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Title: Corporations


1
Corporations
  • March 16, 2008
  • Casebook pages 819-862
  • rwargo_at_frigolaw.com

2
Takeovers Part II
  • Extension of the Unocal/Revlon Framework to
    Negotiated Acquisitions
  • Omnicare v. NCS Healthcare
  • Extension of the Unocal/Revlon Framework to
    Shareholder Disenfranchisement
  • Hilton Hotels v. ITT
  • State and Federal Legislation
  • CTS v. Dynamics

3
Discouraging Competitive Bidding
  • A key planning issue in negotiated acquisitions
    is preventing competitive bidding.
  • The acquirers rationale is obvious
  • It might lose and even if it wins, it ends up
    paying more (and risking over-paying).
  • The target may also want to prevent competing
    bids. Why?
  • Bird in the hand.
  • Side-payments to management.

4
Options
  • Exclusive merger agreements.
  • Lockups.
  • Three-step acquisitions.

5
Exclusive Merger Agreements
  • Best efforts clause
  • Requires each party to use its best efforts to
    get the deal done.
  • Also requires the parties to recommend the deal
    to their shareholders and to use their best
    efforts to obtain shareholder approval.

6
Exclusive Merger Agreements
  • Best efforts clause
  • Subject to the terms and conditions provided
    herein, each of the parties agrees to use its
    best efforts to take, or cause to be taken, all
    action and to do, or to cause to be done, all
    things necessary, proper or advisable under
    applicable law and regulation to consummate and
    make Agreement and Plan of Reorganization

7
Exclusive Merger Agreements
  • Best efforts clause
  • The target's board of directors shall
    recommend that the stockholders . . . vote to
    adopt and approve the Merger . . . and use
    their best efforts to solicit from stockholders
    . . . proxies in favor of adoption and approval
    and . . . take all other action necessary or . .
    . helpful to secure a vote of stockholders in
    favor of the Merger.

8
Exclusive Merger Agreements
  • Best efforts clause
  • No-shop clause
  • Forbids the target from soliciting other bids.
  • May also forbid the target from negotiating with
    other bidders (a.k.a. no negotiation clause).
  • May also forbid target from providing information
    to other bidders (a.k.a. no talk clause).

9
Exclusive Merger Agreements
  • Best efforts clause
  • No-shop clause
  • Cancellation fee
  • Requires target to pay the acquirer some amount
    in case the deal is not consummated by a specific
    drop dead date.
  • In effect, a liquidated damages provision.

10
Best Efforts Clause Issues
  • Assume a competing bid emerges.
  • Assume the competing bid is a better deal.
  • Can the target board get out of the deal?
  • No. They are obliged to recommend the deal and
    use their best efforts to get shareholder
    approval.

11
Best Efforts Clause Issues
  • Assume a competing bid emerges.
  • Assume the competing bid is a better deal.
  • Is such a provision binding, given that a merger
    requires shareholder approval?
  • Distinction between condition precedent to the
    formation of the agreement and a condition
    precedent to the duty to perform.
  • The merger agreement is a contract between the
    corporations.
  • Shareholder approval is a condition precedent to
    the duty to merge the two companies.
  • Other obligations in the agreement are binding
    from the moment it becomes a contract.

12
Best Efforts Clause Issues
  • Assume a competing bid emerges.
  • Assume the competing bid is a better deal.
  • Fiduciary outs
  • E.g., nothing in this section shall relieve
    either Board of Directors of their continuing
    duties to their respective shareholders.

13
Cancellation Fee Issues
  • Two possible purposes
  • Compensate bidder for actual costs plus
    opportunity costs.
  • Compensate bidder for expectation damages (or
    lockup deal)
  • Most end up somewhere between 1 - 5 of the total
    acquisition price.

14
Lockups
  • Broadly defined as any arrangement by which the
    target corporation gives the favored bidder a
    competitive advantage over other bidders.
  • Stock lockup option Target gives bidder an
    option to buy some specified percentage of
    authorized but unissued (or treasury) shares.
  • Depending on size may function as a cancellation
    fee or a lockup.
  • Asset lockup option Target gives bidder an
    option to buy a crown jewel asset.

15
Example
  • Target has 90 shares outstanding.
  • You obtain an option to buy 10 shares at 7.50
    per share.
  • You then make a tender offer at 9 per share.
  • A competitor then emerges and makes a tender
    offer at 10 per share.
  • You exercise your option.
  • There are now 100 shares outstanding.
  • If the competitor buys 51 shares at 10, it will
    have spent 510. But you only need 41 shares to
    have control.
  • If you buy 41 shares at 10, you will have spent
    only 485 (75 to buy option shares and 410 to
    buy shares in tender offer).
  • You could pay up to a total of up to 509
    Subtract the 75 you paid to exercise the option.
    This leaves you with 434 to spend to buy 41
    shares, or 10.60 per share.

