Saturday, May 19, 2018
If you’re anything like me, you’ve spent the last few days procrastinating studying the drama unfolding at CBS. (If you’re not aware, here’s an article summarizing the state of play; the rest of this post assumes readers are familiar with the basic facts).
There’s a lot to chew on here, and I’m sure that as the case develops, there will be much more to say, but here are some off-the-cuff initial thoughts, in no particular order.
[More under the jump]
First, in its TRO briefing, CBS argued that its proposal to issue a dilutive dividend was not unprecedented, in part because of the Hollinger case involving Conrad Black. See Hollinger International, Inc. v. Black, 844 A.2d 1022 (Del. Ch. 2004). As Brian Quinn pointed out on Twitter, Hollinger is distinguishable due to the criminality of the controlling shareholder; nothing like that exists here. In fact, even in Hollinger, the board did not propose to dilute Black’s existing voting power for all purposes; it adopted a poison pill that would take effect upon certain specified actions. Indeed, in Johnston v. Pedersen, 28 A.3d 1079 (Del. Ch. 2011), the court invalidated a dilutive issuance meant to block the controller, even in the face of allegations that the controller had committed fraud or other types of serious misconduct.
I’ve tried to think of any other scenario in which a board was permitted to issue shares for the sole purpose of diluting the vote of existing holders, without giving prior warning before the holders’ acquisition that it intended to do so. I.e., poison pills typically give warning to a would-be acquirer that if they obtain a specified number of shares, then their holdings will be diluted; they don’t usually attempt to dilute existing voting power. The only instance I can come up with where a board was explicitly permitted to issue shares solely for the purpose of diluting existing voting power – without any warning to holders that such action would be forthcoming before they acquired their shares – is in the context of JPM’s takeover of Bear Stearns. But that was a New York court interpreting Delaware law, not a Delaware court, and the case was, shall we say, controversial.
(In In re Quest Software Inc. Shareholders Litigation, 2013 WL 5978900 (Del. Ch. Nov. 12, 2013), such a share issuance was approved by the board, but it was never explicitly permitted by a court; the court simply mentioned it in the context of a settlement hearing).
In fact, in Franz Mfg v. EAC, 501 A.2d 401 (Del. 1985) – which, in light of the bylaw developments, is actually the most on point – the Delaware Supreme Court explicitly drew the distinction between measures that prospectively threatened to dilute holdings based on new stock acquisitions, and measures that dilute the holdings of existing holders.
That said, I don’t have the encyclopedic knowledge of Delaware case law that others have; are there examples I’m missing, whether or not they involve controllers?
The authority to permit dilution of existing holders is, as far as I can tell, entirely traceable to dicta in Mandel. There, the court said:
Where … a board of directors acts in good faith and on the reasonable belief that a controlling shareholder is abusing its power and is exploiting or threatening to exploit the vulnerability of minority shareholders, I suppose … that the board might permissibly [dilute the controller’s stake]. … Thus, while I continue to hold open the possibility that a situation might arise in which a board could, consistently with its fiduciary duties, issue a dilutive option in order to protect the corporation or its minority shareholders … such a situation does not at all appear to have been faced [here].
Not exactly a ringing endorsement of the legality, I gotta say.
With, it seems to me, good reason – for essentially the rationales laid out in the Chancery opinion denying CBS its TRO. Namely, controller’s actions can be invalidated after the fact, and injunctions can be obtained to prevent them from acting prospectively. There seems little reason to dilute their voting power for all purposes, especially since controllers are generally granted freedom to cast their votes selfishly. See Thorpe v. CERBCO, Inc., 1993 WL 443406 (Del. Ch. Oct. 29, 1993). I suppose this is the fundamental rationale behind CBS’s estoppel argument (see below); that’s how it gets to the claim that Shari Redstone should be permanently prevented from exercising control over the company.
