Takeover defenses | Holger Spamann | August 17, 2013

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Takeover defenses

by Holger Spamann Show/Hide
  1. 1 Show/Hide More Unocal v. Mesa Petroleum (Del. 1985)
    Original Creator: Holger Spamann

    In this famous decision, the Delaware Supreme Court ruled that the board has the power to defend against hostile takeovers, even with discriminatory measures, and laid down the judicial standard of review for scrutinizing such defenses.

    The most important things to look for are thus:

    1. What is the threat that the board is defending against?
    2. Who is being protected?
    3. What is the standard of review? How does it relate to our two old friends: the business judgment rule and entire fairness? If it is different, why?


  2. 2 Show/Hide More Moran v. Household International (Del. 1985)
    Original Creator: Holger Spamann

    This decision approved the “rights plan” a/k/a “poison pill” invented by Martin Lipton. “Rights plan” may sound innocuous. But it completely transformed US takeover law and practice.

    The pill has only one goal: to deter the acquisition of a substantial block of shares by anyone not approved by the board. It does so by diluting, or rather threatening to dilute, the acquired block. If anyone “triggers” the pill by acquiring more than the threshold percentage of shares (usually 15%), the corporation issues additional shares to all other shareholders. The number of additional shares is generally chosen so as to reduce the acquirer’s stake by about half. Needless to say, that would be painful – arguably prohibitively painful – to any would-be acquirer.

    Question: How does the pill compare to DGCL 203 – what are their respective trigger conditions, and what are their consequences for the acquirer if triggered? (I recommend that you consult the simplified version of section 203 on simplifiedcodes.com. Note that section 203 was completely overhauled in 1988; the Moran opinion quotes the old version.)

    The pill ingeniously obscures this discriminatory mechanism in complicated warrants. The corporation declares a dividend of warrants to purchase additional stock or preferred stock. Initially, these warrants are neither tradeable nor exercisable. If anybody becomes an “acquiring person” by acquiring more than the threshold percentage, however, the warrants grant the right to buy corporate stock for prices below value. Of course, all shareholders will then rationally choose to exercise the warrant. So what is the point? The point is that by their terms, the warrants held by the acquiring person are automatically void.

    (The description of the pill in Moran may read slightly differently. The reason is that the industry standard pill has evolved since Moran. You can find a contemporary example here.)

    The pill is extraordinarily powerful. In the 30 years since Moran, only one bidder has dared triggering the pill, and that was one with a particularly low trigger of 5% (chosen to preserve a tax advantage). The exercise of the rights did not only dilute the acquirer but caused massive administrative problems (a lot of new stock had to be issued!), leading to a suspension of issuer stock from trading. The issuer, Selectica, also violated the listing rules. See here. What this shows is that the pill really is designed purely as a deterrent – it is intended never to be triggered. It’s MAD (Mutually Assured Destruction) intended to keep out the unwanted acquirer, nothing else.

    The upshot is that nowadays no Delaware corporation can be acquired unless the board agrees to sell. The pill has stopped not only hostile two-tier bids, but all hostile bids. To be sure, a would-be acquirer could attempt to replace a reluctant board through a proxy fight. But one proxy fight may not be enough, if and because the corporation has a staggered board in its charter (cf. Airgas below). In any event, the point is that board acquiescence is ultimately indispensable. The acceptance of the pill was thus a fundamental power shift from shareholders to boards in dealing with “hostile” offers (read: offers that the board doesn’t like).

    Perhaps understandably, the Moran court did not fully understand these implications. Or perhaps it didn’t want to? The SEC’s amicus brief certainly predicted as much. As it were, the Court gives mainly technical, statutory reasons for approving the pill. But as in Schnell, the Court could have brushed those aside since “[t]he answer to that contention, of course, is that inequitable action does not become permissible simply because it is legally possible.” Why didn’t it? Should it have?

  3. 3 Show/Hide More Revlon v. MacAndrews & Forbes (Del. 1986)
    Original Creator: Holger Spamann
    As you have just read, in 1985, Unocal and Moran approved boards’ use of powerful, discriminatory defensive tactics. You will now read Revlon, the 1986 decision that drew the line at playing favorites: if the board decides to sell or break up the company, then it can no longer defend selectively against some bidders but not others. Does this distinction make sense? Where would you draw the line?
  4. 5 Show/Hide More 3G / Burger King merger agreement: Section 6.02 ("go shop")
    In reading Revlon, did you wonder how the Burger King board discharged its duty of “getting the best price for the stockholders” in its acquisition by 3G? Section 6.02 tells you how. Such a “go shop” provision is now a standard feature in merger agreements with Delaware corporations.

