Transcript MA Section 1c: SH litigation

Mergers & acquisitions
Section 1c:
SH litigation
Prof. Amitai Aviram
[email protected]
University of Illinois College of Law
Copyright © Amitai Aviram. All Rights Reserved
S15
Derivative actions
Review of litigation process
• Before we discuss derivative actions, I want to remind you of some
material from Civil Procedure: aspects of the litigation process that
are most relevant for this course
• Stages of litigation
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Preliminaries
Pleadings
Pre-trial
Trial
Post-trial
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Review of litigation process
Preliminaries
• Choice of law
– The “internal affairs doctrine” provides that the internal affairs of a firm
(disputes between the firm, corporate actors & SHs) are governed by the law of
the state of incorporation (McDermott Inc. v. Lewis [Del. 1987])
• Jurisdiction
– Del. Court of Chancery has jurisdiction “to hear and determine all matters and
causes in equity” (10 Del. C. 341), and doesn’t have jurisdiction “to determine
any matter wherein sufficient remedy may be had by common law, or statute
[before another jurisdiction]” (10 Del. C. 342)
• Venue
– Courts outside Delaware may have jurisdiction over SH litigation of Delaware
corporations; in recent years, Delaware has been losing market share in SH
litigation of Delaware corporations.
• In response, companies have started to adopt forum selection bylaws directing
disputes to Delaware courts
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Review of litigation process
Pleadings
• Complaint
– Plaintiff’s complaint commences the lawsuit; must allege:
• Jurisdiction
• Claim (facts showing that plaintiff is entitled to relief)
• Relief (a demand for an appropriate remedy)
• Provisional remedies
– Plaintiff can ask judge for immediate (provisional) remedies when waiting for a
post-trial remedy would cause irreparable harm
– TRO (temporary restraining order): issued before opponent can respond
– Preliminary injunction: issued after opponent responds (but before trial)
– Standard (for both): (a) reasonable probability of success on the merits; (b)
reasonable likelihood moving party will suffer irreparable harm absent the
provisional remedy & that harm outweighs harm to non-moving party from
granting the provisional remedy
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Review of litigation process
Pleadings
• Pre-answer motions (motion to dismiss)
– Can be based on procedural flaw (lack of jurisdiction, improper venue, faulty
process or service) or substantive flaw (failure to state a claim)
– Standard for dismissal for failure to state a claim (Rule 12(b)(6))
• Federal courts: “a complaint must contain sufficient factual matter, accepted as
true, to state a claim to relief that is plausible on its face” (Twombly [US 2007], Iqbal [US 2009])
• Delaware: complaint dismissed for failing to state a claim only if, accepting plaintiff’s
factual allegations as true, “plaintiff would not be entitled to recover under any
reasonably conceivable set of circumstances” (Central Mortgage [Del. 2011])
• Non-moving party’s well-pled allegations are accepted as true, and factual
inferences are made in light most favorable to non-moving party
• Answer
– Defendant responds to complaint, including asserting defenses, counter-claims
(against plaintiff) & joinder (requesting that other necessary parties be
included in the litigation)
• Post-pleading motions (motion for judgment on the pleadings)
– Rule 12(c): granted if pleadings fail to reveal existence of any disputed material
fact & movant is entitled to judgment as a matter of law
– Same standard as a motion to dismiss for failure to state a claim
• Defendant more likely to use a Rule 12(b)(6) motion (than a 12(c) motion) –
answering limits defendant’s future arguments
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Review of litigation process
Later stages of litigation
• Pre-trial: Discovery
– Initial disclosures (info on witnesses, documents & objects that party may use
to support its claims or defenses; computation of damages; insurance
information)
– Discretionary discovery (e.g., interrogatories, depositions, requests for
producing evidence)
• Pre-trial: Motion for summary judgment
– No genuine dispute as to any material fact, and the moving party is entitled to a
judgment as a matter of law
• Genuine dispute: if a rational factfinder could rule in favor of non-moving party
• Material fact: if fact could affect the outcome of the lawsuit
– Factual inferences are made in light most favorable to non-moving party
• Trial
– No jury trials in Delaware Court of Chancery (it is an equity court)
• Post-trial
– Post-trial motions, enforcement of judgment, appeal
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Shareholder litigation
Overview of Section 1c
1. Derivative actions
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Litigation & legal personality
Economics of class actions
Is the action derivative?
