Board of Directors Archives - That's Not Market

A Brief Reaction to a Small Part of “Assessing Silicon Valley Corporate Governance Measures” Article

The Recorder recently ran an article discussing Fenwick & West’s corporate governance study. I believe F&W produces these annually, and they are excellent resources for anyone interested in the up-to-date information about corporate governance practices, particularly for Silicon Valley companies.

However, there was an interesting statement at the beginning of the article:

“When companies are seeking to establish appropriate corporate governance policies, they often look to model themselves after those titans of industry in the Standard & Poor’s 100.”

Well . . . sometimes.

More often, companies will look to the companies that:

they deem somewhat comparable to the themselves; and
they aspire to be.

Typically, that will include prominent companies in their industry, which may or may not include companies in the S&P 100, 500, Pick-A-Number. They also account for size and complexity and other factors.

For many companies, the governance practices of the S&P 100 will be far too complex and have far too many processes and procedures to have any value. There will often be fewer people in the decision-making process, fewer layers of bureaucracy and the fewer issue-specific policies for smaller companies.

That said, the F&W studies tend to be extremely valuable, and I plan to spend a good part of the weekend reading the new one. I hope your weekend is better than that.

Delaware Supreme Court Discusses Meaning of “Business Combination” In Activision Vivendi Case

As it turns out, it isn’t ambiguous.

Link: Activision Blizzard Inc. v Hayes

In an appeal of an injunction, the Delaware Supreme Court took a look at whether a stock buyback would be a “business combination” requiring stockholder approval under Activision’s bylaws.

Background

Activision Blizzard fights for its rights to buyback its shares.

In 2008 Activision bought Vivendi’s video game subsidiary for Activision shares. Vivendi also made a separate cash investment in Activision. Activision’s bylaws were amended to require approval of unaffiliated stockholders with respect to any merger, business combination or similar transaction between Activision and Vivendi. In 2012, Vivendi wanted to sell its Activision stake but found no takers. Activision agreed to a buyback, under which Vivendi would create a non-operating sub, “Amber,” to hold the assets for sale and Activision would purchase Amber. Activision did not seek stockholder approval, which was the part of the reason for the litigation, which resulted in a preliminary injunction.

Court’s Analysis

The court first looked to see if “business combination” was ambiguous. Nope.

“A provision is ambiguous only if it is “reasonably susceptible to more than one meaning,” and the fact that the parties offer two different interpretations does not create an ambiguity. Moreover, a provision “may be ambiguous when applied to one set of facts but not another. Finally, the provision must be read in context.”

The court decided that while the meaning could be ambiguous in some contexts, it was not ambiguous here because under their agreement, Vivendi will sell 429 million shares of Activision stock back to Activision. Because those shares will become treasury stock, control of Activision will shift from Vivendi to Activision’s public stockholders. Vivendi’s holdings will decrease from 61% to 12%, and Vivendi’s representation on Activision’s board will decrease from six appointees to none.

Since there was no “combination or intermingling of Vivendi’s and Activision’s businesses,” it is not a business combination. In fact it is the opposite of a business combination. These companies will be separating themselves. As a result, the stockholder approval requirement does not apply.

In addition, structuring the sale through Amber does not change the analysis. Neither the form of the transaction nor its size changes its fundamental nature. Amber is a shell created to serve as the transaction vehicle. The court stated that calling Amber a business “disregards its inert status” and “glorifies form over substance.”

The size of the deal does not change the analysis. The plaintiffs argued that it was a “value-moving” transaction. However, the bylaws do not require stockholder approval based on size of the deal.

In addition, the bylaws do not require stockholder approval for any deal between Activision and Vivendi, only specified transactions. While the Chancery Court may have been looking out for the non-interested shareholders’ interests, other provisions of the bylaws already provided for independent director approval for related party transactions.

Can Open Market Stock Purchases Resulting In Majority Control Constitute A Breach Of Fiduciary Duty?

How about the board’s granting of the right to engage in those purchases?

Answer: No.

Link: In re Sirius XM Shareholder Litigation

Background

In 2009, Sirius was hurting. Liberty Media was nice enough to provide $530 million for a 40% interest, some board seats and some consent rights. The agreement included a standstill provision preventing Liberty from gaining majority control for three years. Following the standstill period, the agreement prevented Sirius from using a poison pill or charter or bylaw amendment to interfere with additional purchases of Sirius stock by Liberty. The investment and agreement were disclosed publicly.

At the end of the standstill period, Liberty announced it would obtain a controlling position through open market purchases. Sirius opposed it, and even opposed the FCC approval that Liberty would need in order to obtain majority control. However, Liberty was able to get its majority stake.

Plaintiffs sued claiming breach of fiduciary duty on the part of Liberty and the Sirius board of directors.

Fiduciary Duty Claims Against Sirius Board

The court initially noted that the time period for fiduciary duty claims ran from the time of the agreement in 2009, and thus their claims were time barred. The plaintiffs also argued that the board should have instituted a poison pill to prevent Liberty’s additional purchases, the court said this was not the wrongful act. The plaintiff’s complaints arise out of the initial agreement in 2009, and the plaintiffs did not have a good reason for waiting to file a lawsuit. The terms of the deal were fully disclosed in 2009, and the board’s inability to stop Liberty’s purchases were based on the 2009 deal.

