Professor Bainbridge...on law, politics, religion, culture & food

Speaking of Dead Hand Pills

Apropos my prior post on the law governing dead hand poison pills, here is a new research paper, Is There Power Behind the Dead Hand? An Empirical Investigation of Dead Hand Poison Pills, by KATHERINE GLEASON, University of New Orleans - Department of Economics and Finance, and MARK KLOCK, George Washington University - Department of Finance:

Dead hand poison pills prevent potential hostile acquirers from circumventing a poison pill with a proxy contest whereby newly elected directors could redeem the pill. Dead hand provisions only permit continuing directors to redeem. Shareholder rights advocates and legal scholars have criticized dead hand poison pills as an assault on shareholder governance, but economic theory suggests potential shareholder benefits. We provide the first empirical study of dead hand poison pills. We find that adoption of dead hand poison pills leads to gains for shareholders and losses for bondholders. This supports Schwert‘s (2000) conjecture that poison pills provide shareholders with better premiums rather than entrench ineffective managers.

Which makes Quickturn doubly pernicious.

BA Limericks

Jeremy Telman uses the Klein, Ramseyer & Bainbridge Business Associations casebook. He offers up a limerick for the first case in the book, Gorton v Doty:

The court made Ms. Doty the heavy
When Coach Garst demolished her Chevy.
When Soda Springs lost the game,
Coach accepted the blame,
But the principal pays the tort levy.

Jeremy’s complete selection of legal limericks is available here. He’s currently up to the vicarious liability cases. Great stuff.

Does Yahoo’s Severance Plan = A Dead Hand Pill?

That’s the argument plaintiffs are making, as reported by Karen Donovan:

Two Detroit pension plans, which sued Yahoo in March in the Delaware Chancery Court, are now requesting a trial to take place before Yahoo’s August 1 annual meeting, when Yahoo management will face a proxy battle with Icahn, who has put up a slate of directors.

The trial would determine the validity of an employee severance plan that Yahoo put into place as a defense against Microsoft’s unsolicited bid. The severance plan, known as a “tin parachute,” would allow any Yahoo employee who was either terminated or --- and this is what the plaintiffs call “exceedingly rare” --- any employee who quits with “good reason” after a “substantial adverse alteration” to their job. ...

[The] brief filed by the plaintiffs ... claims [that “Yahoo’s board disabled itself from rescinding the severance plans during the pendency of a proxy fight” and because “Icahn’s slate is barred from rescinding the severance plans if it prevails in its proxy contest.”

Sounds like both the current board and any future board’s hands would be tied. A neat trick, and one that the brief says looks a lot like a management defense known as the “dead hand poison pill” --- a tactic that has been struck down by the Delaware courts.

The “dead hand” attack is a clever one, says Professor Stephen Bainbridge of the UCLA School of Law, who has written about the Yahoo severance plan on his widely read blog.

“This is their most interesting argument,” Bainbridge says. Delaware law provides that any limit on a board should be in a corporation’s articles of incorporation.

While interesting, the plaintiffs’ argument is also pernicious. Or, perhaps it would be better to say that the cases on which the argument rests are pernicious.

I addressed the core issue in my article Dead Hand and No Hand Pills: Precommitment Strategies in Corporate Law, in which I explained that:

Precommitment strategies … abound in business life. When a corporation’s board of directors authorizes the inclusion of a negative pledge clause in a bond indenture, the board disables the corporation from issuing certain types of secured debt.  When the board and/or shareholders adopt a mandatory indemnification amendment to the bylaws, they precommit the corporation to a policy of indemnifying officers and directors under circumstances in which the statute does not mandate such indemnification.  And so on.

In Carmody v. Toll Brothers, however, the Delaware chancery court cast considerable doubt on the validity of an emergent corporate precommitment strategy—the dead hand poison pill—suggesting, inter alia, that the board of directors likely lacked authority to adopt such devices. In Quickturn Design Sys., Inc. v. Mentor Graphics Corp., the Delaware supreme court invalidated a related device—the no hand poison pill—solely on grounds that a board of directors lacks authority to adopt such devices.