    1. Do you think buyers like these provisions?
    2. What about sellers? (Hint: it may matter at what point in time you ask them.)
  5. 6 Show/Hide More Current US Debate (2016)
    Original Creator: Holger Spamann

    So where are we now?

    The Airgas excerpt below summarizes the current state of Delaware fiduciary law for takeover defenses. A board can maintain a poison pill for as long as it likes and for the mere reason that it believes the offer price to be inadequate. This means that the only way to overcome determined resistance by an incumbent board is to replace it in a proxy fight.

    Until recently, most large corporations’ charters did not permit replacing a majority of the board in a single annual meeting. Their boards were staggered, i.e., only a third of the directors were up for reelection each year (re-read DGCL 141(d), (k)(1)!). Consequently, an acquirer had to win proxy fights at two successive annual meetings to replace the majority of an intransigent board. This takes at a minimum one year and a couple months, and the acquirer would have had to keep the tender offer open (and capital tied up etc.) during that entire time. Hardly any challenger was willing to attempt this. Airgas is about one of the very few exceptions.

    In recent years, however, the incidence of staggered boards has declined precipitously among the largest U.S. corporations. By 2012, only a fourth of the corporations in the S&P 500 index had staggered boards. Between 2012 and 2014, most of these hold-outs “destaggered” as well. The impetus came from a law school clinic, the Shareholder Rights Project (SRP) based at Harvard Law School. Acting on behalf of several institutional shareholders, the SRP submitted precatory destaggering proposals (why not binding proposals?) for the corporations' annual meetings. Under rule 14a-8, the targeted corporations had to include these proposals on their proxies. Other shareholders generally supported these proposals, and most recipient corporations soon agreed to destagger. At the same time, staggered boards remain the norm in IPO charters — the charters of corporations selling their stock to the public for the first time.

    1. Most observers believe that staggered boards have important consequences for corporate governance and thus ultimately the value of these very large firms. In other words, hundreds of billions are at stake. Other shareholders generally supported destaggering. Why did it take a law school clinic to bring about this change?

    2. Why do institutional investors vote against staggered boards in established corporations but continue buying staggered IPO firms? Put differently, why do IPO charters still include staggered boards?

    Opinions are sharply divided about the desirability of takeover defenses in general, and of staggered boards in particular. Managers and their advisors argue that defenses allow boards to focus on long-term value creation rather than on catering to short-term pressures from the stock market. Opponents claim that defenses shield slack and prevent efficient reallocations of productive assets.

    3. The accountability argument for takeovers is easy to understand. What about the short-termism counterargument? Why would stock markets exert short-termist pressures on boards?

    4. Many are concerned that the rules on poison pills, as policed by Delaware courts, allow management and boards to entrench themselves against shareholder interest, but also believe that the pill can be a valuable tool in the hands of a well-motivated management and board. Distinguishing good and bad uses of the pill in a charter or bylaw provision is probably impossible. What other governance device might align use of the poison pill with shareholder interest?

    1. 6.1 Show/Hide More Airgas (Del. Ch. 2011)
      Original Creator: Holger Spamann
      Airgas (Del. Ch. 2011)
  6. 7 Show/Hide More The UK Approach
    Original Creator: Holger Spamann

    In global perspective, Delaware’s heavy reliance on fiduciary duties and judicial case-by-case scrutiny is an outlier. Some countries are more takeover friendly, others less. Almost all, however, are more rule-centric than Delaware.

    As a counterpoint to Delaware, the UK is particularly interesting. Like the U.S., the UK is a common law country with very developed financial markets and dispersed ownership of most large corporations. You might, therefore, expect UK takeover law to resemble Delaware’s. You would be quite wrong.

    Please read the following excerpts of the Takeover Code, the Companies Act 2006, and the FCA Disclosure Rules and Transparency Rules. Do these rules have analogues in Delaware law or U.S. federal securities law? In particular, consider the following:

    1. Would the poison pill be legal in the UK?
    2. Would other takeover defenses that we have encountered (think of the board actions in Unocal and Revlon) be legal in the UK?
    3. If not, what other rules, if any, protect UK shareholders?
    4. Who makes the rules?
    5. What is the role of the courts?
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August 17, 2013

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