City Capital Associates Ltd. Partnership v. Interco Inc. 551 A.2d 787 (Del.Ch. 1988) is one of my favorite Delaware opinions. Written by Chancellor Allen in 1988, Interco was the case in which Unocal was famously labelled "the most innovative and promising case in our recent corporation law." Ironically, Interco earned a red flag in Westlaw when the Delaware Supreme Court described the case as a "narrow and rigid construction of Unocal" and "reject[ed] such approach as not in keeping with a proper Unocal analysis." See Paramount Communications, Inc. v. Time Inc., 571 A.2d 1140, 1153 (Del.,1989). Now, over 20 years after Interco's apparent demise, Steve Davidoff suggests that Delaware's recent poison pill jurisprudence may be making room for Interco again. I agree.
Though Interco is still well known among corporate lawyers as a case in which Chancellor Allen ordered the redemption of a poison pill under Unocal, the case expresses some concern about Unocal's implications:
The danger that [Unocal] poses is, of course, 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. Thus, inartfully applied, the Unocal form of analysis could permit an unraveling of the well-made fabric of the business judgment rule in this important context. Accordingly, whenever, as in this case, this court is required to apply the Unocal form of review, it should do so cautiously, with a clear appreciation for the risks and special responsibility this approach entails.
In retrospect, this hand wringing seems quaint, as the Delaware courts (particularly the Delaware Supreme Court) have routinely deferred to defensive actions by target directors. Indeed, after Unitrin modified the Unocal standard in 1995, it was hard to imagine a defensive measure that would be invalidated. The Delaware Supreme Court seemed so deferential to target boards that Bob Thompson and I declared Unocal a "dead letter" in 2001, though the Court of Chancery had invalidated a "dead hand" pill and a "no hand" pill a few years earlier. Our point was simply that defensive measures had to be extreme -- "show stoppers" in the parlance of the Delaware courts -- before they would be invalidated. Anything short of that extreme -- even a pill that makes a hostile takeover substantially harder, such as the 5% pill in Selectica, Inc. v. Versata Enterprises, Inc. -- would be approved as a proportionate response to almost any cognizable threat.
Interco offered a more nuanced interpretation of Unocal than the one developed in the subsequent Delaware Supreme Court cases. According to Chancellor Allen, "in the setting of a noncoercive offer, absent unusual facts, there may come a time when a board's fiduciary duty will require it to redeem the rights and to permit the shareholders to choose."
Note that the premise for redemption in Interco is a noncoercive offer. As Professor Davidoff observes, Vice Chancellor Strine seems to invoke the spirit of Interco in Yucaipa American Alliance Fund II, L.P. v. Riggio, decided last month, when he writes: "there is a plausible argument that a rights plan could be considered preclusive, based on an examination of real world market considerations, when a bidder who makes an all shares, structurally non-coercive offer has: (1) won a proxy contest for a third of the seats of a classified board; (2) is not able to proceed with its tender offer for another year because the incumbent board majority will not redeem the rights as to the offer; and (3) is required to take all the various economic risks that would come with maintaining the bid for another year."
The bigger point that I would like to make in this post, however, is that Interco was animated by a sophisticated analysis of the threat prong under Unocal. Where the threat is relatively mild (e.g., "in the setting of a noncoercive offer"), the response should be accordingly muted. The Court of Chancery has been more attentive to this sort of analysis in recent years, and all three recent poison pill cases have something interesting to say on this issue.
- In Selectica the target board of directors was attempting to "prevent the inadvertent fortfeiture of potentially valuable assets, not to proteact against hostile takeover attempts." Vice Chancellor Noble reasoned, "the protection of corporate assets against an outside threat is arguably a more important concern of the Board than restricting who the owners of the Company might be." Given the elevated threat, a more severe defensive action was considered reasonable. (For an argument that the Delaware courts have gone too far, see the latest by Paul Edelman and Randall Thomas.)
- In Yucaipa, Vice Chancellor Strine identified the "threat that the corporation's stockholders would relinquish control through a creeping acquisition without the benefit of receiving a control premium." This does not seem like a terribly severe threat, given the existence of 13D filings that would place the market on alert for creeping acquisitions. Nevertheless, the defensive action in this case was not severe. Yucaipa conceded that the Rights Plan was not preclusive, which left only the issue of whether the Rights Plan fell within the "range of reasonableness" -- a business judgment rule-like inquiry that target boards rarely fail to satisfy.
