Saturday, November 28, 2015
A short while ago, some commentators declared that the Treasury had successfully ended corporate inversions. But after several recent corporate migrations, reports of the inversion’s death appear to have been greatly exaggerated.
A corporate inversion is a complicated and costly transaction used by American corporations to avoid particularly burdensome aspects of the U.S. tax code. The United States not only enforces the OECD’s highest corporate tax rate (the tax rate for most U.S. corporations ranges between 35% to 39%) but also worldwide taxation. This latter feature subjects an American corporation’s entire revenue stream to the United States’ extraordinary tax rate, whereas most countries tax only what is earned inside their territorial borders. In simplified terms, a corporation hoping to invert must merge with a foreign corporation—while satisfying some very idiosyncratic conditions—in order to reorganize in the foreign company’s country. After inverting, a company’s foreign generated income becomes subject to more favorable foreign tax rates, though it must still pay U.S. taxes on domestically generated revenue.
The rhetoric surrounding inversions has been heating up since Pfizer announced its intentions to invert into an Irish entity after acquiring Allegran in a $160 billion deal. The chief complaint against inversions is that inverted companies avoid their “fair share” of taxes (the United States likely lost 33.6 billion in tax revenue in 2014 alone). Not only that, the inversion trend perhaps shifts research and development and intellectual property innovation to foreign countries (see this excellent article by Omri Marian). President Obama famously declared that inversions are “unpatriotic,” Jon Stewart warned his viewers of the “Inversion of the Moneysnatchers,” and countless politicians have proposed ending the inversion loophole.
But why should we demonize inverted companies. First, consider an old Learned Hand quote: “[a]nyone may arrange his affairs so that his taxes shall be as low as possible; he is not bound to choose the pattern which best pays the treasury.” And considering that inverted companies must still pay U.S. taxes on U.S. generated income, the process shields only foreign-based revenue with which the United States has limited association. In fact, if the internal affairs doctrine incentivizes companies to incorporate in whichever U.S. state they wish, why should this policy not include foreign countries?
In the end, what to do about inversions presents a number of complex issues. Critics offer very accurate arguments concerning the deleterious effects of inversions. However, in light of previous attempts, it seems quite unlikely that the tax code could be amended to prohibit future companies from inverting. As of a couple days ago the Treasury just added new inversion restrictions with the caveat that there is only so much that the Treasury can do. Indeed either lowering the corporate tax rate or ending worldwide taxation would likely be the most effective anti-inversion policy. Or the United States could take better aim at the income shifting transactions that corporations use to repatriate foreign income into the United States. But probably the best first step is for us to quit viewing inversions normatively; any well-informed policy prescription should avoid the very commonly used rhetoric of “good” guys and “bad” guys. After all, companies are just following incentivizes that the law offers.
For an excellent discussion of inversions, please read this Virginia Law Review article by Eric Talley.
Friday, November 27, 2015
I try to read everything Lyman Johnson writes, so my Thanksgiving break reading is his recent book chapter The Reconfiguring of Revlon. The abstract is below:
Three decades later, an irksome uncertainty still impedes a settled understanding of the Delaware Supreme Court’s landmark ruling in Revlon, Inc. v. MacAndrews & Forbes Holdings, Inc. For such a towering doctrine, Revlon’s underlying rationales remain controversial, its exact contours and demands continue to be surprisingly unclear, and it holds out scant hope for remedial relief. In spite of these troubling features of today’s Revlon jurisprudence, however, Revlon is slowly being worked back into the larger fabric of Delaware’s fiduciary duty law and away from being a gangling, standalone doctrine. The organizing themes of this judicial project are strong deference in the deal context to decisions made by independent directors without regard to deal structure, the substantially reduced likelihood of equitable or monetary remedies in all types of deal-related lawsuits, and a nascent effort at harmonizing Revlon with Delaware’s more general, and ill-defined, doctrine on corporate purpose.
This chapter discusses the original Revlon decision and its rapid expansion before turning to lingering uncertainties surrounding the reach of Revlon, the decline of Revlon’s remedial clout, and where Revlon stands today in relation to Delaware’s overall fiduciary duty law. Revlon’s sharp focus on immediate value maximization was a breakthrough pronouncement on corporate purpose, a subject of longstanding national debate but one on which the Delaware Supreme Court had been strangely silent. However, grave reservations about whether and when corporate directors should be required to pursue short term goals found useful cover in sustained judicial murkiness over the boundaries of Revlon. Only if Delaware courts resolve the underlying issue of corporate purpose more generally will Revlon either be fitted into the larger body of Delaware law or continue to stand uncomfortably to the side as a doctrinal loner of diminished significance.
Monday, November 23, 2015
Last week was the 30th anniversary of the Delaware Supreme Court’s decision in Moran v. Household International, Inc., 500 A.2d 1346 (Del. 1985). In Moran, decided on Nov. 19, 1985, the Delaware Supreme Court upheld what has become the leading hostile takeover defensive tactic, the poison pill.