16
Negotiating Issues
  • Exercise price At current market or at offer?
  • Number of shares optioned.
  • Stock exchange rules requiring shareholder
    approval of stock issuances roughly exceeding 20
    percent of the outstanding shares.

17
Stockholder lockups
  • Outright purchase of control block raises
    fiduciary duty issues.
  • Get controlling shareholders to sign agreements
    pursuant to which they promise to approve the
    deal.
  • Buttress with irrevocable proxies.

18
Omnicare v. NCS Healthcare
  • Delaware 2003
  • Parties
  • Omnicare (acquiror 1)
  • NCS (target)
  • Genesis (acquiror 2)

19
Omnicare
  • NCS
  • Financially distressed health care company.
  • Omnicare
  • Competitor health care firm
  • Genesis
  • Competitor health care firm had recently lost a
    bidding war to Omnicare

20
Omnicare
  • Will purchase NCS assets for 225 million in a
    bankruptcy sale.
  • (Later raised to 270 million and then to over
    313 million.)
  • Substantially less than NCS outstanding debt.
  • NCS shareholders would get nothing many
    creditors would be paid only in part.

21
Omnicare
  • Lets merge
  • Pay off most of NCS creditors in full.
  • Provide substantial recovery for holders of NCS
    notes.
  • Give NCS shareholders a small return on their
    investments.

22
Genesis Deal Protection Devices
  • Termination fee of 6 million
  • 251 provision (submit Genesis deal to a
    shareholder vote even if the board withdrew
    recommendation)
  • No shop clause
  • Shareholder lockup
  • Dual class stock
  • Two insiders w/ Class B (super-voting) stock
    controlled majority of voting power

23
Talking about Talking
  • NCS representatives received voicemail messages
    from Omnicare asking to discuss the letter. The
    exclusivity agreement prevented NCS from
    returning those calls. In relevant part, that
    agreement precluded NCS from engaging or
    particpating in any discussions or negotiations
    with respect to a Competing Transaction or a
    proposal for one. The July 26 letter from
    Omnicare met the definition of a Competing
    Transaction.
  • Despite the exclusivity agreement, the
    Independent Committee met to consider a response
    to Omnicare. It concluded that discussions with
    Omnicare about its July 26 letter presented an
    unacceptable risk that Genesis would abandon
    merger discussions.

24
Is there such a place as Revlon-land?
  • Revlon issues
  • When do directors stop being defenders of the
    corporate bastion and become auctioneers?
  • Are the Revlon duties really different from those
    imposed by Unocal?

25
Is there such a place as Revlon-land?
  • References to Revlon and Unocal duties
  • When a board decides to enter into a merger
    transaction that will result in a change of
    control, however, enhanced judicial scrutiny
    under Revlon is the standard of review.
  • defensive devices adopted by the board to
    protect the original merger transaction must
    withstand enhanced judicial scrutiny under the
    Unocal standard of review, even when that merger
    transaction does not result in a change of
    control

26
Is there such a place as Revlon-land?
  • Enhanced scrutiny triggered
  • The prior decisions of this Court have
    identified the circumstances where board action
    must be subjected to enhanced judicial scrutiny
    before the presumptive protection of the business
    judgment rule can be invoked.
  • One of those circumstances was described in
    Unocal when a board adopts defensive measures in
    response to a hostile takeover proposal that the
    board reasonably determines is a threat to
    corporate policy and effectiveness
  • Other circumstances requiring enhanced judicial
    scrutiny give rise to what are known as Revlon
    duties, such as when the board enters into a
    merger transaction that will cause a change in
    corporate control, initiates an active bidding
    process seeking to sell the corporation, or makes
    a break up of the corporate entity inevitable.

27
Is there such a place as Revlon-land?
  • A single standard?
  • In Paramount v. QVC, this Court identified the
    key features of an enhanced judicial scrutiny
    test.
  • The first feature is a judicial determination
    regarding the adequacy of the decisionmaking
    process employed by the directors, including the
    information on which the directors based their
    decision.
  • The second feature is a judicial examination of
    the reasonableness of the directors action in
    light of the circumstances then existing.

