A recent Delaware Chancery Court decision reaffirming the vitality of poison pills as a defense against hostile takeovers is being hailed as a ringing endorsement of corporate boards' discretion in takeover attempts—and also leaving shareholder activists with a bitter taste in their mouths.
The Chancery Court ruled on Feb. 15 that board members of Airgas, a $3.8 billion industrial gas company, were within their rights to prevent shareholders from accepting a hostile takeover bid from rival Air Products & Chemicals. The majority decision in Airgas v. Air Products & Chemicals, written by Chancellor William Chandler, plainly stated: “The power to defeat an inadequate hostile tender offer ultimately lies with the board of directors.”
“It's the most important Delaware corporate law decision in a generation,” says Francis Pileggi, author of Delaware Litigation blog and founder of the law firm FoxRothsChild. “It offers the most comprehensive description of Delaware corporate law on the issue of shareholder rights and the duties of directors in the context of a contest for control of a company.”
The decision ends Air Products' last-ditch effort to acquire Airgas by petitioning the Chancery Court to invalidate Airgas' poison pill, after 16 months of negotiations and several failed bids. The Airgas board had repeatedly argued that the company is worth at least $78 per share and that Air Products' final offer of $70 per share ($5.9 billion in total) was inadequate.
A few hours after the ruling, Air Products withdrew its offer and said it won't appeal the decision. “Despite the public comments of the Airgas board, we are convinced they are unwilling to sell the company at any price,” Airgas CEO John McGlade said during a conference call.
The court said the case “brings to the fore one of the most basic questions animating all of corporate law,” striking at the balance of power between directors and shareholders: In the event of a hostile takeover, who gets to decide when and if the company accepts the offer?
Citing the Chancery Court's precedent in Unocal v. Mesa Petroleum, the court said that when a board maintains a poison pill as a defensive measure, the Unocal standard of enhanced judicial scrutiny applies. Under that legal framework, a company under takeover attack can justify its defensive measures by showing: (1) that it had “reasonable grounds for believing a danger to corporate policy and effectiveness existed” and (2) that “any board action taken in response to that threat is ‘reasonable in relation to the threat posed.'”
In practical terms, the court said, that means a board cannot be forced to sell a company whenever a hostile bidder makes a tender offer above the company's market value. Rather, the Airgas decision supports Delaware law's “long-understood respect for reasonably exercised managerial discretion, so long as boards are found to be acting in good faith and in accordance with their fiduciary duties … The Airgas board serves as a quintessential example.”
“Good faith” often boils down to the board's motives, says Marc Wolinsky, a litigation partner of Wachtell, Lipton, Rosen & Katz, who represented Airgas and its board of directors. “Are you trying to feather your own nest, or are you trying to protect the best interest of shareholders?”
The decision effectively means that if a company can stall a takeover for more than a year, it can probably stall it forever, “which I think is a disappointment,” says Charles Elson, director of the John Weinberg Center for Corporate Governance at the University of Delaware.
The decision “really emphasizes the importance of conducting a thoughtful, thorough process so that your directors, if their conduct is called into question, can point to a record to defend themselves with.”
—Marc Wolinsky,
Partner,
Wachtell, Lipton, Rosen & Katz
Delay is the enemy of the takeover, Elson adds. Financing structures or economic circumstances might change, undoing the logic behind a bid. Rejecting an offer might be sensible at first, particularly if the target company wants to finagle a higher price, he says. But stalling a bid for nearly two years—which is what Airgas did—is helpful to nobody.
Chandler expressed some sympathy for Air Products. He noted in his decision that Airgas had more time than any other litigated poison pill in Delaware history to inform its stockholders about the intrinsic value of the company and the inadequacy of Air Products' offer. “In short,” he wrote, “there seems to be no threat here—the stockholders know what they need to know” (about Air Products' offer and the Airgas board's opposition to it) to make an informed decision.
Nonetheless, Chandler continued, he was bound by Delaware Supreme Court precedent to hold that the mere price was a valid threat.