Martin Lipton, the primary developer of the pill, even makes an appearance in the case—and obviously a carefully scripted one: “The minutes reflect that Mr. Lipton explained to the Board that his recommendation of the Plan was based on his understanding that the Board was concerned about the increasing frequency of ‘bust-up’ takeovers, the increasing takeover activity in the financial sector industry, . . . , and the possible adverse effect this type of activity could have on employees and others concerned with and vital to the continuing successful operation of Household even in the absence of any actual bust-up takeover attempt.”
I’m not sure the takeover world would be that different today if Moran had rejected poison pills. I’m reasonably confident the Delaware legislature would have amended the Delaware statute to overturn the ruling, as they effectively did with another ruling decided earlier that same year, Smith v. Van Gorkom, 488 A.2d 858 (Del. 1985). Shortly after Van Gorkom made it clear that directors might actually be liable for violating the duty of care, the legislature added section 102(b)(7) to the Delaware law, allowing corporations to eliminate any possibility of damages for duty-of-care violations.
As my colleague Joan Heminway has pointed out, 1985 was an incredibly important year for M & A practitioners. In addition to Moran and Van Gorkom, a third major case was also decided that year: Unocal Corp. v. Mesa Petroleum Co., 493 A.2d 946 (Del. 1985).
Van Gorkom was decided in late January of 1985, Unocal in June, and Moran in November. Corporations casebooks and treatises are filled with Delaware Supreme Court decisions, but that has to be one of the most important ten-month periods in Delaware corporate law jurisprudence—especially in the mergers and acquisitions area.
Wednesday, October 28, 2015
Earlier this month BLPB editor Ann Lipton wrote about the Delaware Supreme Court opinion in Sanchez regarding director independence (Delaware Supreme Court Discovers the Powers of Friendship). On the same day as the Del. Sup. Ct. decided Sanchez, it affirmed the dismissal of KKR Financial Holdings shareholders' challenge to directors' approval of a buyout. The transaction was a stock-for-stock merger between KKR & Co. L.P. (“KKR”) and KKR Financial Holdings LLC (“Financial Holdings”). Plaintiffs alleged that the entire fairness standard should apply because KKR was a controlling parent in Financial Holdings. The controlling parent argument hinged on the facts that:
Financial Holdings's primary business was financing KKR's leveraged buyout activities, and instead of having employees manage the company's day-to-day operations, Financial Holdings was managed by KKR Financial Advisors, an affiliate of KKR, under a contractual management agreement that could only be terminated by Financial Holdings if it paid a termination fee.
Chief Justice Strine, writing an en banc opinion for the Court, upheld Chancellor Bouchard's finding that KKR could not be considered a controlling parent where "KKR owned less than 1% of Financial Holdings's stock, had no right to appoint any directors, and had no contractual right to veto any board action."
The Delaware Supreme Court upheld the familiar standard of effective control, absent a majority, which focuses on "a combination of potent voting power and management control such that the stockholder could be deemed to have effective control of the board without actually owning a majority of stock."
Chancellor Bouchard had noted that plaintiff's complaint stemmed from dissatisfaction at the contractual relationship between KKR and Financial Holdings which limited the growth of Financial holdings. Chancellor Bouchard wrote:
At bottom, plaintiffs ask the Court to impose fiduciary obligations on a relatively nominal stockholder, not because of any coercive power that stockholder could wield over the board's ability to independently decide whether or not to approve the merger, but because of pre-existing contractual obligations with that stockholder that constrain the business or strategic options available to the corporation.
Sometimes a "nothing new" case provides a good reminder of an established standard and provides clear language for recapping the concept to students. This will become a note case on "effective" control in my ChartaCourse corporations casebook and also a good illustration of the role of private agreements in shaping how legal standards are applied.
You can read the opinion at: Corwin et al. v. KKR Fin. Holdings et al., No. 629, 2014, 2015 WL 5772262 (Del. Oct. 2, 2015).
Wednesday, September 9, 2015
A while back, the CLS Blue Sky Blog featured a post by Michael Peregrine on an article authored by Delaware Supreme Court Chief Justice Leo Strine (Documenting The Deal: How Quality Control and Candor Can Improve Boardroom Decision-making and Reduce the Litigation Target Zone, 70 Bus. Law. 679 (2015)) offering pragmatic advice to corporate directors in deal-oriented decision making. Michael's post summarizes points made by Justice Strine in his article, including (of particular importance to legal counsel) those set forth below.
- "Counsel can play an important role in assuring the engagement of the strongest possible independent financial advisor, and structuring the engagement to confirm the provision of the full breadth of deal-related financial advice to the board; not simply the delivery of a fairness opinion or similar document."
- "[I]n the M&A process, it is critical to be clear in the minutes themselves about what method is being used, and why."
- "Lawyers and governance support personnel should be particularly attentive to documenting in meeting minutes the advice provided by financial advisors about critical fairness considerations or other transaction terms, and the directors’ reaction to that advice."
- "[P]laintiffs’ lawyers are showing an increasing interest in seeking discovery of electronic information that may evidence the attentiveness of individual directors to materials posted on the board portal."
Michael concludes by noting the thrust of Justice Strine's points--that "a more thoughtful approach to the fundamental elements of the M&A process will enhance exercise of business judgment by disinterested board members, and their ability to rely on the advice of impartial experts." All of the points made reflect observations of the Chief Justice emanating from Delaware jurisprudence. Michael also notes that the points made by Justice Strine have application to decision making in other forms of business association as well as the corporation.