Demand
Special litigation committees
2. Board FD in addressing SH activism
3. SH inspection rights
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Derivative actions
Litigation & legal personality
• Since a corporation is an independent legal person, it can
sue and be sued
• When a corporation suffers harm, SH are indirectly harmed
by the decrease in their shares’ value
– To repair the harm, the corporation must sue
– The board decides whether the corporation will sue, but there is
an agency problem: directors are unlikely to sue when the lawsuit
implicates them
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Derivative actions
Litigation & legal personality
• Hypo (derivative cause of action)
– Danny, David and Dana, C Corp.’s three directors, embezzle $1
million from C Corp.’s treasury
• Steve, a SH, wants to sue the directors
• Does he have a cause of action against the directors?
– Steve writes an angry letter to the corporation, demanding that it
sue its directors
• Board convenes to decide on Steve’s request & votes 3-0 not to sue
• Can’t SHs just vote the directors out?
• Can Steve do something against the directors?
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Derivative actions
Litigation & legal personality
• Modified hypo (direct cause of action)
– C Corp. has two classes of shares:
• A shares are entitled to one vote & one share of the profits
• B shares are entitled to one vote & ten shares of the profits
– The three directors do not embezzle money from the corporation.
Instead, they reconfigure the rights of B shares so that each
provides only two shares of the profits.
•
•
•
•
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Steve, a B SH, wants to sue the directors
Did this change harm the corporation?
Did it harm class B SHs?
Does Steve have a cause of action against the directors?
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Economics of class actions
Risk of extortion by litigation
• Various legal mechanisms constrain SHs who sue the firm & its actors
– Enhanced pleading standards
• E.g., persuasiveness of claim (plausible vs. conceivable)
– “Safe harbors” in substantive law
• E.g., applying BJR (rather than entire fairness) if deal requires SC & MSH approval
• Why impose these constraints? Because SH litigation imposes costs
asymmetrically, creating opportunities to extort the firm
– Firm’s reputation can be harmed by litigation; plaintiff usually doesn’t have a
reputation to risk
– Usually firm/actors can’t counterclaim against SH (SH’s only cost is attorney’s fees)
– Typically firm/actors can’t impose significant discovery costs on SH
– Firm has time-sensitive events that can be thwarted if delayed by litigation
(M&A deals, IPOs, SH meetings)
• Defendants would settle a case if costs less than their litigation costs
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– When litigation costs are asymmetrical, the amount firm would be willing to
offer is greater than litigation costs to plaintiff
– So plaintiff would initiate litigation even without a valid case
– To prevent this, law offers tools to terminate litigation at an early stage
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Economics of class actions
Why do we have class actions?
• When a party inflicts a small amount of harm on a large number of
parties, individual lawsuits aren’t a strong deterrent
– E.g., a store illegally overcharges each of its 1M customers $1/month over two
years (total benefit for store: $24M)
• Total cost for each customer: $24 (not enough to hire a lawyer to sue)
– This is a common problem in SH litigation & especially in derivative actions
• Each SH has a small stake in the firm, so directors can steal $24M from the firm
& it won’t make sense for each of firm’s 1M SHs to sue
• Is it a problem?
– Would harm to reputation suffice to deter the store/directors?
– Would government enforcement suffice to deter the store/directors?
• Solution: class actions
– Class actions allow an individual plaintiff to sue on behalf of all persons with
the same cause of action, and in return plaintiff is reimbursed the legal
expenses incurred in the class action (sort of an “involuntary agency”)
– When a SH sues to vindicate a cause of action belonging to the firm, it is called
a derivative action, and is in essence a class action for all SHs
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Economics of class actions
Who is behind class actions?
• Tooley [Del. 2004]: Credit Suisse acquires DLJ (investment bank)
1.
2.
3.
Credit Suisse buys from AXA (owner of 71% of DLJ) its DLJ shares
Credit Suisse launches a tender offer for the remaining 29%
DLJ merges with Credit Suisse subsidiary (freezeout merger)
• The tender offer (step 2)
– Tender offer to expire after 20 days, but extension is allowed by agreement
between DLJ & Credit Suisse
– DLJ & Credit Suisse agree on additional 22-day extension
– Eventually, tender offer closes successfully & freezeout merger takes place
• The lawsuit
– Tooley (a former DLJ SH) challenges the 22-day extension of the tender offer
– Demands the interest he would have received had the tender offer closed 22
days earlier
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Economics of class actions
Who is behind class actions?
