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Material Adverse Change Clauses under UK Law

Interesting post from Narine Lalafaryan on the uncertain state of MAC clauses under UK law.

Delaware Chancery Court Provides Guidance on Breach of Efforts Covenants in M&A Agreements

The failed merger between Anthem and Cigna led to a ton of litigation in both federal and Delaware courts. As the saga winds towards its conclusion, there remained a suit in which both sides are suing the other for breaching covenants requiring each "to take all reasonable steps to consummate the Merger (the “Reasonable Best Efforts Covenant”) and to take “any and all actions” necessary to avoid impediments to the Merger from government entities (the “Regulatory Efforts Covenant”)."

The Delaware Business Litigation Report has a lengthy post on the case, describing the complex background and the issues involved. They key finding is that:

Cigna breached the Efforts Covenants, the Court held that the burden then shifted to Cigna to prove that, even if Cigna had met its obligations under the Efforts Covenants, a condition to closing – the No Injunction Condition—still would have failed. The Court ruled that Cigna had proved, in part based on the opinions of two of its experts, that the District Court would have concluded, and the Circuit Court would have affirmed, that the effect of the Merger on the market for the sale of commercial insurance to national accounts violated the anti-trust laws regardless of Cigna’s breaches and thus would have enjoined the Merger. The Court held, therefore, that Cigna had proved that it was more likely than not, that Cigna’s breaches of the Efforts Covenants would not have affected those courts acting to enjoin the Merger. For that reason, the Court held that, notwithstanding Anthem’s proof of Cigna’s violations of the Efforts Covenants, Anthem was entitled to no damages.

I plan to put this case aside for discussion in the next edition of my M&A casebook and treatise.

Does Van Gorkom's requirement of an informed decision survive Corwin? I'm stumped.

Assume the following:

1. The board of directors is approached by a private equity fund-backed management buyout group.
2. The board approves the transaction but, in doing so, was grossly negligent in failing to inform themselves of all information reasonably available to them.
3. The board then puts the proposal to a vote of the shareholders. The shareholder vote is uncoerced. The proposal is approved by a substantial majority of the disinterested shareholders.
   1. But the proxy statement did not disclose that the directors had been grossly negligent in failing to inform themselves of all information reasonably available to them.
4. Has the shareholder vote satisfied Corwin?
   1. See Stroud v. Grace, 606 A.2d 75, 84 n.1 (Del. 1992) ("We recognize the long-standing principle that to comport with its fiduciary duty to disclose all relevant material facts, a board is not required to engage in “self-flagellation” and draw legal conclusions implicating itself in a breach of fiduciary duty from surrounding facts and circumstances prior to a formal adjudication of the matter. Nonetheless, when a board allegedly breaches its fiduciary duties, we will not uphold shareholder ratification unless the board discloses all material facts relevant to the issue at hand.").

Assuming Corwin applies, is there any room left for rebutting the business judgment rule by showing that the directors failed to satisfy the informed decision requirement laid out by Van Gorkom? Or is that requirement a dead letter?

On the basis of Leo Strine's decision in Singh v. Attenborough, 137 A.3d 151 (Del. 2016), I think the answer to the former is no:

We affirm the judgment of the Court of Chancery solely on the basis of its decision on reargument of October 29, 2015, finding that a fully informed, uncoerced vote of the disinterested stockholders invoked the business judgment rule standard of review. But, we note that the reargument opinion's decision to consider post-closing whether the plaintiffs stated a claim for the breach of the duty of care after invoking the business judgment rule was erroneous. Absent a stockholder vote and absent an exculpatory charter provision, the damages liability standard for an independent director or other disinterested fiduciary for breach of the duty of care is gross negligence, even if the transaction was a change-of-control transaction.Therefore, employing this same standard after an informed, uncoerced vote of the disinterested stockholders would give no standard-of-review-shifting effect to the vote. When the business judgment rule standard of review is invoked because of a vote, dismissal is typically the result. That is because the vestigial waste exception has long had little real-world relevance, because it has been understood that stockholders would be unlikely to approve a transaction that is wasteful.

On the other hand, I take it that Robert Miller disagrees:

Even after Corwin, in the absence of a Section 102(b)(7) provision in the corporate charter, a plaintiff-stockholder may argue post-closing that the stockholder vote was not fully informed, and if the plaintiff succeeds on this score, the directors would be liable in monetary damages for any breaches of their duty of care, including under Revlon. In the presence of a Section 102(b)(7) provision, the plaintiff-stockholder has to argue that any material misstatement or omission in the disclosure resulted from a breach of the board's duty of loyalty--a claim that, in a third-party transaction in which the directors were not otherwise interested--is very unlikely to succeed. See Larkin v. Shah, C.A. No. 10918-VCS, 2016 WL 4485447, at *20 (Del. Ch. Aug. 25, 2016). The upshot is that, even after Corwin, Section 102(b)(7) remains very important in insulating directors from post-closing actions for damages in merger cases.

Robert T. Miller, Smith v. Van Gorkom and the Kobayashi Maru: The Place of the Trans Union Case in the Development of Delaware Corporate Law, 9 Wm. & Mary Bus. L. Rev. 65, 219 n.676 (2017). But note that his article pre-dated Singh.

I welcome comments, but prefer not to get speculation. Cites preferred.

Update: We got a great response from Robert Miller. Here.

Were Easterbrook and Fischel right that target company boards should remain passive in the face of a hostile takeover bid? A comment on Sharfman and Moore. Part 4

In Part I of this essay, I discussed a new article by Bernard Sharfman and Marc Moore, in which they propose reviving the passivity thesis, which argued that target boards faced with a hostile takeover offer should be passive.

In Part II of this essay, I discussed my article, Unocal at 20: Director Primacy in Corporate Takeovers,[1] in which I explained why I disagree with the passivity thesis. My analysis grew directly out of my director primacy model of corporate governance. Because I still think a board-centric approach to corporate governance is appropriate, even in the context of a hostile takeover bid, let me summarize my argument here. I encourage you to go read the whole thing, however.

In Part III, I discussed the final and perhaps most important argument for treating negotiated and hostile acquisitions differently with respect to the scope of the target board’s authority, which rests on the conflicted interests inherent in corporate takeovers.

In this Part, I defend Delaware's approach to takeovers against one aspect of Sharfman & Moore's passivity thesis.

In their discussion of the UK system, which adopts a variant of the passivity thesis, and which they support, Sharfman and Moore point out that (at 32):

Notably, the board passivity rule is an effect- rather than intention-based doctrine, which enables the United Kingdom’s non-judicial Takeover Panel to enforce the rule against target directors and other relevant parties in an administratively straightforward manner, unencumbered by the vexing questions of factual inference and fiduciary duty conformance that typically confront U.S. trial and chancery courts.

In contrast, I think Delaware’s motive-based analysis gets it exactly right.

In its takeover jurisprudence, Delaware has balanced the competing claims of authority and accountability by varying the standard of review according to the likelihood that the actions of the board or managers will be tainted by conflicted interests in a particular transactional setting and the likelihood that nonlegal forces can effectively constrain those conflicted interests in that setting. In other words, the Delaware cases suggest that motive is the key issue. As former Delaware Chancellor Allen explained in the closely related context of management buyout transactions: “The court’s own implicit evaluation of the integrity of the . . . process marks that process as deserving respect or condemns it to be ignored.” Assuming that a special committee of independent directors would be appointed to consider the proposed transaction, Allen went on to explain: “When a special committee’s process is perceived as reflecting a good faith, informed attempt  to approximate aggressive, arms-length bargaining, it will be accorded substantial importance by the court. When, on the other hand, it appears as artifice, ruse or charade, or when the board unduly limits the committee or when the committee fails to correctly perceive its mission—then one can expect that its decision will be accorded no respect.”[1] Our claim is the same is true with respect to board resistance to unsolicited tender offers. If the conflict of interest inherent in such resistance has matured into actual self-dealing, the court will invalidate the defensive tactics. If the board acted from proper motives, even if mistakenly, however, the court will leave the defenses in place.