I could not agree more with the thesis of the post and the article. Maybe it's just my self-centered, egotistical, former-M&A-lawyer self talking, but good lawyering can make a difference in M&A deals and the (seemingly inevitable) litigation that accompanies them. I wrote about this in my article, A More Critical Use of Fairness Opinions as a Practical Approach to the Behavioral Economics of Mergers and Acquisitions, commenting on Don Langevoort's article, The Behavioral Economics of Mergers and Acquisitions. We should be teaching this in the classroom as we frame the lawyer's role in M&A transactions. I use a quote from Steve Bainbridge to introduce this matter to my Business Associations, Corporate Finance, and Cross-Border M&A students:
Successful transactional lawyers build their practice by perceptibly adding value to their clients’ transactions. From this perspective, the education of a transactional lawyer is a matter of learning where the value in a given transaction comes from and how the lawyer might add even more value to the deal.
Stephen M. Bainbridge, Mergers and Acquisitions 4 (2003). Great stuff, imv. I am sure this quote or one like it is in the current version of this book somewhere, too. But I do not have that with me as I write this. Perhaps if Steve reads this he will add the current cite to the comments . . . ?
At any rate, I want to make a pitch for highlighting the role of the lawyer in guiding the client through the legal minefields--territory that only we can help clients navigate most efficaciously. As business law educators, we have a podium that enables us to do this with law students who are lawyers-in-training about to emerge from the cocoon-like academic environment into the cold, cruel world in which fiduciary duty (derivative and direct) and securities class action litigation is around every transactional corner. Let's give them some pointers on why and how to take on this task!
Wednesday, September 2, 2015
As many readers already know, I teach Corporate Finance in the fall semester as a three-credit-hour planning and drafting seminar. The course is designed to teach students various contexts in which valuations are used in the legal practice of corporate finance, the key features of simple financial instruments, and legal issues common to basic corporate finance transactions (including M&A). In the process of teaching this substance, I introduce the students to various practice tips and tools.
As part of teaching M&A in this course and in my Advanced Business Associations course, I briefly cover the anatomy of an M&A transaction and the structure of a typical M&A agreement. For outside reading on these topics, I am always looking for great practical summaries. For example, Summary of Acquisition Agreements, 51 U. Miami L. Rev. 779 (1997), written by my former Skadden colleagues Lou Kling and Eileen Nugent (together with then law student, Michael Goldman) has been a standard-bearer for me. In recent years, practice summaries available through Bloomberg, LexisNexis, and Westlaw (Practical Law Company) have been great supplements to the Miami Law Review article. In our transaction simulation course, which is more advanced, I often assign part of Anatomy of a Merger, written many moons ago by another former Skadden colleague, Jim Freund. Just this past week, I came across a new, short blog post on the anatomy of a stock purchase agreement on The M&A Lawyer Blog. Although I haven't yet given the post a review for teaching purposes, it is a nice summary in many respects and makes some points not made in other similar resources.
I will be revisiting my approach to the M&A part of my Corporate Finance course in the coming weeks. I am curious about how others teach M&A in a context like this--where the topic must be covered in about three-to-five class hours and include practice points, as well as a review of doctrine, theory, and policy. I am always interested in new materials and approaches that may reach more students better. I invite responses in the comments that may be useful to me and others.
Wednesday, August 26, 2015
Yesterday, my husband and I celebrated our 30th wedding anniversary. I am married to the best husband and dad in the entire world. (Sorry to slight all of my many male family members and friends who are spouses or fathers, but I am knowingly and seriously playing favorites here!) My husband and I bought the anniversary memento pictured below a few years ago, and it just seems to be getting closer and closer to the reality of us as a couple (somewhat endearing, but aging) as time passes . . . .
Of course, our wedding was not the only important event in 1985. There's so much more to celebrate about that year! In fact, it was a banner year in business law. Here are a few of the significant happenings, in no particular order. Most relate to M&A doctrine and practice. I am not sure whether the list is slanted that way because I (a dyed-in-the-wool M&A/Securities lawyer) created it or whether the M&A heyday of the 1980s just spawned a lot of key activity in 1985.
- Smith v. Van Gorkom was decided. It was my 3L year at NYU Law. I remember the opinion being faxed to my Mergers & Acquisitions instructor during our class and being delivered--a big stack of those goofy curly thermal fax paper sheets--to the table in the seminar room where we met. Cool stuff. As I entered practice, business transactional lawyers were altering their advisory practices and their board scripts to take account of the decision.
- Unocal v. Mesa Petroleum was decided. The Delaware Supreme Court established its now famous two-part standard of review for takeover defenses, finding that "there was directorial power to oppose the Mesa tender offer, and to undertake a selective stock exchange made in good faith and upon a reasonable investigation pursuant to a clear duty to protect the corporate enterprise. Further, the selective stock repurchase plan chosen by Unocal is reasonable in relation to the threat that the board rationally and reasonably believed was posed." (The italics were added by me.) More changes to transactional practice . . . .