By relying on the scope of the board’s authority, the Delaware supreme court made a serious error. The court misinterpreted relevant Delaware law.  Its unjustifiably called into question the validity of a host of corporate precommitment strategies.  Most important, however, it called into question a basic tenet of Delaware corporate law; namely, the plenary authority of the board of directors.  Delaware law wisely vests formal decisionmaking authority in the hands of the board of directors. Indeed, it is fair to say that if Delaware did not do so, the modern corporation could not exist.  Yet, if read broadly, Quickturn denies the board’s authority to make many ordinary corporate governance devices requiring board self-disablement.

The article provides background on precommitment strategies, showing that both individuals and corporations properly use them in many contexts. The article then moves to a review of poison pills and traces the Delaware law on their validity. I then argued that:

In striking down the no hand poison pills on authority grounds, … the Delaware supreme court seemingly has limited the use of such precommitment strategies by adopting a broad principle that boards have an ongoing duty to constantly reevaluate their decisions.  … [The] Delaware supreme court’s decision was scarcely compelled by the relevant statutory language.

In striking down the no hand pill as lacking statutory authority, the Delaware supreme court relied solely on § 141(a) of the Delaware General Corporation law.  Section 141(a) states:

The business and affairs of every corporation organized under this chapter shall be managed by or under the direction of a board of directors, except as may be otherwise provided in this chapter or in its certificate of incorporation. If any such provision is made in the certificate of incorporation, the powers and duties conferred or imposed upon the board of directors by this chapter shall be exercised or performed to such extent and by such person or persons as shall be provided in the certificate of incorporation.

On its face, § 141(a) is directed to an entirely different problem than the one raised by the no hand pill. In particular, note the reference in the second sentence of § 141(a) to the “powers and duties” of the board being “exercised or performed” by such other persons as provided in the certificate of incorporation. This language clearly reflects a concern with the special problems of close corporations, whose shareholders often seek to modify the default rules of corporate governance so as to run the firm as though it were a partnership.  Delaware has a special set of statutory provisions for close corporations whose articles of incorporation contain an election to be governed by those provisions.  Among the special rules applicable only to such so-called statutory close corporations is a provision authorizing shareholders to limit the powers of the board of directors by mere contract.  Outside of that limited context, however, § 141(a) makes clear that any such shareholder-initiated limitation on the board’s authority must be included in the articles of incorporation.  Taken as a whole, therefore, § 141(a)’s language regarding exceptions to the board’s authority is not concerned with self-imposed limitations on the board’s authority. Instead, § 141(a) is concerned with ensuring the validity of such close corporation governance provisions, while requiring that they be included in the articles of incorporation rather than by mere contract. On its face, nothing in the statute compels a conclusion that the board cannot create self-imposed limitations on its authority.

I then pointed out that “boards of directors commonly bind themselves to particular strategies through the use of various devices. Many such devices limit the discretionary authority not only of the adopting board, but also of future boards that might wish to pursue a different strategy. Indeed, it is the very ability to bind future decisionmakers that is the hallmark of any precommitment strategy.”

I argued that Delaware’s hostility towards certain types of precommitments, such as no shop clauses, was misplaced:

In Phelps Dodge Corp. v. Cyprus Amax Minerals Co., Chancellor Chandler opined that no shop clauses “are troubling precisely because they prevent a board from meeting its duty to make an informed judgment with respect to even considering whether to negotiate with a third party.” But this begs the question of why the board cannot make an informed decision to tie itself to the mast. Suppose the board of directors makes an informed decision that the merger proposal on the table is the best deal they are likely to get for their shareholders and that granting a no shop clause is necessary and appropriate to induce the prospective acquirer to make a formal bid. The board recognizes that a no shop clause will impede its ability to negotiate with any competing bidders who subsequently emerge, but the board decides to accept that risk and go forward. In doing so, the board relies on the old adage that a bird in the hand is worth two in the bush. So long as the decision to enter into the no shop clause was an informed one, why should a board of directors have an on-going fiduciary duty to constantly reevaluate its decision? …

The court’s emerging hostility to precommitment strategies is puzzling. It had taken a more sensible approach to precommitments in Grimes v. Donald, where the board of directors approved an employment agreement with a newly-hired CEO giving the CEO largely unfettered control of the corporation. Among other things, the agreement empowered the CEO to declare unilaterally that he had been constructively terminated if, in his good faith judgment, the board substantially interfered in his management of the company. In that event, the CEO would receive a very substantial severance package. A shareholder complained that “the potentially severe financial penalties which the Company would incur in the event that the Board attempts to interfere in [the CEO’s] management of the Company will inhibit and deter the Board from exercising its duties under Section 141(a).” The court aptly observed that “business decisions are not an abdication of directorial authority merely because they limit a board’s freedom of future action,” a turn of phrase that nicely captures the basic thesis of this Article.