Former Delaware supreme court Justice Moore argued, for example, that his court’s “decisions represent a case-by-case analysis of some difficult and compelling problems.”[2] He later elaborated:

We did not approach [takeover] cases with the question of whether to allow the corporation to continue in its present form or to permit someone else to acquire the company. . . . [T]he question before the Court was whether the directors acted properly in accepting or rejecting the competing offers. . . . As long as the directors adhered to their fiduciary duties, it would have been most inappropriate for any court to intrude upon a board’s business decision. No court has a role in disciplining directors for the proper exercise of business judgment, even if it turns out to be wrong.[3]

Former Delaware Chancellor Allen made much the same point in RJR Nabisco, where he indicated that the basic question is whether the board acted with due care and in good faith:

Surely the board may not use its power to exercise judgment in [an auction of control] as a sham or pretext to prefer one bidder for inappropriate reasons. . . . But the board of directors continues, in the auction setting as in others, to bear the burden imposed and exercise the power conferred by Section 141(a). Assuming it does exercise a business judgment, in good faith and advisedly, concerning the management of the auction process, it has, in my opinion, satisfied its duty.[4]

A federal court similarly described the Unocal standard as asking “whether a fully informed, wholly disinterested, reasonably courageous director would dissent from the board’s act in any material part.”[5]Motive is the consistent theme throughout these summations of Delaware law.

In light of Sharfman and Moore’s description of Delaware law as not being administratively straightforward and being encumbered by vexing questions, they presumably would agree with those who argue that the difficulty of distinguishing between proper and improper motives is so great in this context that courts should simply eschew a motive-based analysis.

Granted, motive analysis is always difficult, but in every other conflicted interest context the board’s authority to act depends upon the validity of the directors’ mo­tives.[6] Unless we are to accept the passivity model and strip the board of decision-making authority in the takeover context, a motive-based inquiry is inescapable.[7]

The Delaware Supreme Court’s leading decision in Paramount Communications Inc. v. QVC Network Inc.,[8]explained that the enhanced scrutiny test Delaware courts use to review takeover defenses is basically a reasonableness inquiry to be applied on a case-by-case basis: “The key features of an enhanced scrutiny test are: (a) a judicial determination regarding the adequacy of the decision-making process employed by the directors, including the information on which the directors based their decision; and (b) a judicial examination of the reasonableness of the directors’ action in light of the circumstances then existing.” The burden of proof is on the directors with respect to both issues. They need not prove that they made the right decision, but merely that their decision fell within the range of reasonableness.

The new reasonableness standard is a logical culmination of our argument that motive is what counts. While a cynic might argue that it is merely a way of justifying a particular result, the reasonableness test in fact is well-calibrated to preventing improper motives from skewing the competition for control. Notice that the reasonableness test parallels the definition of fairness used in the former Revised Model Business Corporation Act provisions governing interested director transactions, namely, whether the transaction in question falls “within the range that might have been entered into an arms-length by disinterested persons.”[9] Both standards seem designed to ferret out board actions motivated by conflicted interests by contrasting the decision at hand to some objective standard. The implicit assumption is that a reasonable decision is unlikely to be motivated by conflicted interest or, at least, that improper motives are irrelevant so long as the resulting decision falls within a range of reasonable outcomes. The operating norm seems to be “no harm, no foul,” which seems sensible enough.

QVC, moreover, strongly indicated that a court should not second-guess a board decision that falls within the range of reasonableness, “even though it might have decided otherwise or subsequent events may have cast doubt on the board’s determination.” In Interco, Chancellor Allen had warned that “Delaware courts have employed the Unocal precedent cautiously. . . . The danger that it poses is, of course, that courts—in exercising some element of substantive judgment—will too readily seek to assert the primacy of their own view on a question upon which reasonable, completely disinterested minds might differ.”[10] QVC made clear that, so long as the board’s conduct falls within the bounds of reasonableness, Delaware courts will not second-guess the board’s decisions.

If that point was insufficiently clear after QVC, it was driven home in unmistakable terms by the Delaware supreme court’s subsequent decision in Unitrin v. American General Corp., in which the court approved an everything but the kitchen sink array of defensive tactics.[11] Unitrin’s board adopted a poison pill, amended the bylaws to add some shark repellent features, and initiated a defensive stock repurchase. The chancery court found the latter “unnecessary” in light of the poison pill. The supreme court reversed. The court deemed “draconian” defenses—those which are “coercive or preclusive”—to be invalid. (Note the parallel to our discussion of the post-Time status of the just say no defense.) Defenses that are not preclusive or coercive are to be reviewed under QVC’s “range of reasonableness” standard. On the facts before it, the court concluded that the shareholders were not foreclosed from receiving a control premium in the future and that a change of control was still possible. Accordingly, the defensive tactics were neither coercive nor preclusive. More important, the supreme court held that the chancery court had “erred by substituting its judgment” for that of the board. The court explained:

The ratio decidendi for the “range of reasonableness” standard is a need of the board of directors for latitude in discharging its fiduciary duties to the corporation and its shareholders when defending against perceived threats. The concomitant requirement is for judicial restraint. Consequently, if the board of directors’ defensive response is not draconian (preclusive or coercive) and is within a “range of reasonableness,” a court must not substitute its judgment for the board’s.

Note, once again, how the balance tips towards authority values even in a context charged with conflicts of interest. Given the significant conflicts of interest posed by takeovers, courts recognize the need for some review. But the Delaware courts also seemingly recognize that their power of review easily could become the power to decide. To avoid that unhappy result, they are exercising appropriate caution in applying the range of reasonableness standard.

In sum, the search for conflicted interests reflects the Delaware courts’ solution to the irreconcilable tension between authority and accountability. Concern for accountability drives the courts’ expectation that the board will function as a separate institution independent from and superior to the firm’s managers. The court will inquire closely into the role actually played by the board, especially the outside directors, the extent to which they were supplied with all relevant information and independent advisors, and the extent to which they were insulated from management influence. Only if the directors had the ultimate decisionmaking authority, rather than incumbent management, will the board’s conduct pass muster. But if it does, respect for authority values will require the court to defer to the board’s substantive decisions. The board has legitimate authority in the takeover context, just as it has in proxy contests and a host of other decisions that nominally appear to belong to the shareholders. Nor can the board’s authority be restricted in this context without impinging on the board’s authority elsewhere. Authority thus cannot be avoided anymore than can accountability; the task is to come up with a reasonable balance. Properly interpreted, that is precisely what the Delaware cases have done.

Reminder: If you want much more detail, be sure to check out my article Unocal at 20: Director Primacy in Corporate Takeovers, 31 DEL. J. CORP. L. 769 (2006), on which the posts have drawn.

Were Easterbrook and Fischel right that target company boards should remain passive in the face of a hostile takeover bid? A comment on Sharfman and Moore. Part 3

In Part I of this essay, I discussed a new article by Bernard Sharfman and Marc Moore, in which they propose reviving the passivity thesis, which argued that target boards faced with a hostile takeover offer should be passive.

In Part II of this essay, I discussed my article, Unocal at 20: Director Primacy in Corporate Takeovers,[1] in which I explained why I disagree with the passivity thesis. My analysis grew directly out of my director primacy model of corporate governance. Because I still think a board-centric approach to corporate governance is appropriate, even in the context of a hostile takeover bid, let me summarize my argument here. I encourage you to go read the whole thing, however.

In this Part, I discuss the final and perhaps most important argument for treating negotiated and hostile acquisitions differently with respect to the scope of the target board’s authority, which rests on the conflicted interests inherent in corporate takeovers.

The conflicted interest argument

Put in my director primacy terminology, the conflicted interest argument is that accountability concerns are so severe in this context that they must trump authority values. Unsolicited tender offers implicate accountability concerns in at least two ways, which might be referred to respectively as transactional and systemic. The former relates to the effect of a hostile takeover on the target in question, while the latter relates to the effect resistance to hostile takeovers can have on public corporations as a whole. Neither justifies wholly barring authority values from playing a part in developing the governing legal rules.