- Moran v. Household International was decided. As a result, I spent a large part of my first five years of law practice promoting and writing poison pills that innovated off the anti-takeover tool validated in this case. The firm I worked for was on the losing side of the Moran case, so we determined to build a better legal mousetrap, which then became the gold standard.
- The Revised Uniform Limited Partnership Act (RULPA) was amended by the Uniform Law Commission. Among the 1985 changes was an evolution of the rules relating to the liability of limited partners for partnership obligations. The 2001 version of the RULPA took those evolutions to their logical end point, allowing limited partners to enjoy limited liability for partnership obligations even if the limited partners exercise management authority over the partnership.
- Landreth Timber Co. v. Landreth was decided. Stock is a security under the Securities Act of 1933, as amended, unless the context otherwise requires. The Court determined that instruments labeled stock that have the essential attributes of stock should be treated as stock in an offering context, even when the stock is transferred to sell a business. Bye-bye "sale of business" doctrine . . . .
That's enough on 30th anniversaries for this post. I am sure you all will think of more 30th anniversaries in business law that we can celebrate in 2015. Feel free to leave those additional 1985 memories in the comments.
Friday, August 21, 2015
In this interview, Delaware Supreme Court Chief Justice Leo Strine singles out C & J Energy Services, Inc. v. City of Miami General Employees’ ("Nabors"), 107 A.3d 1049 (2014) as, perhaps, the most important opinion he has authored as CJ.
Given such an endorsement, I took time to read the case yesterday. The following paragraphs get to the heart of the case, which overturned the Delaware Court of Chancery's mandate to shop the company at issue.
Revlon does not require a board to set aside its own view of what is best for the corporation’s stockholders and run an auction whenever the board approves a change of control transaction. As this Court has made clear, “there is no single blueprint that a board must follow to fulfill its duties,” and a court applying Revlon ‘s enhanced scrutiny must decide “whether the directors made a reasonable decision, not a perfect decision.”
In a series of decisions in the wake of Revlon, Chancellor Allen correctly read its holding as permitting a board to pursue the transaction it reasonably views as most valuable to stockholders, so long as the transaction is subject to an effective market check under circumstances in which any bidder interested in paying more has a reasonable opportunity to do so. Such a market check does not have to involve an active solicitation, so long as interested bidders have a fair opportunity to present a higher-value alternative, and the board has the flexibility to eschew the original transaction and accept the higher-value deal. The ability of the stockholders themselves to freely accept or reject the board’s preferred course of action is also of great importance in this context.
Wednesday, May 20, 2015
The centerpiece of the Florange Law is a mandate that French companies give two votes to any share held for longer than two years. This goes against the historical one-vote-for-every-share system that most countries have. The law allows an opt-out if two-thirds of shareholders approve one by March 31, 2016.
ISS issued a guide (Download Impact-of-florange-act-france) opposing the law and encouraging investors to pressure directors to opt out of the law (through amendments to corporate bylaws) before the deadline.
Professor Davidoff Solomon questions the strength of the one-share-one-vote corporate democracy in the U.S., noting that recent IPOs, like Facebook, went public with two classes of stock as a anti-takeover measure. There is also the related question of what impact a law like this would have given the turnover rates of many institutional investors.
Wednesday, May 6, 2015
Monday, I had the privilege of moderating a discussion on structuring merger and acquisition transactions that I had organized as part of a continuing legal education program for the Tennessee Bar Association. Rather than doing the typical comparison/contrast of different business combination structures (with charts, etc.), I organized the hour-long discussion around the banter that corporate/securities and tax folks have in structuring a transaction. We used the terms of a proposed transaction (an LLC business being acquired by a public corporation) as a jumping-off point.
The idea for the format came from a water cooler conversation--literally--among me (in the role of a corporate/securities lawyer), one of my property lawyer colleagues, and one of my tax lawyer colleagues. The conversation started with a question my property law colleague had about the conveyance of assets in a merger. I told him that mergers are not asset conveyance transactions but, rather, statutory transactions that have the effects provided for in the statute, which include a vesting of assets in the surviving corporation. I told him that I call this "merger magic." I showed him Section 259(a) of the Delaware General Corporation Law:
When any merger or consolidation shall have become effective under this chapter, . . . all property, real, personal and mixed, and all debts due to any of said constituent corporations on whatever account, as well for stock subscriptions as all other things in action or belonging to each of such corporations shall be vested in the corporation surviving or resulting from such merger or consolidation . . . .
We discussed the possibility of an assignment/transfer of assets by operation of law under that provision and more generally under Delaware law in connection with different types of mergers, including recent case law regarding reverse triangular mergers. Ultimately, my property law colleague decided that a direct merger involved an asset sale by the target entity and a purchase transaction by the surviving corporation, as a matter of property law, notwithstanding my "merger magic" explanation I was forwarding as a descriptor under state corporate law.
The tax guy thought all this (both descriptions of a merger) was balderdash. These descriptions were too complex and stilted for his taste. Not to be outdone, he offered that all merger and acquisition transactions are either asset sales or sales of equity. At least, he allowed, that's how federal income tax law looks at them . . . . I told him that asset and equity sale transactions are joined by mergers (direct, reverse triangular, and forward triangular) and share exchange transactions (which are also statutory transactions, available in Tennessee and other Model Business Corporation Act states, but not available in Delaware) in the corporate lawyer's business combination toolkit. I also noted that federal securities law voting and reporting requirements work off these different corporate law descriptors.