• Why does Tooley bother suing?
– Interest rate Tooley could have received on his money in Oct.-Nov. 2000: 6.55%
[Avg. interest rate on a 1-month CD in October 2000]
• For 22 days, this equals ~0.39%
– If Tooley owned $10,000 of DLJ stock, he’s suing for $39.48
• Would you sue for that much?
– With $39.48 you can hire an experienced attorney (20+ yrs.) for 6 minutes, 14
seconds; or hire an inexperienced attorney (fresh out of law school) for 13’, 10”
[03-04 Laffey Matrix, U.S. Attorney’s Office, District of Columbia]
• The key feature of class actions is that plaintiff’s lawyer (not plaintiff)
is in the driver’s seat
– Class actions enlist lawyers as law enforcers, when SHs & government can’t do
the job adequately
– In SH litigation, this reduces SHs vs. management agency costs but creates SHs
vs. lawyer agency costs
14
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Economics of class actions
Dysfunctional outcomes
• In re Oracle Corp. Derivative Litigation [Cal. Super. 2005]
– Larry Ellison, CEO of software giant Oracle Corp., allegedly engaged in insider
trading, selling some Oracle shares while he knew non-public, disappointing
information about Oracle (which ultimately resulted in a 22% drop in share price)
– Joseph Tobacco Jr., a lawyer, brings a class action in California on behalf of
Oracle SHs. The settlement:
• Ellison promises to donate in Oracle’s name $100M over 5 years to a charity of
Ellison’s choice (Ellison had already been donating over $30M a year)
• Oracle will pay Tobacco’s legal fees of $22.5M
– Benefit to Oracle SHs from this settlement?
– Settling derivative actions is subject to a judge’s approval
• Why would a judge approve a settlement like this one?
• Outcome: In Nov. 2005, a San Mateo Superior Court judge approved the
settlement, but only after it was modified so that Ellison, rather than Oracle,
paid Tobacco’s legal fees
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Economics of class actions
Dysfunctional outcomes
• Why do we see these dysfunctional outcomes?
– Guilty defendants may “bribe” plaintiff’s lawyer
to extinguish a meritorious suit
– Innocent defendants may be extorted by
plaintiff’s lawyer to extinguish a frivolous suit
– Good faith plaintiff’s lawyer may
have preferences that do not
represent most SHs’ preferences
• E.g., plaintiff’s lawyer may sincerely want
Oracle to give more to charity, but this
may not be what most SHs want
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Economics of class actions
Agency solutions in SH litigation
• Litigation (sue the lawyers if they do not represent faithfully)
– SHs won’t sue; decision to sue lawyers suffers from same collective action
problem that justified having class actions in the first place
• Exit (allow dissenting SHs not to participate in the suit)
– This is allowed in many class actions, but is not practical in derivative actions,
where the issue is legal rights of the firm (any action the firm takes affects all
SHs; can’t limit the impact to only some SHs)
• Voice (allow SHs to dismiss the suit)
– SH review (SH meetings to decide whether to pursue each suit)?
• Not feasible: very costly, so extortion problem may become worse
• Compromise solution: Board review (as a representative of SHs)
– If an informed and independent board makes a business judgment that a
derivative suit is not in the firm’s interest, court will not second guess that
– Because a SH, not the board, initiates the suit, a process (called a demand on
the board) is needed to facilitate board review:
• Alert the board to plaintiff’s allegations
• Allow the board to make a business judgment whether firm should sue
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Economics of class actions
Agency solutions in SH litigation
• Rules that apply to derivative suits (Del.Ch. Rule 23.1)
– Plaintiff must have been a SH at time of the alleged wrong & maintained that
status throughout the litigation (“contemporaneous ownership requirement”)
• Weeds out some opportunistic plaintiffs (who bought shares in order to litigate)
• How can an opportunistic lawyer get around this requirement?
