In particular, the SEC has not annunciated specific requirements for disclosure related to projections supplied to buyers by targets in the diligence process. Contrast this with the U.K. rule that requires all assumptions underlying disclosed projections to be specifically stated and the policies and calculations supporting them to be examined and reported upon by the buyer’s accountants.19 Accordingly, the parameters of required disclosure in the United States are vague, and buyers tend to underdisclose information received through the due diligence process. Projections relied on by buyers are often not disclosed or are disclosed in a summarized and thus rarely useful form. For example, in the acquisition of Guidant Corp. by Boston Scientific, the parties exchanged projections but did not disclose them in their proxy statement. 20 Even when the disclosure is made, it is often limited. For example, when Gillette Co. was acquired by Procter & Gamble, the parties exchanged projections, but the proxy statement disclosed only projected growth rates for sales, profits from operations, and earnings.21 Shareholders are thus left at the mercy of their company to decide as to the quantity and quality of forward-looking information that is disclosed. And they often choose not to do so.
The consequence of the SEC’s failure to adequately regulate the disclosure process is that Delaware has stepped into the breach. The Delaware courts regularly review disclosure in takeover transactions and increasingly require that corrective disclosure be made. The Delaware courts thus provide the active regulator that the SEC does not, but court-created rules for disclosure are vague and lack definition. In other words, what are Delaware’s disclosure rules? There is no easy answer, and instead someone, a lawyer, must piece it together from the prior case law. The SEC should act to revise its disclosure rules into the modern age and correct the bad disclosure practices that have become all too common in takeovers.
A Modest Proposal for Reforming the Federal Takeover Code
Federal takeover law thus too often either misregulates or underregulates. This is in large part due to the SEC’s withdrawal from active regulation of the takeover market at the end of the 1980s. This has left the takeover code frozen and regulating to a time that no longer exists. The SEC would do well to reenter the business of takeover regulation, rethink the entirety of the federal takeover law, and possibly repeal much of the Williams Act’s substantive requirements.
The best route would probably be to form a takeover commission to study and rework the entirety of the federal code.The last panel of this type was back in 1983. Marty Lipton, one of the deans of the takeover bar, one of the inventors of the poison pill, and a partner at Wachtell Lipton, was on that panel and no doubt would serve on this one.22 The goal would be to create a cohesive takeover code that regulates in conjunction with the current state of the market and takes into account the tremendous change in the market since that time. It would also be a flexible code that regulates to future developments.
Given Delaware’s prominence, the federal law should also be fine-tuned to work better with Delaware law. For example, Delaware requires that a shareholder meeting be held within 13 months of the last annual meeting.23 But if you are a company in the midst of an accounting restatement, you cannot file your proxy with the SEC for that meeting. This puts you within a regime of two competing rules. In a takeover contest, this can permit you to delay holding your annual meeting, something that BEA Systems did when it was in the middle of an options backdating investigation.24 This allowed it to mount a back-door takeover defense to Oracle’s hostile bid giving it an argument to avoid a proxy contest to unseat its directors. Any federal takeover regulatory reform will need to take into account Delaware law.
Delaware Takeover Law
Delaware now dominates the regulation of takeovers and corporate law generally. Delaware accounts for more than 50 percent of all publicly traded incorporations, and in recent times, up to 77 percent of all companies going public have chosen to incorporate there.25 Moreover, the preferred choice of law and forum to govern acquisition agreements has become Delaware.26 Delaware has become the primary arbiter of corporations as well as takeover battles and the regulator of takeovers. But how did this small state become the center of the corporate law universe? In part, it is due to the quality and efficiency of its courts.
Delaware is a quick, efficient, and well-helmed forum for litigation. Historically, the five judges who sit on the Delaware Chancery Court—the court charged in the first instance to hear these corporate law disputes—have been viewed as some of the best in the land. Delaware offers corporations certainty and the ability to obtain rapid adjudication. Because the court is small and capable, Delaware has been able to put forth a relatively coherent corporate law that is viewed as responsive to the demands of a changing market.