Fascinating! Three lawyers, three different conceptions of business combination transactions. The moderated discussion on Monday was, in effect, an attempt by me to recreate, albeit in a different form, parts of that conversation. The discussion was, in my view, decently successful in achieving its limited purpose in the program. Nevertheless, I really wish I had a transcription of that original conversation by the water cooler. That was truly priceless . . . .
Wednesday, April 8, 2015
For thirty years, I have had a pet peeve about the media's routine reporting on mergers and acquisitions. I have kept this to myself, for the most part, other than scattered comments to law practice colleagues and law students over the years. Today, I go public with this veritable thorn in my side.
From many press reports (which commonly characterize business combinations as mergers), you would think that every business combination is structured as a merger. I know I am being picky here (since there are both legal and non-legal common parlance definitions of the verb "merge"). But a merger, to a business lawyer, is a particular form of business combination, to be distinguished from a stock purchase, asset purchase, consolidation, or statutory share exchange transaction.
The distinction is meaningful to business lawyers for whom the implications of deal type are well known. However, imho, it also can be meaningful to others with an interest in the transaction, assuming the implications of the deal structure are understood by the journalist and conveyed accurately to readers. For instance, the existence (or lack) of shareholder approval requirements and appraisal rights, the need for contractual consents, permit or license transfers or applications, or regulatory approvals, the tax treatment, etc. may differ based on the transaction structure.
Thursday, April 2, 2015
Earlier this week I went to a really useful workshop conducted by the Venture Law Project and David Salmon entitled "Key Legal Docs Every Entrepreneur Needs." I decided to attend because I wanted to make sure that I’m on target with what I am teaching in Business Associations, and because I am on the pro bono list to assist small businesses. I am sure that the entrepreneurs learned quite a bit because I surely did, especially from the questions that the audience members asked. My best moment, though was when a speaker asked who knew the term "right of first refusal" and the only two people who raised their hands were yours truly and my former law student, who turned to me and gave me the thumbs up.
Their list of the “key” documents is below:
1) Operating Agreement (for an LLC)- the checklist included identity, economics, capital structure, management, transfer restrictions, consent for approval of amendments, and miscellaneous.
2) NDA- Salmon advised that asking for an NDA was often considered a “rookie mistake” and that venture capitalists will often refuse to sign them. I have heard this from a number of legal advisors over the past few years, and Ycombinator specifically says they won't sign one.
3) Term Sheets- the seminar used an example for a Series AA Preferred Stock Financing, which addressed capitalization, proposed private placement, etc.
4) Independent Contractor Agreement- the seminar creators also provided an IRS checklist.
6) Employment Agreement- as a former employment lawyer, I would likely make a lot of tweaks to the document, and vey few people have employment contracts in any event. But it did have good information about equity grants.
7) Convertible Promissory Note Purchase Agreement- here's where the audience members probably all said, "I need an attorney" and can't do this from some online form generator or service like Legal Zoom or Rocket Lawyer.
8) Stock Purchase Agreement- the sample dealt with Series AA preferred stock.
9) IRS 83(b) form- for those who worry that they may have to pay taxes on "phantom income" if the value of their stock rises.
10) A detailed checklist dealing with basic incorporation, personnel/employee matters, intellectual property, and tax/finance/administration with a list of whether the responsible party should be the founders, attorney, officers, insurance agent, accountant, or other outside personnel.
What’s missing in your view? The speakers warned repeatedly that business people should not cut and paste from these forms, but we know that many will. So my final question- how do we train future lawyers so that these form generators and workshops don't make attorneys obsolete to potential business clients?
Friday, March 20, 2015
Bernard Sharfman has posted a new article entitled “Activist Hedge Funds in a World of Board Independence: Long-Term Value Creators or Destroyers?" In the paper he makes the argument that hedge fund activism contributes to long-term value creation if it can be assumed that the typical board of a public company has an adequate amount of independence to act as an arbitrator between executive management and the activist hedge fund. He also discusses these funds’ focus on disinvestment and attempts to challenge those in the Marty Lipton camp, who view these funds less charitably. In fact, Lipton recently called 2014 “the year of the wolf pack.” The debate on the merits of activist hedge funds has been heating up. Last month Forbes magazine outlined “The Seven Deadly Sins of Activist Hedge Funds,” including their promotion of share buybacks, aka “corporate cocaine.” Forbes was responding to a more favorable view of these funds by The Economist in its February 7, 2015 cover story.
Whether you agree with Sharfman or Lipton, the article is clearly timely and worth a read. The abstract is below:
Numerous empirical studies have shown that hedge fund activism has led to enhanced returns to investors and increased firm performance. Nevertheless, leading figures in the corporate governance world have taken issue with these studies and have argued that hedge fund activism leads to long-term value destruction.