28
Is there such a place as Revlon-land?
  • A single standard
  • Barkan v. Amsted Indus., Inc., 567 A.2d 1279,
    1286 (Del. 1989) Revlon is merely one of an
    unbroken line of cases that seek to prevent the
    conflicts of interest that arise in the field of
    mergers and acquisitions by demanding that
    directors act with scrupulous concern for
    fairness to shareholders.
  • Mills Acquisition Co. v. Macmillan. Inc., 559
    A.2d 1261, 1288 (Del. 1989) there are no
    special and distinct Revlon duties.
  • In re Lukens Inc. Shareholders Litigation, 757
    A.2d 720, 730-31 (Del. Ch. 1999) Revlon
    duties refer only to a directors performance of
    his or her duties of care, good faith and loyalty
    in the unique factual circumstance of a sale of
    control over the corporate enterprise.

29
Is there such a place as Revlon-land?
  • Revlon is a variant of Unocal applicable to a
    unique factual setting rather than a separate
    doctrine Did directors faced with a change of
    control act on an informed basis and make a
    reasonable effort to get the shareholders the
    best possible deal
  • Revlon neither creates a new type of fiduciary
    duty in the sale-of-control context nor alters
    the nature of the fiduciary duties that generally
    apply. Rather, Revlon emphasizes that the board
    must perform its fiduciary duties in the service
    of a specific objective maximizing the sale
    price of the enterprise. Malpiede v. Townson,
    780 A.2d 1075 (Del. Aug. 27, 2001)

30
Standard of Review
  • Enhanced scrutiny
  • Informed decision
  • Reasonable decision
  • If Revlon duties triggered, board must make
    reasonable efforts to get the best deal
    reasonably available for the shareholders
  • If not, Unocal applies
  • Board must show threat to corporate policy
  • Response must not be coercive or preclusive
  • Response must be reasonable in relation to threat

31
Held
  • Standard of review applicable to decision to
    merge with Genesis?
  • Chancery held BJR rather than Revlon
  • Supreme Court assumes that to be true, arguendo

32
Held
  • Standard of review applicable to decision to
    merge with Genesis?
  • Cited Arnold v. Society for Sav. Bancorp, Inc.,
    650 A.2d 1270 (Del. 1994), which held
  • The directors of a corporation have the
    obligation of acting reasonably to seek the
    transaction offering the best value reasonably
    available to the stockholders, in at least the
    following three scenarios (1) when a
    corporation initiates an active bidding process
    seeking to sell itself or to effect a business
    reorganization involving a clear break-up of the
    company (2) where, in response to a bidders
    offer, a target abandons its long-term strategy
    and seeks an alternative transaction involving
    the break-up of the company or (3) when
    approval of a transaction results in a sale or
    change of control. In the latter situation,
    there is no sale or change in control when
    control of both companies remains in a
    large, fluid, changeable and changing market.

33
Held
  • Does a board have authority to give a bidder
    reasonable structural and economic defenses,
    incentives, and fair compensation if the
    transaction is not completed?
  • Yes, subject to enhanced scrutiny per Unocal
  • The NCS directors must first establish that the
    merger deal protection devices adopted in
    response to the threat were not coercive or
    preclusive, and then demonstrate that their
    response was within a range of reasonable
    responses to the threat perceived.

34
Unitrin Digression
  • A response is coercive if it is aimed at
    forcing upon stockholders a management-sponsored
    alternative to a hostile offer.
  • A response is preclusive if it deprives
    stockholders of the right to receive all tender
    offers or precludes a bidder from seeking control
    by fundamentally restricting proxy contests or
    otherwise.

35
Held
  • Do controlling shareholder have a right to sell
    or exchange their shares with a third party at
    any price?
  • Yes
  • Cf. Mendell v. Carroll, 651 A.2d 297 (Del. Ch.
    1994), in which Chancellor Allen held that
    controlling shareholders seeking to effect a
    freeze-out merger had no obligation to support a
    proposed alternative transaction that offered
    target shareholders a higher price.

36
Held
  • So who wins and why?
  • Omnicare wins
  • NCS board was required to contract for an
    effective fiduciary out to exercise its
    continuing fiduciary responsibilities to the
    minority stockholders

37
Key text
  • Deal protection measures must be reasonable in
    relation to the threat and neither preclusive nor
    coercive. The action of the NCS board fails to
    meet those standards because, by approving the
    Voting Agreements, the NCS board assured
    shareholder approval, and by agreeing to a
    provision requiring that the merger be presented
    to the shareholders, the directors irrevocably
    locked up the merger. In the absence of a
    fiduciary out clause, this mechanism precluded
    the directors from exercising their continuing
    fiduciary obligation to negotiate a sale of the
    company in the interest of the shareholders.

38
Key text
  • Deal protection measures must be reasonable in
    relation to the threat and neither preclusive nor
    coercive. The action of the NCS board fails to
    meet those standards because, by approving the
    Voting Agreements, the NCS board assured
    shareholder approval, and by agreeing to a
    provision requiring that the merger be presented
    to the shareholders, the directors irrevocably
    locked up the merger. In the absence of a
    fiduciary out clause, this mechanism precluded
    the directors from exercising their continuing
    fiduciary obligation to negotiate a sale of the
    company in the interest of the shareholders.

