ProfessorBainbridge.com

Twitter and Stakeholder Capitalism

Liz Dunshee observes that Twitter's CEO "emphasized that the board had to act in the best interest of the shareholders, and determined this offer was the best they could do. ... In his “Money Stuff” column yesterday, Matt Levine highlighted how this is a weird thing to hear after so much emphasis on stakeholder capitalism the past several years." It is a fundamental; thesis of my forthcoming book "The Profit Motive" that when push comes to shove the shareholder value maximization norm still trumps stakeholder capitalism.

What is a Poison Pill? And Why do Corporations Use Them?

In April 2022, Elon Musk bought a ~9% stake in Twitter. In response, Twitter's board adopted a shareholder rights plan--more commonly known as a poison pill. In this video, I explain what a poison pill, how it works, and why companies use them. If you want even more information about the poison pill, my book Mergers and Acquisitions has an extended treatment. https://amzn.to/38Pkj06

Usha Rodrigues on the Problems with SPACs

Estimable securities law scholar Usha Rodrigues has posted an article coauthored with Mike Stegemoller on SPACs that focus on the problems inherent in the insider dominance of the vehicles:

Proponents have hailed special purpose acquisition companies (SPACs) as the democratization of capitalism. In a SPAC, a publicly traded shell corporation acquires a private target, thereby taking it public in a manner that circumvents the rigors of a traditional initial public offering (IPO). Known as the “poor man’s private equity,” SPACs have been touted for giving the masses an otherwise rare chance to invest in private companies, and thereby reap the high returns usually reserved for the wealthy. Our original hand-collected data tell a different story.

We focus on two harms that SPACs present. First, they are singularly illiquid investments—even when nominally public, SPACs are generally owned and traded by the very few. Second, SPACs evolved to eliminate meaningful shareholder voice on the acquisition of a private target, using instead a species of “empty voting,” meaning that any such vote had no economic impact. By rendering the shareholder vote a nullity, SPACs can now virtually guarantee that a target will go public. This laxity of process creates the risk that subpar firms will trade side by side with quality public companies, tarnishing the market as a whole.

We are the first to examine this absence of liquidity and shareholder power, both of which are products of SPACs’ domination by insiders. This Article’s original data on SPACs’ empty voting, delinquent public filings, and thin-to-nonexistent trading provide empirical evidence that a small group of insiders use SPACs to manipulate the merger process, free of traditional IPO safeguards. We conclude with a reform proposal to reunite shareholders’ economic interest with voting power. This potential reform addresses the concerns of liquidity and lack of selectivity, while also providing a viable alternative to the traditional IPO.

Rodrigues, Usha and Stegemoller, Michael A., SPACs: Insider IPOs (2021). Available at SSRN: https://ssrn.com/abstract=3906196 or http://dx.doi.org/10.2139/ssrn.3906196

Do State Antitakeover Provisions Matter?

Interesting new paper by Andrew Baker, Do State Antitakeover Provisions Matter? (January 2, 2022). Available at SSRN: https://ssrn.com/abstract=3998607 or http://dx.doi.org/10.2139/ssrn.3998607

A longstanding debate over the impact of state antitakeover provisions has emerged among scholars in law and finance. Corporate law practitioners and researchers argue that the second generation of antitakeover statutes were made redundant by the affirmation of rights plans, while empirical scholars have found wide-ranging impacts from their adoption when used as an exogenous shocks to managerial entrenchment. This paper subjects the standard approach used in the empirical literature to a series of straightforward sensitivity analyses, consistent with the present best practice in panel data analysis. Contrary to the majority of published research, there is scant evidence for a consistent and reliable impact of antitakeover statute adoption on common firm outcome measures. These findings are consistent with the legal argument that takeover statutes provide little additional takeover deterrence in the presence of a “shadow pill.”

The number crunching aspects of the paper are outside my wheelhouse, of course, but the result makes a certain amount of intuitive sense. Most second generation state antitakeover legislation was designed to deter the sort of hostile, junk bond funded, leveraged buyouts that got so much press back in the 1980s and early 1990s. (I discuss the three generations of takeover statutes at 463-82 of my book Mergers and Acquisitions; see also my articles Redirecting State Takeover Laws at Proxy Contests State Takeover and Tender Offer Regulations Post-Mite: The Maryland, Ohio, and Pennsylvania Attempts).

