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More Conflict: Takeovers
There are three ways to acquire control of a company:
• Buy the company’s assets.
• Merge with the company.
• Buy stock from the shareholders.
Takeovers: The Business Judgment Rule
Corporate management has great freedom to resist takeover attempts. However, if it is clear that the
company will be sold, the board must auction the company to the highest bidder; it cannot give
preferential treatment to a lower bidder.
You Be the Judge: Airgas, Inc. v. Air Products and Chemicals, Inc.1
Air Products and Chemicals, Inc. (Air Products) launched a tender offer to acquire 100 percent of the
shares of Airgas, Inc. (Airgas). The Airgas board of directors rejected these bids because they were
lower than the market price. Airgas’ charter provided for a staggered board of nine directors – at each
annual meeting, three would run for election.
At Airgas’s annual meeting in September, shareholders elected three of Air Products’ nominees to the
board. Air Products also proposed a bylaw (the January Bylaw) that switched Airgas’s annual meeting
to January rather than September. This change would mean that the next annual meeting would be in
only four months. Air Products’ plan was to vote out three more directors in January, which would have
the effect of reducing their terms by eight months. Shareholders approved this amendment with a 51
percent vote in favor. Because not all shareholders voted, the favorable vote actually constituted only
45.8 percent of the outstanding shares. To amend the Airgas charter and eliminate the staggered board
would have taken a 67 percent vote of the shareholders who cast ballots.
Airgas filed suit, alleging that the January Bylaw was invalid because it was a back door method of
eliminating the staggered board without a 67 percent vote of the shareholders. (A bylaw is invalid if it
conflicts with the charter.) The lower court upheld the January Bylaw and Airgas appealed.
You Be the Judge: Was the January Bylaw valid?
Argument for Air Products: Airgas’s charter provides that directors serve terms that expire at “the
annual meeting of stockholders held in the third year following the year of their election”. The January
Bylaw complies with this charter provision as written because the January meeting will take place “in
the third year after the directors’ election.” Nowhere does the charter say that directors have to serve
three full years. If Airgas wins this case, corporations in Delaware will have to calculate the dates of
their annual meetings with mathematical precision.
Moreover, 51 percent of the shares at the annual meeting voted in favor of the January bylaw. If it
was unfair, or against the best interests of shareholders, they could have voted against it. Why should
the court thwart the shareholders’ intent?
Argument for Airgas: In 25 years, Airgas has never held its annual meeting earlier than July 28. We
are not arguing that Airgas has to wait exactly 365 days to schedule its next annual meeting, but it
should delay at least 11 months. Moreover, the company’s fiscal year ends on March 31, so if the
meeting were to be held in January, Airgas would not have new financial results to report to its
shareholders.
The charter term is ambiguous – does it mean that directors have to serve into the start of the third
year, or do they have to serve three full years? Regardless of what the actual language says, the intent
is clear – directors are meant to serve three years. Air Products has found a loophole that violates the
spirit of the charter provision and frustrates the purpose of staggered boards, which is to provide
stability. The court should not allow Air Products to avoid the clear intent of the charter so that it can
acquire a company at less than market value.
1 8 A.3d 1182; 2010 Del. LEXIS 585, SUPREME COURT OF DELAWARE, 2010
It is true that that 51 percent of the shares at the meeting voted in favor of the January Bylaw, but
this was only 45.8 percent of the shares outstanding. That is not even a majority, never mind the 67
percent vote required to amend the charter. Moreover, if the January Bylaw is upheld, effectively three
of the board members will be removed without cause. Under the charter, removal without cause also
requires a 67 percent vote.
Holding: The court overruled the trial court, holding the January Bylaw invalid, for the reasons laid out
in the argument. Essentially, it felt that the January Bylaw was an illegal end-run around the charter
provision. Although the argument that only 45.8 percent of the shareholders had approved the January
Bylaw doesn’t make sense in the context of corporate elections (there will always be shares that don’t
vote), the court seemed quite taken with it. The courts in Delaware tend to give great deference to the
actions of a target in any hostile takeover.
Question: Why did the board of directors of Airgas reject the takeover bid of Air Products?
Question: Was Air Products successful in its takeover attempt?