– SH must ask board to sue before suing derivatively (“demand requirement”)
• Facilitates board review (to keep plaintiff’s lawyer accountable)
• In some jurisdictions (e.g., MBCA), demand is universal (must always be made);
in other jurisdictions (e.g., Delaware), demand is excused when it is futile – the
differences will be explored in the next sub-section
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Is the action derivative?
Tooley v. DLJ [Del. 2004]
• Tooley (a former DLJ SH) challenges a 22-day extension of the tender
offer, demanding (as damages for an allegedly unlawful extension)
the interest he would have received had the tender offer closed 22
days earlier
• Tooley’s problem
– Why is Tooley a former SH?
– Contemporaneous ownership requirement: Tooley must hold shares both at
time of challenged transaction & throughout lawsuit
– Result: If the suit is derivative, it must be dismissed since Tooley no longer
owns the DLJ shares
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Is the action derivative?
Tooley v. DLJ
• Del. Ch. Court Rule 23.1: “In a derivative action brought up by 1 or
more shareholders… to enforce a right of a corporation…”
– A suit is derivative when the cause of action belongs to the firm; but how do
we know if a cause of action belongs to the firm or the SHs?
• Tooley court rejects two old tests:
– Whether there was a “special injury” suffered only by some SHs (Lipton)
– Presumption that claim is derivative if it affects all SH equally (Bokat)
• Tooley test – whether suit is derivative or direct is based on:
– Who suffered the alleged harm – corporation or plaintiff SH individually?
– Who would receive the benefit of recovery or other remedy?
• Agostino v. Hicks is endorsed by the Tooley court
– “Looking at the body of the complaint and considering the nature of the wrong
alleged and the relief requested, has the plaintiff demonstrated that he or she
can prevail without showing an injury to the corporation?”
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Is the action derivative?
Tooley v. DLJ
• Applying the Tooley test to the DLJ situation
– Court: The complaint does not state a derivative action, because it
does not show how DLJ suffered an injury
– However, claim is not direct either, because Tooley had no
contractual right to be paid on Oct. 5 rather than Nov. 2
– Result: Complaint states no claim at all – neither direct nor
derivative. Dismissal was proper, but on different grounds than
the Chancery Court stated.
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Is the action derivative?
Who can sue derivatively? (In Del.)
• Common SHs - Yes
• Preferred SHs – Yes, unless this right was specifically limited in
charter or another “appropriate document” [Maginn (Del. Ch. 2010)]
• Creditors [Gheewalla (Del. 2007)]
– Yes, when firm is insolvent
– Unclear, when firm is in the “zone of insolvency”
– No, in all other situations
• Directors – No (though courts may allow in future if needed to
prevent “complete failure of justice”) [Schoon (Del. 2008)]
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Demand
Delaware
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Demand
MBCA (universal demand)
• MBCA §7.42
– A demand is required in all derivative actions
– SH must not bring suit for 90 days after demand is made, unless irreparable
injury would result, or board rejected demand
• MBCA §7.44 - Alternatives for review of the demand:
– If independent directors constitute a quorum, the demand may be reviewed by
the board (but only the independent directors vote)
– In all cases, the independent directors may appoint by majority vote a
committee of two or more independent directors to review the demand
– Upon motion by corporation, court may appoint an independent panel
• MBCA §7.44 (continued)
– If the reviewing institution determines in good faith, after conducting a
reasonable investigation, that the maintenance of the derivative action is not in
the best interest of the corporation, the court will dismiss the complaint
(without examining the reasonableness of the determination)
– Burden of proof as to good faith and reasonable investigation lies on:
• SH, if majority of board is independent, or review was by court appointed panel
• Corporation, if majority of board is not independent
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Demand
Delaware (excusable demand)
• Delaware has a narrower demand requirement: Where the directors
cannot be expected to make a fair decision, demand would be futile
and is excused
• If a demand was made, the directors may reach a decision whether
the company should pursue the cause of action
– BJR applies to the board decision, unless rebutted
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Demand
Delaware: litigation strategy
• Under Del. law, demand must be made unless it is futile
– Making a demand is deemed a concession that a demand was required
• If demand is made, board’s decision regarding the demand benefits
from the BJR, unless it is rebutted
– At this point, plaintiff isn’t entitled to discovery, so info on firm must come from
public sources & SH inspection rights
– Why is this important?