In contrast, the poison pill is effective against a wide range of takeover structures and is an effective negotiating device even in more or less friendly deals.

Today, of course, hostile LBOs are very rare. Indeed, for that matter, hostile takeover bids are rare. In 1988 there were about 160 hostile takeover bids; in 2019, there were about 15. Granted, there was a slight (very) uptick in 2020, but the longterm trend has been towards negotiated takeovers.

It would thus be surprising indeed if state takeover laws mattered all that much.

Having said that, of course, it is true that you see state takeover statutes representations and warranties in most acquisitions of public corporations. The target will typically represent that there is no state antitakeover statute applicable to the deal or, if there is such a statute potentially applicable, that the target has taken all necessary steps in order to ensure that the statute will not impact the deal. But these are uncontroversial boilerplate provisions.

Ordinary Course Covenants in M&A Deals

@fpileggi has a most helpful post re AB Stable VIII LLC v. MAPS Hotels and Resorts One LLC, Del. Supr., No. 71, 2021 (Dec. 8 2021), the new Delaware Supreme Court decision on material adverse effect clauses and ordinary course of business covenants. https://t.co/KUUNh48YhS

— Steve Bainbridge (@PrawfBainbridge) December 13, 2021

The Fourth Edition of Bainbridge's Mergers & Acquisitions (Concepts and Insights) is now out and ready to ship

The Fourth Edition of my Mergers and Acquisitions (Concepts and Insights) treatise arrived today. It's up to date and considerably expanded in coverage at almost 140 pages longer than the prior edition. Practitioners and students will find it useful.

 

The old chapter on mergers and sales of substantially all assets has been split into three chapters: Mergers and Asset Sales; The M&A Deal Process; M&A Contracts. These new chapters clock in at a total of 165 pages, compared to 64 in the old edition. The material on M&A Contracts is especially more detailed, with many more sample clauses and discussion of drafting alternatives.

 

Major new cases like MFW and Corwin get extended coverage, as do important statutory developments like DGCL 251(h).

Valuation of a Business in Legal Settings II: Discounted Dividend Methods

Valuation of a Business in Legal Settings I: Discounting to Present Value

Flannery v. Genomic Health, Inc.: The Delaware Chancery Court Gets the Geography of Revlon-Land Wrong. Again.

Via The Chancery Daily we learn of a recent Revlon decision by Vice Chancellor Slights that is quite striking. 

As I explained in my article, The Geography of Revlon-Land, 81 Fordham L. Rev. 3277 (2013), the Delaware Chancery Court has gone seriously awry in applying Revlon. 

The Delaware Supreme Court had explained that Revlon duties are triggered in three situations:

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 bidder’s 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 “[c]ontrol of both [companies] remain[s] in a large, fluid, changeable and changing market.

Arnold v. Soc’y for Sav. Bancorp, Inc., 650 A.2d 1270, 1289-90 (Del. 1994) (citations, footnotes, and internal quotation marks omitted). In a series of cases, the Delaware Chancery court invented a fourth trigger:

In transactions, such as the present one, that involve merger consideration that is a mix of cash and stock—the stock portion being stock of an acquirer whose shares are held in a large, fluid market—”[t]he [Delaware] Supreme Court has not set out a black line rule explaining what percentage of the consideration can be cash without triggering Revlon.”

In re NYMEX Shareholder Litig., 2009 WL 3206051 at *5 (Del. Ch. 2009).

In Flannery, VC Slights embraced the NYMEX line of cases clearly erroneous approach to all cash deals:

In an all-cash transaction, Revlon applies “because there is no tomorrow for the corporation’s present stockholders.” (59)

NYMEX and progeny were clearly inconsistent with Arnold. They posit that a mix of cash and stock triggers Revlon, but Arnold’s clear implication is that an acquisition by a publicly held corporation with no controlling shareholder that results in the combined corporate entity being owned by dispersed shareholders in the proverbial “large, fluid, changeable and changing market” does not trigger Revlon whether the deal is structured as all stock, all cash, or somewhere in the middle. The form of consideration is simply irrelevant.

