As I explain in my book, Mergers and Acquisitions
Avoiding shareholder voting is the goal of most transaction planners most of the time. In the case of public corporations, the process of obtaining shareholder approval is cumbersome and expensive. Proxies must be solicited, which requires preparation of a proxy statement. Accountants must prepare financial statements and give an accounting opinion. Lawyers must prepare opinion letters on corporate, securities and tax law questions. The lawyers will also draft, or at least review, the proxy statement. The firm typically will hire a proxy solicitation firm to run the shareholder meeting and to solicit proxies. Senior corporate officers must expend time going over documents and gathering materials. And so on. As a result, the cost of the shareholder approval process easily can run well into seven figures. In a straight two party merger, approval by both company's boards and by both company's shareholders is required.
It is difficult to structure a transaction in a way that eliminates voting rights on the part of the target's shareholders. A short form merger will do the trick, but works only as to parent-subsidiary mergers in which the parent already owns 90% or more of the target's stock. A tender offer followed by a freeze-out merger to eliminate any remaining minority shareholders eliminates a meaningful target shareholder vote, but introduces fiduciary duty complications.
Avoiding acquiring company shareholder voting, however, is easy. In a purchase of all or substantially all of the target's assets, the acquiring company shareholders get no vote. In a triangular merger, as Mergers and Acquisitions
the acquiring corporation sets up a shell subsidiary. The shell is capitalized with the consideration to be paid to target shareholders in the acquisitionCsuch as cash or securities of the acquiring corporation. The shell is then merged with the target corporation. In a forward triangular merger, the shell is the surviving entity. In a reverse triangular merger, the target survives. The point is the same in either case. The target company ends up as a wholly owned subsidiary of the acquirer. The former target shareholders either become shareholders of the acquirer or are bought out for cash. In a triangular merger, nothing changes from the target's perspective. Exactly the same approval process must be followed. From the acquiring corporation's perspective, however, much has changed. Only shareholders of a constituent corporation are entitled to vote or to exercise appraisal rights. In a triangular transaction, the constituent parties are the target and the shell. As a result, the parent acquiring corporation is not a formal party to the transaction, and its shareholders are entitled neither to voting nor appraisal rights.
The one potential hitch comes when the acquiring company intends to use its own stock as consideration for the target shares. The state corporate law rules discussed above don't change. If the acquirer does not have enough authorized shares in its certificate of incorporation to effect the deal, it will need a shareholder vote to amend its articles of incorporation to authorize issuing new shares. Although that's technically not a vote on the merger, shareholders will be voting on the amendment will full knowledge that the amendment is necessary to effect the deal as structured. So it's a de facto referendum on the deal.
For NYSE-listed corporations, however, there is a further complication. A transaction that results in a 20-percent or more increase in the number of shares outstanding requires shareholder approval. This is so because NYSE Listing Standard 312.03 provides that:
(c) Shareholder approval is required prior to the issuance of common stock, or of securities convertible into or exercisable for common stock, in any transaction or series of related transactions if:
(1) the common stock has, or will have upon issuance, voting power equal to or in excess of 20 percent of the voting power outstanding before the issuance of such stock or of securities convertible into or exercisable for common stock; or
(2) the number of shares of common stock to be issued is, or will be upon issuance, equal to or in excess of 20 percent of the number of shares of common stock outstanding before the issuance of the common stock or of securities convertible into or exercisable for common stock.
In a merger, where stock is the consideration, and the requisite 20 percent threshold is met, the acquiring company shareholders thus get to vote on the issuance of the stock. technically, that's note a vote on the merger. But if they vote down the issuance, the deal is sometimes impossible.
Why is all of this newsworthy? In Kraft's forthcoming acquisition of Cadbury, Kraft will be using its own stock as the consideration. Famed investor Warren Buffet is Kraft's largest shareholder and opposes the deal. Buffet planned to vote against the issuance of stock that was an essential part of the deal. What were Kraft's options at that point?