• Result: Plaintiff usually loses if demand was made & board rejected it
• Harm to plaintiff from foregoing demand?
– If demand is required & plaintiff didn’t make the demand, litigation will be
stayed while plaintiff makes the demand
• Conclusion: Typically, a plaintiff will not make a demand, and instead
argue that demand was excused
– So most litigation is about whether demand was futile (rather than whether
demand was wrongfully rejected)
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Demand
Delaware: demand excusal
• Primary test: Aronson v. Lewis [Del. 1984]: Demand requirement is
excused if plaintiff shows reasonable doubt that either:
– Majority of the board is independent for purpose of responding to the
demand (@ time complaint is filed)
– Challenged action is protected by the BJR
• Alternative test: Rales v. Blasband [Del. 1993]: test includes only 1st
prong (board independence in responding to demand); applies when:
– P’s claim arises out of board inaction
– P’s claims arise out of transaction not involving a board decision
– A majority of directors that decided on underlying transaction was
replaced by independent directors
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Demand
Delaware: demand excusal
• Beam v. Stewart (Del. 2004): “To create a reasonable doubt as to an
outside director’s independence, a plaintiff must plead facts that would
support the inference that… the non-interested director would be more
willing to risk his or her reputation than risk the relationship with the
interested director.”
• A director is not independent if she:
– has a material interest in the challenged transaction; or
– is dominated/controlled by the alleged wrongdoer or an interested party
• A director may be independent even if she:
– approved the challenged transaction;
– was named as a defendant in the derivative action; or
– was nominated by the alleged wrongdoer
• In Beam, Martha Stewart controlled 94% of MSO, but in itself this did not
create a reasonable doubt regarding the directors’ independence
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Demand
Zucker v. Andreessen [Del. Ch. 2012]
• Actress Jodie Fisher accused Hewlett-Packard CEO Mark Hurd of
sexual harassment, falsifying expense reports & disclosing sensitive
information
• Board investigated, found evidence of falsifying reports (but not
harassment); decided to fire Hurd
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Demand
Zucker v. Andreessen
• Severance agreement gave Hurd $40M in benefits (more than HP was
obligated to give if he resigned or was fired for cause)
• Severance agreement required Hurd:
–
–
–
–
to extend provisions in Hurd’s earlier confidentiality agreements
to release any claims he had against HP
not to disparage HP
to cooperate with HP on future investigations & CEO succession
• Board appoints CFO as interim CEO; begins CEO search
• Zucker, a SH, sues derivatively, alleging that the board:
– committed waste in awarding Hurd $40M while HP received no benefit
– breached duty of care in failing to implement CEO succession plan
• No demand was made, so Zucker needs to show demand was
excused or the suit will be dismissed
• Does Aronson or Rales apply to each of these claims:
– committing waste by awarding Hurd $40M without a benefit to HP?
– breaching duty of care by failing to implement CEO succession plan?
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Demand
Zucker v. Andreessen
• The waste allegation (Aronson)
– Reasonable doubt that the board is independent in responding to a demand?
– Reasonable doubt that challenged act (decision to sign severance agreement) is
protected by the BJR?
• Failure to implement CEO succession plan (Rales)
– Reasonable doubt that the board is independent in responding to a demand?
• Zucker claims board conceded demand futility by forming a
committee to investigate
– Relies on Sutherland, where petition from a Special Litigation Committee (SLC)
to dismiss suit was seen to preclude firm from later requesting dismissal for
demand futility
– Court distinguishes from Sutherland – here committee is not SLC & did not
petition for dismissal
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Special litigation committees
Vulnerability of biased boards
• Firms get one more chance to dismiss a derivative suit when demand
is futile, by forming a Special Litigation Committee
– This is because fair decisions that happen to have been made by a conflicted
board create attractive targets for strike suits
• Firm asks court to apply BJR (i.e., defer) to a decision of an SLC
(composed of disinterested directors) that the derivative action lacks merit
– Unlike demand futility litigation, in SLC litigation plaintiff is entitled to limited
discovery (as to the independence of the SLC members)
• Most states simply apply BJR analysis to SLC’s decision
• Delaware applies two steps (Zapata Corp. v. Maldonado [Del. 1981])
– Quasi-BJR analysis to SLC’s decision
• SLC independence
• SLC good faith
• Reasonable bases for the SLC’s recommendations
– Court may apply its own “independent business judgment” as to
whether to dismiss the suit
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Special litigation committees
In re Oracle Deriv. Litig. [Del. Ch. 2003]
• Plaintiffs allege that four directors of Oracle – Ellison, Henley, Lucas
and Boskin - engaged in insider trading
• Upon being sued, Oracle appoints an SLC of two new directors
(weren’t on the board when alleged events took place)
– Garcia-Molina: chairman of Stanford’s computer science department
– Grundfest: professor at Stanford law school
• Directs Stanford’s director college & the program in law, business and corporate
governance. Is this a coincidence?