The NYMEX line of cases evaded Arnold by misquoting it. VC Slights repeated this sleight of hand in quoting Arnold:

Revlon duties can be triggered in three ways:

(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 bidder’s 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. (37)

The observant reader will note that VC Slights (like the other Chancery Court decisions in the NYMEX line) thereby omitted the critical qualifier Arnold adds to checkpoint # 3. To emphasize the point, let us quote the pertinent part of Arnold again in full:

(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 [c]ontrol of both [companies] remain[s] in a large, fluid, changeable and changing market.

But what about cases involving mixed consideration? Again, the correct answer is that the form of consideration is simply irrelevant. Unfortunately, although VC Slights held that Revlon was not triggered on the facts of Flannery--where 58% of the consideration was stock and 42% was cash, he did not reject the erroneous view that mixed consideration cases do trigger Revlon when the ratio tilts sufficiently towards cash (specifically, it appears that 50% cash is the triggering line; see pp. 62-63).

The bottomline is that VC Slights perpetuates the basic error made by the Chancery Court, albeit tweaking it a bit by suggesting where the line is to be drawn in mixed consideration cases.

Having said that, would it have killed him to cite my article?

Recommended Reading: Carney & Sharfman on Judicial Appraisal (Let's Just Call the Whole Thing Off)

Important new article from Bill Carney and Keith Sharfman:

Abstract For many years, we and other commentators have observed the problem with allowing judges wide discretion to fashion appraisal awards to dissenting shareholders on the basis of widely divergent, expert valuation evidence submitted by the litigating parties. The results of this discretionary approach to valuation have been to make appraisal litigation less predictable and therefore more costly and likely. While this has been beneficial to professionals who profit from corporate valuation litigation, it has been harmful to shareholders, making deals costlier and less likely to complete.

In this Article, we propose to end the problem of discretionary judicial valuation by tracing the origins of the appraisal remedy and demonstrate that its true purpose has always been to protect the exit rights of minority shareholders when a cash exit is otherwise unavailable, and not to judge the value of the deal.

While such reform would be costly to valuation litigation professionals, their loss would be more than offset by the benefit of such reforms to shareholders involved in future corporate transactions. Shareholders presently have adequate protections, both from private arrangements and legal doctrines involving fiduciary duties.

Their "thesis is simple: Whenever a dissenter can exit for cash or its equivalent, there is no need for appraisal."

I concur. In 2010, I wrote: 

I see no useful purpose in the modern appraisal proceeding. As Thompson notes, it has become a vehicle for dealing with some--but not all--instances of majority shareholder oppression in connection with some--but not all--freezeout transactions. Better to abolish appraisal and let shareholders pursue a class action for damages.

At the end of a long 2012 post on valuation in appraisal, I threw up my hands in disgust and wrote:

this issue presents yet another area in which the law governing appraisal rights appears to be broken. Once again, the student comes away from the cases with the unavoidable impression that the Delaware courts are just sort of making this stuff up as they go along. Accordingly, one again comes to the conclusion that the best thing to do would be to toss out current law in its entirety and start over with a blank sheet of paper.

In 2019, referring to an earlier Carney and Sharfman article on appraisal, I wrote:

Do go read the whole thing. And then answer me this question: Why not just abolish appraisal?

AT&T Spin Off of Warner is the Latest Turn in the Sad Saga of Paramount Communications v. Time Inc.

In 1989, Time Inc. and Warner Communications, Inc., announced plans to merge. Before the deal could close, however, Paramount Communications, Inc., intervened with a cash tender offer for Time valued at $200 per share. Time responded by recasting the Warner deal as a tender offer and implemented various other efforts to ensure that Paramount would be unable to close its offer before Time could complete its offer for Warner. Since Paramount would be unable to raise funds to buy the combined Time-Warner entity, the restructured deal would put an end to Paramount's intervention.