Additional Case: Moore Corp. Ltd. v. Wallace Computer Services, Inc.2
Facts: Under the terms of a poison pill, each shareholder had the right to purchase Wallace stock at
half price, in the event that 20 percent of the company’s stock was acquired in a hostile takeover.
Moore offered to buy Wallace’s stock for $56 a share, which was 27 percent over market price.
However, the offer was contingent upon the Wallace board eliminating the poison pill. Goldman,
Sachs, Wallace’s investment banker, advised the company that the offer was inadequate. Moore
increased its offer to $60 per share, but Goldman, Sachs again advised Wallace that the offer was too
low. Both the board and Goldman believed that Wallace’s recently adopted corporate strategy would
cause the stock price to go up. It was true that the company’s recent financial results had been better
than expected. Nonetheless, more than 73 percent of Wallace shareholders offered their shares to
Moore. When Wallace refused to remove the poison pill, Moore filed suit.
Issue: Was the board’s refusal to remove the poison pill a violation of the business judgment rule?
Holding: The board did not violate the business judgment rule. It made a reasonable investigation and
determined that financial results were likely to improve. Shareholders did not understand that the
company’s new business strategy was about to pay off with improved financial results. The board was
better informed than the shareholders.
Question: What premium did Moore offer Wallace shareholders over the existing market price?
Answer: The case says 27 percent, but that was the premium over the first, $56 offer. Wallace
Question: What percent of the shareholders voted to accept Moore’s offer?
Question: Why did the board say “No”?
Answer: Board members felt that their new business strategy was just beginning to work and the
Question: Why did Moore need the board’s approval if 73 percent of shareholders voted in favor
of the offer?
Answer: Because Wallace had a poison pill that gave each shareholder the right to purchase
2 907 F. Supp. 1545, 1995 U.S. Dist. LEXIS 18882 United States District Court for the District of Delaware,
1995
Question: Who was right—the Wallace board or its shareholders? (If students completed the
Wallace Computer Services assignment, they could now report their findings.)
Answer: The shareholders were. Wallace stock fell as low as $15.44. Then in January of 2003,
General Question: If students did the second part of the Wallace Computer Services assignment,
ask them now what they discovered about other companies that successfully fought off takeovers.
Fairness of Takeover Laws
For more than 30 years, both the federal and state governments have regulated takeovers.
Question: Does the law fairly balance the interests of shareholders, management, and bidders?
Answer: If one’s primary concern is the welfare of shareholders, then probably not. Shareholders
generally prefer the highest possible price for their stock, period. The way to maximize stock price
is to permit outright, public bidding wars for the stock. Instead, both common law and some state
statutes permit management to adopt shark repellents that inhibit the bidders.
Question: Can you make an argument that shark repellents help shareholders?
Answer: There is some evidence that shark repellents force bidders to pay higher prices for
Question: If these laws may actually harm shareholders, what is their purpose?
Answer: Two goals:
As we have seen, states are concerned about protecting large employers. It is generally better
Management has effectively used these concerns about stakeholders to protect their own
Research
If students researched state anti-takeover laws, now would be a good time to discuss what they found.
In Illinois, for example, §8.85 of the corporation code provides:
In discharging the duties of their respective positions, the board of directors, committees of the
board, individual directors and individual officers may, in considering the best long-term and
short-term interests of the corporation, consider the effects of any action (including without
limitation, action which may involve or relate to a change or potential change in control of the
corporation) upon employees, suppliers and customers of the corporation or its subsidiaries,
communities in which offices or other establishments of the corporation or its subsidiaries are
located, and all other pertinent factors.