In this article, it is argued that an activist hedge fund creates long-term value by sending affirming signals to the board of directors (Board) that its executive management team may be making inefficient decisions and providing recommendations on how the company should proceed in light of these inefficiencies. These recommendations require the Board to review and question the direction executive management is taking the company and then choosing which path the company should take, the one recommended by executive management, the one recommended by the activist hedge fund or a combination of both. Critical to this argument is the existence of a Board that can act as an independent arbitrator in deciding whose recommendations should be followed.
In addition, an explanation is given for why activist hedge funds do not provide recommendations that involve long-term investment. There are two reasons for this. First, the cognitive limitations and skill sets of those individuals who participate as activist hedge funds. Second, and most importantly, the stock market signals provided by value investors voting with their feet are telling the rest of the stock market that a particular public company is poorly managed and that it either needs to be replaced or given less assets to manage. These are the kind of signals and information that activist hedge funds are responding to when buying significant amounts of company stock and then making their recommendations for change. Therefore, it is not surprising that the recommendations of activist hedge funds will focus on trying to reduce the amount of assets under current management.
Thursday, March 19, 2015
Contrary to widespread belief, corporate directors generally are not under a legal obligation to maximise profits for their shareholders. This is reflected in the acceptance in nearly all jurisdictions of some version of the business judgment rule, under which disinterested and informed directors have the discretion to act in what they believe to be in the best long term interests of the company as a separate entity, even if this does not entail seeking to maximise short-term shareholder value. Where directors pursue the latter goal, it is usually a product not of legal obligation, but of the pressures imposed on them by financial markets, activist shareholders, the threat of a hostile takeover and/or stock-based compensation schemes.
Prof. Bainbridge is with Delaware Chief Justice Strine in that profit maximization is the only role (or at least only filter) for board members. As he asserts, “The relationship between the shareholder wealth maximization norm and the business judgment rule, . . . explains why the business judgment rule is consistent with the director's "legal obligation to maximise profits for their shareholders."
Chief Justice Strine has noted that the eBay decision, which I have written about a lot, says that "the corporate law requires directors, as a matter of their duty of loyalty, to pursue a good faith strategy to maximize profits for the stockholders." I think this is right, but I remain convinced that absent self-dealing or a “pet project,” directors get to decide that what is in the shareholders' best interests.
I have been criticized in some sectors for being too pro-business for my views on corporate governance, veil piercing law, and energy policy. In contrast, I have also been said to be a “leftist commentator,” in some contexts, and I have been cited by none other than Chief Justice Strine as supporting a “liberal” view of corporate norms for my views on the freedom of director choice.
When it comes to the Business Judgment Rule, I think it might be just that I believe in a more hands-off view of director primacy more than many of both my “liberal” and “conservative” colleagues. Frankly, I don’t get too exercised by many of the corporate decisions that seem to agitate one side or the other. I thought I’d try to reconcile my views on this in a short statement. I decided to use the model from This I Believe, based on the 1950s Edward R. Murrow radio show. (Using the Crash Davis model I started with was a lot less family friendly.) Here’s what I came up with [Author's note, I have since fixed a typo that was noted by Prof. Bainbridge]:
I believe in the theory of Director Primacy. I believe in the Business Judgment Rule as an abstention doctrine, and I believe that Corporate Social Responsibility is choice, not a mandate. I believe in long-term planning over short-term profits, but I believe that directors get to choose either one to be the focus of their companies. I believe that directors can choose to pursue profit through corporate philanthropy and good works in the community or through mergers and acquisitions with a plan to slash worker benefits and sell-off a business in pieces. I believe that a corporation can make religious-based decisions—such as closing on Sundays—and that a corporation can make worker-based decisions—such as providing top-quality health care and parental leave—but I believe both such bases for decisions must be rooted in the directors’ judgment such decisions will maximize the value of the business for shareholders for the decision to get the benefit of business judgment rule protection. I believe that directors, and not shareholders or judges, should make decisions about how a company should pursue profit and stability. I believe that public companies should be able to plan like private companies, and I believe the decision to expand or change a business model is the decision of the directors and only the directors. I believe that respect for directors’ business judgment allows for coexistence of companies of multiple views—from CVS Caremark and craigslist to Wal-Mart and Hobby Lobby—without necessarily violating any shareholder wealth maximization norms. Finally, I believe that the exercise of business judgment should not be run through a liberal or conservative filter because liberal and conservative business leaders have both been responsible for massive long-term wealth creation. This, I believe.
Friday, January 9, 2015
There are many Delaware cases from 2014 that are worth reading, but below are three relatively recent Delaware cases that I found worthwhile. I provide the case name, my very short takeaway, and links to the case and additional commentary for those who wish to dive deeper.
In re Zhongpin Inc. Stockholders Litigation, controlling stockholders, decided Nov. 26, 2014. In denying a motion to dismiss, the Delaware Court of Chancery found a reasonable inference that a 17.3% stockholder/CEO could be a “controlling stockholder.” I have not done an exhaustive search on this issue, but this is a lower percentage of ownership for a “controlling stockholder” than I have seen in most cases, though (of course) the analysis is case specific. Additional commentary by Toby Myerson (Paul Weiss).