I then argued that precommitments are perfectly defensible in my director primacy model of corporate governance.

I concluded:

Quickturn was wrongly decided because prophylactic limitations on the board of directors’ authority are unacceptable. Recognizing that many readers will not accept such an expansive understanding of the directors’ primacy, in this section I assume arguendo that at least some prophylactic restrictions on board authority are appropriate. Even with that concession, however, Quickturn still was wrongly decided. We have seen that Quickturn—plausibly interpreted—threatens to invalidate any precommitment strategy not authorized in the articles of incorporation.  Surely the Delaware supreme court did not intend such a result. At the very least, one would have expected such a sweeping change in the law to be more explicitly signaled. Yet, as we have also seen, Quickturn already has been extended—fortunately only in dicta—to no shop clauses.  In sum then, the weakness in the supreme court’s Quickturn opinion is twofold: (1) the court cannot possibly intend for their holding to be read broadly, but (2) their opinion provides no firebreak between valid and invalid precommitment devices.

In my opinion, no such firebreak exists. …

If there is no firebreak, what should the Delaware supreme court have done? Instead of creating a novel doctrine based on statutory authority, the court should have relied on the well-established principles outlined in Unocal and its progeny.  Dead hand and no hand pills unquestionably raise very serious issues of target director fiduciary duty.  The market for corporate control and, in particular, the unsolicited tender offer are critical accountability mechanisms by which agency costs are constrained in the corporate setting.  Director action that impedes unsolicited bids therefore is tainted by a conflict of interest, as Unocal recognized.  Indeed, it is difficult to imagine a legally cognizable threat sufficiently severe for a dead hand pill to pass muster under the proportionality prong of Unocal.  Binding someone else’s hands, as the dead hand pill does, does seem more problematic than binding one’s own. Such concerns become even more pronounced, when the decision to disable another is tainted by a conflict of interest situation.

Yet, never before had the Delaware supreme court adopted a prophylactic prohibition in response to that taint. To the contrary, the court rejected just such an approach when it rejected academic calls for a rule mandating director passivity in the face of an unsolicited bid. Moreover, Delaware courts have employed even Unocal cautiously. They recognize the danger “that courts—in exercising some element of substantive judgment—will too readily seek to assert the primacy of their own view on a question upon which reasonable, completely disinterested minds might differ.” Consequently, just as is called for by Arrow’s analysis, Unocal and its progeny establish an “intermittent” accountability mechanism “capable of correcting errors” but which does not “destroy the genuine values of authority.”

The Delaware supreme court should acknowledge that both self-disablement by the board of directors and disablement by the board of other constituencies are legitimate and accepted corporate governance practices. It then should emphasize that such self-disablement raises issues of fiduciary duty, especially when tainted by the sort of potential conflict of interest inherent in takeover defense decisions.

The Delaware courts should use the Yahoo case as a vehicle for reversing Quickturn’s pernicious limitation on the scope of a board of directors’ authority to adopt precommitment strategies. It then should apply standard Unocal analysis to the severance plan. Apropos of which I told Donovan that:

Under Delaware law, takeover defenses are allowed as long as they do not have a “preclusive effect.” On this score, he also does not hold out much hope for the plaintiffs, who claim the plan would potentially cost $2.4 billion. That amounts to less than 5 percent of Microsoft’s initial $44.6 billion offer for Yahoo.

And Delaware courts have put their seal of approval on management tactics that are far more costly--- such as termination fees for failed deals that broach 10 percent of a deal. On the other hand, tin parachutes usually extend to exiting senior management --- not to every employee, as the Yahoo plan does.