Multiple Choice Questions
1. If a manager engages in self-dealing, which of the following answers will NOT protect him from a
finding that he violated the business judgment rule:
(a) The disinterested members of the board approved the transaction
(b) The transaction was of minor importance to the company
(c) The disinterested shareholders approved the transaction
(d) The transaction was entirely fair to the corporation
2. The duty of care:
(a) Is not a requirement of the business judgment rule
(b) Protects directors who make an uninformed decision if it was entirely fair to the company
(c) Protects a decision that has a rational business purpose, even if the activity was illegal
(d) Will not protect directors who make a decision that harms the company
3. Under the Williams Act:
(a) If shareholders offer more stock than the bidder wants, it must purchase shares pro rata
(b) Target companies must reveal the names of any shareholders who acquire more than 5 percent
of its stock
(c) A bidder must file a disclosure statement at least 24 hours before the tender offer begins
(d) Once a shareholder has accepted a tender offer, she cannot withdraw it
4. When Attack made an offer to acquire the stock of Target, the Target board welcomed the offer. Not
so when Francis Co. also indicated an interest in Target. In its negotiations with Francis, the Target
board of directors failed to reveal that Microsoft had offered to pay $450 million for Target’s patent
portfolio. Francis made an offer that was slightly lower than Attack’s. Which of the following
statements is true?
(a) The Target board has the right to sell the company to whomever it wants.
(b) The Target board must appoint a special committee of disinterested directors to assess both
offers.
(c) The Target board has no obligation to Francis, because its offer was lower than Francis’s.
(d) The Target board had an obligation to tell Francis about the Microsoft offer because, if it had
known, it might have made a higher offer.
5. Oil Co. was a controlling shareholder of Pogo, a company that drilled for oil and gas in the Gulf of
Mexico. When some additional leases became available, Oil Co. purchased all of them for itself.
Which of the following statements is true?
(a) To avoid liability, Oil Co. had to offer the leases to Pogo’s board of directors.
(b) To avoid liability, Oil Co. had to offer the leases to Pogo’s other shareholders.
(c) Oil Co. could avoid liability by proving that Pogo could not afford to pay for the additional
leases.
(d) Both (a) and (b).
(e) (a), (b) and (c).
Case Questions
1. You Be the Judge: WRITING PROBLEM Asher and Stephen formed a
corporation named “Ampersand” to produce plays. Both men were employed by the corporation.
Stephen decided to write Philly’s Beat, focusing on the history of rock and roll in Philadelphia. As
the play went into production, however, the two men quarreled over Asher’s repeated absences
from work and the company’s serious financial difficulties. Stephen resigned from Ampersand and
formed another corporation to produce the play. Did the opportunity to produce Philly’s Beat belong
to Ampersand? Argument for Stephen: Ampersand was formed for the purpose of producing
plays, not writing them. When Stephen wrote Philly’s Beat, he was not competing against
Ampersand. Furthermore, Ampersand could not afford to produce the play even if it had had the
opportunity. Argument for Asher: Ampersand was in the business of producing plays, and it
wanted Philly’s Beat. Ampersand was perfectly able to afford the cost of production—until Stephen
resigned.
Answer: Producing “Philly’s Beat” was clearly within the scope of Ampersand’s business.
2. Both Viacom and Paramount owned a diverse group of entertainment businesses. QVC was a
televised shopping channel. The Paramount board of directors accepted a merger offer from Viacom
at a price of $69 per share. QVC and Viacom then entered a bidding war for Paramount. QVC
ultimately made the highest offer at $90 per share. The Paramount board rejected QVC’s bid on the
grounds that a Viacom merger would be more in keeping with Paramount’s business strategy. Does
a board of directors have the right to reject a high bidder on the belief that the low bidder would be
better for the company?
Answer: The Paramount board had no right to turn down the high bidder on the grounds that it
preferred the low-bidder’s long-term strategy. No matter which bidder was successful, control of
3. Congressional Airlines was highly profitable operating flights between Washington, D.C., and New
York City. The directors approved a plan to offer flights from Washington to Boston. This decision
turned out to be a major mistake, and the airline ultimately went bankrupt. Under what
circumstances would shareholders be successful in bringing suit against the directors?
Answer: Even if the plan was bad, it met the standard of having a “rational business purpose.”
4. Ulrick and Birger started an air taxi service in Berlin, Germany, under the name Berlinair, Inc.
Birger was approached by a group of travel agents who were interested in hiring an air charter
business to take German tourists on vacation. Birger formed Air Berlin Charter Co. (ABC) and was
its sole owner. On behalf of ABC, he entered into a contract with the Berlin travel agents. Birger
concealed his negotiations from Ulrick, even though he used Berlinair working time, staff, money,
and facilities. Birger defended his behavior on the grounds that Berlinair could not afford to enter
into a contract with the travel agents. Has Birger violated the corporate opportunity doctrine?