39
Key text
  • Deal protection measures must be reasonable in
    relation to the threat and neither preclusive nor
    coercive. The action of the NCS board fails to
    meet those standards because, by approving the
    Voting Agreements, the NCS board assured
    shareholder approval, and by agreeing to a
    provision requiring that the merger be presented
    to the shareholders, the directors irrevocably
    locked up the merger. In the absence of a
    fiduciary out clause, this mechanism precluded
    the directors from exercising their continuing
    fiduciary obligation to negotiate a sale of the
    company in the interest of the shareholders.

40
Key text
  • Deal protection measures must be reasonable in
    relation to the threat and neither preclusive nor
    coercive. The action of the NCS board fails to
    meet those standards because, by approving the
    Voting Agreements, the NCS board assured
    shareholder approval, and by agreeing to a
    provision requiring that the merger be presented
    to the shareholders, the directors irrevocably
    locked up the merger. In the absence of a
    fiduciary out clause, this mechanism precluded
    the directors from exercising their continuing
    fiduciary obligation to negotiate a sale of the
    company in the interest of the shareholders.

41
Precommitments (again) under Omnicare
  • The majority emphasized the boards continuing
    responsibility to effectively exercise its
    fiduciary duties at all times after the merger
    agreement is executed.
  • Cf. Ace Ltd. v. Capital Re Corp. It is one
    thing for a board of directors to agree not to
    play footsie with other potential bidders or to
    stir up an auction. It is another for the target
    board to agree to a no talk clause.
  • Do such statements suggest that any attempt by a
    board of directors to precommit the corporation
    to a particular course of conduct is inherently
    invalid?

42
What could the board have done?
  • The majority stated
  • Under the circumstances presented in this case,
    where a cohesive group of stockholders with
    majority voting power was irrevocably committed
    to the merger transaction, effective
    representation of the financial interests of the
    minority shareholders imposed upon the NCS
    board an affirmative responsibility to protect
    those minority shareholders interests.
  • Just what could the board have done?

43
Questions left open by Omnicare
  • What if less than a majority of the voting power
    (e.g., 30) is locked up from a controlling but
    non-majority shareholder?
  • What if a bidder is given a contractual right to
    purchase the controlling stockholders stock at a
    fixed price regardless of outcome of vote?

44
The Standard Poison Pills Key Vulnerability
  • Redeemable
  • A determined hostile bidder could trigger the
    pill, moreover, launch a proxy contest for
    control of the targets board of directors, and,
    if successful, cause the newly-elected board to
    redeem the pill
  • Validity of nonredeemable pills called into
    question by Quickturn
  • How else could target block a proxy contest
    intended to elect a board that will redeem pill?

45
Background Blasius Case
  • Blasius owned 9.1 of Atlas stock
  • Blasius proposed a restructuring of Atlas
    involving the sale of assets, substantial new
    borrowing, and using the proceeds for stock
    buybacks and dividends
  • Atlas board of directors and financial advisors
    reject plan
  • Blasius responds with a consent solicitation to
    amend Atlas bylaws to increase the number of
    directors from 7 to 15, and to elect 8 Blasius
    nominees
  • Blasius directors would control a majority of the
    Atlas board, if passed

46
Digression on Written Consents
  • DGCL 228(a) Unless otherwise provided in the
    certificate of incorporation, ... any action
    which may be taken at any annual or special
    meeting of such stockholders, may be taken
    without a meeting, without prior notice and
    without a vote, if a consent or consents in
    writing, setting forth the action so taken, shall
    be signed by the holders of outstanding stock
    having not less than the minimum number of votes
    that would be necessary to authorize or take such
    action at a meeting of the shareholders

47
Digression on Written Consents
  • Written consents can be used by bidder to
  • Remove directors w/o cause
  • Amend bylaws or even articles
  • Elect new directors
  • Standard takeover defense
  • Per DGCL 228(a)Unless otherwise provided in
    the certificate of incorporationamend articles
    to eliminate written consents

48
Background Blasius Case
  • Atlas board amended the bylaws to increase the
    board size to 9 then named two new directors to
    fill the new vacancies
  • Hence, even if Blasius consent solicitation was
    successful, it would result in a board with 9
    incumbents or directors selected by the
    incumbents, and only 6 Blasius-nominated directors

49
Standard of Review
  • Enhanced scrutiny?
  • Informed decision
  • Reasonable decision
  • If Revlon duties triggered, board must make
    reasonable efforts to get the best deal
    reasonably available for the shareholders
  • If not, Unocal applies
  • Board must show threat to corporate policy
  • Response must not be coercive or preclusive
  • Response must be reasonable in relation to threat

50
Standard of Review
  • Under Unocal, Atlas board probably wins
  • Threat prong
  • Chancellor Allen Having heard the evidence, I
    am inclined to think Blasius plan was not a
    sound proposal.
  • Proportionality prong
  • Response blocks Blasius from taking control
    immediately, but leaves Blasius free to secure
    control at the next annual meeting.