33
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Special litigation committees
Oracle
• Compensation: $250/hour (below their market price)
– To preserve their objectivity, SLC members agreed to give up compensation if
court determined that it impaired their impartiality
• Advisors’ objectivity
– The SLC hires legal counsel (Simpson Thacher) & economists (NERA). Court
examines the advisors’ objectivity and finds no problem.
– What evidence would taint the advisors’ objectivity?
• SLC’s report
– SLC interviewed 70 witnesses. Its report was 1,110 pages long. Court finds no
problems with the SLC’s investigation procedure
– SLC recommends to dismiss the claims
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Special litigation committees
Oracle
Legal analysis (Zapata)
• Step 1: Quasi-BJR analysis
– SLC members’ independence
– SLC members’ good faith
– Reasonable bases for the SLC’s recommendations
• Step 2: “Independent business judgment”
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Special litigation committees
Oracle
SLC members’ independence
Ellison
Garcia-Molina
Boskin
Lucas
Grundfest
What the SLC report disclosed:
• Boskin is a Stanford Professor
• Lucas made certain donations to Stanford, and donated $50,000 to after Grundfest
delivered a speech to a Venture Capital Fund in which Lucas’ son is a partner (half the
money went to Grundfest’s research account)
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Special litigation committees
Oracle
Boskin
• Taught Grundfest when G was a Ph.D. student
• Both Boskin & Grundfest are steering committee members at the
Stanford Institute for Economic Policy Research
Lucas
• A major donor to Stanford Law School & Stanford Institute for
Economic Policy Research
Ellison
• Ellison & Oracle make significant contributions to Stanford
• But: Ellison’s child applied to Stanford and was rejected
– Ellison apparently continued to consider donations to Stanford after this
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Special litigation committees
Comparing Beam & Oracle
Oracle: “Homo sapiens is not merely
homo economicus… an array of other
motivations exist to influence human
behavior… envy… love, friendship,
and collegiality.”
Beam: “…for presuit demand purposes,
friendship must be accompanied by
substantially more…”
• Why is the analysis and outcome different?
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Shareholder litigation
Overview of Section 1c
1. Derivative actions
2. Board FD in addressing SH activism
– Historical background on SH activism
– Legal analysis of Board FD in influencing SH voting
3. SH inspection rights
39
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Board FD in addressing SH activism
Historical background on SH activism
What’s so special about the 1980s?
• Weinberger (1983)
• Van Gorkom (1985)
• Unocal (1985)
• Revlon (1986)
• Blasius (1988)
80s
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Board FD in addressing SH activism
Historical background on SH activism
Corporate America in the 1980s
Start a bit earlier…
Post-World War 2 Corporate America
1. Management as an expertise
2. Diversification theory
Result: trend towards conglomerates
• More predictable profits
• But lower profits
• Low debt (reliance on reinvested profits)
3. Bond market primarily used by large, creditworthy firms
•
•
Small & less creditworthy firms borrow from banks/customers/suppliers
Firms that can borrow large amounts are a small, elite club
Result: hostile takeovers are rare
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Board FD in addressing SH activism
Historical background on SH activism
Corporate America in the 1980s

Trends
Mutual funds become popular


Less demand for investing in conglomerates
Junk bond finance emerges


Don’t need to be a conglomerate to access
bond market
“Nobodys” can borrow enough money to
take over big, established firms
 This breaks up the “gentlemen’s code”
that discouraged hostile takeovers…
 … Just at a time that out-of-fashion
conglomerates are juicy targets for
hostile takeovers
Fake cover of Fortune magazine,
used in the movie Wall Street
42
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Board FD in addressing SH activism
Historical background on SH activism
Corporate America in the 1980s
Results

Hostile takeovers increase


Conglomerates are broken up
Boards try to preempt potential raiders


Increasing SH profit rather than firm stability
Increasing short-term profitability


Keeping less cash & borrowing more


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Long-term plans that depress short-term
results invite hostile takeovers
Harder to turn quick profit from hostile takeover
when company has little cash & much debt
Also, using more borrowed money increases
both risk & return of the company
© Amitai Aviram. All rights reserved.
