Hostile takeovers in India are not very common. The use of advanced takeover defenses is hardly ever required and directorial conduct in such situations never comes under any serious scrutiny. Sometime back, I wrote about the standard of conduct required of board of directors in India (click here to view the post). The post elaborates on that and looks at the business judgment rule in the United States, plus, the takeover defenses commonly used by the boards of companies in the United States.
The U.S. law on this subject comes from case laws (as do most U.S. legal precedents) with Delaware corporate law being the most developed in the field.
Business Judgment Rule
Business judgment rule is the common law principle which has become the starting point in judging directorial conduct defines the set of circumstances in which courts will not second guess the decisions by the board of directors. Accordingly, if the board of directors acted in a disinterested, independent and informed manner then the court won’t second guess a director’s decision and will not impose liability for bad decisions. In such cases the burden is on the plaintiff to rebut the presumption that the rule applies.
Aronson v. Lewis, 473 A2d at 812: If the business judgment rule applies there is a presumption that in making a business decision, the directors of a corporation acted on an informed basis in good faith and in the honest belief that the action taken was in the best interests of the company.
Smith v. Van Gorkom, 488 A2.d 858; 46 A.L.R.4th 821[1]: In this successful appeal from a class action brought by shareholders originally seeking rescission of a cash out merger, the CEO met a well known takeover specialist and agreed to a cash out merger proposal at a price arrived at without any proper valuation[2]. After a brief discussion between the CEO and the takeover specialist, the CEO called a special meeting of the board of director’s to persuade them to approve the offer and place it for a shareholder vote. At the meeting he framed the question before the board not as to whether the price arrived is the highest price obtainable, but as, “whether it was a fair price and whether the stockholders should be given an opportunity to accept or reject?” The board of directors, relying on a 20 minute presentation made by the CEO and without any documents concerning the proposed transaction before them decided to put the proposal for a shareholder vote.
Held: The board was grossly negligent in that it failed to act with informed reasonable deliberation in agreeing to the merger proposal. Directors have a duty to act in an informed and deliberate manner in determining whether to approve a merger agreement before submitting the agreement to shareholders. A board cannot abdicate that duty by leaving the decision to approve or disapprove a proposal to shareholders alone.
In the Van Gorkom case there was a substantial premium in the price proposed (i.e. in the price at which the shares were being proposed to be purchased) but the court observed that a substantial premium may provide one reason to recommend a merger but in the absence of other sound valuation information the fact of a premium alone does not provide an adequate basis upon which to assess the fairness of an offering price. The observation suggests that just because a company is doing well does not mean that it cannot do any better, an issue which has been highly debated in India particularly in cases involving disinvestment of government owned undertakings.
Enhanced Scrutiny & Takeover Defenses
Revlon v. Mac Andrews Forbes Holdings, 506 A2d 173; 66 A.L.R.4th 157: The case presented yet another situation where the board was found guilty of violating its fundamental duty of care. Faced by the threat of a hostile bid from Pantry Pride, The board of directors of Revlon adopted a poison pill (a commonly employed takeover defense which makes it near impossible to take over the company unless the board approves the takeover) in the form of a note purchase right plan[3]. The initial adoption of the poison pill was held to be in good faith on the part of the directors because it was meant to protect the corporate entity from the threat of a hostile takeover. Later however, the Revlon board accepted a proposal by Forstmann for a buyout of the company claiming that (a) it was for a higher price, (b) it protected the note holders (the value of these notes had faltered in the market), in as much as Forstmann agreed to honor the notes by exchange of new notes in its place, and because (c) Forstmann’s financing was firmly in place. In return Revlon board agreed to (i) immediate acceptance of this offer, (ii) sell its Vision Care and National Health Laboratories divisions to Forstmann for $525 million, a price that was $100-$175 million below the value ascribed by the bankers, if another buyer got 40% of Revlon shares, (iii) a no-shop provision and (iv) $25 million cancellation fee placed in an escrow.
Pantry Pride further raised its bid, this time above the price being offered by Forstmann and challenged the provisions of takeover defenses in the court.