Second, in NAI’s filings, it argued that it had no intention (before this dispute) of replacing the Board – with one exception. It claimed that it had notified CBS that it wanted to remove a single director, Charles Gifford, due to (unspecified) “incidents” in 2016 and 2017. Notably, however, CBS’s proxy filing for its 2018 Annual Meeting (now delayed) makes no mention of NAI’s objection to Gifford, and in fact states that NAI planned to support the election of the full slate. Was NAI or CBS planning to … tell the public … at some point … that one director was slated for removal? Because I realize the public vote was something of a charade but you’re still not permitted to make misleading omissions on a proxy filing or, for that matter, under Rule 10b-5.
Third, CBS’s complaint details the unimpeachable independence of its Board, and identifies that independence as a source of value. Which really stands in marked contrast to the opinion in Fueur v. Redstone where, at least for pleading purposes, the court accepted that the Board had committed waste in awarding Sumner Redstone compensation simply, well, for being Sumner Redstone. To be fair, the current board is slightly different than the board under consideration in that case, but. Still not a great look.
Fourth, as an example of Shari Redstone’s abuse of her control, CBS cites her refusal to entertain third party offers for the company, including her apparent efforts to forestall third party bids for the Board’s consideration. This, of course, is a difficult position to take, because it is well-established that controlling shareholders have no obligation to sell their shares to a third party acquirer even if doing so would benefit the minority shareholders. See Mendel v. Carroll, 651 A.2d 297 (Del. Ch. 1994). CBS is clearly aware of this fact, and so tries to frame it as an argument that if it were able to at least receive third party bids, it could use those bids as a bargaining point in its negotiations with Viacom. I … am not persuaded, given that Viacom would surely, you know, know that Redstone would never accept a third party bid.
Fifth, CBS’s main legal argument – which the court accepted as at least as colorable – is that the Redstones repeatedly represented to public shareholders that the Board would operate independent of their influence, public shareholders purchased their shares in reliance on this representation (which added to the stock’s value), and therefore the Redstones should now be estopped from violating that promise. In support of that argument, CBS cited two cases, Shamrock Holdings v. Iger, 2005 WL 1377490 (Del. Ch. June 6, 2005) and Dousman v. Kobus, 2002 WL 1335621 (Del. Ch. June 6, 2002), both of which court itself cited in its ruling. Both cases seem to me, however, to be distinguishable. The first involved an intentional lie to influence a specific shareholder action (running a proxy contest); the second involved misdescription of existing corporate procedures, on which shareholders relied when soliciting consents. Here, however, the claim is not necessarily that the Redstones misrepresented the truth at the time the statements were made, or even misrepresented their intentions at the time, but simply that Shari Redstone may have changed her mind and/or disagreed with Sumner Redstone when she later gained control.
The most on-point case therefore may be In re Delphi Financial Group Shareholder Litigation, 2012 WL 729232 (Del. Ch. Mar. 6, 2012) (disclaimer: I worked on Delphi when I was in practice). There, a company went public with a dual-class share structure that awarded high vote shares to the controller. The charter stated that the high vote shares would have the same economic interest as the low vote shares, and therefore would receive the same consideration in any merger. Despite that fact, when a merger was proposed, the controller refused to sell his shares without a charter amendment permitting him to receive disparate consideration. The court found that this potentially violated the controller’s fiduciary duties and possibly even his contractual obligation of good faith and fair dealing, on the theory that public investors paid a higher price for their shares in reliance on the controller’s promise.
Now, obviously, Delphi dealt with a charter and not simply a public statement, but nothing in the company’s charter technically forbade the actions proposed by the controller, and the “reliance” interest of the public shareholders was – as in CBS – the fact that they presumably paid a higher price for their shares.
Sixth, it seems fairly evident, at least to me, that CBS’s concerns over Shari Redstone – and the actions she might take, such as dismantling the Board – were based at least in part on private conversations and interactions. But CBS also didn’t want to admit as much in public filings – the closest it came was a statement in oral argument that NAI’s “private conduct doesn’t often match the public statements” – so instead it based its arguments on things that had been reported in the press. That, of course, gave NAI an opening to argue that CBS’s concerns were based on “unsourced media reports and conjecture.”