Transactional accountability. As with business judgment rule scholarship generally, a failing of the academic literature on takeovers is the almost universal tendency to conflate the roles of corporate officers and directors. The legal literature speaks of “management resistance” and “management defensive tactics,” rarely recognizing any separate institutional role for the board. Most commentators simply assume that even independent directors are in thrall to senior managers and will ignore shareholder interests if necessary to preserve their patrons’ jobs.[2]

In contrast, the Delaware courts take the board’s distinct role quite seriously, especially with respect to its independent members. As a doctrinal matter, the board’s burden of proof is more easily carried if the key decisions are made by independent directors.[3] As a practical matter, the court’s assessment of the outside directors’ role often is outcome-determinative.[4]

Why have the Delaware courts insisted on drawing such sharp distinctions between the board’s role and that of management? Because while the conflict of interest unsolicited tender offers pose for the target company’s managers is inescapable, the independent director’s conflict of interest is merely a potential problem. For the independent directors, the conflicts posed by unsolicited tender offers are no different than those posed by freezeout mergers, manage­ment buyouts, interested director transactions, or a host of similar situations. Corporate law neither prohibits these transactions, nor requires complete board passivity in connection with them, simply because they potentially involve conflicts of interest. Instead, it regulates them in ways designed to constrain self-interested behavior. Unless one makes a living on the buy-side of corporate takeovers, it is not clear why hostile takeovers should be treated differently.

Consider, for example, the somewhat analogous case of management-sponsored leveraged buyouts. Like unsolicited tender offers, these transactions inherently involve a strong risk of management self-dealing. While management is acting as the sellers’ agents and, in that capacity, is obliged to get the best price it can for the shareholders, it is also acting as a purchaser and, in that capacity, has a strong self-interest to pay the lowest possible price. Like unsolicited tender offers, management buyouts also create conflicts of interest for the independent directors. Just as an independent director may resist an unsolicited tender offer to avoid being fired by the hostile bidder, he may go along with a management buyout in order to avoid being fired by the incumbent managers. Alternatively, if an independent director is inclined to resist a hostile takeover because of his friendship with the insiders, why should he not go along with a management-sponsored buyout for the same reason? Strikingly, however, the empirical evidence indicates that shareholder premiums are essentially identical in management-sponsored leveraged buyouts and arms-length leveraged buyouts.[5] This evidence suggests that the potentially conflicted interests of independent directors are not affecting their ability to successfully constrain management misconduct. Accordingly, while judicial review of management buyouts tends to be rather intensive, courts have not prohibited such transactions, but have addressed the problem of conflicted interests by encouraging an active role for the firm’s independent directors in approving a management buyout proposal.[6] Why should the same not be true of the board’s response to unsolicited tender offers?

In sum, the conflict of interest present when the board responds to an unsolicited tender offers thus differs only in degree, not kind, from any other corporate conflict. Although skepticism about their motives is thus appropriate, their conflict of interest does not necessarily equate to blameworthiness. Rather, it is simply a state of affairs inherently created by the necessity of conferring authority in the board of directors to act on behalf of the shareholders. To be sure, proponents of the no resistance rule will respond that such a state of affairs could be avoided by declining to confer such authority on the board in this context. Yet, if the legal system deprives the board of authority here, it will be hard-pressed to decline to do so with respect to other conflict transactions. As has been the case with other situations of potential conflict, we therefore would expect the courts to develop standards of review for takeover defenses that are designed to detect, punish, and deter self-interested behavior. Because the risk may be greater in this context, stricter than normal policing mechanisms may be required, but this does not mean that we must set aside authority values by divesting the board of decisionmaking authority.

Systemic accountability. Because the incumbent directors and management’s transactional conflict of interest is neither so severe nor unusual as to justify a wholly new governance system for tender offers, opponents of target resistance to tender offers must find some other basis for depriving the board of its normal decisionmaking authority. For most critics of takeover defenses, such a basis is to be found in the systemic agency cost effects of management resistance. Sharfman and Moore, for example, make this point at pp. 22-23.

In agency cost theory, disciplinary actions against employees and mid-level managers are expected to take the form of dismissals, demotions, or salary adjustments imposed by senior management. Where it is senior management that requires discipline, however, alternative mechanisms become necessary. According to the standard academic account, hostile takeover bidders provide just such a mechanism. Making the standard efficient capital market assumption that poor corporate performance will be reflected in the corporation’s stock price, opponents of target resistance claim that a declining market price sends a signal to prospective bidders that there are gains to be had by acquiring the corporation and displacing the incumbent directors and managers. Of course, the signal will not always be correct. Sometimes the firm’s market price may be declining despite the best efforts of competent management, as where some exogenous shock—such as technological change or new government regulation—has permanently altered the corporation’s fundamentals. If close examination by a prospective bidder reveals that the declining market price is in fact attributable to shirking by senior management, however, a disciplinary takeover could produce real gains for division between the target’s shareholders and the successful acquirer. This prospect creates positive incentives for potential bidders to investigate when the market signals a firm is in distress. Conversely, because keeping the stock price up is the best defense managers have against being displaced by an outside searcher, the market for corporate control—more specifically, the unsolicited tender offer—is an important mechanism for prevent­ing manage­ment slacking. Indeed, some would argue, the market for control is the ultimate monitor that makes the modern business corpora­tion feasible.

By making possible target resistance to unsolicited takeover bids, so the theory goes, takeover defenses thus undermine the very foundations of corporate governance. The first prospective bidder to identify a prospective target incurs significant search costs, which become part of the bidder’s overall profit calculation. By announcing its offer, however, the first bidder identifies the prospective target to all other potential bidders. Subsequent bidders thus need not incur the high search costs carried by the first bidder, perhaps allowing them to pay a higher price than is possible for the first bidder. If target resistance delays closing of the offer, subsequent bidders have a greater opportunity to enter the fray. At the very least, target resistance may force the initial bidder to raise its offer, reducing the gains to search. Target resistance therefore reduces bidders’ incentives to search out takeover targets. Reductions in bidders’ search incentives results in fewer opportuni­ties for shareholders to profit from takeover premia. More important, a reduction in search incentives also reduces the effectiveness of interfirm monitor­ing by outsiders. In turn, that reduces the market for corporate control’s disciplinary effect. A rule prohibiting target resistance is therefore likely to decrease agency costs, and increase stock prices, benefiting shareholders of all firms, even those whose companies are never targeted for a takeover bid.[7]

All well and good, but who died and left the unsolicited tender offer in charge? A no resistance rule in effect creates a kind of private eminent domain: bidders can effectively “condemn” target shares by offering even a slight premium over the current market price.[8] Awarding the lion’s share of the gains to be had from a change of control to the bidder, however, only makes sense if all gains from takeovers are created by bidders through the elimination of inept or corrupt target managers and none are attributable to the hard work of efficient target managers. Unfortunately for proponents of the no resistance rule, the evidence is that takeovers produce gains for a variety of reasons that are likely to differ from case to case.[9]

In order for a no resistance rule to make sense, the unsolicited tender offer also must be the critical mechanism by which incumbents are disciplined. In fact, however, unsolicited tender offers are so rare and sporadic that a director or manager who shirks his responsibilities by playing golf when he should be working is undoubtedly more likely to be struck by lightening while on the course than to be fired after a hostile takeover. As a result, the disciplinary effect of takeovers has been grossly overstated by proponents of the no resistance rule. Instead, as our analysis of Delaware’s takeover jurisprudence will suggest, the critical disciplinary mechanism is the board of directors, especially the independent directors. In turn, the tenure and reputation of outside board members are determined by the performance of the inside managers, which gives indepen­dent directors incentives to be vigilant in overseeing management’s conduct.

If independent directors were the sole bulwark against managerial shirking, concerns about structural and actual bias might be troubling, but they do not stand alone. Although monitoring by institutional investors is weak, and problematic given our theory of the firm, it likely has some effects on the margins. Whatever one makes of institutional investor activism as a monitoring device, important accountability mechanisms continue to be supplied by the product market in which the firm operates and the internal and external job markets for the firm’s managers.[10] Corporate directors and managers do not get ahead by being associated with sub-par performance in the product markets. Indeed, as between shareholders and managers, it is the latter who have the greatest incentives to ensure the firm’s success. Shareholders can and should hold diversified portfolios, so that the failure of an individual firm will not greatly decrease their total wealth, while managers cannot diversify their firm-specific human capital (or their general human capital, for that matter). If the firm fails on their watch, it is the incumbent directors and managers who suffer the principal losses.