Anything the board did that is subject of the plaintiffs’ complaint was based upon 2009 activity and, therefore, the statute of limitations ran from 2009. As the court said, “[u]nder Delaware law, a plaintiff’s cause of action accrues at the moment of the wrongful act – not when the harmful effects of the act are felt – even if the plaintiff is unaware of the wrong.”

Fiduciary Duty Claims Against Liberty

The Plaintiffs also argued that Liberty had a fiduciary duty even if it was a non-controlling shareholder when it initially invested in 2009. This duty of fairness would preclude Liberty from buying additional shares in the open market unless the Sirius board approved the terms.

The court disposed of this claim as well. First, they are time-barred because they were still the product of the arms-length negotiations and deal in 2009 when Liberty was not even a stockholder, much less a controlling stockholder. Second, open market purchases after disclosing the intent to make such purchases do not involve any control over Sirius’ board or misuse of Sirius’ resources by Liberty. There was no allegation of insider trading or an attempt to effect a going private transaction. To the contrary, even the plaintiffs conceded that Liberty’s purchase announcement would result in the market price for the Sirius shares to increase prior to purchase. As a result, what the plaintiffs are really claiming is a repackaging of their opposition to the 2009 deal.

The only real complaint of the plaintiffs is that the board did not institute a poison pill, which was not only prohibited by contract but is not actionable under Delaware law without additional bad acts (recall the Landry’s case, Louisiana Municipal Police Employees’ Retirement System v. Fertitta, 2009 WL 2263406 (Del Ch. July 28, 2009)).

The court finished with its adherence to basic corporation law and contracts:

“There are many situations when corporations enter into contractual arrangements that have important implications for corporate control in conceivable future situations; for example, debt instruments commonly give creditors rights that, if used, may result in their assuming control. The use of such rights to obtain control in the situations specifically contemplated by those contracts does not constitute a fiduciary breach. As this court has explained, even “[a] controlling shareholder is not required to give up legal rights that it clearly possesses; this is certainly so when those legal rights arise in a non-stockholder capacity.””

A Simple Question: What Does “Annual” in “Annual Meeting” Mean?

According to the Massachusetts Supreme Court, the answer isn’t quite so simple.

Link: Brigade Leveraged Capital Stuctures Fund, Ltd. v. PIMCO Income Strategy Fund

“Annual” means “annual,” right? How hard could it be. Let’s allow some ambiguous drafting, course of dealing and New York Stock Exchange regulations make it complicated.

Background

PIMCO is a big fund company and Brigade is an investor in two of its funds, each of which is a Massachusetts business trust.

The funds sent notices to investors of their intent to hold annual meetings as usual. Brigade sent notice that it was going to nominate a trustee for election at the annual meetings. PIMCO rescheduled the meetings to the last day of its fiscal year.

The funds’ declarations of trust require annual meetings at least 15 months after the first sale of shares and thereafter as specified in the bylaws.

The funds’ bylaws provide that annual meetings shall be held, so long as common shares are listed for trading on the NYSE, on at least an annual basis.

The NYSE requires listed companies to hold an annual shareholders’ meeting during the fiscal year.

Brigade filed suit seeking an injunction requiring PIMCO to hold the annual meeting as soon as practical and a declaration that the bylaws require an annual meeting at least once within any twelve month period.

Brigade contends that the rescheduling to nineteen months after the last annual meeting does not count as “annual,” which means within twelve months of the last annual meeting. PIMCO says “annual” means “during the fiscal year.”

What the Court Says “Annual” Means

Interpretation of Governing Documents

The court noted that the reference to the NYSE clearly means that an annual meeting must be held, at the very least, once every fiscal year, even though the bylaws do not explicitly say that.

However, the court reviewed the bylaw provision for shareholder notices together with the annual meeting requirement.¹ It also noted that the bylaws provided for a special meeting in lieu of annual meeting, which may take place outside of the “annual period,” a thirty day window following the anniversary of the previous year’s annual meeting, which is not an “annual meeting,” but a “special meeting.”

The court also noted that this interpretation is consistent with how PIMCO historically scheduled its meetings and the usual meaning of “on an annual basis.”

There is more going on here than contract interpretation, and you may already know this if you have ever dealt with this issue before a court.

The Real Issue

Many courts don’t come out and say it, but the Brigade court did. Where the bylaws are ambiguous, it will construe them against the drafters, in other words, the company.

The upshot is that courts do not like it when companies try to escape the wrath of a shareholder vote. As the court said,

“Moreover, where “bylaw provision are unclear, we resolve any doubt in favor of stockholders’ electoral rights.””

The court went on to quote a variety of shareholder friendly cases for the proposition that voting in corporate elections is a fundamental right of shareholders, and the court will not interpret ambiguous governing documents to allow the company to postpone an election.