When Paramount and Time shareholders challenged the restructured deal, Time's management justified its decision on grounds that pursuing the deal with Warner would in the long run produce higher returns to shareholders. As famed Delaware Chancellor William T Allen wrote:

In the longer term, Time's advisors have predicted trading ranges of $159-$247 for 1991, $230-$332 for 1992 and $208-$402 for 1993. ... The latter being a range that a Texan might feel at home on.

Paramount Commun. Inc. v. Time Inc., 1989 WL 79880, at *13 (Del. Ch. July 14, 1989), aff'd, 565 A.2d 281 (Del. 1989).

In a decision I still teach in my Mergers and Acquisitions class, the Delaware Supreme Court held that Time's management had not violated their fiduciary duties to Time's shareholders. Time was thus able to complete its merger with Warner.

Thus began a long and winding road, which the WSJ illustrated as follows:

All of which prompted me to post this tweet:

I wish some finance guru would answer the following question: If you were a #Time shareholder back in 1989 and had held through all the changes, would you be better off today than if they had taken the Paramount deal and you had invested your proceeds in a S&P500 index fund. https://t.co/dKpXSu9NWA

— Steve Bainbridge (@PrawfBainbridge) May 18, 2021

In response to which, a friend reminded me of a 2003 WSJ article observing that:

By now, even schoolchildren know of Time Warner's folly in merging with America Online. However, the story of shareholder value destroyed through acquisition starts much earlier, back in 1989 when shares in Henry Luce's empire, Time Inc., traded for around $100. That spring, Time tried to combine with Warner Communications in what M&A practitioners call a "merger of equals" -- neither party paying a premium for the other's shares. ...

The executives of Time Inc. got to keep their jobs but the shareholders didn't fare so well, particularly with the double whammy of the AOL combination. If you were a shareholder of Time back in 1989 and held your shares through various splits over the years, they would now be worth $113.76 each, about where they were trading more than 14 years ago and far below the Paramount offer. Meanwhile, if you'd just bought the stocks in the S&P 500 index, you would have almost tripled your money.

Meanwhile, I calculated that if you had taken the Paramount deal in 1989 and invested the $200 per share in the S&P 500, you'd have $5,182.69 today. I'd still love to know what those who held their Time shares all these years would have today. I'm betting it's a lot less than $5,000. 

You might think that I'd be critical of the Delaware Supreme Court decision that made all of this loss of value possible. And I am, but not for the reasons you might think. I think the Court reached the right result via hopelessly muddled thinking.

If you're interested, I refer you to my article Unocal at 20: Director Primacy in Corporate Takeovers. Delaware Journal of Corporate Law, Vol. 31, No. 3, pp. 769-862, 2006, available at SSRN: https://ssrn.com/abstract=946016 or my book Mergers and Acquisitions.

In the latter, I explain that:

Time’s defensive actions depended almost wholly on the combined entity’s great size. While the extent of the combined entity perhaps made it unlikely that a subsequent bidder would emerge to unwind the transaction, the possibility existed. The market for corporate control thus could exert some constraining influence on Time’s board, which reduced the likelihood that the board was acting for improper motives, especially in comparison to the defensive restructurings just described.

In addition, it’s critical to the outcome here that Time’s business strategy was motivated by a desire to advance legitimate corporate interests; it had not been cobbled together simply to justify takeover defenses. As a result, Paramount was essentially asking the court to enjoin Time’s board from continuing to operate the corporation’s business and affairs during the pendency of the takeover bid. The Delaware courts were properly reluctant to do so, as a hostile bidder has no right to expect the incumbent board of directors to stop an ongoing business strategy in mid-stream.

In sum, Time presented a highly unusual set of facts, which rebutted the inference that the board acted from improper motives and rendered the result—if not the reasoning—in that particular case relatively unobjectionable.