Delaware judges obtain a sense of this market by constantly speaking publicly about corporate law issues and appearing responsive to the corporate law bar. In fact, they are mini-celebrities, coveted for corporate law speaking engagements and at law schools.Vice Chancellor Leo Strine Jr., a judge on the Chancery Court, now even coteaches a mergers and acquisitions class at Harvard Law School.
The financial crisis of the past years showed Delaware’s capabilities. Litigation is often viewed as a long slog of meaningless discovery and appeals taking years to complete. In contrast, during the past two years, Delaware acted quickly to decide these takeover battles soundly. Consider, for example, the litigation involving Cerberus Capital Management and United Rentals. In that case, United Rentals sued to force Cerberus to complete the $4 billion acquisition it had agreed to. Chancellor Chandler took the case from the first filing of complaint to trial and an opinion in about a month, siding with Cerberus and allowing it to walk away from the transaction.
Chancellor Chandler’s opinion was generally considered to be a good and well-reasoned one. This was not unusual for these cases, as time and again the Chancery Court has bent over backward to adjudicate quickly. In the litigation between Hexion Specialty Chemicals and Huntsman, which took only two and a half months to go from complaint to trial, Vice Chancellor Lamb delivered his thoughtful opinion only a few weeks after completion of the trial.
It was not just in this takeover litigation that Delaware showed its ability in the past two years. JPMorgan Chase Co.,’s agreement to acquire Bear Stearns posed a political landmine for Delaware. Bear Stearns was incorporated in Delaware, and the Bear Stearns deal and the mechanisms that JPMorgan negotiated with the federal government’s cooperation were designed to force the deal through over any protesting Bear Stearns shareholders.
The terms of JPMorgan’s acquisition skirted the edge of validity under Delaware law. But when push came to shove, the Delaware courts decided to abstain from ruling in the case, deferring instead to a pending New York suit covering similar issues. Delaware watchers laughed at this result. Delaware’s refusal to rule on this suit was quite contrary to Delaware’s penchant for retaining jurisdiction on the most tenuous hooks. However, abstention allowed Delaware to kick the case to New York and for it to be decided there.
Keeping it in Delaware would have forced Delaware either to stop the acquisition or to make bad law and uphold a legally uncertain takeover. The former would have brought Delaware into direct conflict with the federal government, which adamantly wanted the acquisition to go through. The judge who decided to abstain, Vice Chancellor Parsons, may have been on shaky precedential ground, but it shows the sensibility that Delaware judges bring to their cases. Delaware passed another test.27
Before 1913, New Jersey was the preferred site for incorporations. New Jersey’s dominance ended when its governor at the time, Woodrow Wilson, led a successful push for stricter corporate regulation. Corporations promptly decided to abscond to a more favorable jurisdiction, Delaware. How Delaware has kept its dominance since that time is a puzzle for corporate law scholars. Is it because Delaware continues to pander to corporate managers by offering more lenient regulation? Or is it because Delaware’s law is simply the bes
t available, which removes the incentive to switch?28 Perhaps it is simply inertia and the failure of any other state to compete effectively. The only real exception here is North Dakota, which recently legislated a new shareholder-friendly corporate code in an attempt to attract some of these corporations and the revenue they bring.29 There has yet to be any corporate stampede north, though.