It is for this reason that the capital markets also have a disciplinary function. Incompetent or even unlucky management eventually shows up in the firm’s performance. These signs are identified by potential debt or equity investors, who (if they are willing to invest at all) will demand a higher rate of return to compensate them for the risks of continued suboptimal performance. In turn, this makes the firm more likely to flounder—taking the incumbent managers down with it.

Our point is not that the tender offer has no disciplinary effect, but merely that the tender offer is only one of many mechanisms by which management’s behavior is constrained. Once we view corporate governance as a system in which many forces constrain management behavior, the theory of the second best becomes relevant. In a complex, interdependent system, it holds that inefficiencies in one part of the system should be tolerated if “fixing” them would create even greater inefficiencies elsewhere in the system as a whole.[11]Even if we concede the claim that a no resistance rule would reduce agency costs, such a rule would still be inappropriate if it imposes costs in other parts of the corporate governance system. By restricting the board’s authority with respect to tender offers, the various academic proposals impose just such costs by also restricting the board’s authority with respect to the everyday decisions upon which shareholder wealth principally depends. Accordingly, it is not surprising that Delaware has rejected the academic approach to the unsolicited tender offer. This half of Delaware’s takeover jurisprudence, like that regulating negotiated acquisitions, is best explained as implicitly concluding that the benefits of preserving authority outweighs the costs of doing so.

Reminder: If you want much more detail, be sure to check out my article Unocal at 20: Director Primacy in Corporate Takeovers, 31 DEL. J. CORP. L. 769 (2006), on which the posts have drawn.

Were Easterbrook and Fischel right that target company boards should remain passive in the face of a hostile takeover bid? A comment on Sharfman and Moore. Part 2

In Part I of this essay, I discussed a new article by Bernard Sharfman and Marc Moore, in which they propose reviving the passivity thesis, which argued that target boards faced with a hostile takeover offer should be passive.

A long time ago, in my article, Unocal at 20: Director Primacy in Corporate Takeovers,[1] I explained why I disagree with the passivity thesis. My analysis grew directly out of my director primacy model of corporate governance. Because I still think a board-centric approach to corporate governance is appropriate, even in the context of a hostile takeover bid, let me summarize my argument here. I encourage you to go read the whole thing, however.

Given the Delaware courts’ normal sensitivity to conflicts of interests, the clear evidence that management resistance to unsolicited tender offers is at best a risky proposition for shareholders and at worst economically disastrous (note that I do not quibble with the empirical evidence Sharfman and Moore rehearse at 38-55, I'm just not persuaded it overcomes the arguments herein), and the undeniable fact that the no resistance rule does a more thorough job of removing management’s conflicted interests from the tender offer process than does Unocal, is it not surprising that Delaware courts adopted a standard that permits target resistance? The Delaware courts’ consistent rejection of the no resistance rule suggests that the courts have perceived some dimension to the puzzle that has escaped the attention of academics.

Analysis should begin with the proposition that all doctrinal responses to corporate conflict of interest transactions have two features in common. First, so long as the board of directors is disinterested and independent, it retains full decision-making authority with respect to the transaction.[2] Second, the board’s indepen­dence and decision-making process is subject to judicial scrutiny. Here, as ever, we see the competing influences of authority and accountability.

In a sense, Delaware’s takeover cases do no more than to simply bring this traditional corporate governance system to bear on target resistance to tender offers.[3] Admittedly, the form of review is unique, but so too is the context. Just as has been the case with all other corporate conflicts of interest, Delaware decisions in the unsolicited tender offer context strive to find an appropriate balance between authority and accountability. We see the courts’ concern for accountability in, for example, Unocal’s explicit recognition of the conflict of interest that target directors and officers face in an unsolicited takeover bid. Of course, it is one thing to recognize this conflict of interest and quite another to do something about it. As a doctrinal matter, the Delaware supreme court concretely demonstrated its sensitivity to management’s conflicted interests by placing the preliminary burden of proof on the board. This action demonstrated considerable judicial sensitivity to the board’s conflicted interests, because outside of areas traditionally covered by the duty of loyalty, putting the initial burden of proof on the board of directors is a very unusual—indeed, essentially unprecedented—step.

At the same time, however, we see the value of authority reflected in, for example, Unocal’s express rejection of the passivity model. Even plainer evidence of the Delaware courts’ concern for authority came when Chancellor Allen wrote that unless Unocal was carefully applied “courts—in exercising some element of substantive judgment—will too readily seek to assert the primacy of their own view on a question upon which reasonable, completely disinterested minds might differ.”[4] Is it not striking how precisely Allen echoes our argument that one cannot make an actor more accountable without simultaneously transferring some aliquot of his decision-making authority to the entity empowered to hold him to account?

In contrast, virtually all of the policy prescriptions to emerge from the academic accounts of the tender offer’s corporate governance role would create an entirely corporate governance system, in which the board is stripped of some or all of its normal decision-making authority. Recast in our terminology, the academic proposals reflect an overriding concern with accountability. There is no room in the academic account for the value of authority. Indeed, the academic proposals reject the very notion that authority has any legitimate role to play in developing takeover doctrine. Deciding whether the judiciary or the ivory tower has the better argument is the task to which the remainder of this section is devoted.

We approach the problem by asking whether the unsolicited tender offer differs in kind, not just degree, from any other conflicted interest transaction. If so, perhaps a special governance scheme applicable only to unsolicited tender offers can be justified. If not, however, we would expect the law to treat unsolicited tender offers just as it treats other conflicted interest transactions. In other words, the law can be expected to develop mechanisms for policing incumbent conflict of interests, but cannot be expected to deny incumbents a role in the process.

The question of comparative advantage

According to most critics of Delaware’s takeover jurisprudence, corporate law gives the board decision-making authority because in most situations the directors have a competitive advantage vis-a-vis the shareholders in choosing between competing alternatives. They then argue that directors have no such competi­tive advantage when it comes to making tender offer decisions and, accordingly, reject granting the board decision-making authority in the tender offer context. Certainly, it is true that even the most apathetic investor is presumably capable of choosing between an all-cash bid at $74 per share and an all-cash bid at $76. This analysis, however, obscures two important rationales for granting the board decision-making authority in the tender offer context.

At the outset, it is important to recognize that unsolicited tender offers and negotiated acquisitions have a good deal in common. From a practical perspective, it is often increasingly difficult to tell the two apart. In today’s market place most takeovers follow a fairly convoluted path. They start out quasi-hostile, but end up as quasi-friendly, or vice-versa. They start out as a merger proposal, which is restructured as a tender offer for tax or other business reasons, or vice-versa. The problem is usefully illustrated by Chancellor Allen’s opinion in TW Services v. SWT Acquisition.[5] SWT’s unsolicited partial tender offer for TW Services was subject to a number of conditions, including a requirement that the transaction be approved by TW Services’ board of directors. The TW Services’ board saw the tender offer as a ruse designed to extort greenmail or to put the company into play. Accordingly, the board declined to redeem the company’s outstanding poison pill. SWT filed a lawsuit seeking invalidation of the pill. Because SWT conditioned its offer on the TW Service board’s support, the case presented a problem of characterization that the legal literature largely ignores. If the transaction is characterized as a merger, then most commentators would permit the board an active decision-making role. Conversely, if the transaction is characterized as a tender offer, they would preclude the board from exercising decision-making authority. Categorizing this transaction, however, is a non-trivial task.[6] Attempting to define the scope of the board’s authority by the nature of the transaction at hand thus quickly proves an unsatisfactory resolution.

Even if one were wholly confident of one’s ability to appropriately characterize transactions, however, the comparative advantage argument still would not justify precluding the board from exercising decision-making authority in tender offers. Consider transactions like the defensive restructuring at issue in City Capital Associates v. Interco. In the face of an all-cash hostile bid at $74 per share, Interco’s board of directors proposed to sell certain assets and to borrow a substantial amount of money. The joint proceeds of those transactions would then be paid out to Interco’s shareholders as dividends. The dividends would be paid in three forms: cash, bonds, and preferred stock. The dividends’ total value was said to be $66 per share. Interco’s investment banker opined that, after this series of transactions, Interco’s stock would trade at no less than $10 per share. The proposed defensive measures thus purportedly would give Interco’s shareholders a total value of $76—$2 more than the hostile bid. In rebuttal, the bidder’s investment bankers valued the defensive plan at $68-$70 per share.[7] It is precisely because passive, widely dispersed shareholders have neither the inclination nor the information necessary to decide between these sort of alternatives that the corporate law in other contexts allocates the decision to the board.[8] Only compelling accountability concerns can justify treating tender offers differently. The comparative advantage argument thus collapses into a variant of the agency cost arguments discussed below.