5. Wallace, Inc. adopted a poison pill. Five years later, Moore Corp. offered to buy all Wallace’s stock
for $56 a share, which was 27 percent over the existing market price. However, the offer was
contingent upon the Wallace board eliminating the poison pill. Wallace consulted with its
investment banker, which advised the company that the offer was inadequate, but did not indicate
what the shares were really worth. Moore then raised its offer price to $60 per share, and again the
bankers opined that the offer was inadequate. Both the board and its banker believed that Wallace’s
recently adopted corporate strategy would lead to an increased stock price. Indeed, the company’s
recent financial results had been better than expected. Despite these improved results, more than 73
percent of Wallace shareholders offered their shares to Moore. When Wallace refused to remove
the poison pill, Moore filed suit. Was the board’s refusal to remove the poison pill a violation of
the business judgment rule.
Answer: The court ruled for Wallace, on the grounds that the board had a good faith belief that the
Discussion Questions
1. Some companies adopt a staggered board of directors as an antitakeover defense. How does a
staggered board affect cumulative voting?
Answer: A shareholder of a company that has a staggered board must control the votes of more
1
1elected being directors ofNumber
goutstandin shares ofNumber
director oneelect toshares ofNumber
To review this formula, see Chapter 33, Life and Death of a Corporation. Under cumulative
115
0165,000,00
x
+ 1
= 10,312,501 shares to elect a director.
With a staggered board, only five directors would be up for election, in which case the
shareholder would have to control
15
0165,000,00
x
+ 1
2. ETHICS Ronald O. Perelman, chairman of the board and CEO of Pantry Pride, met with his
counterpart at Revlon, Michel C. Bergerac, to discuss a friendly acquisition of Revlon by Pantry
Pride. Revlon rebuffed Pantry Pride’s overtures, perhaps in part because Bergerac did not like
Perelman. The Revlon board of directors agreed to sell the company to Forstmann Little & Co. at a
price of $56 per share. Pantry Pride announced that it would engage in fractional bidding to top any
Forstmann offer by a slightly higher one. To discourage Pantry Pride, the Revlon board granted
Forstmann the right to purchase Revlon’s Vision Care and National Health Laboratories divisions
at a price some $100–$175 million below their value. Was the board within its rights in selling off
these two divisions? Do the shareholders of Revlon have the right to prevent a sale of the company
to Forstmann at a price lower than Pantry Pride offered? Is it ethical for a board to base a takeover
decision on personal animosity? What are a board’s ethical obligations to shareholders?
Answer: The court prohibited the low-price sale of two divisions because the sale could not
rationally be related to any benefit to the stockholders. Further, it held that when the break-up of
3. Eve bought defective ball bearings from Saginaw Corp. Alfred was the sole shareholder of the
company and also its landlord. After Alfred sold all of Saginaw’s assets, he withheld enough money
to cover the rent that Saginaw owed him. As a result, Saginaw had no money to pay Eve. Does Eve
have a claim against Alfred?
Answer: The court ruled that Alfred had engaged in self-dealing, which violated his fiduciary duty
to Saginaw. Because he was the only shareholder and director, there were no disinterested parties
4. An appraiser valued a subsidiary of Signal Co. at between $230 million and $260 million. Six
months later, Burmah Oil offered to buy the subsidiary at $480 million, giving Signal only three
days to respond. The board of directors accepted the offer without obtaining an updated valuation
of the subsidiary or determining if other companies would offer a higher price. Members of the
board were sophisticated, with a great deal of experience in the oil industry. A Signal Co.
shareholder sued to prevent the sale. Is the Signal board protected by the business judgment rule?
5. James owned Despatch Industries. When his son, Wade, and son-in-law, Alan, started working for
the company, they both signed identical employment contracts, which provided for a severance
payment if they left the company. After Wade and James had a falling out, Wade resigned. The
Despatch board agreed to make severance payments of $1.3 million to both Wade and Alan,
although Alan continued to work for the company and receive a salary. There were no disinterested
directors or shareholders. Did the company have the right to make these payments?
Answer: Since there were no disinterested directors or shareholders, the court held it would only
uphold the payments if they were “entirely fair.” The payment to Wade was fair, because it was