51
But a New Standard Emerges
  • Allen rejects Unocal
  • A decision by the board for the primary
    purpose of preventing the effectiveness of a
    shareholder vote involves the question of who, as
    between the principal and the agent has authority
    with respect to a matter of internal corporate
    governance. This is not, in my opinion, a
    question that a court may leave to the agent
    finally to decide so long as he does so honestly
    and competently.
  • Board must carry the heavy burden of showing a
    compelling justification conduct that
    interferes with shareholder voting

52
Background Schnell v. Chris-Craft
  • In Blasius, the board did something that normally
    would be entirely permissible under Delaware law.
  • Allen cites Schnell v. Chris-Craft A Delaware
    court may invoke its equity powers to invalidate
    conduct permissible under the statute.
  • One instance in which a court will do so is where
    the board interferes with the shareholder vote
    for self-dealing reasons. Such actions
    purportedly are per se invalid.
  • Not Blasius. The board acted to preserve its own
    incumbency, to be sure. But it apparently did so
    for the purpose of defeating what it saw as a
    most unwise business plan put forward by Blasius.
  • But the board still could not prevent the
    shareholders from electing a majority of new
    directors.

53
Background Takeover Defenses and Proxy Contests
  • Shark repellents
  • Classified boards
  • Limit shareholder ability to act without a
    meeting through written consents
  • Limit shareholder ability to call a special
    meeting
  • Pills
  • Define the beneficial ownership provision of a
    poison pill broadly so that acquisition of voting
    rights by proxy triggers the pill
  • Create a control block
  • Issue shares to an ESOP
  • Stock repurchase or recapitalization that
    concentrates shares in management hands
  • Sell a large block to a single holder

54
Background Stroud v. Grace
  • Where board action in response to an unsolicited
    tender offer affects the shareholder franchise,
    Unocal does apply. But
  • Act that purposefully disenfranchises the
    shareholders is strongly suspect and requires
    a compelling justification.

55
Hilton v. ITT
  • Nevada 1997
  • Parties
  • Hilton (acquiror)
  • ITT (target)

56
Hilton Hotels v. ITT
  • ITT was founded in 1920 by Sosthenes Behn.
  • He began ITT to create a worldwide system of
    interconnected telephone lines by acquiring two
    small telephone companies in Puerto Rico and
    Cuba.
  • When Behn turned to the U.S. market, he felt
    inadequate to the task and stepped down. His
    successor was Harold Geneen.
  • Under Geneen, ITT quickly became one of the
    fastest growing corporations in the U.S.

57
Hilton Hotels v. ITT
  • ITT was a classic conglomerate
  • A company that has a number of subsidiaries in a
    number of unrelated markets. For example, ITT at
    one point owned a telephone system, a cruise
    line, and Wonder Bread
  • In the 1970s, conglomerates fell out of fashion
    and ITTs stock price dropped from 60 to 12
  • Geneen stepped down in 1977. His successors began
    a plan of divesting assets and reorganizing the
    company into more manageable segments.

58
Hilton Hotels v. ITT
  • By 1997, only three major lines of business were
    left
  • The hotel and casino business
  • Technical schools
  • Yellow pages publishing
  • Hilton wanted to buy ITT for its casinos and
    hotels, selling off the rest
  • ITT board adopts a restructuring plan to spin off
    the main lines of business into separate
    companies.

59
The Comprehensive Plan
  • ITT Destinations gets a classified board with
    three classes of directors each serving for three
    years
  • 80 shareholder vote required to remove directors
    w/o cause
  • 80 shareholder vote required to declassify board
  • Some fancy tax work created a tax liability of
    1.4 billion that would be triggered if Hilton
    acquired more than 50 of ITT stock, for which
    Hilton would bear 90 liability

60
Why not Just Classify the Board?
  • The Comprehensive Plan makes more sense under
    Delaware law than under Nevada law.
  • Under Nevada law, the board may amend the by-laws
    to create a classified board without shareholder
    approval.
  • Under DGCL 141(d), a by-law creating
    (post-incorporation) a classified board must be
    approved by the shareholders.
  • Probably wanted to make sure the 80
    supermajority vote requirements would stick.