C.J. Energy Services, Inc. et al v. City of Miami General Employees’ and Sanitation Employees’ Retirement Trust, M&A/Revlon, decided Dec. 19, 2014. The Delaware Court of Chancery held that “there was a ‘plausible’ violation of the board’s Revlon duties because the board did not affirmatively shop the company either before or after signing.” (pg. 3). The Delaware Court of Chancery enjoined the shareholder vote on the transaction at issue for 30-days and “required [the defendant] to shop itself in violation of the merger agreement . . . which prohibited [the defendant] from soliciting other bids.” Id. In this case, the Delaware Supreme Court reserved, stating that the Court of Chancery did not fulfill the stringent requirements for issuing a mandatory injunction, reminding that there are various ways to satisfy Revlon, and mentioning that this case did not have evidence of “defensive, entrenching motives,” as seen in Revlon and QVC. Note that the 38-page opinion was cranked out in just two days after the case was submitted. The handling of these expedited cases by the Delaware courts is one of the things that make Delaware attractive to corporations. Additional commentary by Brian Quinn (Boston College).
United Technologies Corp. v. Lawrence Treppel, books and records, decided Dec. 23, 2014. The Delaware Supreme Court reversed the Delaware Court of Chancery’s holding that the Court of Chancery did not have authority to restrict documents produced in a books and records inspection to use only in cases filed in Delaware courts. The Delaware Supreme Court remanded to the Delaware Court of Chancery to decide whether the Court of Chancery will exercise its discretion to so restrict the use of the information obtained in the books and records inspection. In this case, United Technologies insisted that Treppel sign a confidentiality agreement when he sought to inspect books and records, which is fairly common, but the confidentiality agreement also limited the forum, of any claim brought using the information inspected, to Delaware courts. At the time of the inspection request, United Technologies did not have a forum selection clause in its bylaws, but it later adopted one. As the broader forum selection debates continue, it will be interesting to see how the Delaware Court of Chancery handles this case in the books and records context, especially because the Delaware Court of Chancery has been encouraging plaintiffs to use the “tools at hand,” such as books and records requests, before filing derivative lawsuits. Beyond the substance, one remarkable thing about this decision is that Chief Justice Leo Strine authored an opinion that was only 14 pages. When he was on the Court of Chancery he would author 100+ page opinions with some regularity. Granted, the Court of Chancery is a trial court and their opinions tend to be a good bit longer than the Delaware Supreme Court opinions, regardless of the judge. Additional commentary by Celia Taylor (Denver Law).
For reading beyond these three cases, former Delaware Supreme Court Justice Jack Jacobs comments on two additional recent Delaware cases here (M&A related).
Wednesday, January 7, 2015
I had very limited time at AALS this year (unfortunately) but I still walked away with some great ideas (and a chance to say hello to a few, but not enough, friendly faces). I am borrowing from many ideas shared in the panel cited below, as well as a few of my own. As many of you prepare to teach BA/Corporations for the spring (or making notes on how to do it next time), here are a few fun new resources to help illustrate common concepts:
- HBO's The Newsroom. A hostile takeover, negotiations with a white knight-- all sorts of corporate drama unfolded on HBO's Season 3 of The Newsroom. I couldn't find clips on youtube, but episode recaps (like this) are available and provide a good reference point/story line/hypo/exam problem for class.
- Related, for those of you who teach or encourage the use of Bloomberg services, the Bloomberg terminal was even featured prominently in the season.
- This American Life-- Wake Up Now Act 2 (Dec. 26, 2014). This brief radio segment/podcast tells the story of two investors trying to reduce the pay of a company CEO. The segment discusses board of director elections, board duties, board functions and set up some large questions about whether or not shareholders are the owners of the corporation and their profit maximization is the ultimate goal for a company. This could be followed with Lynn Stout's 2012 NYT Dealbook article proposing the opposite view.
- HBO's Silicon Valley. For all things tech, start up, entrepreneurship and basic corporate formation, clips (you will want to find something without all of the swears, I suspect) and episode recaps from this popular show illustrate concepts and connect with students. Again, great for discussion, hypos, and exam fact patterns.
- The Shark Tank!. I have to thank Christyne Vachon at UD for this idea. There are tons of clips on youtube and most offer the opportunity to talk about investors bringing different things to the table, how to apportion control, etc. Here is an episode involving patent issues. I think that I am going to open my experiential Unincorporated/Drafting class with a Shark Tank clip on Monday.
- Start Up Podcasts. These 30-minute episodes cover a wide range of topics. Here is one podcast on how to value a small business. At a minimum, I will post some of these to my course website this spring. (Thank you Andrew Haile at Elon for this recommendation.).
- Planet Money. The podcasts are a great resource, but what I love is the Planet Money Twitter page because it is a great way to digest daily news, current events and topical developments that may be incorporated into your class.
- Wall Street Journal--TWEETS. (that felt like an oxymoron to write). Aside from the obvious, I find the Twitter feed to be the most useful way to use/monitor the WSJ. I will admit it, I don't "read" it every day, but this is my proxy.
