The U.S. Court of Appeals for the Sixth Circuit has affirmed a District Court judgment holding an interloper that breached its standstill agreement liable for tortious interference to the winning bidder in an auction. The interloper is required to pay the winner the incremental amount – over $100 million – that it took to secure shareholder approval for its deal, and may also be liable for punitive damages. In addition to providing important guidance on tortious interference claims in the M&A context, the case offers useful reminders for buyers, sellers and would-be over-bidders in the art of running, winning and “topping” an auction for a public company.

The case stems from a four-year old transaction in which, after our client Ventas won an auction to buy Sunrise REIT, losing bidder Health Care Property Investors (“HCP”) went public with a topping bid at a 20% premium, even though this was prohibited by its standstill agreement with the target. The public announcement of the topping bid did not disclose that it was conditional or that it violated the standstill. Ventas demanded that Sunrise REIT enforce HCP’s standstill agreement as required by the merger agreement. Both the Ontario trial and appellate courts ordered Sunrise REIT to do so, upholding a selling board’s prerogative to structure an auction in a manner that the board believes will maximize shareholder value (including by requiring “best and final” offers from participants and agreeing to enforce a standstill obligation against a losing bidder).

…continue reading: Sixth Circuit Upholds Tortious Interference Verdict Against Auction Loser’s Overbid

How did the Romans finance capital-intensive endeavors such as the erection of temples, the pavement of roads, or the trading of goods from foreign countries? This question has fascinated generations of classical readers and scholars. It is, however, also of interest to the corporate lawyer of today, because Ancient Rome helps us better understand the functions of corporate law and its role within the broader economic, social, political, and legal setting.

What We Know About Ancient Rome

For more than 175 years, historians, economists, and lawyers have speculated or even claimed that, as early as the Roman Republic (6th to 1st century BC), businessmen formed large firms with publicly traded shares similar to modern stock corporations (since Orelli, 1835). Most recently, a longer Journal of Economic Literature article argues that there was evidence for such an “early form of shareholder company” (Malmendier, 2009).

In a new book, however, I conclude that such claims are unwarranted. [1] I consider all legal and literary sources, both in Latin and classical Greek, that have come down to us, such as the works of Polybius (2nd century BC), Cicero (1st century BC), Livy (around the time of Christ’s birth), Pliny the Elder (1st century AD), or Plutarch (2nd century AD), as well as great collections like the New Testament (1st/2nd century AD) or the Digest (6th century AD). None of these sources brings to light evidence for larger “capital associations” (my term for entities that helped finance projects which, on account of their scope, duration or risk, exceeded the capacity of single individuals), let alone associations with publicly traded shares.

…continue reading: Corporate Law Lessons from Ancient Rome

In the paper, Firm Mortality and Natal Financial Care, which was recently made publicly available on SSRN, we ask three related questions about the survival of U.S. public firms in the 1985 to 2006 period. First, what is their death rate as a function of age after their initial public offerings (IPOs)? Second, do financial intermediaries in the IPO process affect this death rate function? Third, if they do, how?

To address the first question, we adopt the econometrics from the actuarial sciences and construct a mortality table for U.S. public companies during 1985–2006. Following Queen and Roll (1987), we classify births of public companies as their appearance on the Center for Research in Security Prices (CRSP) tape, and deaths as their disappearance from the CRSP tape. We focus on bad deaths (liquidation, delisting, permanent trading halts) rather than good deaths (e.g., mergers and takeovers), since bad deaths incur substantial economic and social welfare costs. The mortality rate table reveals that the death rates of U.S. public firms increase with age, peak at three years at a level three times higher than the long-term mortality rate, and then decrease with age. This finding is an important contribution in its own right, because the mortality literature in the economics of industrial organization notes that survival risk decreases as a firm ages. With mortality rates first increasing and then decreasing, we are the first to document that U.S. public firms have to survive up to three years after their IPO—the critical age—before the survival risk starts diminishing.

