality method as a default from which companies are free to opt-out via bylaw or charter amendment. And presuming that a company has the authority to amend the bylaws in its charter, it would be able to install this method unilaterally. In the unlikely event, however, that a company had a shareholder-adopted bylaw specifying the method for contested elections it would need to seek shareholder approval to implement this method.
I also do not think Chinese Menu Ballots would be subject to scrutiny under Blasius. Indeed, this method does not limit votes, it actually permits shareholders who voted for an eliminated candidate in one round to continue to have their vote counted in each successive round of the election. An analysis of this method under the federal proxy rules also indicates its legality. The Chinese Menu Ballot will need to include a space that permits withhold votes in accordance with Rule 14a-4(b)(2), but otherwise the proxy rules do not prohibit this method. I also note that this method would be difficult to implement, though not impossible, for companies that permit cumulative voting.
For assistance with implementing a Chinese Menu Ballot or other proxy access related issues, I am available for consultation.
Recently, the Ontario Securities Commission announced its reasons for its January ruling that led to the withdrawal of HudBay Minerals’ proposed acquisition of Lundlin Mining. In doing so, the OSC expressed concerns about potential conflicts of financial advisers who are compensated on the basis of the success of a transaction:
“[Contingent] fees create a financial incentive for an advisor to facilitate the successful completion of a transaction when the principal focus should be on the financial evaluation of the transaction from the perspective of shareholders. While the Commission does not regulate the preparation or use of fairness opinions, in our view, a fairness opinion prepared by a financial advisor who is being paid a signing fee or a success fee does not assist directors comprising a special committee of independent directors in demonstrating the due care they have taken in complying with their fiduciary duties in approving a transaction.”
The statement may signal an increased sensitivity by OSC to this issue – and call into question the ability of a board to rely on a fairness opinion where the financial advisor has a contingent fee arrangement. For more on this, see the related memos posted in our “Canadian M&A” Practice Area.
A few weeks ago, Delaware Vice Chancellor Lamb issued his opinion in San Antonio Fire & Police Pension Fund v. Amylin Pharmaceuticals that had challenged “poison puts” in debt agreements. The Court interpreted the fairly common “continuing director” provision in the indenture in a way that could have been expected, stating the board may approve as continuing directors persons nominated by dissident stockholders.
However, the Court did not rule – as not yet ripe – on the duty of good faith and fair dealing claim alleging the directors agreed to approve the dissidents here for purely self-interested reasons, but the Court suggested that the board must be fully informed about the inclusion of such provisions in debt instruments and might face a fairly high hurdle in justifying their agreeing to them. We have posted memos analyzing the opinion in our “Change-in-Control” Practice Area.
At Amylin’s annual meeting last week, dissident shareholders Carl Icahn and Eastbourne Capital each elected one director from their slate – thus avoiding triggering of the CIC provision at issue, as noted in this DealBook blog. We previously blogged about Icahn and Eastbourne’s unique no-action letters from the SEC to “round out” a short slate with other dissident’s nominees.
Some interesting news comes courtesy of Target, whose annual meeting is being held today. This will be no “regular” annual meeting as William Ackman, whose Pershing Square Capital Management owns a 7.8% stake, is seeking a seat for himself and four other nominees on Target’s board (as noted in this article) as well is seeking the company to use a “universal ballot” (as noted in The Corporate Library blog).
Although it’s become fairly common for dissidents in the throes of a proxy fight to leverage the Web (see this list of examples I have collected), it’s still fairly rare for companies to do the same. That’s why it’s worth noting Target’s annual meeting page to point out how they “get it” when it comes to campaigning online in their defense.
A number of the items posted on the company’s annual meeting home page were recommended in my article from the Spring ’08 issue InvestorRelationships.com entitled “The Coming Online IR Campaigns: The Future of Director Elections” (which is still available for free). To begin with, Target bothered to create an annual meeting home page. That’s a critical first step. They highlight endorsements from proxy advisors. They even post a white paper making their argument why they think one proxy advisor’s report is flawed (as noted in this article).
Have a good look. I predict these types of shareholder meeting sites will become more of the norm for IR departments/corporate secretaries when we live in a proxy access world without broker non-votes (ie. next year)…
You want further proof that the Web is changing the job of a corporate secretary? How about when a shareholder proponent posts a transcript of his remarks from the annual meeting? Governance guru Bob Monks did just that yesterday on his blog, right after he presented five proposals at Exxon-Mobil’s annual meeting.
Deal Protection: The Latest Developments in an Economic Tsunami
We have posted the transcript from our recent webcast: “Deal Protection: The Latest Developments in an Economic Tsunami.”
Last week, Corp Fin granted General Motors exemptive relief so that GM can move fast and exchange its debt. The relief is highly unusual, but certainly seems merited under the circumstances. GM has something like 26 series of debt outstanding, the federal government has lent the company billions under the TARP/TALF program – and pursuant to the terms of those loans, the company must restructure its debt (and operations) within a limited time period.
Therefore, GM had to commence its exchange offers immediately and begin soliciting consents to postpone the maturity dates. The two primary forms of relief granted by the Staff to GM include:
– Ability to solicit consents before a definitive proxy statement has been filed; and
– Ability to cut off withdrawal rights after 20 business days, but before the exchange offers necessarily expire.
I believe similar relief was granted to Chrysler back in the early ’80s under similar circumstances…