- In eBay v. Newmark, as noted in my earlier post, Chancellor Chandler held that the target directors did not reasonably perceive a threat to the corporation's policy and effectiveness. Thus, the poison pill was unjustified.
While we might debate the correctness of any of these decisions, I applaud the Court of Chancery for continuing to develop its Unocal jurisprudence. Like Chancellor Allen, I have long thought that Unocal has great potential to calibrate the actions of incumbent directors. The question remains: will the Delaware Supreme Court embrace this more nuanced analysis?
He ends the column by engaging our own Conglomerate forum topic on poison pills. He starts with a comment that eBay isn't all that interesting as a poison pill case. To follow Christine's analysis (and to borrow from craigslist lingo), perhaps we should flag Chancellor Chandler's posting as "miscategorized" -- is the case really about takeovers or about minority shareholder oppression or disenfranchisement?
Steven then gives a nice summary of what two cases that clearly do change poison pill jurisprudence -- Selectica and the Vice Chancellor Strine's opinion in the Barnes & Noble litigation -- mean for the looming legal battle over Air Product's takeover attempt on Airgas.
While I was teaching in London this past month, I told my students -- most of whom had just finished their first year of law school -- that their job prospects would brighten substantially over the next two years, led by a boom in mergers and acquisitions. My prediction was accompanied by the usual disclaimers: the views expressed here are entirely impressionistic and not based on systematic study or expertise. Nevertheless, the stars seem to be aligning. Banks are strengthening their balance sheets and becoming profitable. The weak economy has exposed vulnerable companies, but it has helped many other companies to become leaner. Consider the following from today's FT:
In a buoyant second-quarter results season, two-thirds of European groups beat analyst forecasts; predictions suggest that leading American companies will report record profits this year. Businesses are flush with cash as they reap the benefits of rigorous cost-cutting and borrowing rates at historic lows.
Even the most bullish executives privately acknowledge that there are risks to the recovery as some of the reasons underlying it evaporate and concerns persist over how developed countries tackle their public debt. But for now many of them are basking in a remarkable corporate renaissance in which size is a factor. “The strong are getting stronger and the weak are getting weaker. The competitive advantage has gone to the bigger companies,” says the chief executive of one group with $100bn revenues.
With the exception of Europe, global merger activity has already picked up this year. And John Carney's latest at CNBC suggests that at least some lawyers on getting ready:
As John observes, we are projecting based on anecdote, and the risks are still grave, but there seems to be some cause for optimism.
The move of the Hanrahan team from midtown’s Lipstick building to One Chase Manhattan Plaza, in the heart of the financial district, shows that New York law firms are prepping for a big comeback for M&A debt financing. It seems likely that the clients of these lawyers—big financial institutions—are letting them know that lending standards may once again be easing and credit becoming more available for leveraged finance driven deals.
UPDATE: Larry Ribsten posted on John's story over at Truth on the Market, asking "Would a big increase in m & a activity mean a rebirth of Big Law?" Larry notes that this is area of legal practice in which Big Law is thought to have big advantages, but he is still wondering about the effect of outsourcing and technology. It's worth reading his Death of Big Law to see the argument in full.
Newsweek is on the block. The Washington Post Co. is accepting nonbinding bids for the 77 year-old magazine, and a few prospective buyers are lining up. However, most name brands have declined: Bloomberg, Thomson-Reuters, U.S. News & World Report.
I used to love Newsweek. It was my airport purchase of choice. I never had a subscription though, because it was so expensive. I remember getting a call form a marketer once who would give me three other subscriptions for free (I think my picks were Oprah, Vanity Fair and something else) for purchasing a Newsweek subscription. When I was in practice, I received an offer a week to purchase a subscription for "half off the newstand price," but it was still expensive. Weekly magazines subscriptions are expensive.