61
Delaware in Nevada
  • Was court correct to apply Delaware law?
  • NRS 120 gives board sweeping authority full
    control over the corporation.
  • NRS 138 clearly rejects Revlon by allowing
    board to consider nonshareholder interests.
  • NRS 138 also broadly authorizes board
    resistance without Unocal safeguards.

62
Hilton Hotels v. ITT Holding
  • Applying the Unocal standard, the court
    determined that the sole threat to corporate
    policy and effectiveness was that of price
    inadequacyi.e., Hiltons 70 bid was allegedly
    too low.
  • Applying the proportionality prong of the Unocal
    standard the court determined that the
    installation of a classified board was
    preclusive.
  • The court further determined that the classified
    board disenfranchised ITTs shareholders without
    a compelling justification for doing so and,
    accordingly, violated Blasius.

63
Digression Revlon
  • Court declines to reach Hiltons Revlon argument.
    If it had, were Revlon duties applicable here?
  • (1) when a corporation initiates an active
    bidding process seeking to sell itself or to
    effect a business reorganization involving a
    clear break-up of the company
  • ITT had not initiated an active bidding process
    (query whether that process must involve a break
    up of the company).
  • (2) where, in response to a bidders offer, a
    target abandons its long-term strategy and seeks
    an alternative transaction involving the break-up
    of the company
  • ITT Destinations, representing over 90 of the
    pre-break up assets and the subject of ITTs
    principal remaining business strategy, remained
    intact.
  • (3) when approval of a transaction results in a
    sale or change of control.
  • None

64
Questions
  • Would a classified board be preclusive absent a
    restructuring program like the Comprehensive
    Plan?
  • Bidder could win two consecutive proxy contests
  • At least in theory
  • Would a classified board be preclusive if coupled
    with a (redeemable) poison pill?
  • Bidder could win two consecutive proxy contests
  • At least in theory
  • Although apparently no one has done so

65
Transaction Planning for Issuer Counsel
  • Adopt a staggered board.
  • But adopting a staggered board requires a charter
    amendment.
  • Institutional investors wont vote for one.
  • Put staggered board in charter before IPO.
  • Go public with poison pill?
  • No. Easy enough for board to adopt one when
    needed.

66
State Takeover Regulation
  • Began contemporaneously with the federal Williams
    Act
  • First generation were mainly disclosure
    statutes.
  • But also imposed procedural and substantive
    requirements creating substantial obstacles for
    takeover bidders.

67
Edgar v. Mite
  • U.S. Supreme Court (1982) struck down the
    Illinois Business Takeover Act.
  • Many separate opinions.
  • A majority of the court (per Justice White) was
    able to agree only one issuei.e., the Illinois
    Act was unconstitutional because the burden it
    placed on interstate commerce outweighed the
    local interests served by the statute.

68
Second Generation Statutes
  • In almost every case, state legislatures were
    only too happy to help protect important local
    business by adopting antitakeover laws.
  • Minor problem Mite didnt seem to leave very
    much room for state statutes to pass muster.

69
The Internal Affairs Doctrine
  • The MITE majority recognized that a state has a
    legitimate interest in regulating the internal
    affairs i.e., the corporate governance of
    corporations it incorporates.
  • Tender offers are not part of the internal
    affairs of a corporation
  • A tender offer is a third party transaction in
    which shareholders individually make a decision
    to transfer their shares to a third party.

70
Second Generation Statutes
  • To pass muster under Edgar v. Mite, states
    avoided directly regulating tender offers.
  • Rather, regulated things traditionally subject to
    state internal affairs rules
  • Shareholder voting rights.
  • Mergers.
  • And so on.
  • Legislation was limited to domestic corporations
    no unconstitutional extraterritorial effects.

71
Fair Price Statutes
  • Early second generation statutes modeled on shark
    repellents, especially the fair price provision.
  • Required that the bidder get shareholder approval
    of a back-end merger unless the bidder paid a
    fair priceas defined by statutein the merger or
    the deal was approved by supermajority vote.

72
Control Share Acquisition Statutes
  • State corporate statutes had long required
    shareholder approval of mergers, asset sales and
    the like.
  • So why not require shareholders to vote on tender
    offers?
  • Looked like an internal affair voting rights on
    control transactions, something state law again
    had long required.

73
Control Share Acquisition Statutes
  • Control share acquisition occurs when the bidder
    crosses some specified threshold level of stock
    ownership.
  • Usually, at least 20 of the outstanding shares.
  • The control share acquisition must be approved by
    a majority of the outstanding disinterested
    shares.
  • Disinterested shares being defined to exclude
    those already owned by the offeror or by target
    managers.
  • If the disinterested shareholders did not approve
    the acquisition, the shares purchased in the
    control share acquisition did not receive voting
    rights.