Nonetheless, Delaware caters to its interests—the corporations that incorporate there, the parties who select Delaware law for their agreements and disputes, and the lawyers and bar of Delaware. Delaware must account for those interests or otherwise lose the $600 million in annual revenue it receives from corporate franchise taxes.30 This may be why Delaware has endorsed takeover defenses and otherwise adopted relatively promanagement policies.To be fair to the judges of Delaware, however, they have also cracked down on egregious conduct such as in the 2007 NetSmart case, where the CEO together with his board attempted to bias the process by excluding certain bidders.31
Moreover, Delaware cannot go too far in favoring management because of another of Delaware’s fears: the always-pending prospect of federalization of corporate law. This fear was particularly acute at the time of the Sarbanes-Oxley Act of 2002. The legislation invoked cries of creeping federalization of corporate law and raised the prospect that Delaware could be displaced.32
The Delaware courts quickly reacted, appearing responsive to claims of corporate mismanagement in cases involving options backdating and executive compensation. As Professor Mark Roe has postulated, Delaware often judges in response to the federal government and the public mood at the time, attempting to avoid federal intervention.33 This is probably why Delaware refused to intervene in the Bear Stearns deal, and why any litigation in Delaware challenging other federal bailouts is apt to go nowhere. Today, the fear has arisen again in the realm of executive compensation, as Congress has moved to actively regulate this area. It remains to be seen how Delaware reacts, but it is likely to respond with its own regulation in order to attempt to mitigate any federal response.34 Nonetheless, corporate governance and regulation of corporations is increasingly affected by capital markets regulation, an arena dominated by the federal government. In the coming post-financial crisis regulatory reforms, Delaware is apt to lose some power to more central capital markets regulation.
Despite the federal threat, Delaware is still dominant in regulating corporations and takeovers. It is likely to remain so, and full federalization of corporate law is unlikely. The crises of the past year show that there really is no other substitute for this type of quick adjudicative response. Even when mistakes are made, the responsiveness of the Delaware judges, through their engagement with the corporate bar, ensures it is only a short misstep. It appears that this has made Delaware’s takeover regulation a more coherent and responsive market code than other areas of its corporate jurisprudence.
But this does not mean that Delaware is a perfect takeover regulator. Its multiple standards of review and for litigation discussed in prior chapters have left even the most experienced litigators puzzled as to the likely outcome of a decision. Moreover, there are limits to Delaware’s prominence. Delaware is a court-driven takeover regulator. It cannot issue out rules and instead decides cases based on the facts at hand. Because of this, there will always be ambiguity in Delaware’s jurisprudence and a need for an overlaid federal system. Finally, Delaware is no angel, and there remain flaws in its takeover jurisprudence. I have discussed some of these throughout the book, including its seemingly too permissive approach to lockups and its need to set a proper balance on MACs. However, it is worth highlighting one area not yet discussed in this book, the regulation of management buyouts (MBOs).
Management BuyOuts and Going Privates
Despite its many standards of review, Delaware has yet to set significant, distinct standards for MBOs. In the 1970s, there was a fierce struggle over the appropriate regulation for going-private transactions. In the process, heightened review standards on both state and federal levels were adopted.The federal going-private rules apply to both MBOs and to take privates by controlling shareholders of their subsidiary companies. Delaware’s special rules also apply to both types of transactions, but there is an important procedural difference.
In instances of controlling shareholder-subsidiary going-private transactions, the Delaware courts will always review these transactions under the “entire fairness” standard.35 Conversely, at least one Delaware Chancery Court judge has held that an MBO transaction can be subject to deferential review under the business judgment rule.36 According to this court, this can occur if the transaction is with management, they do not have a controlling stake in the company, and the transaction is approved or ratified by a fully informed vote of the noninterested shareholders. The problems with a gap like this were ably on display in the recent 2008 failed MBO of Landry’s Restaurants, Inc., the owner and operator of Landry’s Seafood House, the Rain Forest Café, and a number of other restaurant concepts.
On January 28, 2008, Landry’s Restaurants, Inc. announced that its CEO and chairman of the board,Tilman Fertitta, was proposing to buy the company. Fertitta, who already owned 39 percent of Landry’s, proposed to pay $23.50 a share for the rest of it, for a total deal value of $1.3 billion. The amount he offered was a 41 percent premium over Landry’s closing share price of $16.67 on the day before the bid was announced.37
The Landry’s board then did what boards usually do in such situations. The board established a special committee to consider the proposal. However, the committee got off to a slow start and did not officially announce the retention of its financial adviser, Cowen & Company, until April 2. The reasons for the delay appear to be related to complications surrounding the retention of Cowen and the negotiations of Cowen’s engagement and fee letter. But it may also have been a sign of the committee’s inexperience.
