Two superb M&A lawyers from Cleary Gottlieb Steen & Hamilton LLP, Victor Lewkow and Christopher Austin, provide an interesting insight into the issues relating to board control in US M&A transactions.
Conventional wisdom is that the key player in any US M&A transaction is the Board of Directors. The Board is the principal gatekeeper, determining when and how to pursue transactions, including whether to permit shareholders to have an effective opportunity to accept a hostile offer. There are indications, however, that this paradigm may be beginning to shift, with shareholders becoming more assertive.
On the sell side, until recently it was almost universally the case in the United States that a transaction recommended by a target’s Board of Directors was approved by shareholders unless a higher bid emerged. Unlike the United Kingdom and some other jurisdictions, shareholders have approved transactions even if they suspected that the company might be worth more than the bid price at some time in the future.
On the other hand, the use of “poison pill” rights plans means that hostile transactions opposed by a target’s Board, even if at a significant premium, are very difficult to complete. They require a very committed bidder with sufficient resources and patience to pursue a lengthy, distracting and expensive process that often results in the target staying independent (though possibly restructuring) or being sold to a third party.
For buy-side transactions, Boards have even more flexibility. Shareholder approval of even very large transactions generally is not required unless the purchase price includes buyer shares that will increase the number of shares outstanding by 20%. Thus, a cash acquisition of a large target – even one larger than the bidder -- does not require shareholder approval. This is true even if the plan is to refinance through a public offering of stock in the near term.
The doctrinal support for the Board’s preeminent position begins with the principle, embedded in Delaware (and other state) corporate law, that a corporation shall be managed by its board of directors. Shareholders have the right to elect directors, with directors and management having very little ability to interfere with elections other than to argue the merits. But once elected, the Board has the right, indeed the responsibility, to manage the corporation in accordance with its fiduciary duties, without deferring to shareholder views. A second underpinning of the Board’s role is the doctrine that an acquisition offer at a price that the Board determines is inadequate (even if at a large premium), can constitute a threat to the corporation justifying -- and possibly requiring -- the implementation of defensive tactics. The Unitrin case in Delaware noted that “pursuant to Delaware corporate law, a board of directors’ duty of care . . . required it to respond actively to protect the corporation and its shareholders from perceived harm”. Finally, the courts have recognized that, even when faced with a premium acquisition offer, a Board generally has no obligation to facilitate a sale and may “just say no” to a proposed transaction and use its rights plan to make that “no” meaningful.
While Boards have very limited ability to interfere with shareholders’ rights to elect (and, in many cases, to remove) directors, once elected the directors have significant ability to limit the right of shareholders to accept an acquisition offer. Chancellor Chandler of the Delaware Chancery Court, who recently presided over the Delaware litigation arising from Air Products’ hostile offer for Airgas, took note of this apparent anomaly:
“[T]he Delaware Supreme Court apparently has concluded that stockholders may be simultaneously intelligent enough to decide whether to oust directors from office but not intelligent enough to decide whether an offer to purchase their property is in their best economic interest . . ..”
A relatively common illustration of this situation is raised where a target has a staggered board (with one-third of the Board elected annually and not generally subject to majority shareholder removal without “cause”) and a rights plan in place that effectively limits the ability of a hostile bidder to acquire the company without Board approval. In order to complete a hostile acquisition in this situation, a bidder would need to replace a majority of the target’s directors with directors who would be prepared to withdraw the rights plan; the staggered board means it would take at least two annual meetings to do this. And even the election of the bidder’s nominees does not assure that even those directors will support the bid or even redemption of the poison pill. This was illustrated in the CF/Terra and Air Products/Airgas situations where the newly elected directors joined in the recommendation of the continuing directors to recommend against the bid. (Bidders normally nominate candidates who are truly independent of the bidder so as not to be accused of nominating individuals who will not properly exercise their fiduciary duties once elected.)
The Board’s central position in US acquisition transactions is somewhat unusual globally. In most other jurisdictions, there are significant limits on the ability of a target board to prevent shareholders from accepting an offer. There are “anti-frustration” principles in the United Kingdom (enforced by the Takeover Panel) and a number of other jurisdictions. With respect to buy-side transactions, many jurisdictions require shareholder approval of acquisitions that meet certain size thresholds, regardless of the form of consideration. For example, in the United Kingdom, any acquisition that meets any of the “Class 1” tests (one of which is any acquisition involving consideration that exceeds 25% of the bidder’s market capitalization), must be approved by shareholders.
Although there is unlikely to be any fundamental change in the role of the Board in US acquisition transactions in the foreseeable future, there are some indications that, at the margin, shareholders are becoming more assertive and important in M&A transactions.
This phenomenon is most evident in a number of recent transactions where shareholders have actively opposed transactions recommended by a Board. For example, in Blackstone’s proposed acquisition of Dynegy, shareholders of Dynegy did not approve the negotiated transaction even after a price increase offered by Blackstone; and they later rejected a higher bid made by Carl Icahn – despite the Board’s recommendation and its warning that Dynegy faced serious liquidity issues. Similarly, in the bidding war for Dollar Thrifty, the Dollar Thrifty shareholders voted against the recommendation of the Board that shareholders vote in favor of the Hertz proposal rather than wait for the higher – but in the Board’s view less certain – Avis offer. Also, 3M’s acquisition of Cogent faced substantial opposition from Cogent holders but received a bare 52% of the shares tendered thanks to the pre-announcement agreement of Cogent’s CEO with 38% of the shares to accept the offer. Cedar Fair’s shareholders – led by two large shareholders – voted to reject the Board’s negotiated acquisition by private equity firm Apollo.
