Board and Shareholders Take Charge

June 2009 ■ Volume 13 ■ Issue 6

Board and Shareholders Take Charge Before considering what takeover defenses are Takeover Defense available or appropriate, boards of directors and their advisors need to start by understanding the fi - Reviews Are No duciary duties that frame the actions of target company boards. These fi duciary duties are defi ned by Longer Routine As applicable state corporate law, which for most U.S. corporations means that they will be looking to LAWYER Unsolicited Bids Delaware law. Whether the exercise of fi duciary duties results in Become More a sale of the target depends on numerous fact specifi c criteria. While a review of Revlon, Unocal, Unitrin Mainstream and the other preeminent Delaware takeover cases is beyond the scope of this article, it is possible, howev- BY FRANK AQUILA er, to generalize two critical requirements for the target’s directors: (1) they must not promote a transac- Frank Aquila is a partner in the Mergers & Acquisitions Group of Sullivan & Cromwell LLP. The views and opin- tion in which they have a personal stake (other than ions expressed in this article are his and do not necessar- the vesting of their equity awards in line with other ily represent those of Sullivan & Cromwell LLP. Contact: employees’ awards) without disclosing their interests [email protected]. to the rest of the board; and (2) they must act with

e M &A due care. These duties are not merely aspirational. Just a few years ago takeover defense reviews Boards that act with these key principles in mind were largely theoretical. With ever-rising share will not only create a record that should withstand prices, the likelihood that an unsolicited bid would the painful scrutiny of 20/20 hindsight in derivative Th arrive was fairly low and if it did arrive, it was usu- or shareholder class action litigation, but will ulti- ally at a very attractive price. Not anymore! Given mately achieve the right result for all constituencies. the rapid and signifi cant decrease in the share prices It is also crucial to recognize that following the for almost all companies, unsolicited bid concerns public announcement of an unsolicited proposal, are greater than they have been in a decade. Today, a target’s shareholder base will change rapidly and, strategic buyers view unsolicited bids as just an- in some cases, dramatically. Target company shares other tool in their chest to achieve strategic objec- will move from the company’s traditional, long-term tives. InBev, Microsoft, Samsung, PepsiCo, Roche shareholders into the hands of arbitrageurs, hedge and Astellas, a veritable international corporate funds and other “shortterm” holders who seek to “Who’s Who”, have all gone public with unsolic- profi t on the spread between the offer price and the ited offers in the last year. Even bluechip companies current trading price. From their perspective, the such as GE and IBM have used unsolicited bids as faster a deal is done the greater their return on in- part of their M&A arsenal. vestment. While boards of directors must act in the Every change of control proposal, solicited or best interests of all shareholders, they must insure unsolicited, requires a thorough evaluation based that this rapid change in shareholder base does not upon all relevant factors. While not every unsolic- lead to the sale of the company at less than full value. ited proposal should be accepted simply because its The proper use of takeover defenses, consistent with offer price is at a premium to the target’s unaffected the board’s exercise of their fi duciary duties, should share price, neither should every unsolicited propos- successfully enable the board to reject an inadequate al be summarily rejected on the basis that the offer is price or negotiate a price that represents a full and “hostile”. With the continuing trend towards global fair value for the target company. consolidation, the recent precipitous drop in share prices and the growing respectability of unsolicited Back to the Future bids, there will likely be a steady stream of such pro- In order to understand the dynamics of unsolic- posals in the months and years to come. ited bids, as well as the development of most current

Reprinted with permission.