Recommended Reading: Robert Miller on "Pandemic Risk and the Interpretation of Exceptions in MAE Clauses"

Here at PB.com we dote on material adverse change clauses. We look forward immensely to the day we teach them in Mergers & Acquisitions. (We exaggerate only slightly.) We also admire greatly Robert Miller's corporate law scholarship. (We exaggerate not at all.) So we are delighted that they have joined forces:

In business combination transactions, Material Adverse Effect (MAE) clauses allocate risks to the target’s business that arise between signing and closing. The COVID-19 pandemic adversely affected many businesses and so led to a series of broken deals in which acquirers claimed they were entitled to terminate a pending merger agreement because the pandemic had had a material adverse effect on the target. MAE clauses typically allocate to the acquirer many systematic risks to the target’s business by removing them from the definition of “Material Adverse Effect” in broadly worded exceptions. A key issue in the MAE disputes arising from the pandemic has thus been whether one or more of these exceptions shifted the relevant risk to the acquirer. In some cases, the issue has been the relatively straightforward one of whether the pandemic should count as a “natural disaster” or “calamity” in an exception related to force majeure events. In other cases, however, the issues have been considerably more complicated. In particular, when the causal chain from the pandemic to the material adverse effect on the company passes through multiple events (e.g., from pandemic to governmental lock-down orders to a drop in demand for the company’s products or services to the material adverse effect), and when, further, some of these events fall into exceptions in the MAE definition but others do not, the ultimate allocation of the risk depends on how we should understand the relation between the exceptions and the base part of the definition and the interrelations among the exceptions themselves. Working from the assumption that the sophisticated commercial parties that enter into business combination transactions are rational profit-maximizers, this article presents a general theory of how exceptions from MAE definitions should be interpreted in order to produce an efficient (i.e., ex ante joint-surplus maximizing) agreement.

Miller, Robert T., Pandemic Risk and the Interpretation of Exceptions in MAE Clauses (March 9, 2021). Journal of Corporation Law 2021, Available at SSRN: https://ssrn.com/abstract=3826378

More on "May The Board Let The CEO Decide To Sell The Company?"

In response to a recent post of mine on the titular question, the invaluable Keith Paul Bishop explains:

As a question of agency law, I agree that a board could delegate to the CEO decisions as to when, whether and on what terms the corporation could be sold.  However, Section 300 of the California Corporations Code provides that the business and affairs of the corporation shall be managed and all corporate powers shall be exercised under the "ultimate direction of the board". Thus, it is possible that a court would conclude that a grant of unfettered discretion would constitute an abdication of the "ultimate direction of the board".

I agree. He goes on to review additional reasons that would be a very dubious idea as a matter of law.

 

What is the scope of a CEO's authority with respect to corporate mergers?

Over on Twitter my friend David Skeel posed an interesting question:

Helpful thread by @PrawfBainbridge on the NRA corporate authority issue. One question: I assume the Board that while the Board could auth the CEO to sign a merger agreement, it couldn't auth her to decide whether and when to propose a merger on behalf of the Bd? https://t.co/yBEccXGnrF

— David Skeel @ Penn (@daskeel) April 12, 2021

I discuss the general authority of corporate CEOs in my book Corporate Law (Concepts and Insights). In it, I observe that:

Corporate employees, especially officers, are agents of the corporation.[1] As such, they can have authority or apparent authority. Actual authority exists when the agent reasonably believes the principal has consented to a particular course of conduct.[2]

Actual authority can be express, as where the principal instructs the agent to “sell Whiteacre on my behalf.” In the corporate context, express actual authority is usually vested in officers by a resolution of the board and/or a description of the officer’s duties set forth in the bylaws.[3] Actual authority can also be implied, however, if the principal’s acts or conduct are such the agent can reasonably infer the requisite consent.

Apparent authority exists where words or conduct of the principal lead the third party to reasonably believe that the agent has authority to make the contract.[4] Of particular importance with respect to the authority of corporate officers is the concept of apparent authority implied by custom. If it is customary for officers holding the position in question to have authority to make the contract in question, it would be reasonable for a third party to believe this officer has that authority.