On April 4, only one day after the special committee had begun to supply Cowen with information, Fertitta lowered the price he was willing to pay to $21 per share. In a letter to the special committee, he sought to justify these revised terms by citing the declining state of the market, drops in Landry’s stock price, and the company’s deteriorating results from operations. At the time, he stated that he was “fully prepared to proceed with the transaction in an expedited manner.”
On June 16, Landry’s announced that it had agreed to be acquired by an acquisition vehicle controlled by Fertitta for that same $21 a share. The total value of the transaction was approximately $1.3 billion, including approximately $885 million of Landry’s outstanding debt. At the time, Fertitta announced that this acquisition vehicle had received a debt commitment letter from the investment banks Jefferies and Wells Fargo to fund the acquisition. In connection with the deal, Landry’s retained a 45-day go-shop period that permitted it to solicit third-party bids after the agreement’s announcement. If a third-party bid materialized during this time period, Landry’s would be required to pay only a termination fee of $3.4 million. In addition, Fertitta could terminate the acquisition agreement until August 15 and pay only a reverse termination fee of $3.4 million. Thereafter, he could walk from the transaction at any time by paying a reverse termination fee of $24 million.
The terms were very beneficial to Fertitta and effectively gave him a cheap option to purchase the company. It was later disclosed by Landry’s that Fertitta bargained hard for this deal and optionality. He threatened to revoke his offer if the company was shopped prior to the signing of an agreement with him, refused to neutralize his shares in any vote, and refused to allow a condition that the transaction be approved by a majority of the Landry’s stock he did not control. In negotiating against Fertitta, it seemed the committee was able to gain very little.The one time they threatened to refuse to approve the deal if he didn’t agree to their demands, they quickly caved when he refused to do so.
On August 1, Landry’s announced that it did not receive any third-party proposals to acquire the company during the go-
shop period. This was not surprising: Fertitta was the company’s chief executive and chairman, and he controlled 39 percent of Landry’s stock. Given his head start and voting advantage, a third-party bidder would be starting from behind in any bid, and at a distinct disadvantage.
On October 7, Fertitta informed the special committee that “in view of the closure of the company’s properties in Kemah and Galveston [due to a recent hurricane], the instability in the credit markets, and the deterioration in the casual dining and gaming industries, the debt financing required to complete the pending transaction is in jeopardy at the current $21.00 per share price.”
On the evening of October 19—at 6:17 PM, to be exact—Landry’s issued a Saturday night special, a press release announcing that the acquisition agreement had been amended so that Fertitta would pay a reduced $13.50 per share. The price reduction was still not enough to save the deal. On January 12, 2009, the Landry’s deal was terminated. The reason put forth by Landry’s was a bit tortured and, frankly, odd. According to Landry’s:
The S.E.C. was requiring the Company to disclose certain information from a commitment letter issued by the lead lenders to Fertitta Holdings Inc. and Fertitta Acquisition Co … and [Landry’s] about the proposed financing for the going private transaction and for the alternative financing (in the event the going private transaction did not occur).38
Landry’s asserted that the commitment letter had a confidentiality clause that prohibited this disclosure and that the lead lenders Jefferies & Company and Wells Fargo refused to waive the clause. Instead, the lenders stated that they would assert a breach if the SEC required this disclosure and would cite this breach to terminate their commitment letters.
According to Landry’s, this left it with no choice but to terminate the acquisition in order to preserve the company’s alternative financing if the transaction did not occur. Conveniently, since it was Landry’s that terminated the transaction, the company was not even entitled to the $15 million reverse termination fee from Fertitta’s affiliates that it might otherwise have been entitled to. It still remains unclear why exactly Landry’s terminated the transaction in a manner that left the company without any recompense.
Gods at War: Shotgun Takeovers, Government by Deal, and the Private Equity Implosion Page 33
