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Weekly UpdatesCSX Corp. v. Children's Inv. Fund Mgmt. (UK) LLP
Message to activist shareholders: accumulate with great care
BY COLIN DIAMOND
CSX CORP. SUED The Children's Investment Fund (TCI), a hedge fund seeking to elect its nominees to CSX's board, alleging that it had violated Section 13(d) of the Exchange Act by failing to disclose its beneficial ownership of more than 5% of CSX's common stock pursuant to total return swaps (TRSs). The court--the case was adjudicated in the Southern District of New York--did not find that the long party to a TRS is automatically the beneficial owner of the reference security. However, it held that in this instance TCI had engaged in a scheme to prevent the vesting of beneficial ownership. TCI was therefore "deemed" to be the beneficial owner of CSX's stock because it deliberately spread its TRS positions among several counterparties, each of which hedged its position on an almost share-for-share basis and was likely to vote and dispose of the shares in accordance with TCI's wishes, and none of which met the 5% disclosure threshold.
The CSX decision highlighted the use of derivative equity positions to accumulate significant undisclosed economic, and potential ownership, interests in a company's stock in connection with battles for corporate control. As a result of the decision, activist shareholders will need to act with great care when accumulating significant undisclosed positions through derivatives, including TRSs, and ensure they have no impermissible understandings regarding the voting or disposition of the reference securities.
While ostensibly confined to its facts, the judgment injects a degree of uncertainty regarding the determination of beneficial ownership in connection with cash-settled TRSs and may be used in other contexts that the court did not envisage in determining beneficial ownership.
Colin Diamond is a partner in White & Case's Capital Markets Practice with experience counseling public companies in securities law compliance, corporate governance, and capital raising transactions. He can be contacted at cdiamond@whitecase.com.
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IN RE LORAL SPACE AND COMMUNICATIONS INC. CONSOLIDATED LITIGATION
Fairness inform must be accompanied by fairness in substance
BY DOUG RAYMOND
THEY USED A SPECIAL COMMITTEE and got a fairness opinion. But they didn't get a fair deal. The judge rewrote the terms, and Loral directors learned that treating stockholders fairly goes beyond lip service. Loral involved a challenge to a $300 million preferred stock purchase by Loral's largest stockholder. Since five of nine directors were affiliated with the stockholder, the board appointed a special committee. This gesture turned out to be hollow, because the chairman was one of the five stockholder-affiliated directors. During negotiations he divulged the committee's fallback position to the stockholder and even asked the stockholder to invest $40 million in his own company. The second member "brought the scientific concept of inertia to the Special Committee." The committee's financial advisor never conducted a market check. As months passed, the committee hewed to its mandate of dealing only with the stockholder and did not investigate alternative transactions.
The court found the process and the terms unfair. Stated the judge: "When, over the course of nearly a year, there appears to be no instance in which the Special Committee took any of the numerous opportunities available to it to explore the marketplace and determine whether it could obtain better terms than were available from the controlling stockholder ... it is impossible for me to conclude that the Special Committee acted as an effective guarantor of fairness."
Rewriting the deal in terms it deemed fair, the court took the dramatic step of converting the controlling stockholder's preferred stock into nonvoting common. This underlined its message: Fairness in form must be accompanied by fairness in substance.
Doug Raymond is a partner in the law firm Drinker Biddle & Reath LLP and heads the firm's Corporate and Securities Group. He can be contacted at doug.raymond@dbr.com. Kathy Wynn, an associate with Drinker Biddle & Reath, assisted in the preparation of this case summary.
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IN RE BRIDGEPORT HOLDINGS, INC.
Directors knocked for 'sitting on their hands' while company faltered
BY ELIZABETH B. BURNETT
TIMING IS EVERYTHING. That is the message to directors of distressed companies in In re Bridgeport Holdings, Inc., a Delaware Bankruptcy Court ruling that upheld bad faith claims based on directors' delay in addressing their company's deteriorating financial condition and their subsequent "uninformed and hurried sale" of the company's assets for "grossly inadequate consideration."
