978-1285860381 Chapter 34 Solution Manual Part 2

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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

(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

(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

(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.

(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.

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

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

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