And they say Student-Edited Law Reviews Suck

I just got home from my annual trip to Napa to find the following series of emails from a faculty-edited law review in re my essay Reflections on Twenty Years of Law Teaching: Remarks at the Rutter Award Ceremony. Feel free to try to guess which journal did it:

EMAIL # 1:

Dear Professor Bainbridge--

[redacted name of chief editor] has assigned me the pleasant task of doing the initial edit on your fine speech at the Rutter Teaching Award ceremony. Attached is my markup with some suggested additions marked in red and deletions and comments appearing in balloons in the margin. All changes have been tracked, and you can easily accept or reject any of them, as well as make any other changes you wish. The most substantial issue I noticed is how your clever critique of Saul Levmore’s classroom Internet ban late in the piece (a view, btw, that I happen to share) may create the impression that Levmore was the nameless UVA torts prof mentioned earlier in the piece. It seems to me fwiw that clarifying that Levmore either was or wasn’t this torts prof may be a worthwhile. [SMB: He wasn’t.] Beyond that, I’ve inserted a few citations for you (but do you have a page reference for the cite to McCormack?), and made some other nonsubstantive suggestions. I hope you will find at least some of this work helpful, and I look forward to hearing back from you at your convenience with a revised final draft that I could then send along to [redacted name of chief editor] for conversion into galley proofs. And please feel free to contact me with any questions or concerns.

Sincerely,

[redacted]

EMAIL # 2:

Professor Bainbridge:

I have a number of additional comments about the piece (some of which are substantive) that my earlier email did not reflect and which I hope you will forgive me for not mentioning sooner. ...

[SMB: All stuff I would have been happy to fix.]

As with my other suggestions, I hope that you will find these helpful, and I hope that in particular you will do your best to address point #1. And as before, feel free to contact me with any questions or concerns or to let me know of any other way in which I might be helpful. ... But should you have any concern that requires immediate attention, you could always contact [redacted name of chief editor].

EMAIL #3:

Dear Professor Bainbridge

I am writing to apologize. Although, as [the author of the first two emails] points out, there is a lot to like about your Rutter speech, we have opted *not* to publish it in the [journal name redacted]. We do hope you will keep the [redacted] in mind for future projects. I am very sorry for any time and trouble our scrambled communications have caused you.

Sincerely,

[redacted name of chief editor]

Contracts was 20-odd years ago, so my memory is a little hazy, but couldn’t you argue that my submission of my article was an offer and the first email was an acceptance by the journal?

Anyway, after an 8 hour drive, I’m too tired to come up with any thing witty to say about this. Suffice it then to say that I’ve never had a student-edited law review pull such a lame stunt. Suffice it also to say that not only will I not be keeping this journal “in mind for future projects,” I’ve cancelled my subscription. I find the episode highly unprofessional. You don’t accept an article, start editing it, send an email asking for changes, and then unaccept (disaccept?) the damn thing!

In any case, any student edited journal out there want to publish the essay? 

Federalist Society Corporate Practice Group

I am now the Chairman of the Federalist Society’s Corporations Practice Group. Our Group includes corporate governance, securities regulation, and antitrust. We’ve got programs coming on FTC merger enforcement, consumer credit, and shareholder access to the proxy statement. I think it’s going to be a very good year. I’d encourage lawyers and academics with an interest in these areas to join us.

Can a Target Just Say No?

In a fine column analyzing Yahoo’s tin parachute, the NY Times’ Deal Professor (a.k.a. Steven Davidoff) opines that:

… the Yahoo board here is permitted under Delaware law to reject Microsoft’s bid and just say no.

I’m a long-time skeptic that the just say no defense is really viable or authorized under Delaware law. As I explain in Unocal at 20:

… many commentators concluded Time validated the so-called “just say no” defense, pursuant to which the target’s board simply refuses to allow the firm to be acquired, and backs up that refusal by a poison pill or other takeover defenses. I find this reading of Time unpersuasive. At the chancery court level, Chancellor Allen’s analysis hinged on his observation that Time’s acquisition of Warner “[did] not legally preclude the successful prosecution of a hostile tender offer” for the resulting entity. More importantly, he also indicated that defensive tactics used against a hostile offer by Paramount or some other bidder for the combined entity after Time’s acquisition of Warner would present a different issue.

The supreme court’s opinion is similarly limited. While it is true the court rejected any inference that directors are obliged to abandon a pre-existing business plan in order to permit short-term shareholder gains, Time’s plan was deemed reasonable and proportionate to the Paramount threat precisely because it was “not aimed at ‘cramming down’ on its shareholders a management-sponsored alternative,” but was only intended to carry forward “a pre-existing transaction in an altered form.” The supreme court also expressly affirmed Chancellor Allen’s finding that Time’s actions “did not preclude Paramount from making an offer for the combined Time-Warner company.”