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¹Bylaws Section 10(c):

“To be timely, the Shareholder Notice must be delivered to or mailed and received at the principal executive offices of the Trust not less than forty- five (45) nor more than sixty (60) days prior to the first anniversary date of the date on which the Trust first mailed its proxy materials for the prior year’s annual meeting; … provided, … however, if and only if the annual meeting is not scheduled to be held within a period that commences thirty (30) days before the first anniversary date of the annual meeting for the preceding year and ends thirty (30) days after such anniversary date (an annual meeting date outside such period being referred to herein as an “Other Annual Meeting Date”), such Shareholder Notice must be given in the manner provided herein by the later of the close of business on (i) the date forty-five (45) days prior to such Other Annual Meeting Date or (ii) the tenth (10th) business day following the date such Other Annual Meeting Date is first publicly announced or disclosed” (emphasis added).

Outsourcing Corporate Boards?

An interesting proposal by a couple of corporate law professors may cause you to rethink how companies populate their boards.

Law professors M. Todd Henderson (U. Chicago) and Stephen M. Bainbridge (UCLA) have proposed a novel way to expand further the universe of corporate service providers by allowing the outsourcing of board functions.

The profs note that critics complain that the array of tasks for a board to deal with are too vast for a board to perform effectively. They also note that “boards fail to police managers adequately or make good decisions” and that they are generalists without the breadth of experts the company may need.

First, boards generally, and exchange listed board committees specifically, have the ability to hire expert advisors directly without relying on company management.

However, this brings up a point that has bothered me for a while. Before, and particularly after, Sarbanes-Oxley, the corporate governance “experts” have emphasized the need for independent board members, free of the influence of management. However, with respect to the operations and performance of a company, that responsibility and information resides with management.

In other words, particularly in the post-Sarbanes-Oxley world, the most sensitive and important decisions are under the purview of the people with the least connection to the company and the least access to the information. I understand the fear of conflicts of interest and the desire for input free of the influence of management, but this seemed to me to be a mismatched solution.

Basically, I’m not sure I agree with the critics. You can point to specific governance horror stories, but there are thousands of public companies and many thousands more private companies where corporate boards operate adequately or even successfully. There are actual instances of effective governance that pre-date Sarbanes-Oxley, if you can believe it. In the case of policing management and making crucial policy decisions, why would you have those responsibilities rest with the individuals furthest removed from the company?

In addition, there are many examples of corporate boards with structures resembling the All Governance Expert Blue Ribbon Panel Paradigm that turned out to be miserable governance failures (*cough*Enron*cough*).

I know this was a bit of tangent, but it was my first reaction to the profs’ article. There will be more. It is recommended reading.

Thinking You’ll Do A Better Job Than The Other Guy Is Not Reason Enough For A Board Of Directors To Avoid “Approval” Of Dissident Board Nominees That Will Harm The Corporation

Withholding approval is a threat to the shareholder franchise when the incumbent board retains power to approve a dissident slate but refuses to entrench itself.

SandRidge Energy found itself in a proxy fight launched by hedge fund instigator, TPG-Axon. TPG launched a consent solicitation to de-stagger SandRidge’s board, amend the bylaws, remove all of the current directors and install its own slate. Let’s just say that SandRidge’s performance had been lacking at the time.

The SandRidge board resisted and warned stockholders that the election of TPG’s slate would be a change of control that would trigger a requirement for SandRidge to repurchase its outstanding notes, referred to colorfully as the “Proxy Put.” If a new board majority is not approved by an incumbent board, the Proxy Put was triggered for purposes of the notes.

A stockholder claimed breach of fiduciary duty because the sitting SandRidge board did not have a proper basis for failing to approve the TPG slate for the purposes of the Proxy Put.

The court said that a board deciding whether to approve directors for the purposes of the Proxy Put could not act consistently with its fiduciary duties by simply failing to approve any director candidates opposing the incumbents.

The duty of loyalty demanded that the incumbents may only refuse to grant approve if the dissidents posed such a material threat of harm to the corporation that it would constitute a breach of the duty of loyalty to pass control to them. For example, unless the dissidents lacked ethical integrity, were looters or proposed a program that would demonstrably be materially adverse to the company’s ability to meet its obligations to the creditors, then the incumbents should approve the dissidents and allow the stockholders to vote.

The incumbents noted that the dissidents did not have sufficient energy experience, although several members of their slate had substantial experience, even if not in the upstream oil and gas industry. However, that the incumbents believed that they were better suited to run the company is not a sufficient fiduciary basis to deny approval of the dissidents. The incumbents did not have reason to doubt the integrity of the dissident slate. As the court said:

“In other words, the incumbent board has simply made the same determination that all incumbents who seek to continue in office make: we are better than the new guys and gals, so keep us in office.”

The court went on to disparage a company that would enter into an agreement with a Proxy Put without hard negotiation and clear economic advantage given the obvious entrenching purposes of a Proxy Put as the court believes that the costs of resisting such a term would be insubstantial to non-existent.*

Update:
SandRidge and TPG settled, and SandRidge added four TPG nominees to the board.

Links:
Kallick v. SandRidge Energy
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*Ed. Note: Not really. Many lenders/noteholders/counterparties want to know exactly who they will be dealing with during the term of their agreement. The Proxy Put is probably more widely used and integral to many transactions than the court realizes.