The bypass argument

An alternative justification for treating the tender offer differently than negotiated acquisitions rests on the former’s elimination of the need for target management’s cooperation. As we saw above, the target board’s gatekeeper role in negotiated acquisitions creates a conflict of interest, which is constrained principally by the ability the tender offer gives a bidder to bypass the target’s board by purchasing a controlling share block directly from the stockhold­ers. According to some academics, authority values thus are only appropriate in the negotiated acquisition context if the board is denied the ability to resist tender offers.[9]

This argument looks good on paper, but ultimately is unpersuasive. In the first place, it too ignores the problem of characterization alluded to in the preceding section. In addition, tender offers are not the only vehicle by which outsiders can appeal directly to the shareholders. Proxy contests similarly permit a would-be acquirer to end-run management. How a shareholder votes in director elections seems just as an individual decision as that of whether to tender to a hostile bidder. Yet, nobody expects a board to be passive in the face of a proxy contest. To the contrary, the incumbent board’s role is very active indeed. Why? Because the incumbent board members remain in office and therefore also continue to be legally responsible for the conduct of the business until they are displaced. Complete passivity in the face of a proxy contest thus would be inconsistent with the directors’ obligation to determine and advance the best interests of the corporation and its shareholders.[10]

The same is true of a tender offer. While the analogy between tender offers and proxy contests is unconvincing for most purposes, the courts may have correctly sensed a fit at this most basic level. The directors will remain in office unless the offer succeeds and they thereafter resign or are removed by the new owner. As a doctrinal matter, the board of directors has a “fundamental duty” to protect shareholders from harm, which can include an unsolicited tender offer that the directors truly believe is not in the shareholders’ best interests. As Unocal recognized, complete passivity in the face of such an offer would be inconsistent with their fiduciary duties.[11] To the contrary, their on-going fiduciary duty obliges them to seek out alternatives. At the bare minimum, it thus would be appropriate for the board to use takeover defenses to delay an inadequate bid from going forward while the board seeks out an alternative higher-valued offer, because until the board has time to arrange a more attractive alternative there is a risk that the shareholders will “choose an inadequate tender offer only because the superior offer has not yet been presented.”[12]

The structural argument (a.k.a. shareholder choice)

A more substantial argument against authority values in the unsolicited tender offer context contrasts the board’s considerable control in negotiated acquisitions with the board’s lack of control over secondary market transactions in the firm’s shares. Corporate law generally provides for free alienability of shares on the secondary trading markets. Mergers and related transfers of control, however, are treated quite differently. As we saw above, corporate law gives considerable responsibil­ity and latitude to target directors in negotiating a merger agreement. The question then is whether unsolicited tender offers are more like secondary market trading or mergers.

The so-called structural argument—also known as the shareholder choice argument—asserts that the tender offer is much more closely analogous to the former. According to its proponents, an individual shareholder’s decision to tender his shares to the bidder no more concerns the institutional responsibilities or prerogatives of the board than does the shareholder’s decision to sell his shares on the open market or, for that matter, to sell his house.[13] Both stock and a home are treated as species of private property that are freely alienable by their owners.

The shareholder choice argument actually cuts against one of Sharfman and Moore’s arguments. They suggest (at 23-24) that some hostile bids are motivated by private information asymmetrically held by the bidder. I doubt that happened very often even in the hostile takeover’s heyday, but if true would not allowing a bidder to act on that information be inconsistent with shareholder choice? After all, we no longer live in a world of caveat emptor. Major purchases these days come with masses of disclosure (I vividly recall the mountain of information I reviewed at my house closing). Assume the law requires the bidder to disclose its private information. Would the passivity thesis preclude management from undertaking changes in response to learning that information?

In any case, none of the normative bases for the structural argument prove persuasive. That shareholders have the right to make the final decision about an unsolicited tender offer does not necessarily follow, for example, from the mere fact that shareholder have voting rights. While notions of shareholder democracy permit powerful rhetoric, corporations are not New England town meetings. Put another way, we need not value corporate democracy simply because we value political democracy.[14]

Indeed, we need not value shareholder democracy very much at all. In its purest form, our authority-based model of corporate decision making calls for all decisions to be made by a single, central decision-making body—i.e., the board of directors. If authority were corporate law’s sole value, shareholders thus would have no voice in corporate decision making. Shareholder voting rights thus are properly seen not as part of the firm’s decisionmaking system, but as simply one of many accountability tools—and not a very important one at that.

Nor is shareholder choice a necessary corollary of the shareholders’ ownership of the corporation. The most widely accepted theory of the corporation, the nexus of contracts model, visualizes the firm not as an entity but as a legal fiction representing a complex set of contractual relation­ships. Because shareholders are simply one of the inputs bound together by this web of voluntary agreements, ownership is not a meaningful concept under this model. Each input is owned by someone, but no one input owns the totali­ty. A shareholder’s ability to dispose of his stock thus is not defined by notions of private property, but rather by the terms of the corporate contract, which in turn are provided by the firm’s organic documents and the state of incorporation’s corporate statute and common law. The notion of shareholder ownership is thus irrelevant to the scope of the board’s authority. As Vice Chancellor Walsh observed, “shareholders do not possess a contractual right to receive takeover bids. The shareholders’ ability to gain premiums through takeover activity is subject to the good faith business judgment of the board of directors in structuring defensive tactics.”[15]

Finally, and most importantly, the structural argument also ignores the risk that restricting the board’s authority in the tender offer context will undermine the board’s authority in other contexts. Even the most casual examination of corporate legal rules will find plenty of evidence that courts value preservation of the board’s decision-making authority. The structural argument, however, ignores the authority values reflected in these rules. To the contrary, if accepted, the structural argument would necessarily undermine the board’s unquestioned authority in a variety of areas. Consider, for example, the board’s authority to negotiate mergers. If the bidder can easily by-pass the board by making a tender offer, hard bargaining by the target board becomes counter-productive. It will simply lead to the bidder making a low-ball tender offer to the shareholders, which will probably be accepted due to the collective action problems that preclude meaningful shareholder resistance. Restricting the board’s authority to resist tender offers thus indirectly restricts its authority with respect to negotiated acquisitions.[16]

Indeed, taken to its logical extreme, the structural argument requires direct restrictions on management’s authority in the negotiated acquisition context. Suppose management believes that its company is a logical target for a hostile takeover bid. One way to make itself less attractive is by expending resources in acquiring other companies. Alternatively, the board could effect a preemptive strike by agreeing to be acquired by a friendly bidder. In order to assure that such acquisitions will not deter unsolicited tender offers, the structural argument would require searching judicial review of the board’s motives in any negotiated acquisition.

To take but one more example, it is quite clear that managers can make themselves less vulnerable to takeover by eliminating marginal operations or increasing the dividend paid to shareholders and thus enhancing the value of the outstanding shares. A corporate restructuring thus can be seen as a preemptive response to the threat of takeovers. It is hard to imagine valid objections to incumbents securing their position through transactions that benefit shareholders.[17] Why then should it matter if the restructuring occurs after a specific takeover proposal materializes? The structural argument not only says that it does matter, but taken to its logical extreme would require close judicial scrutiny of all corporate restructurings.

