PARTNERSHIPS, CORPORATIONS AND THE VARIANTS PROF. BRUCE MCCANN SPRING SEMESTER LECTURE 4 CHANGES IN CONTROL Business Organizations Lectures

How Can Control of a Corporation Change? Lec. 4 Sem 2, pp Corps Prof. McCann Voluntarily 1. It can sell all of its assets.  Alternatively, it can swap its assets for stock in another company. 2. It can sell all of its stock.  Alternatively, it can swap its stock for the stock of another company, leaving the other company holding all of its stock. 3. It can formally merge with another company.

How Can Control of a Corporation Change? Lec. 4 Sem 2, pp Corps Prof. McCann Involuntarily (from the directors’ standpoint) 1. It can be the target of a tender offer to the shareholders.

Why Prefer One Approach to Another? Lec. 4 Sem 2, pp Corps Prof. McCann Purchase of Assets  Simpler  Leaves corporate liabilities as the problem of the shareholders of the old corporation (But, see Knapp, p. 709)  Tax benefits of asset purchases simpler Purchase of Stock  Broader range of rights usually acquired (e.g., brand, employees)  Inherit business contracts,  BUT also all liabilities

Merger Lec. 4 Sem 2, pp Corps Prof. McCann The joining of one corporation into another whereby the former ceases to exist and the latter keeps its identity and assumes the assets and liabilities of the former

De Facto Merger Lec. 4 Sem 2, pp Corps Prof. McCann Despite the characterization given to the transaction by the parties, a transaction which has, in practical effect, the characteristics of a merger.  The combination of two corporations  The virtual extinction of one of them in its previous form with respect to  Asset value or type  Stock value  Nature of its business  Management  Control  And the stock of the acquiring corporation going to the shareholders of the disappearing corporation

Antipathy to the De Facto Merger Doctrine Lec. 4 Sem 2, pp Corps Prof. McCann Delaware holds all forms of consolidation or amalgamation entitled to ‘equal dignity’ and the label used by management will control whether shareholder approval and appraisal rights apply.

Other Responses Lec. 4 Sem 2, pp Corps Prof. McCann California  Denominates a general classification termed “reorganizations”  A. Merger  B. Exchange (one corp gets 50% or more of stock of another in exchange for its own shares)  C. Sale of Assets Reorganization (assets for cash or stock)  Majority of Shareholders of both corporations must approve A and C.  Majority of acquiring corp shareholders must approve B reorganization.  Where Shareholder approval required, shareholders generally have appraisal rights if they dissent.

Other Responses Lec. 4 Sem 2, pp Corps Prof. McCann Model Act  Shareholder approval required if an issuance of shares  A. Is for other than cash or cash equivalents; AND  B. The voting power of the shares issued comprise more than 20% of the voting power of the shares outstanding before the transaction.

Anatomy of a Takeover Lec. 4 Sem 2, pp Corps Prof. McCann Predator buys small percentage of stock of Prey Predator makes tender offer to shareholders of record, often “two tiered,”  One price will be paid until Predator has acquired majority interest (“first tier”).  Predator will take control of board of directors.  Second, often lower, price will be paid to those who don’t sell in the first tier. “Mopping Up.”

T. Boone Pickens C.E.O., Mesa Petroleum Lec. 4 Sem 2, pp Corps Prof. McCann

THE MOST COMMON FORM OF TAKEOVER DEFENSE IS THE SHAREHOLDERS' RIGHTS PLANS, WHICH ACTIVATES AT THE MOMENT A POTENTIAL ACQUIRER ANNOUNCES ITS INTENTIONS. UNDER SUCH PLANS, SHAREHOLDERS CAN PURCHASE ADDITIONAL COMPANY STOCK AT AN ATTRACTIVELY DISCOUNTED PRICE, MAKING IT FAR MORE DIFFICULT FOR THE CORPORATE RAIDER TO TAKE CONTROL. SHAREHOLDERSPURCHASECORPORATE RAIDER Anti-Takeover Techniques: Shareholders Rights Plan

VOTING-RIGHTS PLAN SEPARATES CERTAIN SHAREHOLDERS FROM THEIR FULL VOTING POWERS AT A PREDETERMINED POINT. FOR INSTANCE, SHAREHOLDERS WHO ALREADY OWN 20% OF A COMPANY MAY LOSE THEIR ABILITY TO VOTE ON SUCH ISSUES AS THE ACCEPTANCE OR REJECTION OF A TAKEOVER BID. Voting Rights Plans

A STAGGERED BOARD OF DIRECTORS (B OF D), IN WHICH GROUPS OF DIRECTORS ARE ELECTED AT DIFFERENT TIMES FOR MULTIYEAR TERMS, CAN CHALLENGE THE PROSPECTIVE RAIDER. THE RAIDER NOW HAS TO WIN MULTIPLE PROXY FIGHTS OVER TIME AND DEAL WITH SUCCESSIVE SHAREHOLDER MEETINGS IN ORDER TO SUCCESSFULLY TAKE OVER THE COMPANY.STAGGERED BOARD OF DIRECTORSPROXY FIGHTS Staggered Board

A COMPANY MAY BUY BACK ITS RECENTLY ACQUIRED STOCK FROM THE PUTATIVE RAIDER AT A HIGHER PRICE IN ORDER TO AVOID A TAKEOVER. IT TYPICALLY COMES WITH THE REQUIREMENT THAT THE RAIDER NOT PURSUE ANOTHER TAKEOVER ATTEMPT. BECAUSE THE SHARES MUST BE PURCHASED AT A PREMIUM OVER THE TAKEOVER PRICE, THIS "PAYOUT" STRATEGY IS A PRIME EXAMPLE OF HOW SHAREHOLDERS CAN LOSE OUT EVEN WHILE AVOIDING A HOSTILE TAKEOVER. THE PRACTICE WAS EFFECTIVELY CURTAILED IN THE U.S. BY AN AMENDMENT TO THE U.S. INTERNAL REVENUE CODE, WHICH APPLIED A PUNISHING 50% TAX ON GREENMAIL PROFITS.TAX Greenmail