Most of the case law on the apparent authority of corporate officers relates to the powers of presidents. Corporate presidents are regarded as general agents of the corporation vested with considerable managerial powers. Accordingly, contracts that are executed by the president on the corporation’s behalf and arise out of the ordinary course of business matters are binding on the corporation.^[5]

An important line of cases limits the implied actual and the apparent authority of corporate officers—of whatever rank—to matters arising in the ordinary course of business.^[6]

There is no bright line between ordinary and extraordinary acts. It seems reasonable to assume, however, that acts consigned by statute to the board of directors will be deemed extraordinary.[7] The Model Business Corporation Act provides that the following decisions may not be delegated to a committee of the board, but rather must be made by the board as a whole: (1) Authorize dividends or other distributions, except according to a formula or method, or within limits, prescribed by the board of directors. (2) Approve or propose to shareholders action that the statute requires be approved by shareholders. (3) Fill vacancies on the board of directors or, in general, on any of its committees. (4) Adopt, amend, or repeal bylaws.[8] DGCL § 141(c) is similar. Certainly, if those decisions may not be delegated to a board committee they may not be delegated to officers.

This is critical for our purposes, because approval of a merger requires approval by both the board of directors and the shareholders. Hence, it seems clear a CEO would lack both implied actual and apparent authority to bind the corporation to a merger.

Obviously, however, the board of directors could delegate substantial authority with respect to a merger to a CEO and thereby vest the CEO with express actual authority. The board doubtless can (and usually does) authorize the CEO to hire legal and financial advisors, negotiate with potential merger partners, and negotiate the terms of the merger agreement.[9] The board also could authorize the CEO to explore alternative transactions.[10] Once the board of directors has approved the agreement and plan of merger, the board doubtless could (and usually does) delegate authority to the CEO to sign the merger agreement on the corporation’s behalf.[11]

Could the board thus authorize the CEO to decide whether and when to contact a potential target or buyer? I think this would be valid. It differs in degree but not in kind from the things we know a CEO can be given actual authority to do. While I haven’t found a case on point, I note that in the famous Trans Union case, CEO Van Gorkom initiated the sale of the company without first getting any authorization from the board to do so and, while that may have been unwise, the court did not use that fact to invalidate the deal.[12]

Some thoughts on advising an acquiring company's board of directors in acquisition transactions

I was recently asked by a reporter to discuss the lawyers role in advising an acquiring company's board of directors in acquisition transactions. The conversation induced me to add a section on the topic to the forthcoming fourth edition of my Mergers and Acquisitions treatise. Herewith some thoughts derived therefrom:

Many corporate acquisitions turn out badly for the acquirer and its shareholders. A 1989 study concluded that although target shareholders experienced positive returns from takeovers, “since 1975, takeover bidders have earned at best a zero, and perhaps a slightly negative, net-of-market return.”[1] More recent studies confirm that acquirer shareholders frequently experience significant losses.[2] Many acquirers either overpay or botch the post-acquisition process of integrating the two companies.

Despite the substantial risk that acquiring company management and directors will make poor acquisition decisions, there is a critical difference between the liability risk exposure of a target and an acquirer board in acquisitions. As Judge Henry Friendly observed, “a merger in which it is bought out is the most important event that can occur in a small corporation's life, to wit, its death.”[3] Although the target board thus faces a classic final period problem, the acquirer’s board remains in a repeat relationship with its shareholders. As a result, any conflict of interest on the part of the acquiring company’s managers and boards is tempered by market forces. Not surprisingly, acquiring company directors are rarely sued and face a very low risk of liability.[4]

Acquiring company shareholders face two significant hurdles in challenging a board decision to approve an acquisition. First, cases brought against acquirer boards typically must be brought as derivative suits.[5] The procedural rules governing derivative litigation impose substantial obstacles for shareholder plaintiffs.[6] Second, assuming that the case reaches the merits, the shareholder plaintiff typically must overcome the business judgment rule.[7]

            Ideally, despite their resulting low liability risk, the acquiring board should nevertheless be actively engaged in making important acquisition decisions and, perhaps even more importantly, supervising post-acquisition integration of the two firms. In particular, the acquirer’s board should seek advice from outside legal and financial advisors. Just as with a target board, the acquiring company’s best defense is evidence that they made an informed decision.