Believers in more power for shareholders, and less for directors, suffered a setback recently in the context of targets of hostile takeover attempts. The recent 16 month battle by Air Products to acquire Airgas came to an end in February when the Delaware Chancery Court ruled that a fully-informed target Board (which included three new independent members who had been nominated by Air Products and elected in a proxy contest at the most recent annual meeting of shareholders) which concluded that the offer price was clearly inadequate, could keep its poison pill in place indefinitely and thereby prevent shareholders from making their own decision as to whether to accept the offer. The Chancellor reached this conclusion, based on his interpretation of Delaware Supreme Court precedents, even though (a) Air Product’s “best and final” all-cash offer was for 100% of the shares with a majority-tender condition and thus was not “structurally coercive”; (b) the Airgas Board did not claim that it needed more time (or intended) to explore other alternatives, and (c) the Airgas shareholders had, the Chancellor concluded, received all necessary information to make their own decisions.
Prior to this ruling, the Chancellor indicated some concern with the Board having the ability to block a bid indefinitely, asking the parties:
“Airgas has offered no financial alternative to the Air Products tender offer. Instead, Airgas insists that it is worth far more than the Air Products tender offer and it characterizes the Air Products tender offer as ‘grossly inadequate.’ Given that this dispute appears to be about price and price alone, under what principle of Delaware corporate law should the Airgas stockholders be required to endure all of the risk that the Airgas board’s valuation judgment is correct?”
But despite these seeming qualms, the Chancellor concluded that, under existing Delaware Supreme Court precedent, he could not order elimination of the poison pill rights plan in this case.
The increased assertiveness of shareholders in negotiated transactions may influence tactics by bidders and targets. Among other things, in view of the increased risk that shareholders will reject bids recommended by the Board, we would not be surprised to see an increase in the number of negotiated transactions where bidders insist that a termination fee be payable by the target in the event of a “naked no vote” by target shareholders. (Vice Chancellor Strine, in the litigation arising from the rejection by Lear’s stockholders of a negotiated acquisition, approved a termination fee payable in such a circumstance, albeit only one percent of transaction value, well less than the fee payable in the context of a higher bid.) Furthermore, in light of the experience of CF and Air Products referred to above, hostile bidders in the future may seek to nominate directors who commit to elimination of the rights plan after an appropriate period of time for the target Board to consider alternatives and communicate the Board’s recommendation to shareholders. However, in view of the fiduciary duties of the newly-elected directors they will, at a minimum, need to become fully informed and form a view as to the adequacy of the offer. If they conclude the offer is inadequate, especially if they conclude it is “clearly inadequate,” it is uncertain after the Airgas decision whether the directors – even if elected on a “let the shareholders decide” platform – can give no recommendation or a negative recommendation and then remove the poison pill and allow the shareholders to make the final decision as to whether to accept the offer.
Despite the Court’s decision involving Airgas, the pendulum is swinging towards more of a shareholder role in merger activity in the United States generally. Is that a good thing? It is certainly the case that target shareholders -- and particularly hedge funds and arbitrageurs who often buy a substantial portion of the target shares once a deal is announced (or just rumored) -- often have a very short term perspective and do not take into account the target’s long-term potential. But of course the only way those short-term investors can buy shares is if pre-transaction shareholders are willing to sell at the post-bid market price, notwithstanding arguments about longer-term potential. There may be the rare circumstance where the Board has better information than shareholders (e.g., where some new intellectual property or product is the pipeline that cannot for commercial reasons be disclosed), but in the vast majority of cases involving a non-coercive hostile offer for all outstanding shares with the Board having a full opportunity to explore alternatives and express its views to the shareholders, the fundamental question noted by Chancellor Chandler is a legitimate one: is it appropriate for shareholders who are presumed capable of making intelligent decisions when electing directors not to be considered similarly capable in the acquisition environment?
On the flip-side, in the context of a sale of a company negotiated and endorsed by its Board, why shouldn’t the stockholders sometimes decide that they would rather take the long view, and not sell at the correct time at the offered price? Of course, some cases that may lead the Board and senior management to resign, as in the Dynegy situation after both bids recommended by the Board were rejected by stockholders, or may even lead to bankruptcy, as occurred a few years ago after Lear Corp. shareholders twice rejected an acquisition.
Finally, in the context of an acquirer which needs stockholder approval because of the percentage of its stock to be issued in the transaction, there is a danger that short-tem investors will seek to block deals that have long-term value because they want to avoid short-term dilution and to have excess capital be used for dividends or stock repurchases rather than to expand the business.
This is an updated and revised version of the article that appeared in the printed editorial of The International Who's Who of Merger & Acquisition Lawyers 2011