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.

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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