At issue in Bridgeport Holdings was the conduct of the directors during the two-year financial deterioration of the company, followed by the rushed sale of its assets. The court found that, prior to the sale, the directors "failed to follow through with any ... options to improve the Company's financial condition" and instead "continued to sit on their hands and disregard their responsibilities to act in the best interest of the Company. ... "Then, when the sale occurred, the court found that the directors "abdicated crucial decision-making authority" to a restructuring advisor, failed to canvas the market for alternative purchasers, and rushed through a "fire sale" for "grossly inadequate consideration."
Bridgeport Holdings is significant for two reasons. First, notwithstanding that the directors were disinterested and independent, the court upheld the bad faith claim against them based on their intentional disregard of duties to the company. Second, the decision illustrates the necessity for board minutes to clearly document the basis for directors' action, or inaction. Noticeably absent from the decision is any reference to minutes that could have justified the directors' "wait and see" approach to the company's financial problems or the accelerated sales process.
Elizabeth B. Burnett is a partner at the law firm of Mint; Levin with a special expertise in business fraud, corporate governance, and director and officer fiduciary duty matters. She can be contacted at eburnett@mintz.com.
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IN RE LEAR CORPORATION SHAREHOLDER LITIGATION
Affirming the importance of independent directors, deliberative processes
BY POLLY SNYDER
Lear was one of three almost contemporaneous opinions issued by the Delaware Chancery Court addressing a board's fiduciary obligations in a sale-of-the-company transaction. The court dismissed claims that the board acted in bad faith in agreeing to a $25 million no-vote termination fee (constituting .9% of the transaction price). Because the directors were protected by a 102(b)(7) exculpatory provision, liability required a showing of more than "gross negligence," and instead required a showing that the directors breached their duty of loyalty by acting contrary to the interests of the company and its shareholders.
Several factors made it more difficult for plaintiffs to make this showing, including that the board consisted of a supermajority of independent directors, had used a thorough process to consider whether to approve the revised agreement, and had a solid financial basis from which to conclude that the per-share offer was fair.
Rejecting plaintiffs' argument that bad faith was established because the directors "knew" that the shareholders would not approve the agreement, the court cautioned about the "danger" in applying the Caremark standard for systemic oversight violations to "a discrete transaction" approved by a disinterested majority. The court also emphasized that only a "very extreme set of facts" would sustain a disloyalty claim in this context.
As such, the opinion underscores the deference that fundamental principles of corporate governance afford decisions made by independent directors pursuant to a deliberative process and thus, relatedly, the importance of that process.
Polly Snyder, a counsel in the Washington, D.C., office of Clifford Chance, is a member of the firm's Litigation & Dispute Resolution Practice. She regularly represents corporations and individuals in shareholder class actions and derivative suits. She can be contacted at polly.snyder@cliffordchance.com.
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LYONDELL V. RYAN
Upholding director discretion in negotiating transactions
BY GARY HOROWITZ
CORPORATE DIRECTORS had reason to fret about the outcome of this case since last summer, when Delaware's influential Chancery Court held that board members could be personally liable for duty of loyalty claims stemming from an allegedly flawed transaction.
Shareholders of Houston-based Lyondell Chemical Co. had charged directors of breaching their fiduciary duties in hastily agreeing to a 2007 merger with Netherlands-based Basell International Holdings, at a price they claimed undervalued their company. Although the merger was completed at the end of 2007, the subsequent U.S. entity later filed for bankruptcy protection--fueling shareholder ire against the board.
Delaware's Supreme Court saw it differently. In a decision this past March, the justices reversed the Chancery Court's 2008 ruling, giving directors substantial discretion in applying their fiduciary duties while negotiating a sale or responding to an acquisition proposal. Ultimately, Lyondell reaffirms that directors are not liable for decisions--even questionable decisions--during a sale process where they have no conflicts of interest, so long as they acted in good faith.
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