74
Control Share Acquisition Statutes
  • How could bidder minimize statutes effect?
  • Condition a tender offer on a favorable
    shareholder vote.
  • Is the bidder likely to succeed if the tender
    offer is structured this way?

75
Business Combination Statutes
  • Prohibits a target from engaging in any business
    combination, such as a merger or asset sale, with
    an interested shareholder of the target
    corporation for a set period of time following
    the date on which the interested shareholder
    achieved such status.
  • Freeze period varies, but three or five years is
    typical.
  • Following initial freeze period, business
    combination requires either a supermajority
    shareholder vote or specified fair price
    criteria.

76
Business Combination Statutes
  • An interested shareholder is typically defined
    as the beneficial owner, directly or indirectly,
    of more than a specified percentage (ranging
    between 10 and 20) of the outstanding shares of
    the target corporation.
  • Business combination is typically defined to
    include not only back-end mergers, but also a
    whole host of other transactions.

77
Miscellany
  • Statutes authorizing discriminatory poison pills.
  • Nonshareholder constituency statutes.

78
CTS v. Dynamics Corporation
  • Supreme Court 1987
  • Parties
  • CTS (target)
  • Dynamics (acquiror)
  • Indirect State of Indiana

79
CTS Corp. v. Dynamics Corp.
  • Supreme Court (1987) upheld Indianas control
    share acquisition statute.
  • Our focus is on preemption aspects.

80
CTS Corp. v. Dynamics Corp.
  • Majority purports to use same preemption standard
    as in Mite
  • Whether the state law stood as an obstacle to the
    accomplishment of the Congressional purpose
    underlying the Williams Act.
  • The basic purpose of the Williams Act was said to
    be protection of the independent shareholder from
    both the offeror and target management.

81
CTS Corp. v. Dynamics Corp.
  • Why did the majority think the statute was
    consistent with the Williams Act?
  • Majority held that the Indiana Act protects
    shareholders from the coercive aspects of certain
    tender offer tactics, especially an unfair or
    inadequate two-tier offer.

82
CTS Corp. v. Dynamics Corp.
  • In dissent, Justice White pointed out that the
    Act was intended to protect investors, as opposed
    to shareholders. Why is that distinction
    important?
  • Williams Act was primarily intended to protect
    individual investorsi.e., each individual
    investor should be free to make his or her own
    decision.
  • In contrast, the Indiana statute was designed to
    protect shareholders as a group.
  • By allowing a majority of the disinterested
    shareholders to frustrate the wishes of
    individual shareholders, the Indiana statute
    frustrated the Williams Acts purposes.

83
CTS Corp. v. Dynamics Corp.
  • MITE emphasized Congressional policy of
    neutralityi.e., the Williams Act was supposed to
    be neutral, favoring neither target nor bidder.
  • For the CTS majority, was neutrality a means or
    an end of the Williams Act?
  • A means.
  • The CTS majority apparently would uphold a
    statute that tips the balance in favor of
    management, as long as the statute mainly
    protects shareholders.

84
CTS Corp. v. Dynamics Corp.
  • At bottom, Justice Powell and Justice White
    appear to disagree as to the social desirability
    of takeovers.
  • As a matter of sound social policy, there are
    good arguments on both sides of the debate.
  • As a matter of constitutional law, does it matter
    which Justice is right about social policy?
  • Scalia a law can be both economic folly and
    constitutional.

85
Delaware Decides
  • Three days after the CTS decision, the Delaware
    Secretary of State asked the corporate law
    section of the state bar to decide whether or not
    Delaware should adopt takeover legislation and,
    if so, of what type.
  • Bill adopted was a considerably modified version
    of the older business combination statutes.

86
DGCL 203
  • A Delaware target may not engage in a business
    combination for a period of three years after an
    offeror becomes an interested stockholder.
  • Again, business combination is defined to include
    back-end mergers and comparable transactions.
  • Interested shareholder is defined, in part, as
    the owner of 15 or more of the targets
    outstanding shares.

87
DGCL 203 When is Three-year Freeze Period
Inapplicable?
  • Prior to the date on which the bidder crosses the
    15 threshold, the business combination or the
    triggering acquisition is approved by the
    targets board of directors OR
  • The bidder, in a single transaction, goes from
    less than 15 to more than 85 of the targets
    voting stock (not counting shares owned by inside
    directors or by employee stock plans in which the
    employees do not have the right to determine
    confidentially whether shares held by the plan
    will be tendered) OR
  • During the three year freeze period, the
    transaction is approved by the board of directors
    and by the two-thirds of the outstanding shares
    not owned by the bidder OR
  • The targets board of directors approves a white
    knight transaction.

