Recently, in the Mergers and Acquisitions course at Harvard Law School, three preeminent M&A practitioners discussed the Merger Agreement as a Contract with Vice Chancellor Leo Strine, Jr., who teaches the class. The panelists were Rick Climan, a partner in the Mergers and Acquisitions group at Dewey & LeBoeuf LLP; Faiza Saeed, a partner in the Corporate Department of Cravath, Swaine & Moore LLP; and Kim Rucker, Senior Vice President and General Counsel of Avon Products, Inc.

The panel went through the main parts of an acquisition agreement, including:

• Representations and warranties;
• Disclosure schedules (”The power is in the disclosure schedules”, remarked Kim);
• Pre-closing covenants that apply between signing and closing, including the strength of covenants and the difference between covenants and closing conditions;
• Closing conditions, the standards to which they must be met, and the risk of a deal failing to close.  Faiza gave the example of the breakdown of the General Electric-Honeywell transaction, which led to a discussion of regulatory risks and their effect on the transaction, and the consequent standards of covenants to obtain necessary consents, such as “hell-or-high-water” provisions.

…continue reading: The Merger Agreement as a Contract

This post comes to us from Eric Helland of Claremont McKenna College and Jonathan Klick of the University of Pennsylvania Law School.

Regulation and litigation do not occur in isolation. In almost every case of a harm which leads to litigation some regulatory agency had initially monitored the activity that lead to the harm. Thus pharmaceutical litigation does not occur in isolation of the FDA and auto accident litigation does not occur in isolation of the enforcement of traffic laws. While this point may seem obvious it has important implications of the design of regulatory systems as well as limitations placed on the ability of potential plaintiffs to seek redress using the civil justice system. In a series of papers Steve Shavell (“A Model of the Optimal Use of Liability and Safety Regulation.” RAND Journal of Economics, 1984 and. “Liability for Harm Versus Regulation of Safety.” Journal of Legal Studies, 1984) examines the tradeoff between regulation and litigation. The basic intuition is that litigation maybe a substitute or a complement to regulation. In the case of substitutes we would expect that an increase in regulation reduces the need for litigation at least at the margin.

In a new paper, The Relation between Regulation and Class Actions: Evidence from the Insurance Industry, which we recently presented at the Law and Economics seminar at Harvard Law School, we investigate the relationship between litigation and regulation, using a unique data source covering the experience of insurance companies with class action litigation. The dataset contains information on class actions against firms in the insurance industry from 1992 to 2002. We examine four different facets of the regulation litigation tradeoff. The first is to examine whether regulator’s interest in a particular cause of action reduces the likelihood that class actions covering this cause of action will be filed in the regulator’s home state. We examine several measures of regulatory stringency in the state to determine whether there is a substitution effect between regulatory action and litigation. We also examine whether class actions are less frequent when regulators issued an administrative decision on a particular issue previously or if there are no existing state laws on the particular issue. We examine the impact of electing judges on patterns of filing. The hypothesis is that elected judges are more sympathetic to plaintiffs and hence class actions are more likely to be filed in states that elect their judges. Lastly, we examine the impact of pervious litigation both in the state and the specific line of litigation.

…continue reading: Regulation and Class Actions

This post is a review of Robert Pozen’s recent book, “Too Big to Save: How to Fix the US Financial System” by Sean Cameron, MBA Candidate at Harvard Business School.

Bob Pozen’s book, Too Big to Save: How to Fix the US Financial System is one of the most important books on financial reform written to date. The book not only provides an overview of how the US economy entered into a deep recession, but also a comprehensive plan for reform and a return to growth. Filled with original insight, the book clearly explains the failure of our modern capitalist society that has morphed into one-way capitalism that penalizes taxpayers who do not participate in upside gains but are exposed to losses from bailed out financial institutions. The book offers pragmatic advice for policymakers and important guidelines for all readers to understand the nature, causes, and appropriate reforms associated with the current US financial crisis. There has not been a more timely and important book written this decade.

Furthermore, Bob Pozen approaches each potential idea of reform with a well-reasoned perspective on the legal, economic, political and cultural implications of such reform. Pozen has a unique ability to describe complex phenomona such as the housing boom and bust and explosive growth in the use and complexity of financial derivatives with ease. His grasp of the complex issues is second to none, and his ability to convey these complex ideas in easily understandable, succinct prose is remarkable. Pozen’s suggestions for reform – including reducing moral hazard problems, strengthening boards, and improving the regulatory system – present feasible, necessary steps that policymakers must heed to improve financial markets and the real economy.