These limitations on the court’s holding are important because they eliminate the “just say no” defense, as well as some of the other more apocalyptic interpretations of Time. The “just say no” defense does cram down a particular result—independence—on the shareholders, and also attempts to preclude anyone from making an offer for the combined company, both of which the court said management could not do. Therefore, Time does not necessarily compel one to conclude that the “just say no” defense will be deemed to be proportional to an adequate, noncoercive offer.

Yahoo’s Tin Parachute

Gordon Smith on the latest developments in the Yahoo takeover fight:

Even as Yahoo and Microsoft try to hammer out a deal over a round of golf and Carl Icahn clears the way to acquire more shares, the Yahoo shareholders litigation plows forward in Delaware. Chancellor Chandler unsealed the plaintiffs’ amended complaint this morning, giving us a lot more detail about the severance plan that we have had to date. (You can find all of the litigation documents on the website of BLB&G.) This is suddenly a lot more interesting case than it was two weeks ago.

At that time, I ventured the following opinion about the plaintiffs’ case: "The claims raised in the shareholder litigation are not viable." In response to Steve Bainbridge’s comment and post on the possibility of Unocal review based on Yahoo’s "threatened" deal with Google, I noted: "The short response to your comment is that there is no Google maneuver, yet. The two sides have been talking, but that seems pretty far from a ‘defensive action’ for purposes of Unocal." I continued, "Other than the severance agreements with Yahoo officers (perhaps), I don’t see anything that Yahoo has done that looks like a defensive action."

Well, the plaintiffs are still arguing about the threatened Google transaction, and I still think that argument is a loser, but the real traction comes from the claims about Yahoo’s severance plan. This is something I have never seen before, and I don’t think we have a clear answer from the courts on this issue. The new complaint makes the plan look like a defensive measure, and this will trigger Unocal review. But the plan does not seem to be either preclusive or coercive, as defined in Unitrin, which leaves the court to decide whether it falls within the "range of reasonableness." Plaintiffs do not have a great batting average against the "range of reasonableness," but this plan is pushing the envelope.

The first thing you should know about the plan is that it covers 100% of Yahoo’s employees. When this proposal was initially disclosed to Tim Sparks, president of Compensia, an outside compensation firm hired by Yahoo, he responded via email, "That’s nuts." Uh, yeah.

The second thing to notice is the potential costs of the plan. Of course, the fact that it covers all of Yahoo’s employees is still a key fact, but also note two things: (1) the size of the benefits, and (2) the breadth of the trigger. The benefits include immediate 100% acceleration of all outstanding equity rights as well as a cash payment, and those benefits are triggered not only by involuntary termination of employment, but also by voluntary termination "for good reason." According to the plan, Yahoo employees have good reason to terminate their employment whenever they are subject to a "substantial adverse alteration" in their duties or responsibilities. The plaintiffs argue that the court should consider the costs of the plan at 100% reduction in force, which seems a bit much, but that would place the costs north of $2 billion. Even at lower amounts, the plan would cost hundreds of millions.

In Minstar Acquiring Corp. v. AMF Inc., 621 F.Supp. 1252 (SDNY 1985), AMF established a “Severance Allowance Plan” providing for an increase in the severance allowance for certain salaried employees on the corporate staff. The Plan doubled AMF’s prior formula of 1 1/2 weeks base pay for each year of completed service. The Plan would become effective only in the event of any involuntary termination during the two year period following a “change in control.” Interpreting New Jersey law, but also citing a lot of Delaware cases, the court held that:

… we find the case of Norlin Corp. v. Rooney Pace Inc., 744 F.2d 255 (2d Cir.1984) to be very instructive. In Norlin the Second Circuit raised a “strong inference that the purpose of [the challenged acts] was not to benefit the employees but rather to solidify management’s control ...” 744 F.2d at 265, thus the burden was shifted to the directors to show that the transaction was fair and reasonable. Id., citing Johnson v. Trueblood (Rosenn J. concurring and dissenting).