From: Financial Times (2/21/09)
Board FD in addressing SH activism
Blasius Indus. v. Atlas Corp. [Del. Ch. 1988]
• Lubin & Delano control Blasius (a private equity firm)
– Raises money from public by selling junk bonds
– Looks for poorly performing firms to buy, fix & sell
• Atlas realizes it is a potential takeover target
–
–
–
–
–
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Atlas owns a variety of businesses; profitability low
Weaver (CEO) sells 3 of 5 divisions
Closes domestic Uranium operations
Focuses on gold-mining business
How does this plan make Atlas less of a takeover target?
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Board FD in addressing SH activism
Blasius
• But is Atlas too late?
– Blasius buys 9.1% of Atlas’ common stock
– Blasius announces it considers taking control of Atlas
• Atlas considers its response
– Atlas CEO (Weaver) writes in his diary: “All agree we must dilute
these people down by the acquisition of another Co. w/stock, or
merger or something else.”
– What does he mean?
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Board FD in addressing SH activism
Blasius
• Blasius presents its plan for Atlas: Leveraged restructuring
– Under the plan, Atlas will sell assets & borrow money (using its
assets, such as gold reserves, as collateral). Atlas will then
distribute this money as dividends.
– Example: Suppose Atlas has $150 in assets & no debt
• Atlas sells $50 in assets, then borrows another $90, secured by the
remaining assets ($100). Atlas then distributes a dividend of $140.
• Atlas now has $100 in assets and $90 in debt
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Board FD in addressing SH activism
Blasius
• Atlas drags its feet
–
–
–
–
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Atlas takes a month until it meets with Blasius to hear its plan
Meet on Dec. 2
Atlas doesn’t want to meet again until January
Why is Atlas stalling?
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Board FD in addressing SH activism
Blasius
• Blasius attacks: Solicits SHs for a written consent
– Resolution recommending the board implements Blasius’ plan
• Why not order implementation of the plan?
• And why bother recommending?
– Amend Atlas’ bylaws to expand the board from 7 to 15 members
• 15 is maximum size allowed under Atlas’ charter
– Fill the eight new board positions with Blasius’ nominees
– What’s the effect of the written consent?
• Note: Atlas had a staggered board
– Why use a written consent (rather than SH meeting)?
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Board FD in addressing SH activism
Blasius
• Atlas’ board counter-attacks
–
–
–
–
Weaver decides to add two directors to the board
Wants a board meeting that day, but doesn’t have a quorum
Has a telephone meeting the following day
Board amends bylaws to expand board from 7 to 9 and appoint
two directors (Atlas’ board’s nominees)
– What is the effect of the board’s actions?
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Board FD in addressing SH activism
Blasius
• To decide on SoR, court determines that:
– Board’s actions were intended to thwart Blasius’ written consent
solicitation
– But board did not act for the purpose of entrenchment; they
thought Blasius’ plan was bad
• Suppose the court found that the board’s purpose was not
to thwart Blasius
– What SoR applies to the board’s actions now?
• Now suppose the court found that the board’s purpose was
to keep their jobs (entrenchment)
– What SoR applies to the board’s actions now?
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Board FD in addressing SH activism
Blasius
• If plaintiff proves that the board acted for the primary purpose of
interfering with the free exercise of the SHs’ franchise, board must
demonstrate that there was a compelling justification for its actions
– Blasius court: Atlas board didn’t have a compelling justification
• Mercier v. Inter-Tel (Del.Ch. 2007) re-interprets Blasius as an
application of the enhanced scrutiny SoR to cases of SH voting
• Enhanced scrutiny SoR applies when the board deploys corporate
power against SHs to achieve greater good for the corporation
1.