Were Easterbrook and Fischel right that target company boards should remain passive in the face of a hostile takeover bid? A comment on Sharfman and Moore. Part 1

In 1965, my friend and mentor the late Henry Manne published the seminal article on the market for corporate control, Mergers and the Market for Corporate Control.[1] As my friend Bill Carney explains, Manne “rejected the received wisdom: ‘Take-overs of corporations are too expensive generally to make the ‘purchase’ of management compensation an attractive proposition.’”[2] “The returns from acquiring control, Manne argued, were from improving management. Improving management would, in turn, increase cash flows that would be capitalized by the market.”[3]

As a result, Manne argued, a market for corporate control exists because outsiders can profit by buying control of a poorly managed company, firing the incompetent or venal incumbent managers, and replacing them with competent managers who would focus on shareholder wealth maximization:

The market for corporate control is really to be understood in consumer-protection terms, with “consumers” in that market being shareholders. In the pre-Manne era, the prevailing academic paradigm treated shareholders--that is, consumer-purchasers of corporate shares--as chumps. They were routinely, and so predictably, bamboozled by managers supposedly advancing shareholder welfare but really maximizing their own welfare. Management operated seemingly without constraints in bilking shareholders.

But, Manne noted, the corporate control needed to undertake such machinations is subject to market forces. And if markets ordinarily operate reasonably competitively, would not shareholder sovereignty emerge in this market, just as consumer sovereignty emerges in competitive markets generally? So, Manne wrote, mergers “are of considerable importance for the protection of individual non-controlling shareholders . . . .” Thus, … for the first time the famous Berle-Means concern about the separation of ownership and control was seen for what it truly is: an undeniable fact but one that invites, and has elicited, a market solution because it offers manager-entrepreneurs individual gains while protecting other shareholders as well.[4]

The chief difficulty with Henry’s thesis was that the principal acquisition technique of the time—the merger—is ill-suited to play a role in hostile takeovers, because approval of a proposed merger by the target’s board of directors is an essential prerequisite to the accomplishment of a merger.

The solution was coming down the tracks of history at high speed, however. One piece of the puzzle was the emergence of the tender offer. Tender offers were possible in 1965—the first hostile tender offer reportedly took place in 1956[5]—but two barriers had to be overcome before they could become commonplace.

First, as Carney explains, new sources of financing were necessary:

Remarkably, the article predicted leveraged buyouts, noting that any gains from efficient management could be leveraged through borrowed funds, “although American commercial banks are generally forbidden to lend money for this purpose.” It took development of other sources of funds--notably junk bond markets and non-bank institutional lenders--for this leveraging to flower two decades later.[6]

Second, as I have explained elsewhere, there needed to be a major cultural shift on Wall Street:

Given the tender offeror's comparative advantages, it is somewhat surprising that they were relatively rare before the 1960s. Although there are various explanations for that phenomenon, I suspect that the social mores of the business, financial, and legal communities played a major role. Before the 1960s, hostile tender offers were regarded as bad form by most of the key players. See David Halberstam, The Reckoning 674-75 (1986).[7]

Once those pieces were in place, sometime in the mid-1970s,[8] the short-lived era of the hostile takeover began.

In response to the emergence of the hostile takeover, incumbent managers hired talented lawyers to develop an array of defenses—such as the shark repellent, the poison pill, and the Pac-man defense—that allowed the target board to assert a gatekeeping function in the tender offer comparable to the one it long played in the merger.[9]

That development led to one of the most famous of all corporate law review articles; namely, Easterbrook and Fischel’s The Proper Role of a Target's Management in Responding to a Tender Offer.[10] As John Coffee summarizes their argument:

Viewed through the lens supplied by the “market for corporate control” thesis, the role of the tender offer is to replace inefficient management. The bidder, it is argued, pays a premium over the market price because it believes that the target's assets have not been optimally utilized and that under superior management they would earn a higher return, thereby justifying the tender offer premium. In this light, the higher the premium, the greater the degree of mismanagement that the bidder must perceive. So viewed, the hostile tender offer appears a benign and socially desirable phenomenon, which benefits both the bidder and the target's stockholders, who simply divide among themselves the value that the incumbent management's inefficiency denied them.

The Disciplinary Hypothesis places special weight on the target management's resistance to the takeover to demonstrate that the anticipated gain that motivated the acquisition was probably predicated upon the displacement of an inefficient target management. … [According to Easterbrook and Fischel, managerial] resistance is comprehensible only if the interests of the target's management deviated from those of its shareholders. Such a conflict would arise either because the management of the target expected to be replaced by the bidding firm, or because it saw an opportunity to demand a side payment for its acquiescence. The significance of this perspective then lies in its clear implication that “hostile” acquisitions are disproportionately motivated by the bidder's desire to realize enhanced value through replacing an inferior management while “friendly” acquisitions are typically motivated by other business considerations that pose less of a threat to the incumbent management. This logic also leads to the conclusion that hostile bids have a unique role in corporate governance as a policing mechanism.[11]

In turn, those insights led Easterbrook and Fischel to advance what became known as the passivity thesis:

They propose that the management of a corporation subject to a tender offer, the target, should be prohibited from resisting the offer in any fashion. The authors view hostile takeovers as a significant means of displacing poor managers and argue that facilitating tender offers increases the incentive of all managers to perform in the best interests of their shareholders. The passivity thesis has found a sympathetic audience. Many legal scholars have accepted the basic claim that most defensive tactics are undesirable, although some authors would preserve management's right to engage in some limited responses.[12]

Despite their success in the academic arena, Easterbrook and Fischel lost where it matters; namely, in the real world. The passivity thesis developed no traction in the courts. In particular, the one court system that really matters in corporate law—that of Delaware—summarily dismissed the passivity thesis:

It has been suggested that a board's response to a takeover threat should be a passive one. Easterbrook & Fischel, supra, 36 Bus.Law. at 1750. However, that clearly is not the law of Delaware, and as the proponents of this rule of passivity readily concede, it has not been adopted either by courts or state legislatures. Easterbrook & Fischel, supra, 94 Harv.L.Rev. at 1194.[13]

Now, however, come Bernard Sharfman and Marc Moore—two respected and thoughtful corporate law commentators with whom I have frequently corresponded to my benefit—to argue for a restoration of the passivity thesis:

Unfortunately, while a vibrant hostile takeover market did exist in the United States during the 1960s, 70s, and 80s, this has not been the case for many years. By contrast, the United Kingdom, despite having a broadly similar capital market environment and corporate governance system to the U.S., has gone down the path of allowing its hostile takeover market to flourish. Thus, the U.K. has been able to successfully retain the hostile takeover as a corrective mechanism in corporate governance.

We find the current domestic state of affairs unacceptable. Without a vibrant hostile takeover market, a significant corrective mechanism has been lost. Therefore, with a view to correcting this inefficiency, we use as our primary authority the core principles identified in the U.K.’s regulatory legal framework, and especially its longstanding board passivity (or “non-frustration”) rule. More than any other element of the British framework, the board passivity rule has allowed for the creation of an enduring and successful hostile takeover market in the U.K. Accordingly, this Article recommends that domestic state corporate law statutes be amended to include a safe harbor for a hostile bidder when making an all-cash, all-shares tender offer that includes a guarantee of the same or higher price if a back-end or squeeze-out merger occurs.

The use of the above safe harbor would effectively disallow a board’s use of the poison pill as a takeover defense unless a specific takeover defense, such as a poison pill, is provided for in the corporate charter. In this way, private ordering can always be used to trump the statutory safe harbor.[14]

I strongly encourage you to read their article. It is an excellent, yet concise, history of the evolution of the market for corporate control, the academic theorizing about that market, and the development of the law. It also provides a very useful and insightful comparative law treatment of the problem by contrasting US and UK law. In addition, they offer a very helpful review of the empirical literature on the costs and benefits of hostile takeovers. They also make a unique contribution by tying the Delaware courts’ resistance to the passivity thesis to the Delaware courts’ resistance to private ordering in the corporate context, which leads them to proffer a private ordering solution, as noted above.

In Part II, however, I will explain why I don't buy the passivity thesis.

Ann Lipton finds the purity of the interpretative questions posed in two recent M&A case aesthetically pleasing

She explains here.

Material Adverse Effect Clauses in M&A: Is COVID-19 a Material Adverse Change?