Under the facts of this case we believe that at least as strong an inference is raised. This inference is based upon the fact that the severance benefits, like the other defensive tactics, are triggered only by the change in control. Minstar points out that AMF has already announced a long term plan which calls for substantial staff reductions in some areas. Thus, an employee who is to be terminated pursuant to the Plan, will receive twice as many severance benefits, if Minstar takes over, even though the decision to terminate him was already made by the present AMF board. AMF claims the changes are “prudent steps designed for the most part to safeguard rights and benefits already earned by and owed to AMF employees” (defendants’ memorandum at 42). It goes on to argue that the increases were made to bring AMF in line with “severance plans in effect at other companies.” Id. at 44. If this was in fact the true justification then conditioning the program on a change in control would be unnecessary.

In Tate & Lyle PLC v. Staley Continental, Inc., 1988 WL 46064 (Del.Ch. 1988), the court noted that Staley had, among other defenses, adopted a tin parachute providing “that upon an employee’s termination, even for good cause, the employee shall receive the greater of: (1) one month’s pay for each year of employment; or (2) one month’s pay for each $10,000 of annual pay. In total, the tin parachutes could cost Staley at least $3,490,000.” (Emphasis supplied.) The fact that the severance would be paid even if the employee was terminated for cause seems even more questionable that the walk away provision in the Yahoo tin parachute. The court held that:

The compensation packages, consisting of the golden and tin parachutes and the tax gross-ups, however, were each proposed and unanimously approved by an outside directors Committee. Compensation decisions are generally the sole prerogative of the directors. Beard v. Elster, Del.Supr., 160 A.2d 731 (1960). Even when a compensation decision directly benefits directors, if the **432 decision is approved by a committee of disinterested directors, it is afforded the protection of the business judgment rule. Puma v. Marriott, supra.

The Compensation Committee, made up of all the outside directors, unanimously approved the compensation plans. Although the tax gross up provisions are particularly troublesome, as is the totality of the parachute benefits, the defendants seem to have shown that the plans were adopted in a good faith response to possible future hostile tender offer advances and that the directors were not misinformed or uninformed and were not grossly negligent in adopting the plan. Therefore, under the rule in Moran v. Household International, Inc., Del.Supr., 500 A.2d 1346 (1985), the defendants have shown the reasonable probability that the directors’ action in adopting the plans is immune from further judicial scrutiny pursuant to the business judgment rule.

As for that problematic trigger, HR.com tells us that:

Generally, certain events must occur prior to the payment of change-in-control benefits, says Howard Golden, a senior executive compensation consultant in Mercer´s New York office. Benefits may be “triggered” by the change in control itself or by certain actions on the part of either the company or the executive. These triggers typically fall into one of three categories:

Single trigger. Benefit becomes payable automatically upon a change in control or upon a voluntary termination by the executive for any reason within a specified time period following the change in control. Only 3.8% of parachute plans today have such a trigger, compared to 15.8% in 1997, Mercer´s study shows.

Double trigger. Benefits become payable after both a change in control and the subsequent termination of the executive´s employment, either by the company without “cause” or by the executive for “good reason” (i.e., a “constructive termination"). More than two-thirds of the companies (68.4%) had this type of trigger in 2000 - a number that´s remained relatively stable in recent years.

Modified single trigger. Benefits become payable subject to a double trigger. In addition, the executive may voluntarily terminate employment for any reason during a specified “window period” (typically the 30-day period following the one-year anniversary of the change in control). More than a quarter of the companies (27.8%) had this trigger method in 2000, up from 16.3% in 1997.

Apparently, these sort of walk away provisions are fairly common, at least in golden and silver parachutes.

All told, my guess is that unless the size of the benefits is so huge as to be deemed preclusive under Unitrin, that these arrangements will survive Unocal review.

In analyzing the question of whether the tin parachute would be preclusive, we might analogize that question to judicial review of a termination fee. A termination fee of 3% of enterprise value would seem quite reasonable. A termination fee of, say, 100% of enterprise value likely would be deemed be preclusive. (See this review.)

Weiss gets 30 Months

From the Law Blog:

Melyvn Weiss, the plaintiffs’ lawyer who pioneered a controversial and lucrative area of law suing corporations on behalf of shareholders, was sentenced today in federal court in Los Angeles to 30 months in prison. Weiss pleaded guilty in March to racketeering conspiracy.