Quasi-BJR: did the board find, in good faith & after a reasonable
investigation, that firm faced a threat that warranted the board’s act?
•
•
•
2.
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Purpose: board must identify a legitimate threat/purpose justifying its act
Good faith: duty of loyalty analysis (no self-dealing or bad faith)
Reasonable investigation: duty of care analysis (no negligence)
Was the act a reasonable response proportionate to the threat posed?
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Shareholder litigation
Overview of Section 1c
1. Derivative actions
2. Board FD in addressing SH activism
3. SH inspection rights
52
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SH inspection rights
Purposes
• SH inspection rights can:
– Facilitate SH voting: getting non-public information that will
persuade SHs to support an insurgent in proxy contest (e.g.,
uncovering info that shows the board did a poor job managing the
firm & shouldn’t be re-elected)
– Facilitate SH litigation: getting non-public information that
sufficiently substantiates allegations that the complaint survives a
motion to dismiss
• Why not give SH an automatic right to access all of the
corporation’s info?
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SH inspection rights
DGCL
• Proper purpose (DGCL §220(b))
– SH must make a written demand, presenting a “proper purpose”
(i.e., a purpose “reasonably related to such person’s interest as a
stockholder”)
• Who has BoP whether purpose is proper? (DGCL §220(c))
– If SH seeks access to the SH list, BoP on the firm to show that SH
does not have a “proper purpose”
– If SH seeks access to other corporate records, BoP on the SH to
prove “proper purpose”
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SH inspection rights
Pershing Square v. Ceridian [Del. Ch. 2007]
• Pershing Square, a hedge fund, is Ceridian’s largest SH (11.3%)
– Ackman is its portfolio manager
• Comdata is Ceridian’s largest operating subsidiary
– Krow is Comdata’s president
• Ackman learns that Krow sold Ceridian stock; calls Krow to learn why
– How does Ackman know about Krow’s sale of stock?
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SH inspection rights
Pershing Square v. Ceridian
• Krow tells Ackman he’s about to quit because he disagrees with the
business strategy pursued by Marinello, Ceridian’s new CEO
– Krow wants Comdata spun off
– Marinello prefers to keep Comdata & make new acquisitions
– What motivates Marinello, Krow and Ackman in choosing between the
strategies?
– Ackman & Krow discuss Pershing Square running a
slate of directors at the upcoming elections
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Gary
Krow
Kathryn
Marinello
SH inspection rights
Pershing Square v. Ceridian
• Krow meets with Ackman at an airport
– Tells Ackman which Ceridian SHs supported a Comdata spin-off and would
support Ackman’s director slate
– Also tells Ackman that he wrote two letters to Ceridian’s board, detailing
mismanagement by the previous Ceridian CEO & hinting that the board failed
to oversee the CEO
– How is the info useful for Pershing’s bid to elect directors?
• Previous CEO was terminated & replaced by Marinello, but Krow
thinks that the letters damaged his relationship with the board &
Marinello was hired with the intention of firing Krow
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SH inspection rights
Pershing Square v. Ceridian
• Pershing makes a DGCL §220 demand to receive:
– A copy of Ceridian’s current bylaws
– SH list
– Copies of the two letters Krow mentioned
• Ceridian provides bylaws & SH list; refuses to provide the letters
– Claims confidentiality & lack of proper purpose
• Court examines stated purposes
• Purpose is proper if it is reasonably related to one’s interest as a SH
– Investigating suitability of directors
– Communicating with fellow shareholders about board elections
• Ceridian: This makes every board-level document available for inspection
– Court: stating a proper purpose does not automatically grant inspection rights
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SH inspection rights
Pershing Square v. Ceridian
• Conditions for SH inspection right:
1. Written demand from a shareholder (record owner or beneficial owner)
2. Proper purpose
– Purpose is proper if it is reasonably related to one’s interest as a SH
– That purpose must be SH’s true/primary purpose
– SH must have evidence establishing a credible basis for that purpose
3. Proper records
– Requested records are necessary & essential for the purpose
– Safeguards may be imposed to protect confidentiality of the records
• In this case:
– Pershing’s stated purposes are proper
– But Pershing’s true purpose is improper: finding a legal vehicle to publicly
broadcast improperly obtained confidential information
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