Steven Davidoff explains that Kraft had a number of ways by which to end run the shareholder approval requirement:
In its recently concluded hostile offer for Terra Industries, CF Industries Holdings offered to issue preferred shares without voting power to avoid triggering this rule. Only after the Terra acquisition’s completion would CF then put to its shareholders the vote required by the N.Y.S.E. to let those preferred shares be converted into voting common shares. If the offer had been accepted, CF would then have been able to present the acquisition as a fait accompli when its shareholders cast this vote.
Companies can also avoid triggering the rule if “delay in securing stockholder approval would seriously jeopardize the financial viability of the enterprise.” Bear Stearns relied on this exception to issue shares with a 39.5 percent voting interest to JPMorgan Chase. Wachovia acted similarly in its sale to Wells Fargo.
In both cases, Bear and Wachovia were doing the N.Y.S.E. a favor by claiming this exemption, since they could have just as easily ignored it: the only penalty for violations is a delisting. So if companies have no requirements to maintain a listing – like debt covenants or other contractual obligations – and are willing to bear shareholder approbation, this is another possible, if extreme, alternative.
Of course, companies’ easiest way around the rule is to offer cash or less than 20 percent of their outstanding shares.
Initially, Kraft would have been caught up in Rule 312, since it proposed issuing an amount of shares above the 20 percent threshold. It therefore called a shareholder meeting and even circulated a proxy statement to obtain this approval. It was this solicitation that Berkshire Hathaway initially rejected.
Now, Kraft has taken the easy way out. It has simply reduced the amount of new stock in its bid to below the 20 percent level. Kraft could do this because of the rejuvenated debt markets and the availability of additional financing to replace stock. ...
Then there’s the option of making one company or other the acquirer to avoid a shareholder vote. The seminal example of this is the late-1980s merger of Time and Warner. In the face of a hostile takeover bid by Paramount in the middle of the merger, Time became the acquirer and paid enough cash to obviate the need for a shareholder vote. Time initiated this deal restructuring after the N.Y.S.E. rejected its request for a reprieve from the shareholder vote rules.
The deal led to a substantial destruction of Time shareholder value as the company borrowed billions of dollars to finance the deal and over-leveraged itself. Nevertheless, the acquisition passed muster in Delaware court.
Davidoff goes on to note the policy issues at stake:
As part-owner of Kraft, he deserves the right to reject the Cadbury acquisition. His case is enhanced by management’s tendency to overbid in the heat of a takeover contest. A shareholder vote can serve as an important check on management overreaching – though to be fair, shareholders can also make mistakes. After all, investors approved the AOL-Time Warner deal.
The response to the shareholder empowerment argument is that while Mr. Buffett is a shareholder, Kraft is run by a board of directors better situated to judge whether a major transaction is appropriate. So long as the deal does not significantly dilute Mr. Buffett’s holdings, he should defer to the directors’ judgment.
I come down firmly on the latter side. As I explain in Mergers and Acquisitions
Allocating the principal decisionmaking role to the board of directors reflects the general deference corporation law gives board decisions. It also makes good sense from a governance perspective. The board knows much more than its shareholders about the company’s business goals and opportunities. The board also knows more about the extent to which a proposed merger would promote accomplishment of those goals. The board is also a more manageable body. The familiar array of collective action problems that plague shareholder participation in corporate decisionmaking obviously preclude any meaningful role for shareholders in negotiating a merger agreement. Rational shareholders will expend the effort to make an informed decision only if the expected benefits of doing so outweigh its costs. Because merger proxy statements are especially long and complicated, there are unusually high opportunity costs entailed in attempting to make an informed decision. In contrast, shareholders probably do not expect to discover grounds for opposing the proposed transaction in the proxy statement. Frequently there are none, and even where grounds exist they will often be very difficult to discern from the proxy statement. Accordingly, shareholders can be expected to assign a relatively low value to the expected benefits of careful consideration. As a result, negotiated acquisitions are likely to be approved even where approval is not the decision an informed shareholder would reach.