…continue reading: Too Big to Save: How to Fix the US Financial System

Annette Nazareth is a partner in the Financial Institutions Group at Davis Polk & Wardwell LLP. This post is based on a Davis Polk & Wardwell LLP client memorandum by Ms. Nazareth together with Donald Bernstein, Luigi De Ghenghi, John Douglas, Randall Guynn, Arthur Long, Margaret Tahyar and Reena Agrawal Sahni.  The memorandum, including an appendix table summarizing the key differences between the resolution of assets and claims under the Bankruptcy Code and under the House’s draft bill, is available here.

The legislative season for financial regulatory reform is now in full swing. In the last two weeks, the leadership of the House Financial Services Committee and Treasury have jointly proposed a revised version of the Obama Administration proposals of last summer. Thereafter, the House Financial Services Committee began to amend the proposal, titled the Financial Stability Improvement Act of 2009, and the Chairman of the Committee, Representative Barney Frank (D-MA), has made clear that further changes will be made next week. This week, Senator Christopher Dodd (D-CT), Chairman of the Senate Banking Committee, released his own competing discussion draft of regulatory reform, entitled the Restoring American Financial Stability Act of 2009.

This memorandum analyzes the resolution provisions in the House Interim Version (by which we mean the House Financial Services Committee’s version as of November 6, 2009). We also identify any significant differences between the House Interim Version and the Senate Banking Committee’s discussion draft. This memorandum focuses on the key issues raised by the resolution of financial companies that could, in the future, be deemed to be systemically important. While the proposed resolution authority is only one of several regulatory restructuring proposals under consideration both in the United States and abroad, we view it as the most technically challenging. It is also key to many other reforms since it will be at the core of the political compromise around the knotty problems of “too big to fail,” moral hazard, and the global interconnectedness of highly leveraged institutions.

…continue reading: The House and Senate Debate Resolution Authority

This post comes to us from Mark Lebovitch and Laura Gundersheim. Mark Lebovitch is a partner at Bernstein Litowitz Berger & Grossmann LLP, where he is primarily responsible for the firm’s corporate governance litigation practice. Laura Gundersheim is an associate at Bernstein Litowitz Berger & Grossmann LLP.

One of the fundamental tenets of market capitalism is the freedom of willing buyers and willing sellers to transact business. Ironically, this basic rule does not apply in the world of corporate mergers and acquisitions. Because of so-called “poison pills,” corporate mergers and acquisitions effectively require the support of the target company’s board of directors. Based on massive value losses from withdrawn tender offers a result of poison pills in the last few years, we suggest that it is time to revisit the broad judicial deference that has allowed directors to use poison pills to stand between bidders and stockholders indefinitely.

Poison pills emerged in the 1980s as a solution to corporate raiders use of “two-tiered” tender offers to coerce shareholders into tendering their shares for unfair prices. In Moran v. Household Int’l Inc., the Delaware Supreme Court upheld directors’ power to use this powerful defensive device, but with conditions. The Court seemingly tied its validation of the poison pill on two points: (1) a board’s decision to keep a pill in place is always subject to fiduciary duties (and therefore open to judicial review) and (2) if shareholders do not like how a board is using the pill, the shareholders preserve their ability to remove the directors from their jobs by running a proxy fight.

…continue reading: The Wrong Prescription? Revisiting the Justification for Poison Pills

Robert Monks, a legendary shareholder activist and founder of ISS (which was later acquired by RiskMetrics) and the Corporate Library, recently gave a talk as part of the Shareholder Activism course here at Harvard Law School about the past, the present, and the future of shareholder activism.

Mr. Monks began his talk by emphasizing the importance of shareholders. He noted that in the absence of having an informed, motivated and powerful counter force to management, the corporation will always have the problem of autocrat who is answerable to no-one. The capital markets generate tremendous wealth. The key issue is who is entitled to this wealth.

Mr. Monks discussed his past experience with Sears Roebuck, where he submitted himself as a nominee for director, and Exxon Mobil, where he filed proposals to separate the chairman and CEO roles. Throughout this discussion, he noted that the current system is in need of serious reform, in part because of the asymmetry of resources available to the company compared with the activist shareholder. Mr. Monks also discussed his proposal for a mandatory rule that gives 5% of the shareholders the right to call a special meeting at which a majority of the shareholders present can remove any or all of directors with or without cause.