Miller, Robert T., Material Adverse Effect Clauses and the COVID-19 Pandemic (May 18, 2020). Available at SSRN: https://ssrn.com/abstract=3603055 or http://dx.doi.org/10.2139/ssrn.3603055

This paper considers whether the COVID-19 pandemic, the governmental responses thereto, and actions taken by companies in connection with both of these constitute a “Material Adverse Effect” (MAE) under a typical MAE clause in a public company merger agreement. Although in any particular case everything will depend on the exact effects suffered by the company and the precise wording of the MAE clause, this paper concludes that, under a typical MAE clause, given the current tremendous contraction in economic activity, most companies will have suffered a material adverse effect as such term in used in the base definition of most MAE clauses. The question thus becomes whether the risks of a pandemic or of governmental responses thereto have been shifted to the acquirer under exceptions to the base definition. This paper considers some of the difficult causal questions that would arise in answering this question, including the relation of actions taken by the company to remain solvent while suffering the effects of COVID-19 and governmental lockdown orders, and concludes that, in some instances, a company will have suffered an MAE even if the MAE clause contains exceptions for pandemics, changes in law, or both.

The tax on M&A for the benefit of plaintiff lawyers has moved from state to federal court, but there's a glimmer of hope

I admit that that headline is not the most neutral one I've ever written, but C'mon. We've known for years that merger objection litigation is basically of no benefit to shareholders or companies. The only winners are lawyers. The plaintiffs' lawyers extract fees as part of a settlement that gives shareholders no meaningful benefits and, of course, the defense lawyers bill their clients.

Shareholder litigation challenging corporate mergers is ubiquitous, with the likelihood of a shareholder suit exceeding 90%. The value of this litigation, however, is questionable. The vast majority of merger cases settle for nothing more than supplemental disclosures in the merger proxy statement. The attorneys that bring these lawsuits are compensated for their efforts with a court-awarded fee. This leads critics to charge that merger litigation benefits only the lawyers who bring the claims, not the shareholders they represent. ...

Specifically, under current law, supplemental disclosures are viewed by courts as providing a substantial benefit to the shareholder class. In turn, this substantial benefit entitles the plaintiffs' lawyers to an award of attorneys' fees. Our evidence suggests that this legal analysis is misguided and that supplemental disclosures do not in fact constitute a substantial benefit. As a result, and in light of the substantial costs generated by public-company merger litigation, we argue that courts should reject disclosure settlements as a basis for attorneys' fee awards.

Jill E. Fisch et. al., Confronting the Peppercorn Settlement in Merger Litigation: An Empirical Analysis and A Proposal for Reform, 93 Tex. L. Rev. 557 (2015)

Kevin LaCroix reports:

These days just about every public company merger transaction draws at least one merger objection lawsuit. These lawsuits formerly were filed in Delaware state court alleging violations of Delaware law, but since the 2016 Delaware Chancery Court decision in the Trulia case, in which the court expressed its distaste for this type of litigation, the lawsuits have been filed in federal court based on alleged violations of Section 14 of the Securities Exchange Act of 1934. These cases, through frequently filed, are rarely litigated. They typically are resolved by the defendants’ voluntary insertion of supplemental proxy disclosures and agreement to pay the plaintiff a “mootness” fee.

Federal courts have basically rubber-stamped these settlements, which has just encouraged more lawsuits.

As LaCroix also reports, however, a company with a spine finally met a judge with a brain and the combination gave the merger objection suit the dismissal it so richly deserved. Go read the whole thing. 

 

Ann Lipton thinks VC Laster's Dell Decision is About Judicial Primacy Not Director Primacy

A few days ago, I posted VC Laster's Dell Decision Gives a Very Director Primacy Spin on MFW, in which I argued that:

In his recent opinion in In re Dell Techs. Inc. Class V Stockholders Litig., 2020 WL 3096748 (Del. Ch. June 11, 2020), Vice Chancellor Laster gave a very board-centric spin on the MFW rule. Tyler O'Connell's Morris James blog post explains:

The Delaware Supreme Court’s MFW decision provides a safe harbor for controlling stockholder buyouts that are conditioned upon approval of a special committee of independent directors and a majority-of-the-minority vote, provided, inter alia, “there is no coercion of the minority.” Kahn v. M & F Worldwide Corp. (MFW), 88 A.3d 635, 645 (Del. 2014). The Court of Chancery’s recent decision in In re Dell Tech. Inc. Class V. S’holders Litig., 2020 WL 3096748 (Del. Ch. Jun. 11, 2020), held that a redemption of minority stockholders’ shares failed to satisfy MFW due to the company’s decisions to give the special committee an impermissibly narrow mandate and then bypass it to negotiate directly with minority stockholders. 

The Vice Chancellor didn't cite my work on director primacy, but the opinion is very much in the spirit of director primacy ....

I go on to explain. Ann Lipton, however, thinks I'm wrong. Instead, she thinks the decision is about judicial supremacy:

The part that I’m interested in, however, is Laster’s attention to the varying incentives of even the “disinterested” stockholders.  That’s what I was discussing in Shareholder Divorce Court, namely, how large institutional shareholders are likely to have cross-holdings that affect their preferences, and lead them to favor nonwealth maximizing actions at a particular company if they benefit the rest of the portfolio (after the article was published, I posted about additional empirical work in this area here).  Laster has historically been especially sensitive to these kinds of conflicts.  ...

The problem, though – as I discuss in Shareholder Divorce Court and What We Talk About When We Talk About Shareholder Primacy– is that if you’re going to recognize the heterogeneity of shareholder interest due to these different types of portfolio-wide investments, it’s unclear why a majority vote should be permitted to drag along the minority in a particular deal.  Which conflicts will we recognize as generating bias, and which will we ignore?  That’s the problem that cases like Corwin v. KKR Fin. Holdings LLC, 125 A.3d 304 (Del. 2015) and MFW are forcing Delaware to confront.  Laster’s far more willing to engage here; so far, other judges have, umm, avoided the issue. ...

In practical effect, it seems, Laster is less about director primacy than judicial primacy, in a way that often puts him at odds with other members of the Delaware judiciary.  (See, e.g., my discussion of Salzberg v. Sciabacucchi, and the differing views of the nature of the corporation expressed by Laster and the Delaware Supreme Court).  Because once you hold that shareholders are too biased to make decisions, that doesn’t necessarily lead to director primacy; instead, it creates more space for the judiciary to step in to protect the interests of the abstract notion of shareholder, distinct from the ones who actually cast ballots. 

It's an interesting spin. Professor Lipton is an exceptionally accomplished student of Delaware law, especially in the M&A context. Which worries me.

If she's right, and Laster is really pushing a view that when "shareholders are too biased to make decisions" the judiciary ought to step in, that's a serious break from how I understand Delaware law both descriptively and normatively.

Justice Jackson famously observed of the Supreme Court: “We are not final because we are infallible, but we are infallible only because we are final.”[1] Neither courts nor boards are infallible, but someone must be final. Otherwise we end up with a never-ending process of appellate review. The question then is simply who is better suited to be vested with the mantle of infallibility that comes by virtue of being final—directors or judges?

Corporate directors operate within a pervasive web of accountability mechanisms. A very important set of constraints are provided by a competition in a number of markets. The capital and product markets, the internal and external employment markets, and the market for corporate control all constrain shirking by directors and managers.[2] Granted, only the most naïve would assume that these markets perfectly constrain director decision making.[3] It would be equally naïve, however, to ignore the lack of comparable market constraints on judicial decision making. Market forces work an imperfect Darwinian selection on corporate decisionmakers, but no such forces constrain erring judges.[4] As such, rational shareholders will prefer the risk of director error to that of judicial error. Hence, shareholders will want judges to abstain from reviewing board decisions.

The shareholders’ preference for abstention, however, extends only to board decisions motivated by a desire to maximize shareholder wealth. Where the directors’ decision was motivated by considerations other than shareholder wealth, as where the directors engaged in self-dealing or sought to defraud the shareholders, however, the question is no longer one of honest error but of intentional misconduct. Despite the limitations of judicial review, rational shareholders would prefer judicial intervention with respect to board decisions so tainted.[5] The affirmative case for disregarding honest errors simply does not apply to intentional misconduct.