Lessons Learned
The ruling provides some important lessons for boards faced with a hostile takeover. First, ensure you can support your view that the offer is inadequate. For example, the court recognized that Airgas had enough data from independent advisers—three of them—to support its argument that the Air Products' offer was too low.
And the valuation must come from independent and well-respected financial experts. “If there is any evidence that the financial adviser giving you the opinion is not independent, than the court is not giving that expert opinion on the value of the stock any weight,” Pileggi says.
Second, document every detail on deliberations on the hostile offer—a point on which the Airgas board can be commended. Wolinsky says the decision “really emphasizes the importance of conducting a thoughtful, thorough process so that your directors, if their conduct is called into question, can point to a record to defend themselves with.”
ANALYSIS OF AIRGAS CASE
The following excerpt from Air Products and Chemicals, Inc. v. Airgas, Inc. provides the court's analysis of the Airgas board's actions:
Has the Airgas Board Established That It Reasonably Perceived
the Existence of a Legally Cognizable Threat?
Under the first prong of Unocal, defendants bear the burden of
showing that the Airgas board, “after a reasonable investigation . . .
determined in good faith, that the [Air Products offer] presented a threat . . .
that warranted a defensive response.” I focus my analysis on the
defendants' actions in response to Air Products' current $70 offer, but I note
here that defendants would have cleared the Unocal hurdles with greater
ease when the relevant inquiry was with respect to the board's response to
the $65.50 offer.
In examining defendants' actions under this first prong of Unocal,
“the presence of a majority of outside independent directors coupled with a
showing of reliance on advice by legal and financial advisors, ‘constitute[s]
a prima facie showing of good faith and reasonable investigation.” Here,
it is undeniable that the Airgas board meets this test.
First, it is currently comprised of a majority of outside independent
directors—including the three recently-elected insurgent directors who were
nominated to the board by Air Products. Air Products does not dispute the
independence of the Air Products Nominees, and the evidence at trial
showed that the rest of the Airgas board, other than McCausland, are
outside, independent directors who are not dominated by McCausland.
Second, the Airgas board relied on not one, not two, but three outside
independent financial advisors in reaching its conclusion that Air Products'
offer is “clearly inadequate.” Credit Suisse, the third outside financial
advisor—as described in Section I.Q.2—was selected by the entire Airgas
board, was approved by the three Air Products Nominees, and its
independence and qualifications are not in dispute. In addition, the Airgas
board has relied on the advice of legal counsel, and the three Air Products
Nominees have retained their own additional independent legal counsel
(Skadden, Arps).
In short, the Airgas board's process easily passes the smell
test.
Source: Air Products and Chemicals, Inc. v. Airgas, Inc., Feb. 15, 2011.
The court said its conclusion was bolstered by Air Products' own three nominees to the Airgas board, who were elected to Airgas in September 2010 but joined in the Airgas board's determination to use its poison pill anyway. “Had those three voted against the pill, I'm pretty convinced [Chancellor Chandler] would have thrown it out,” says Elson.
In addition, the ruling raises several questions to consider when mounting a hostile takeover defense:
Does the company have independent advisers?
Are there procedures in place to get all the available information?
Does the board engage in a thoughtful and thorough deliberation process?
Does the board have a reasonable, factual basis for its conclusions?
“The court spends a lot of time focusing on the process and the procedure that the board puts in place to make sure that its decision is based on independent advice, independent data, and is in the best interest of the shareholders,” Pileggi says.
Corporate governance experts say the decision breathes new life into the use of poison pills, which shareholder activists and governance purists have frowned on for years. Poison pills typically work by requiring a prohibitively expensive price for company stock once a takeover group wants more than a certain threshold, usually about 20 percent of total shares.
“Any company that is the subject of a takeover attack is going to put in a pill, if they don't already have one,” Wolinsky says.
Typically, pills work most effectively in combination with staggered boards—which Elson described as a “toxic combination” for shareholders. Therefore, this ruling will embolden investors to oppose staggered boards much more strongly.
“I think you will see that the movement will now shift to the institutional investors with their newfound voting power, voting staggered boards out around the country,” Elson says.
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