Promises Broken, Shareholders Sue Murdoch

Playing with poison can be a dangerous thing. So, it seems, can be playing with a company’s promises to shareholders.

News Corp. has suffered a winter of discontent with its shareholders, as the two sides argued in court about whether the company could renege on a 2004 promise not to adopt a poison pill. Rupert Murdoch’s media conglomerate made that pledge to win shareholder support for a plan to reincorporate the company from Australia to Delaware—and then last November, renewed its poison pill for another two years anyway.

Several institutional investors promptly filed suit against News Corp., and the case is currently scheduled for trial in Chancery Court next month.

Legal issues aside, the squabble raises a fundamental question: At what price comes the flouting of promises to shareholders? If management says it will refrain from some action unless shareholders vote on it, can the company later change its mind?

Grant

Stuart Grant, a partner at Grant & Eisenhofer and representing the plaintiff pension funds, is blunt: “Our view is that when boards make promises, they are stuck with it.”

Others agree that News Corp.’s actions don’t look good. Stephen Lubben, a law professor at Seton Hall, says the board may have danced close to the line by agreeing to the deal. “It looked like reincorporation was in serious trouble until [the shareholders] got those representations,” he says. “It looked like something the other side relied upon.”

The law firm of Dewey Ballantine wrote in a seven-page analysis that the company’s press release and letters to shareholders stated the board policy would not permit the pill to be rolled over without stockholder approval. But, the analysis says, the case hinges on the larger issue of whether a company and its directors are contractually obligated to protect the rights granted to stockholders by a board policy.

“If the board finds the company has a contractual obligation not to revoke a board policy, traditionally viewed as revocable by boards at any time, it would significantly alter the current understanding of the obligations created by implemented board policies,” the Dewey Ballantine memo warned.

EXCERPT

Below is an excerpt of the legal analysis from Dewey Ballantine about the News Corp. litigation:

Plaintiffs alleged that News Corp. and its board entered into a contract when the plaintiffs agreed to vote in favor of News Corp.’s reorganization in consideration for News Corp.’s promise to submit any extensions of its poison pill to a stockholder vote. The contract, which plaintiffs argued existed either in writing evidenced by the Oct. 6, 2004 press release and Oct. 7 letter to stockholders or orally, allegedly provided that News Corp. would adopt an irrevocable board policy preventing the “roll-over” of the poison pill without stockholder approval. The court recognized that plaintiffs’ complaint asserted few facts to support the existence of such a contract, but because it was required to draw crucial inferences in plaintiffs’ favor, concluded that plaintiffs’ breach of contract claim survived defendants’ motion to dismiss.

Defendants argued that the parties never discussed making the board policy irrevocable and that, under Delaware law, a board policy is non-binding and revocable by the board at any time. The court noted that defendants were correct that board policies, like resolutions, were typically revocable by the board at will. However, the court disagreed with defendants’ citation to In re General Motors (Hughes) Shareholders Litigation in support of the proposition that board policies are always revocable. The court noted that in General Motors the Delaware Chancery Court stated that “if a board policy has the effect of a board resolution, it might be revocable at any time.”

Source

News Corp. Case: Possible Enforcement Of Board Policies (24 Jan. 2006)

Serio

Robert Serio, a securities litigation partner at the firm of Gibson, Dunn & Crutcher, acknowledges that some court rulings have found that boards can bind themselves with promises to shareholders. “But it remains to be seen if the court will find a binding promise in this case,” he adds. “That will depend on exactly who said what to whom, and whether or not the shareholders really changed their position in the reasonable belief that they had a binding commitment from the board."

Regardless, attorneys say, the mere fact that the case was allowed to go to trial will have a major effect on future negotiations and deals between companies and large shareholders.

Lubben

“You will see more caution by boards,” Lubben says. “Boards don’t want to be bound. They will qualify every statement with shareholder groups.”

He also expects shareholders will insist that companies put everything in writing. Indeed, the judge in the News Corp. case apparently believes this to be a critical issue. In a footnote to one of his decisions, the judge writes: “It is not entirely clear why … plaintiffs accepted a promise to adopt a board policy, which is a more transitory right than a charter provision, especially when sophisticated parties such as these must have understood the significant difference between a charter provision and a board policy.”

The judge also suggests he is not confident the plaintiffs can win, noting that “there is no set of facts that would entitle plaintiffs to prevail on their contract theory. Although plaintiffs’ claim is sufficient to withstand a motion to dismiss because of the liberal standard applied in this context, it will be plaintiffs’ burden going forward to demonstrate a factual and legal basis for this claim.”

Essentially, Lubben says, “he is dubious about their ability to win the claim but can’t rule out that they won’t.”

What are the ramifications of the case? Dewey Ballantine says if the court’s holding means that boards implementing new policies during negotiations with shareholders may be unable to revoke such policies, they may be greatly discouraged from that practice.

“In light of the holding in this case, and as companies enter into this year’s proxy season, boards of directors and their advisors should consider the value of including a provision in their board policies that permits them to vary from their policies if they believe it is necessary to do so in the exercise of their fiduciary duties,” Dewey Ballantine notes in its analysis.

Much depends on the outcome of a trial in the News Corp. case as well. If News Corp winds up winning, Serio says the shareholders simply did not meet the burden of proof that there was a binding contract.

And if the shareholders win? “It would be more momentous,” Serio insists, and reinforce the conclusion that boards shouldn’t enter into such shareholder agreements lightly.