A STRATEGIC PARTNER THAT MERGES WITH THE TARGET COMPANY TO ADD VALUE AND INCREASE MARKET CAPITALIZATION. SUCH A MERGER CAN NOT ONLY DETER THE RAIDER, BUT CAN ALSO BENEFIT SHAREHOLDERS IN THE SHORT TERM, IF THE TERMS ARE FAVORABLE, AS WELL AS IN THE LONG TERM IF THE MERGER IS A GOOD STRATEGIC FIT. A GOOD EXAMPLE OF THIS IS THE ACQUISITION OF BEAR STEARNS BY WHITE KNIGHT JPMORGAN CHASE (NYSE:JPM) IN AT THE TIME OF THE ACQUISITION, BEAR STEARNS' MARKET CAP HAD DECLINED BY 92% ON CONCERNS OF ITS VULNERABILITY TO THE GLOBAL CREDIT CRISIS AT THAT TIME, MAKING IT EXTREMELY VULNERABLE TO HOSTILE TAKEOVER AND EVEN INSOLVENCY. JPMORGAN CHASEJPMCREDITINSOLVENCY White Knight

BY INCREASING DEBT SIGNIFICANTLY, COMPANIES HOPE TO DETER RAIDERS CONCERNED ABOUT REPAYMENT AFTER THE ACQUISITION. HOWEVER, ADDING A LARGE DEBT OBLIGATION TO A COMPANY'S BALANCE SHEET CAN SIGNIFICANTLY ERODE STOCK PRICES. BALANCE SHEET Increase Debt

THE COMPANY CAN MAKE AN ACQUISITION OF ANOTHER COMPANY, PREFERABLY THROUGH STOCK SWAPS OR A COMBINATION OF STOCK AND DEBT. THIS HAS THE EFFECT OF DILUTING THE RAIDER'S OWNERSHIP PERCENTAGE AND MAKES THE TAKEOVER SIGNIFICANTLY MORE EXPENSIVE. ALTHOUGH STOCK PRICES MAY DROP UPON THE TARGET'S ACQUISITION OF THE THIRD PARTY, SHAREHOLDERS CAN BENEFIT IN THE LONGER TERM FROM OPERATIONAL EFFICIENCIES AND INCREASED REVENUES. WHEN INBEV MADE AN UNSOLICITED BID FOR ANHEUSER-BUSCH (NYSE:BUD) IN 2008, THE LATTER COMPANY IMMEDIATELY SOUGHT TO PURCHASE OUTRIGHT BOTH GRUPO MODELO OF MEXICO AND CROWN INTERNATIONAL OF INDIA IN AN ATTEMPT TO MAKE THE ACQUISITION TOO COSTLY FOR ITS SUITOR.BUD Buy Another Company

MOUNT A BID TO TAKE OVER THE RAIDER. THIS REQUIRES RESOURCES AND SHAREHOLDER SUPPORT, AND IT REMOVES THE POSSIBILITY OF ACTIVATING THE OTHER DEFENSIVE STRATEGIES. THIS STRATEGY, CALLED THE PAC-MAN DEFENSE, AFTER BENDIX CORPORATION ATTEMPTED TO ACQUIRE MARTIN MARIETTA IN 1982, VERY RARELY BENEFITS THE SHAREHOLDERS. MARTIN MARIETTA DEFENDED ITSELF BY PURCHASING BENDIX STOCK AND SOUGHT A WHITE KNIGHT IN ALLIED CORPORATION.PAC-MAN DEFENSE Pac Man Defense

A TRIGGERED STOCK OPTION VESTING STRATEGY FOR LARGE STAKEHOLDERS IN A COMPANY CAN BE USED AS A DEFENSE, BUT IT RARELY BENEFITS ANYONE INVOLVED BECAUSE IT OFTEN RESULTS IN MASSIVE TALENT MIGRATION. GENERALLY, THE SHARE PRICE DROPS WHEN THE CLAUSE IS ADDED TO THE CHARTER AS EXECUTIVES SELL OFF THE STOCK AND LEAVE THE COMPANY. Trigger Stock Option Vesting

Unocal Lec. 5 Sem 2, pp Corps Prof. McCann Is offer in the best interests of the corporation? If contend it is not, the board must show:  Offer is threat to corporate policy or effectiveness  Via evidence of investigation  The defensive response is “proportional” to the threat.

Directors and Tender Offers Lec. 4 Sem 2, pp Corps Prof. McCann The “Enhanced Business Judgment Rule”  Directors must determine if takeover proposal is in the best interests of the corporation and its shareholders.  If they act to repel the takeover, their decision are shielded by the BJR if  Directors first establish that they had reasonable grounds for believing that the takeover posed a danger to corporate policy and effectiveness.  Burden is satisfied by showing “good faith” and “reasonable investigation”  There is no fraud, misconduct or breach of duty of loyalty

Revlon Lec. 5 Sem 2, pp Corps Prof. McCann Once board takes steps to sell the corporation (or where sale inevitable) duty of board is to maximize the price. Defensive measures are “moot”. Triggered at least two ways:  When corporation initiates active bidding process to sell itself or  When a corporation seeks to reorganize in such a way that it involves a clear break-up of the company