The student questions covered a broad range of topics, from whether increased litigation would lead to more activism or more reliance on ISS voting guidelines, to the desirability of government versus private sector employment.

Background materials about Mr. Monks and his talk are available here. A video of the talk is available here (Quicktime .mov format).

(Editor’s Note: This post is based on an article that first appeared in the Atlantic.)

As we now know all too well, the credit crisis and the global recession stemmed, in important part, from stark failures of boards of directors and operating business leadership in important financial institutions: the witch’s brew of leverage, poor risk management, creation of toxic products, lack of liquidity – all made more poisonous by compensation systems which rewarded short-term revenues/profits without regard to risk.

Buffeted by the recession and the seizing up of the credit markets, GM and Chrysler veered into bankruptcy, burdened by decades of questionable decisions.

As a result of these dramatic collapses in both the financial and industrial sectors, trust in corporate leaders – indeed in the ability of corporations to govern themselves – has eroded dramatically (even though there are, of course, well run corporations in both areas of the economy). This crisis in confidence, due to problems real or perceived, has spawned numerous public sector initiatives, both here and abroad, to impose new limits on private sector governance and self-determination.

…continue reading: Shareholders: Part of the Solution or Part of the Problem?

(Editor’s Note: This post comes to us from Anil Shivdasani of the University of North Carolina at Chapel Hill and Irina Stefanescu of Indiana University.)

In our paper, How Do Pensions Affect Corporate Capital Structure Decisions?, which was recently accepted for publication in the Review of Financial Studies, we investigate the importance of pension contributions as a source of tax shields and their effect on companies’ marginal tax rates, and whether companies treat pension liabilities as a substitute for debt financing. To date, the bulk of capital structure research has focused on explaining the leverage choice as it is reported on the balance sheet. Yet companies have sizable assets and liabilities that do not appear anywhere on the balance sheet, the largest of which relates to corporate pension plans.

We study all publicly traded firms on Compustat from 1991 to 2003. About a fourth of these firms have defined benefit pension plans. For some companies, the magnitude of pension assets and liabilities is substantial. On average, pension plan assets are 16.4% of the book value of assets recorded on the balance sheet and represent 62% of the market value of the firm’s equity, though there is considerable variation across firms.

…continue reading: Pensions and Corporate Capital Structure Decisions

(Editor’s Note: This post comes to us from Sanford J. Lewis, Counsel to the Investor Environmental Health Network.)

A clash is emerging between the needs and duties of directors and investors to manage risks, and attorneys who advise “don’t ask; don’t tell” to minimize corporate liability in any possible future litigation. The task of mitigating this clash falls on the shoulders of regulators at the Securities and Exchange Commission and the Financial Accounting Standards Board.

When the Financial Accounting Standards Board (FASB) took up the issue of contingent liability disclosures on behalf of investors in 2008, it appeared progress would be made. However, under pressure from the corporate legal community, which sought to block any requirements to require disclosure of potentially prejudicial information, the FASB may now be about to take a step backward unless the directors and investors can be mobilized.  The Securities and Exchange Commission is also in a position to act to make vital improvements in disclosure of information relevant to potential liabilities.

Will we have to wait for a flood of lawsuits, or will regulators act to establish clearer reporting rules that encourage better management of risks?

…continue reading: Don’t Ask, Don’t Tell: A Poor Framework for Risk Analysis by Both Investors and Directors

(Editor’s Note: This post comes to us from Simon Wong of Northwestern University Law School.)

Shareholders around the world are seeking greater dialogue with boards of directors of investee companies on an expanding array of topics. For example, demands by investors in the US and other markets for greater shareholder rights – such as an advisory vote on remuneration – are in part efforts to engage the board on important governance issues. In a recent article, available here, I draw upon my experience in the UK and other markets to offer practical suggestions to boards on improving engagement with their shareholders.

To start, boards should strive to build a long-term, trust-based relationship with their most significant shareholders. In practice, this means that the board – particularly the chairman, lead independent director and remuneration committee chair – should interact directly with shareholders rather than delegating this function to the investor relations team.

The focus on building trust means that regular meetings are important, as relationships and goodwill are built through repeated encounters. Meetings with shareholders do not have to be especially formal. In most situations, casual conversation often works better. Quality of discussion, particularly when sensitive topics are on the agenda, is often inversely proportional to the number of people in the room. As a principle, both sides should strive to minimize the number of attendees.

…continue reading: Effective Board Engagement with Shareholders