Seventh, just before the court hearing, NAI used written consents to amend CBS’s bylaws. First, it required that dividend issuances be approved by 90% of the directors (which would make it impossible for the independent directors to act without the cooperation of the Redstones). And second, it required that any director action to amend the bylaws would, again, require a 90% vote. The second bylaw was necessary; under Delaware law (though not the MBCA) there is nothing – so far – that prevents a bylaw war, so that shareholders enact a bylaw and directors repeal it and so on and so forth, except that shareholder-enacted bylaws pertaining to the number of votes necessary to elect directors cannot be repealed by directors. See DGCL §216. So you could end up with things like the Bank of America situation, where the Board unilaterally repealed a shareholder bylaw, though it eventually caved to shareholder demands and held a vote to ratify the change. (The shareholders did so ratify.)
CBS apparently intends to argue that Redstone’s bylaws are invalid. It has been reported that CBS plans to argue no bylaw changes take effect for 20 days, and – per Twitter (here and here)– I have learned that the basis for this argument is apparently Rule 14c-2, though its application to written consents solicited by stockholders is perhaps contested.
Now in Franz, a new controller used written consents to alter the corporate bylaws to limit actions that the incumbent board could take, and the Delaware Supreme Court upheld the bylaws; CBS may also intend to argue that, unlike Franz, in this case, the bylaw amendments were simply inequitable (which was an argument that prevailed in Hollinger).
Eighth, there’s a subtext in all of this, and it’s that Shari Redstone in particular is an untutored interloper, interfering in a business that she knows little about having finally managed to wrest control from her ailing – and often-estranged – father. That’s explicit in this NYT article, it’s implied in CBS’s briefing (arguing that Shari Redstone is violating Sumner Redstone’s promise of independence and improperly meddling in corporate affairs), and it was adverted to in oral argument, when Ted Mirvis stated, “A dual-class controlling stockholder is not a founding entrepreneur but a legacy claim, an inheritor.”
That, of course, is not true – I mean, it’s true in this case but it’s not true as a defining characteristic of a dual-class holder, though it does represent one of the main concerns about dual-class stock structures.
So what do I make of this? It’s hard not to wonder about something of a gendered undercurrent in this kind of commentary, and that, in turn, taints CBS’s general depiction of Shari Redstone as a gossipy – and they don’t use that word but that is the implication when they allege that Redstone basically is saying mean things about people – busybody in corporate affairs.
Yet regardless of the merit of CBS’s argument (and by the market judgment, anyway, CBS has the right of it), and despite the views of some, I’m not certain this case is really the vehicle for a challenge to the dual-class system. It certainly illustrates the problems, in the sense that the Redstone family is able to maintain control of one/two powerful public companies for decades without serious challenge to their stewardship, but simply from a doctrinal perspective, if and when Shari Redstone forces through a merger, courts can evaluate the deal simply as a controlling shareholder transaction without the need for a fundamental rethink of dual-class shares. The issue with respect to dual-class shares is that everything from the business judgment rule to independent shareholder ratification is predicated on the notion of one-share/one-vote, but those concepts aren’t going to be in play here anyway. That said, if Delaware wants to start engaging this issue, it could take the dual-class structure into account when evaluating any merger’s overall fairness: for example, it could use Redstone’s outsize voting power relative to her equity interest as a factor in concluding the process was unfair – though honestly, given recent events, Delaware courts aren’t exactly going to be hurting for evidence of unfairness.
More likely, the case may serve as a warning shot for the market with respect to dual-class share structures. It could even serve as Exhibit A for regulators or creators of market indexes. So, we might see investors approach dual-class shares with more trepidation, or we might see initiatives for some type of regulatory control. But I don’t think this particular case requires Delaware courts to re-evaluate their approach, unless they’re spoiling for the fight.
So where are we now? What it comes down to is, a lot of CBS’s arguments are on shaky legal ground. That said, I agree with Ronald Barusch that the main purpose of these legal skirmishes may be less to actually limit NAI’s power than to create an extraordinarily persuasive record that any attempt Shari Redstone may make to combine CBS and Viacom will be accomplished over the objection of the independent directors, and in violation of her duties as a controller. And that leaves Redstone with unattractive choices: proceed with a merger and face a potential injunction on the front end and/or very high damages on the back end, or give up the attempt entirely. And putting Redstone in that position? Is likely CBS’s ultimate goal.