But now I rarely buy it, even in the airport. If the morning newspaper seems to have stories that are already familiar, then reading a weekly magazine seems a lot like reading a 6 day-old newspaper. And Newsweek's concept was news. Mostly short pieces similar to a newspaper article or a blog post, with a few longer pieces, with more texture and interviews. So, these days, you're paying $4 for the two long pieces, a lot of articles you've already read, and the cartoon/quotations page. The weekly format just got squeezed by the Internet. Weekly deadlines make sure that almost everything is stale and nothing is incredibly deep and thoughtful. I actually love the articles in Vanity Fair, which are often about the financial industry, well-written and in-depth. But I'm sure they take more than 4 days to write.
But what about People magazine? It's a weekly, it's expensive, and it's very popular. But what is in there isn't available on the Internet. They have exclusive photographs. Good ones, that I'm sure they pay for. They also have exclusive interviews with celebrities, which they may also pay for. Yes, you see on the Internet that Sandra Bullock is separated from her husband, but People magazine has the exclusive interview. Two other things that sets People magazine out from the crowd. First, it's more reliable than their competition. If you look at a grocery store checkout aisle, four other magazines will have a cover that says that Hollywood couple No. 347 is divorcing because of (1) strange religious practice; (2) same-sex affair; (3) opposite-sex affair; (4) plastic surgery; (5) baby or lack thereof; or (6) aliens. The cover of People magazine will be silent on the topic. I don't believe any celebrity gossip unless it's in People magazine. Second, People magazine may sell to a different demographic than the one that is following every celebrity on Twitter and scanning the internet constantly for news. So, what's in People is still news to the mom at the grocery store who gets to check Facebook every other day, and People is amazingly good at getting things in the weekly magazine that seemed to have happened six hours ago. The same people who would buy Newsweek have already kept up with most of the news that's in the latest issue.
So, stay tuned to see who wins the auction and what they will do with Newsweek once they win.
The NY Times is reporting that United and US Air are in merger talks.
Ten years ago, the last time these two airlines were courting each other, I lived in D.C., and it was that market that caused the most antitrust concerns. United has a hub at Dulles, while US Air has one in Philadelphia and has major operations out of National.
Will this courtship turn out differently? Are the continuing struggles of the airlines enough to overcome union and antitrust obstacles? (Don't ask me. I won't even pretend to be an antitrust scholar.)
Which of the potentially eight hubs of the combined airline (SF, LAX, Phoenix, Denver, O'Hare, Philly, Dulles, Charlotte) would be downgraded? Living in the Southwest, I hope it would be none of the western ones. Phoenix might seem like a good candidate, although the city has stealthily grown into one of the five largest in the country. I am also rooting for Philly to remain viable. The US Air hub there keeps prices down when we fly back to God's Country (aka New Jersey).
During the financial crisis, the last administration, staffed by investment bankers, tried to furiously deal its way out of the mess. TED has a post up that suggests that perhaps we should not be surprised, given the business model, and ultimately the culture, of investment banking:
My most recent article, Private Equity and the Heightened Fiduciary Duty of Disclosure, is coming out in the latest volume of NYU's Journal of Law & Business.
There, I argue that Delaware courts are concerned with conflicts of interest in private equity deals and are subjecting them to more intense scrutiny than strategic transactions. As a result of this scrutiny, several private equity deals have been enjoined, while strategic deals with similar defects have not.
The interesting thing, at least to me, is how Delaware is doing it. Instead of enjoining transactions on loyalty grounds, which would be deadly to those deals, courts are finding disclosure deficiencies. Using this approach, Delaware tries to have its cake and eat it too. It voices its disapproval of the process and ultimately allows shareholders to decide if they want the fruits of the tainted search.
Check it out and let me know what you think.
It is that time of year, and via Above The Law, here's the M&A league tables for the first three quarters of 2009. Congratulations to Skadden, and it looks like Davis Polk is coming back after a terrible 2008.
Before signing off, I want to thank The Conglomerate for allowing me to use this forum to share some of my ideas with all of you. I would also like to thank the terrific readers who have reached out to me these past few weeks with some very insightful comments. I am impressed by the wide readership of The Conglomerate which includes scholars, practitioners and students. Earlier in my posts I asked whether "to blog or not to blog" and, thanks to the input from David, Usha, and some Glom readers, I look forward to blogging again in the near future. I am beginning to be convinced that (to borrow from Edward R. Murrow) “This instrument can teach, it can illuminate; yes, and even it can inspire, but it can do so only to the extent that humans are determined to use it to those ends.” So I hope The Conglomerate crew continues with the great work that keeps those like me inspired followers.
