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— Judgment Call —
The recent plunge in the stock price of many public companies has left them with market capitalizations well below historical levels and has exposed many to an enhanced risk of a hostile takeover attempt. The risk is particularly acute for small and medium-sized companies, as many large cap companies continue to hold considerable cash balances and untapped lines of credit available for acquisition funding. Boards confronted with a fully financed, all-cash offer at a substantial premium to current market value will have to take those offers seriously and carefully consider their legal duties and obligations in light of them. The issue confronting boards is complicated by the difficulty in determining what a fair and adequate price is for an enterprise operating in a recession environment with limited access to capital markets. Some stockholders will believe the company should be valued with reference to historical market values while others will be more willing to accept a premium to current market price, even if below historical levels.
Under Delaware law, however, an offer at a premium to the current market price is not the sole measure of the adequacy of the offer. Moreover, many public companies have either terminated anti-takeover devices or permitted them to expire, often due to pressure from shareholder rights advocates and shareholder advisory services such as RiskMetrics Group Inc. Boards unprepared to deal with a hostile takeover attempt expose the enterprise to the risk of being unable to execute its corporate strategy, expose its stockholders to risk of an inadequate sales price and expose its directors to criticism for failure to meet their duty of care. Delaware courts give wide latitude to boards to protect legitimate corporate and stockholder interests and to respond to actual threats to those interests under the business judgment rule. To avail itself of the protection of the business judgment rule, a board must demonstrate that it has met the duty of loyalty and the duty of care. To do so, a board must show that it acted in a disinterested manner and with due consideration of the risks and alternatives confronting the corporation or its stockholders. By their nature, these decisions are typically made only by the independent directors and without the participation of management, often by a special committee composed entirely of independent directors. Boards that meet these standards are entitled to a presumption that their decisions, even if later proved to be ill advised, were made in good faith and will be respected by Delaware courts, insulating the board members from liability to stockholders. In taking defensive action, boards must consider two questions under Delaware law under the so-called "Unocal test": Is there a threat that justifies the board's taking defensive actions? And are the actions taken reasonable in relation to the threat? The burden is on the board to demonstrate that the actions taken are not done for the purposes of entrenchment. If the actions are authorized by independent directors acting without management influence, the standard is presumptively met. Once that burden is carried, a properly functioning board becomes entitled to the protection of the business judgment rule. Any public company with a deeply depressed stock price is entitled to protect itself against the threat of a takeover at an inadequate price or at a time when a long-term strategy initiative has not had the opportunity to be fully implemented and return value to the stockholders. Even before a specific threat is identified, most public companies operating in such an environment will meet the first part of the Unocal test. Public companies have a multitude of alternatives available to protect themselves from a hostile takeover, including:
Some of these alternatives, such as supermajority voting requirements and defensive mergers, require stockholder approval while others, like shareholder rights plans, may be implemented by the board alone. There are two important things to remember in structuring protective devices. First, while it is permissible under Delaware law for the board to adopt measures designed to prevent a company from being acquired at an inadequate price, it is not permissible to adopt measures designed to prevent a company from being acquired at any price. Any device or plan that deprives stockholders of the opportunity to realize a premium in a change of control transaction when no other short or long-term alternative can reasonably be expected to result in a higher price will not be respected by Delaware courts. Similarly, Delaware courts will examine very closely any protective measure having the effect of making it more difficult to remove the board or management. Accordingly, adopting staggered board provisions, eliminating the ability to call special meetings and similar measures will be rigorously scrutinized to determine whether they are reasonable responses to a perceived threat or simply a way to entrench management. Shareholder advisory services have traditionally opposed the adoption of many protective devices, including poison pills, as generally not in the best interest of stockholders. The opposition of these groups to poison pills is one reason a number of stockholder rights plans have either been terminated or permitted to expire. RiskMetrics Group's position remains that it will recommend a vote against directors who adopt a poison pill without the opportunity for stockholders to approve it -- either before or within 12 months of adoption -- and has indicated that it will assess on a case by case basis whether it will recommend the approval of a stockholder rights plan submitted to stockholders for a vote. Delaware cases provide considerable guidance to directors as they consider adopting anti-takeover protections. Boards should regularly assess the degree to which their company is exposed to the risk of a hostile takeover and monitor the situation closely as circumstances evolve. Defensive actions taken thoughtfully and in response to a generalized risk environment rather than hurriedly and in response to a specific threat are more likely to be sustained. Companies at risk should undertake contingency planning to defend against a coercive takeover attempt, which may include the identification and retention of professionals, a public relations strategy and similar steps. Delaware courts will likely respect actions taken to defend a well-thought-out corporate strategy intended to provide stockholders with long-term value. The lesson for corporate directors is to examine the risk environment in which their corporation operates and to consider proactively a series of strategic responses, of which one or more protective devices may be integral. Delaware courts also tend to confirm defensive actions taken as the
result of an organized and deliberate board process that supports the
conclusion that the directors have satisfied their duty of care. The
attributes of this process include:
Any structural defense adopted by the board should be proportional to the threat identified, as a defensive measure adopted by the board that acts as an absolute bar to a change of control will not be enforced by a Delaware court. Boards must focus their attention on provisions that protect
shareholders against a legitimate risk but continue to provide
stockholders with an opportunity to realize a change of control premium
when a change of control is in their best interest. William D. Gutermuth is a senior partner at Bracewell & Giuliani LLP. |
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