takeover defenses, we need to look back to the 1980s. but only to the extent that the interests of all share- This decade was a hotbed of activity for the corpo- holders are satisfi ed. rate raider in all sectors of the economy. The M&A The prevalence of other anti-takeover provisions, boom of the 1980s spawned hostile bids that unal- such as advance notice provisions and supermajority terably changed America’s corporate landscape. voting requirements, likewise increased, as potential Vulnerable companies, lacking adequate defenses targets identifi ed additional ways to deter unsolic- to hostile bids, often found themselves at the mercy ited bids. In spite of—or perhaps because of—their of corporate raiders. In most cases, potential take- effi cacy, critics of anti-takeover provisions have over targets were defenseless until the New York seemed determined to eliminate or neutralize these M&A Bar crafted a broad range of effective defens- provisions. es.1 In 1982, the shareholder rights plan2—the so- called “poison pill”—was developed to fend off hos- Effective Defenses Lead to Criticism tile takeover attempts and provide U.S. companies Criticism of company-adopted takeover defenses with at least some modicum of protection against has been consistent and plentiful. These criticisms corporate raiders. are largely premised on a belief that anti-takeover A shareholder rights plan is not designed to, nor defenses are inconsistent with today’s corporate does it, prevent hostile takeovers. Rather, it allows governance environment. Critics contend that the directors of a target the time necessary to evaluate changed environment, in which investor confi dence alternatives in order to maximize value for all share- has been near an all-time low and shareholder de- holders. The extra time simply provides directors mands for more infl uence and corporate account- ability are at an all-time high, requires a different with leverage in any negotiations with the unsolicited approach when it comes to how companies respond bidder. After several judicial rulings on their validity, to unsolicited takeover bids. shareholder rights plans were quickly recognized as Criticism of shareholder rights plans and stag- a legitimate and effective anti-takeover device. gered boards are amplifi ed in the press. Financial The “classifi ed” or “staggered” board is another journalists often appear to favor shareholder efforts anti-takeover defense that, although utilized since to eliminate anti-takeover defenses. The fi nancial the early twentieth century, became prevalent in the press tends to label companies that redeem their 1980s. A classifi ed board structure generally consists shareholder rights plans or destagger their boards, of three groups, or “classes,” of directors, with each as “shareholder friendly” or “at the forefront of cor- group composed of roughly the same number of di- porate governance best practices.” rectors. All directors are elected to three year terms, Since rights plans are adopted by the company’s with one class of directors up for election each year. board of directors without shareholder approval, As a result, only one-third of the board is subject to there is little that shareholders can do to eliminate change in any given year. The staggered board pre- the rights plan once adopted. Supported by Risk- vents bidders from obtaining control of the corpora- Metrics, Glass Lewis, the Corporate Library and tion by replacing the entire board in a single proxy other shareholder watchdog groups, activists have contest. used two primary tools to attack rights plans. First is In its absence, a bidder could gain control of the the shareholder proposal asking the board to simply board by electing its own directors to the target eliminate the shareholder rights plan. The proposal board in a single proxy contest, with the risk that is merely a precatory resolution placed on the agen- an inadequate bid would then be approved without da of the company’s annual meeting by one or more consideration for its adequacy or shareholder value shareholders. While the resolution is not binding on maximization. As with the shareholder rights plan, either the company or the board, essentially it is sim- creating a classifi ed board does not prevent the ulti- ply a request that the rights plan be terminated, and mate success of an unsolicited bid. A bidder may still its adoption by holders of a majority of the shares replace one-third of the board and then exert pres- can send the company’s board a clear signal. Second sure within the boardroom on the rest of the board is the withhold vote. Except in the rare case of a to negotiate, and ultimately approve, the takeover proxy contest, corporate directors run unopposed. proposal. In this way the bid may still be accepted, Since the bylaws of most U.S. companies provide

that directors are elected by a plurality (although a company concludes that a lighter anti-takeover ar- many companies are now adopting some variant of senal is suffi cient, the most prudent course of action majority voting) of the shares voting, the only way is to only remove those anti-takeover provisions that to register opposition to directors is by withholding may be easily reinstituted and to remove them in a votes for their election. manner that allows for their reintroduction to the RiskMetrics and the institutions they represent extent ultimately needed.3 When it comes to anti- will withhold votes for directors for a variety of reasons. Two of those reasons relate directly to their takeover protections and corporate governance, one opposition to a shareholder rights plan. To the ex- size does not fi t all. Charter and bylaw provisions, tent that the board has failed to act on a shareholder as with shareholder rights plans, must be tailored to approved resolution to remove the shareholder rights the particular needs of each corporation. Remem- plan, then RiskMetrics will recommend withholding ber, decisions made today may very well have signifi - votes for the directors’ reelection. RiskMetrics will cant ramifi cations in the future. also recommend withholding votes from directors if the company has a rights plan that has not been approved by shareholders or does not otherwise meet NOTES RiskMetrics’ criteria. 1. Takeover defenses that were adopted by many Because of the opposition from the institutional U.S. corporations included shareholder rights investor community, many companies are simply plans, staggered board provisions, anti-greenmail permitting their rights plans to expire (most rights provisions, supermajority voting provisions, fair plans have a ten-year term) and some companies price provisions, provisions requiring advance are even terminating their rights plans. As a conse- notice of director nominations, caps on the quence, today less than a majority of the S&P 500 number of directors, provisions requiring the vote companies have a shareholder rights plan. While that of a majority of directors to fi ll newly created number has been dropping over the last few years, directorships or vacancies, provisions allowing given the recent rise in the unsolicited bid threat we removal of directors only with cause, provisions are likely to see many boards taking a closer look at disallowing shareholders ability to call special rights plans. At a minimum, most companies with- meetings, provisions requiring that shareholder out a shareholder rights plan in place have one on action by written consent would only be effective the shelf and ready to go should the unsolicited bid when signed by holders of all outstanding shares ever arrive. and provisions allowing the repurchase of its own shares. Many companies also eliminated Conclusion preemptive rights and cumulative voting. Unsolicited bids for giants such as Anheuser- 2. If triggered, a shareholder rights plan would Busch and Yahoo! highlight the reality that even render a takeover markedly more expensive by companies with huge market capitalizations are allowing the target’s existing shareholders, other not immune from attack. Bare anti-takeover arse- than the hostile bidder, to buy the bidder’s stock, nals leave companies of all sizes vulnerable to unsolicited bids. or the target’s own stock, at a great discount Although the pressure may be intense, companies when a hostile bidder acquires more than a would be unwise to simply follow the trend of dis- certain, predetermined percent of the target’s mantling their takeover defenses without consider- stock without prior board approval. ing the potential consequences. Before taking any 3. For instance, a shareholder rights plan could action, companies must seriously consider the con- be redeemed or allowed to expire now, but sequences that a bare anti-takeover arsenal may have could be adopted by the corporation’s board of on their company’s future and the vulnerabilities directors when needed in the future. However, to which it may be exposed in the wake of a well- a decision to eliminate a staggered board is fi nanced hostile bid. essentially irreversible since such a provision can Companies must take a long-term view when con- generally only be reinstated with the approval of sidering takeover protections. Therefore, even when shareholders.