As for me, I hope to continue my research on reverse termination fee (RTF) provisions. In one of my earlier posts I talked about the increasing use of RTF provisions to provide greater contractual flexibility and greater creativity in allocating deal risks. I also spoke about some of the lingering problems of the RTF structure, including the process by which the actual amount of the fee was set and the lack of clear disclosure to shareholders about the risks faced by both the buyer and the seller when agreeing to contracts with RTF structures. Some of these problems have much to offer for judicial review of board decision-making and public company disclosure – topics that I will explore in a companion paper that I hope to post on SSRN in the coming months. Of course I welcome your thoughts on these topics.
I first want to thank Gordon Smith and company for the invitation to guest blog on The Conglomerate. I have been a devoted follower of this blog going back to my days as a transactional lawyer. In fact, Gordon and crew helped to inspire me to enter academia, and I learned a lot from their blog, as well as from other faculty blogs, about how to transition from practice to this fabulous new life. After seven years as a corporate lawyer, I began teaching at UC Davis School of Law in 2007.
I am pretty passionate about corporate law, especially comparative corporate law, transactional law and deal-making. During my visit, I hope to explore some of these issues, as well as share some thoughts on incorporating transactional law and skills in the classroom.
My current obsession (and my poor family really does see this as an obsession) is with reverse termination fees (RTFs) as a risk allocation tool in merger agreements. While standard termination fees, i.e. fees payable by the seller to the buyer, have been analyzed for years by both practitioners and scholars, RTFs have received minimal attention. I think that it is time that both scholars and practitioners think more deeply about these and other similar provisions (like ticking fees), their current uses and their potential for deal innovation. It is clear that there are some others who are also thinking about these issues (HT: M&A Law Prof blog).
For the past couple of years there have been anecdotal reports of an increasing use of RTFs in strategic deals. My current paper confirms these reports through a study of strategic acquisition agreements involving US public companies during two separate periods, January 1, 2003 through December 31, 2004 and January 1, 2008 through June 30, 2009. An analysis of each of these agreements demonstrates that in the 2003-04 period parties predominantly used RTF provisions to allocate similar risks to those allocated by STFs, such as the risk that the buyer would terminate the agreement due to a superior proposal for the buyer. Thus, it was unsurprising that in a substantial majority of the reviewed agreements, the RTF was equal to the STF. The findings were quite different for the 2008-09 period. Not only has there been a significant increase in the use of RTFs, as compared to the 2003-04 period, but the data also shows that while in some transactions RTFs continue to be set at an equal amount to STFs, parties have also become more creative by using hybrid and liability cap approaches. This more creative approach to RTFs reflects the use of the provisions to allocate deal risk beyond just the risk of non-consummation due to a competing offer for the buyer, such as financing risk or the risk of a breach of contract by the buyer. Furthermore, in a sizeable number of the 2008-09 transactions that I studied, parties had altogether abandoned specific performance as a contractual remedy and specified that the RTF was the seller's sole remedy in the event the deal failed to close for any reason.
Overall, the study demonstrates that the shift in contractual triggers that give rise to RTFs provides buyers greater flexibility to walk away from transactions. In future posts I will talk about some theories as to why this shift has occurred and the implications it may have on the ways in which we view merger agreements and review board decision-making. Suffice it to say, I think that my obsession with RTFs has led me to think and write even more about these issues.
So, in a time that is a little light on interesting mergers and acquisitions, here's a story we can chew on for awhile. (Ha, ha.) Kraft has made a bid for Cadbury, at a price with a substantial premium (31% over share price), only to be told that it is way too low. Well, there goes that whole efficient market thing. Cadbury is in the middle of a strategic plan to increase profitability and share price, and here comes Kraft trying to buy into that momentum. WSJ story here; NYT story here. Cadbury is known in Europe for chocolate, but it also has gum. Kraft doesn't have gum. In recessions, people eat gum. Hmmm.