The mere fact that shareholders are heterogenous, however, does not mean that directors are conflicted. Absent evidence that the directors themselves are conflicted or beholden to someone who is, courts should not second-guess board decisions. Other Delaware jurists have consistently recognized this proposition:

Even in the takeover context, where Delaware courts have long acknowledged the potential for directors to be conflicted, Chancellor William Allen warned that Delaware courts need to employ “the Unocal precedent cautiously. . . . The danger that it poses is, of course, that courts—in exercising some element of substantive judgment—will too readily seek to assert the primacy of their own view on a question upon which reasonable, completely disinterested minds might differ.” City Capital Assocs. Ltd. P’ship v. Interco, Inc., 551 A.2d 787, 796 (Del. Ch. 1988).

In the same heightened scrutiny context, then VC and later Justice Jack Jacobs likewise observed that: “[a]lthough ‘enhanced scrutiny’ must be satisfied before business judgment rule presumptions will apply, that does not displace the use of business judgment in the board room.” QVC Network, Inc. v. Paramount Commc’ns, Inc., 635 A.2d 1245, 1268 (Del. Ch. 1993), aff’d, 637 A.2d 34 (Del. 1994).

In the past, VC Laster has recognized that Delaware law is director-centric. not judge-centric. See Travis Laster & John Mark Zeberkiewicz, The Rights and Duties of Blockholder Directors, 70 BUS. LAW. 33, 35 (2015) (“Delaware corporate law embraces a ‘board-centric’ model of governance."); In re CNX Gas Corp. Shareholders Litig., 2010 WL 2705147, at *10 (Del. Ch. July 5, 2010) ("Delaware law would seem to call for a consistently board-centric approach.").

One assumes he also recognizes that the logic of director primacy is one of judicial deference to the board's authority absent a conflict of interest or other evidence that the need for accountability justifies intervention.

What is a merger?

2/ @VolunteerTwit also linked to a video in which she and some colleagues discussed that issue. I'm going to have my fall M&A class watch it. It's quite good. https://t.co/NAzfUrwLhJ

— ProfessorBainbridge.com (@PrawfBainbridge) July 15, 2020

Yours truly quoted by Korn Ferry re being an M&A acquirer in COVID-19

From Briefings Magazine:

After lying low at the start of the outbreak, well-stocked firms are hunting for merger deals. Could that speed up any recovery? ...

Stephen Bainbridge, a UCLA law professor who specializes in M&A, says leaders are often overly optimistic about their ability to turn around businesses in deep trouble—and end up creating more financial problems than solving them. “Merging a failing company into a healthy one could get the healthy company in trouble,” says Bainbridge. “It could end up being dragged down.”

Or, as Bainbridge says, “Successful mergers depend on the ability to build a new team and integrate cultures in a way that gets buy-in from everyone as quickly as possible, and that’s going to be incredibly hard to do over Zoom.”

VC Laster's Dell Decision Gives a Very Director Primacy Spin on MFW

In his recent opinion in In re Dell Techs. Inc. Class V Stockholders Litig., 2020 WL 3096748 (Del. Ch. June 11, 2020), Vice Chancellor Laster gave a very board-centric spin on the MFW rule. Tyler O'Connell's Morris James blog post explains:

The Delaware Supreme Court’s MFW decision provides a safe harbor for controlling stockholder buyouts that are conditioned upon approval of a special committee of independent directors and a majority-of-the-minority vote, provided, inter alia, “there is no coercion of the minority.” Kahn v. M & F Worldwide Corp. (MFW), 88 A.3d 635, 645 (Del. 2014). The Court of Chancery’s recent decision in In re Dell Tech. Inc. Class V. S’holders Litig., 2020 WL 3096748 (Del. Ch. Jun. 11, 2020), held that a redemption of minority stockholders’ shares failed to satisfy MFW due to the company’s decisions to give the special committee an impermissibly narrow mandate and then bypass it to negotiate directly with minority stockholders. 

The Vice Chancellor didn't cite my work on director primacy, but the opinion is very much in the spirit of director primacy:

MFW’s dual protections contemplate that the Special Committee will act as the bargaining agent for the minority stockholders, with the minority stockholders rendering an up-or-down verdict on the committee’s work. Those roles are complements, not substitutes. A set of motivated stockholder volunteers cannot take over for the committee and serve both roles.

The MFW framework contemplates that the special committee will act as “an independent negotiating agent whose work is subject to stockholder approval.” Flood, 195 A.3d at 767. Through the involvement of the special committee, the MFW framework ensures that there are “independent, empowered negotiating agents to bargain for the best price and say no if the agents believe the deal is not advisable for any proper reason ....” MFW, 88 A.3d at 644 (internal quotation marks and emphasis omitted). Like a board of directors in an arm’s-length transaction, the committee has superior access to internal sources of information, can deploy it’s the Board’s statutory authority under Section 141(a) as delegated to the committee under Section 141(c), and can “act as an expert bargaining agent.” In re Cox Commc’ns, Inc. S’holders Litig., 879 A.2d 604, 618 (Del. Ch. 2005); see 8 Del. C. § 141(c). Like a board of directors, the committee “does not suffer from the collective action problem of disaggregated stockholders” and is therefore well positioned “to get the last nickel.” Id. at 619; see also In re Pure Res., Inc. S’holders Litig., 808 A.2d 421, 441 (Del. Ch. 2002) (“Delaware law has seen directors as well-positioned to understand the value of the target company, to compensate for the disaggregated nature of stockholders by acting as a negotiating and auctioning proxy for them, and as a bulwark against structural coercion.”).

He then described the shareholders' role in the MFW framework as being "more limited":

They have “the critical ability to determine for themselves whether to accept any deal that their negotiating agents recommend to them.” MFW, 88 A.3d at 644 (internal quotation marks omitted). But “the ability of disaggregated stockholders to reject by a binary up or down vote obviously ‘unfair’ deals does not translate to their ability to do what an effective special committee can do, which is to negotiate effectively and strike a bargain much higher in the range of fairness.” Cox Commc’ns, 879 A.2d at 619.

Laster's interpretation of the relative board and shareholder roles is consistent with the approach I outlined in The Geography of Revlon-Land, 81 Fordham L. Rev. 3277 (2013):

In their efforts to decide who decides, the Delaware courts have grappled with the limits of a target corporation's board of directors' power to act as a gatekeeper in corporate acquisitions. In other words, to what extent can the target's board of directors prevent the target's shareholders from deciding whether the company should be acquired?

In a merger, two corporations combine to form a single entity. In an asset sale, the selling corporation transfers all or substantially all of its assets to the buyer. In both transactions, approval by the target board of directors is an essential precondition.

In both major forms of statutory acquisitions, the board thus has a gatekeeping function. Shareholders have no power to initiate either a merger or asset sale, because the statute makes board approval a condition precedent to the shareholder vote. If the board rejects a merger proposal, the shareholders thus have no right to review that decision. Instead, the shareholder role is purely reactive, coming into play only once the board approves a merger proposal.

The board also has sole power to negotiate the terms on which the merger will take place and to enter a definitive merger agreement embodying its decisions. Shareholders have no statutory right to amend or veto specific provisions, their role typically being limited to approving or disapproving the merger agreement as a whole . . . .

If the board disapproves of a prospective acquisition, the would-be acquirer therefore must resort to one of the nonstatutory acquisition devices. The proxy contest, share purchase, and tender offer all allow the bidder to bypass the target board and make an offer directly to the target's shareholders. Since the 1960s, the tender offer has been the most important and powerful of these tools. Almost as soon as the hostile tender offer emerged as a viable acquirer tactic, however, lawyers and investment bankers working for target boards began to develop defensive tactics designed to impede such offers. If validated by the courts, these takeover defenses promised to reassert the board's primacy by extending its gatekeeping function to the nonstatutory acquisition setting.

Consider the poison pill, for example, which has been called the “de rigeur tool of a board responding to a third-party tender offer.” … Proponents of pills contend that these plans thus do not deter takeover bids, but rather simply give the target board leverage to negotiate the best possible deal for their shareholders or to find a competing bid. In any case, it is clear that “the poison pill has made the board the ‘gatekeeper’ instead of the shareholders.” As a result, target boards have been empowered to play an active--and often determinative--role in the very class of transactions originally designed to bypass them entirely.

NOL Poison Pills to make a comeback?

Interesting post from some Cleary lawyers.