88
DGCL 203
  • No restrictions once freeze period expires.
  • Fewer restrictions on bidders use of target
    assets to finance an acquisition in connection
    with older business combination statutes.
  • E.g., permits bidder to sell off target assets to
    third parties (subject to the usual fiduciary
    duty and voting rules).

89
DGCL 203 Constitutionality
  • BNS Inc. v. Koppers Co., Inc. interpreted CTS as
    meaning that neutrality between bidders and
    targets was no longer regarded as a purpose of
    the Williams Act in itself, but rather merely as
    a means towards the true congressional end of
    shareholder protection.
  • State statutes having a substantial deterrent
    effect are now permissible, as are statutes
    favoring management, so long as these effects are
    merely incidental to protecting shareholders.

90
DGCL 203 Constitutionality
  • States must preserve a meaningful opportunity
    for hostile offers to succeed.
  • Does the state law protect independent
    shareholders from coercion?
  • Does it give either side an advantage in
    consummating or defeating an offer?
  • Does it impose an unreasonable delay?
  • Does it permit a state official to substitute his
    views for those of the shareholders?

91
Contrast Amanda Acquisition
  • Upheld Wisconsin business combination statute.
  • Because it is not inconsistent with the Williams
    Act, applies only to Wisconsin corporations, and
    does not discriminate against interstate
    commerce.
  • Wisconsin need not allow mergers at all, and if
    it chooses to allow them only in limited
    circumstances, that does not make the statute
    unconstitutional or preempted.

92
Contrast Amanda Acquisition
  • Judge Easterbrook in Amanda reads CTS
  • The Williams Act is intended exclusively to
    regulate the process and terms of tender offers,
    while the states apparently remain wholly free to
    reconstruct the ground rules of corporate law in
    a fashion that makes hostile tender offers
    infeasible.
  • In other words, Judge Easterbrook holds that the
    Williams Act regulates the process by which
    tender offers take place.
  • Distinguishes state statutes that affect the
    tender offer process and state statutes that
    affect the outcome.

93
Nonshareholder Constituencies and Unocal
  • Under its first prong, Unocal permitted the board
    to consider
  • the impact of the bid on constituencies other
    than shareholders (i.e., creditors, customers,
    employees, and perhaps even the community).

94
What did Unocal Mean?
  • Assume a fairly priced, noncoercive offer.
  • Bidder announces plans to close plants and lay
    off numerous workers.
  • The targets board of directors reasonably
    concludes that the negative impact on its
    employees exceeds the gains shareholders will
    garner.
  • Did Unocal permit the board to turn down such an
    offer?

95
Revlon says NO!
  • Revlons provisos
  • Revlon expressly forbids management from
    protecting stakeholder interests at the expense
    of shareholder interests. Rather, any management
    action benefiting stakeholders must produce
    ancillary shareholder benefits.
  • Where the Revlon duties have triggered,
    shareholder wealth maximization is the boards
    only appropriate concern.

96
Nonshareholder Constituency Statutes
  • Thirty one states have adopted nonshareholder
    constituency statutes.
  • Authorize directors to consider nonshareholder
    interests when making corporate decisions,
    typically by amending the existing statutory
    statement of the directors duty of due care.

97
Nonshareholder Constituency Statutes
  • Thirty one states have adopted nonshareholder
    constituency statutes.
  • Typically provide that directors may consider the
    effects of a decision on a list of other
    constituency groups, such as employees,
    suppliers, customers, creditors, and the local
    communities in which the firm does business.

98
Intended to Displace Revlon
  • Despite some judicial holdings to the contrary,
    it seems clear that nonshareholder constituency
    statutes were intended to reject Revlons
    constraints on director decisionmaking.
  • Especially those statutes that expressly permit
    directors to consider the corporations long term
    interests even in takeover contestsimplicitly
    rejecting Revlons command that short term
    shareholder wealth maximization be the directors
    sole concern once a corporate control auction
    begins.

99
Judicial Scrutiny
  • Court should scrutinize closely managements
    arguments.
  • Require a convincing demonstration that no less
    restrictive defense is available.
  • Evidence as the specificity of managements
    plans, the record of the boards deliberations,
    and expert testimony from both sides.

100
Next Class March 23, 2009
  • March 23, 2009
  • Casebook pp. 863-901
  • Corporate Debt
  • March 30, 2009
  • REVIEW, PRACTICE EXAMINATION
  • April 6, 2009
  • Final Review
  • April 13, 2009
  • FINAL
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