Stay tuned. Hershey, which already has a distribution deal with Cadbury, may jump in.
I'm rushing off to class, but I wanted to note quickly that I.B.M. has broken off negotiations with Sun over the weekend. But lawyers take heart: I.B.M.'s change in tone came after 100 lawyers engaged in extensive due diligence. So, there is a second-year associate somewhere who can't believe the coolest deal she's gotten to work on so far just died over the weekend, but at least her hours for March were good.
With so few fun deals to talk about these days, we have to enjoy the ones we have. The IBM acquisition of Sun Microsystems seems to be coming to fruition at $9.55 a share ($7B), representing an almost 100% premium over the pre-announcement (or pre-rumor) price. (WSJ story here.) In fact, Sun recently lowered it's original asking price to make sure it kept I.B.M. in the game. The new agreement has a lower price but a pretty strong termination penalty, according to reports.
Remember that Sun shares were $250 in 2000, when Sun touted that it was the "dot in 'dot.com'" and this acquisition takes on a lot more narrative than it had before. Here is the old guard, I.B.M., snagging up Sun, one of the hottest hardware companies in the 1990s. Everything old is new again.
For nostalgia's sake, here is a 10-year retrospective on Sun's share price, as compared to the NASDAQ composite index:
Usha's post below, with its reference to Ronald Gilson's 1984 article on value creation by lawyers, prompts me to a short rant, not about Usha's post, but about the article, which Usha rightly calls a "classic" and "the reigning academic account of what business lawyers actually do." Honestly, with all due respect to Professor Gilson (who joined the Stanford faculty the year I left as a student), the article has bugged me since I read it a couple years ago; indeed, I have a comprehensive list from a Lexis search I did a while back of every article that had cited it, because I was trying to do a literature search to see if anybody else had said what I'm about to say here. Since I haven't followed up on my list, I don't know, and I therefore apologize if I'm repeating a critique somebody has already written. I also apologize for the stream of consciousness approach that follows.
What about the article bugs me? Let me count the ways:
1. If I were taken with law and economics in 1984, but had no way of showing empirically that the reams and reams of hours that lawyers spent doing deals actually produced anything with intrinsic value (which Professor Gilson forthrightly admitted, at pp. 247-48 of the article), but was inclined to hope that they did, with an interest in justifying their existence (as again Professor Gilson forthrightly admitted at footnote 149), this is, I suppose, exactly the article I would write. What we have here is an attempt to make sense of the world, by way of scientific (or quasi-scientific) theory, but it is "over-determined" in the sense that the theory selected happens to be rational actor economics, rather than, say, the theoretical view Clifford Geertz applied to Balinese cock-fighting.
2. The theory is capsuled as follows. All transactions occur because buyers value an asset more than sellers. The difference between the two values is surplus. Haggling over the split of the surplus is of no interest generally to economists; that is mere strategic bargaining. Each party, being rational, would know that hiring a lawyer to grab a bigger portion of the surplus won't work, because the other side will respond in kind, and the lawyers, not the parties, would get the benefit of the surplus. So, in the long run, rational actors being what they are, it must be the case that "[t]he increase must be in the overall value of the transaction, not merely in the distributive share of one of the parties. That is, a business lawyer must show the potential to enlarge the entire pie, not just to increase the size of one piece at the expense." That's a rational actor trope, and one that I have criticized in another context here.
3. As I said in a comment to Usha's post, if I were to apply an economic model to lawyers in deals it would be the Prisoner's Dilemma. Both clients would be better off cooperating by throwing all the lawyers out of the room for most of the issues in the deal, hence eliminating the transaction cost of arguing over myriad reps and warranties and other contract niceties that don't make any difference anyway. So imagine a Prisoner's Dilemma matrix with Party A and Party B, and the choice for each is "Lawyer" or "No Lawyer." The payoff for each side choosing "No Lawyer" is a huge reduction in costs (say, 5, 5) compared to both sides choosing "Lawyer" (say, 10, 10)" But both sides keep their lawyers, for fear of the (1, 20) or (20, 1) outcomes in the Lawyer/No Lawyer boxes that are akin to one prisoner confessing but the other one not.