Held: The board may have regard for various constituencies (such as the note holders here) in discharging its responsibilities provided there are rationally related benefits accruing to the stockholders. However such concern for non stockholder interests is inappropriate when an auction among active bidders is in progress and the object no longer is to protect or maintain the corporate enterprise but to sell it to the highest bidder”.
The case led the court to put the Revlon board under an enhanced scrutiny and the judgment resulted in the laying down of the Revlon standard of scrutiny[4]. In a later case,[5] the court clarified that (i) initiating an active bidding process to sell the corporation or (ii) effecting a business reorganization involving a clear break-up of the corporate entity are not the only instances where enhanced scrutiny may be implicated. There may be other circumstances in which Revlon duties may be triggered such as where, in response to a bidder’s offer, a target abandons its long-term strategy and seeks an alternative transaction involving the breakup of the company.
Paramount Communications v. Time, 571 A2d 1140: Time entered into a merger agreement with Warner (which created the present day Time Warner). Paramount made a very high premium bid for the acquisition of time shares. Time’s board was convinced that Warner would provide the best fit for Time to achieve its strategic objectives and that a Time-Warner merger would preserve the news oriented culture of the corporation, expand its business and would be a better long term investing opportunity. Based on this, Time board rejected the paramount offer and adopted several takeover defenses. It was held that the board was under no duty to maximize immediate shareholder value; Paramount’s bid for Time did not put Time up for sale and hence the decision of the board of directors to combine with Warner notwithstanding the higher immediate shareholder value provided by the Paramount offer, was protected by the business judgment rule.
Analysis
In the Van Gorkom case the directors were found grossly negligent in as much as they abdicated their duties completely and relied solely on the judgment of one director and failed to assess the offer independently. It was held that the decision to approve an offer cannot be left to the shareholders alone and that the board of directors are under a fiduciary duty to make an independent assessment of the offer before recommending it to shareholders.
Revlon on the other hand lays down the standard of conduct required of the board of directors in case of sale or break up of the corporate entity. It holds that the directors are under an obligation to secure the best price reasonably available for the stockholders when it becomes clear that the corporate life will come to an end. It was also held that “when bidders make relatively similar offers or when dissolution of the company becomes inevitable, the directors cannot fulfill their enhanced duties by playing favorites with the contending factions”.
The facts in Time-Warner were quite different since it was a stock for stock merger and there was no change of control because time had a 100% free float, as the court stated “Time would be owned by fluid aggregation of unaffiliated stockholders both before and after the merger”. Moreover, in Time Warner the decision of the Time board of directors to not sell to Paramount and to merge with Warner instead was based on the long term goals of Time. The court held that whether to sell is a strategic decision and directors are best equipped to assess an offer in this regard. The directors of a corporation are in the best position to compare the merit of an offer with the value of the company based on its long term objectives. Once the management determines that an offer is not in the best interest of the company and decides to protect the corporate entity the court will not second guess there decision and will not order the board of directors to reconsider a decision or not to utilize takeover defenses merely because of a high premium offer. There decision will be protected by the business judgment rule.
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[1] One of the only cases finding breach of the duty of care of the directors. Also see, Graham v. Allis-Chalmers, Delaware Supreme Court 1963, upholding director action as protected by the business judgment rule.
[2] It was noted in the judgment that “the record is devoid of any competent evidence that the price per share proposed represented the per share intrinsic value of the company”.
[3] Under this takeover defense each Revlon shareholder would receive as a dividend one note purchase right for each share of common stock with the rights entitling the holder to exchange one common share for a $65 principal Revlon note at 12% interest with a one year maturity. The rights would become effective whenever anyone acquired beneficial ownership of 20% or more of Revlon’s shares unless the purchaser acquired all the company’s stock for cash at $65 or more per share. In addition, the Rights would not be available to the Acquirer, and prior to the 20% triggering event the Revlon board could redeem the rights for 10 cents each.
[4] The Revlon standard: The board members of publicly-owned companies have a duty to get the highest price for its shareholders once it puts itself up for sale. In such a situation there duties are to be seen from the point of view of an auctioneer trying to get the highest value for the company and not as a protector of the corporate bastion.
[5] Paramount Communication v. QVC Network, 637 A.2d 34
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