Special thanks to the participants in the Agency, Partnership & the Law's panel on Bringing Numbers into Basic and Advanced Business Associations Courses: How and Why to Teach Accounting, Finance, and Tax
Moderator: Jeffrey M. Lipshaw, Suffolk University Law School
Lawrence A. Cunningham, The George Washington University Law School
Andrew J. Haile, Elon University School of Law
Usha R. Rodrigues, University of Georgia School of Law
Christyne Vachon, University of North Dakota School of Law
Eric C. Chaffee, University of Toledo College of Law
Franklin A. Gevurtz, University of the Pacific, McGeorge School of Law
And Happy New Year BLPB Readers!
Friday, December 12, 2014
The Delaware Court of Chancery recently denied a motion to dismiss in In re Comverge, Inc. Shareholders Litigation. In this case, the plaintiff claimed bad faith by the board of directors that approved an allegedly unreasonable termination fee in a merger agreement. Transactional attorneys and professors who teach M&A will want to read this case.
I am deep into grading my business associations exams, so I will outsource to a nice client alert on the case by Steven Haas at Hunton & Williams. A bit of the alert is below, and you can access the entire alert here.
The court then found that the termination fees of 5.55% of equity value (or 5.2% of enterprise value) during the go-shop period and 7% of equity value (or 6.6% enterprise value) after the go-shop period “test the limits of what this Court has found to be within a reasonable range for termination fees.” The court also analyzed the termination fee in connection with the convertible note held by the buyer in connection with the bridge financing. The plaintiff alleged that the conversion feature in the note, which allowed the buyer to purchase common stock at a price below the merger consideration, would significantly increase the cost to a topping bidder of acquiring the company. Factoring in that cost to the existing termination fee, the plaintiff argued, would result in a total payment equal to 11.6% of the deal’s equity value during the go-shop period and 13.1% of the deal’s equity value after the go-shop period.
The court concluded that, for purposes of surviving a motion to dismiss, it was “reasonably conceivable that the Convertible Notes theoretically could have worked in tandem with the termination fees effectively to prevent a topping bid” from a buyer that might otherwise offer greater value to the company’s stockholders. Perhaps more importantly, the court found that the plaintiff adequately alleged that the board of directors acted in bad faith in approving these terms....
Despite the amount of litigation challenging M&A transactions, there are not many Delaware rulings that have upheld challenges to deal protections such as termination fees, matching rights, and no-shop provisions. This is because the Delaware courts have generally created a body of precedent that provides helpful guidance to buyers and sellers and also recognized the value of such terms. In Comverge, the parties appear to have deviated from this precedent, but more importantly, the court looked to the bridge loan to view the aggregate effect of the various terms on the ability of a third party to make a topping bid.
Monday, December 8, 2014
In the comments to my post last week on teaching fiduciary duty in Business Associations, Steve Diamond asked whether I had blogged about why we changed our four-credit-hour Business Associations course at The University of Tennessee College of Law to a three-credit-hour offering. In response, I suggested I might blog about that this week. So, here we are . . . .
Thursday, September 25, 2014
Professor Dionysia Katelouzou of Kings College, London has written an interesting empirical article on hedge fund activisim. The abstract is below:
In recent years, activist hedge funds have spread from the United States to other countries in Europe and Asia, but not as a duplicate of the American practice. Rather, there is a considerable diversity in the incidence and the nature of activist hedge fund campaigns around the world. What remains unclear, however, is what dictates how commonplace and multifaceted hedge fund activism will be in a particular country.
The Article addresses this issue by pioneering a new approach to understanding the underpinnings and the role of hedge fund activism, in which an activist hedge fund first selects a target company that presents high-value opportunities for engagement (entry stage), accumulates a nontrivial stake (trading stage), then determines and employs its activist strategy (disciplining stage), and finally exits (exit stage). The Article then identifies legal parameters for each activist stage and empirically examines why the incidence, objectives and strategies of activist hedge fund campaigns differ across countries. The analysis is based on 432 activist hedge fund campaigns during the period of 2000-2010 across 25 countries.
The findings suggest that the extent to which legal parameters matter depends on the stage that hedge fund activism has reached. Mandatory disclosure and rights bestowed on shareholders by corporate law are found to dictate how commonplace hedge fund activism will be in a particular country (entry stage). Moreover, the examination of the activist ownership stakes reveals that ownership disclosure rules have important ramifications for the trading stage of an activist campaign. At the disciplining stage, however, there is little support that the activist objectives and the employed strategies are a reflection of the shareholder protection regime of the country in which the target company is located.
September 25, 2014 in Business Associations, Corporate Finance, Corporate Governance, Corporations, Current Affairs, Financial Markets, M&A, Marcia Narine, Securities Regulation | Permalink | Comments (0)
Tuesday, September 2, 2014
Last week, news of the proposed Burger King & Tim Horton's merger fueled the already raging fire on corporate inversions as the Miami-based burger chain announced plans, through the merger, to possibly relocate to Canada. As I have written about on this blog, here and here and in the Huffington Post, inversions may offer US companies tax savings.
Stephen E. Shay, a professor of practice at Harvard Law School, provides a short article (12 pages) describing the tax issues in corporate inversions and possible regulatory fixes. This article is very helpful in taking the debate from the headlines into a more complex legal analysis illuminating the tax consequences and offering a better understanding of the legal remedies available. Worth the read.