4. There are places where lawyers reduce transaction costs, say, by mediating between two positions to reach a solution, but there's nothing particularly lawyerly about that. That's a negotiating skill. Moreover, lawyers may well be necessary to getting the deal through the regulatory thicket, whether it is Hart-Scott-Rodino pre-merger notification or CFIUS review. But that hardly seems fair, because lawyers created the regulatory thicket.
5. We have a neighborhood association in northern Michigan. A lot of people in the association are rich. When something happens that they don't like, they say things like, "if you do that, I'll have 10 lawyers from the Humungous Law Firm, who I have on retainer, up here the next day." Since I'm a lawyer, and I used to be a partner at the Humungous Law Firm, I laugh at that, but it's an effective club when wielded against non-lawyers. I rarely hear non-rich people say this, which goes to my next point.
6. Professor Gilson's "empirical" testing of this theory is to walk through the most heavily lawyered of all documents, the typical business acquisition agreement. If lawyers really created value accordingly to the theory, we ought to be able to test it not in mega-million or mega-billion dollar deals, but in little deals that happen all the time. But the reality there is that most transactions occur without lawyers. Sometimes there is boilerplate that lawyers had a hand in. But if a lawyer being involved in a transaction necessarily made the pie bigger, why don't lawyers appear in almost all transactions?
7. Professor Gilson spends many pages on the information-exchanging value of representations and warranties, and puzzles over the lack of any indemnification mechanism in public company deals (the representations and warranties expire at closing largely because once the proceeds in stock or cash are distributed to widely dispersed shareholders, there's no putting Humpty-Dumpty back together again). He acknowledges that indemnification may be partial or limited in time (there's also the "basket" or deductible, but I don't think that gets mentioned), but the real question, it seems to me, is whether the actual instances of acting on the indemnification clauses warrant the investment in the reps and warranties. My guess is they have some amount of in terrorem effect, but neither of us have a whole lot of data to go on. (The one empirical study of which I'm aware on this subject is by Steve Schwarcz, and it is based on surveys of clients who hire transactional lawyers. To quote Steve's abstract: "Contrary to existing scholarship, which is based mostly on theory, this article shows that transactional lawyers add value primarily by reducing regulatory costs, thereby challenging the reigning models of transactional lawyers as 'transaction cost engineers' and 'reputational intermediaries.'")
8. My equally non-testable theory is that lawyers sometimes add value to deals, sometimes subtract value, and appear most of the time during the deal for the same reason neckties do: it's part of the ritual. There is no intrinsic reason they have to be there. Lawyers, like neckties, have value, not because they necessarily make the pie bigger, any more than neckties make the pies bigger, but because somebody values the lawyer enough to pay more for her to be there than it cost for her to get there (marginally speaking, of course). That's the reason we buy $75 neckties and Rolex watches as well. But we don't feel a need to justify the presence of the necktie or the watch as a "transaction cost mechanism."
9. I am persuaded by years of observation that great lawyers (like Jim Freund, who Professor Gilson cites repeatedly) help make deals, but that there is nothing particularly lawyerly about it. It is, as Vic Fleischer suggests, quarterbacking, or as David Zaring suggests, closing. That strikes me as an aspect of leadership, something business schools teach, but with which law schools and law (qua law) struggle immensely.
10. Mostly, though, I step back and see the process as something akin to a Balinese cockfight, a ritual or ceremony that gives us some limited assurance of certainty in a highly uncertain and contingent world. I find it equally plausible that the presence of all those lawyers doesn't do a damned thing to make the pie bigger - but they are necessary, and they do have value, just as the accoutrements to the cock-fight have value to the participants. Their value is in what they do to give us the courage to overcome fear, panic, seller's remorse, buyer's remorse, and risk averseness. Again, as I said over in the comments, lawyers provide an alternative model for resolving disputes about the deal that is better than pistols at twenty paces, but the idea that the contract language provides certainty in anything other than trivial cases is a self-justifying illusion for lawyers. I suppose what really bugs me comes from my intuition that the Gilson thesis is theory-laden in the sense that Ian Shapiro criticized in The Flight from Reality in the Human Sciences. What comes first is the economic model and its assumptions about value and rationality, which is then imposed on a linguistic exercise, which is itself an imperfect model of a complex world.