…continue reading: Firm Mortality and Natal Financial Care

Today, I want to talk about capital formation. For over 30 years, I advised many clients as to their capital raising efforts in order to grow their businesses, and I worked with institutions that held significant stakes in companies who grew their operations by making better products, and selling more of them.

I have been growing increasingly concerned about the discussion that is taking place in our country regarding capital formation. This discussion seems to confuse the singular act of capital raising with the much broader concept of capital formation. Moreover, this discussion fails to take into account the importance of disclosure in helping investors assess risks and make informed investment decisions. Disclosure leads to an informed investor – and informed investors are ones who will make investment decisions that collectively, in the aggregate, will yield productive benefits and growth to the real economy.

I know you understand exactly what I mean. The Council is an association of members who have a long-term stake in the U.S economy. You are self-described as the “patient capital” of the markets because, in general, you have “30-year investment horizons and heavy use of indexing strategies.” You understand that for most investments to make money, the company generally requires organic or strategic growth over a period of time.

I share this long-term view.

…continue reading: Facilitating Real Capital Formation

The extent of agency problems in publicly traded firms and the need for reform of executive compensation remain the subject of active debate. In the paper, Agency Problems in Public Firms: Evidence from Corporate Jets in Leveraged Buyouts, recently made available on SSRN, I bring new evidence to this debate by measuring a particular kind of firm behavior where there is potential for managerial abuse—the use of corporate jets.

Motivated by a large literature that finds improvements in efficiency and performance when firms are purchased by a private equity (PE) fund in a leveraged buyout (LBO), I use novel data to compare the fleets of jets operated by publicly traded and privately held firms. In the cross-section of firms from 2008, I find that PE-owned firms average about 40% smaller jet fleets than publicly traded firms, even after controlling for firm size, industry, and location in a variety of flexible ways. One could still worry, however, that these cross-sectional differences do not represent a causal effect of PE ownership due to omitted variables or other factors. Thus, I also measure changes in jet fleets within firms that are taken from public to private by a PE fund in an LBO between 1992 and 2007, and I find fleet reductions of a similar magnitude. Of course, the selection of firms into PE-ownership is not random, and I discuss assumptions under which these comparisons across and within firms provide estimates of lower and upper bounds on the average treatment effect of taking a firm from public to private in an LBO.

…continue reading: Agency Problems in Public Firms

The Committee on Mergers & Acquisitions of the American Bar Association’s Section of Business Law recently released the 2008 Strategic Buyer/Public Target M&A Deal Points Study. I am the Chair of the Committee’s M&A Market Trends Subcommittee, which oversaw the preparation of the Study, and Jim Griffin of Fulbright & Jaworski in Dallas is the Chair of the working group that compiled the Study.

The Study examines key deal points in acquisitions of publicly traded companies by strategic buyers announced in 2007. It also compares the data from the 2007 deals to the data from the Subcommittee’s prior studies of public company acquisitions, which cover deals announced in 2004, 2005 and 2006.

Among the many interesting findings of the Study is that 48% of the acquisition agreements in the Study sample contained a non-reliance clause—a clause to the effect that the target is not making, and the buyer is not relying on, any representations regarding the target’s business except for the specific representations expressly provided in the acquisition agreement. By comparison, only 18% of the acquisition agreements for deals announced in 2005 and 2006 included a non-reliance clause.

So why the significant increase? One possible explanation might be found in the February 2006 decision of the Delaware Court of Chancery in ABRY Partners, and the extensive discussion of that case by leading M&A practitioners throughout the country. In ABRY Partners, Vice Chancellor Strine underscored the effectiveness of a non-reliance clause in limiting a buyer’s fraud-based remedies in the context of an acquisition of a privately-held company. Even though ABRY Partners involved a privately-held target, the extensive discussion that followed also focused on the potential usefulness of non-reliance clauses in deals involving publicly traded target companies. Then, in late 2007, the Tennessee Chancery Court decided Genesco, Inc. v The Finish Line, Inc. In that case, a non-reliance clause in the merger agreement was viewed by the Court as an important element in its determination that Finish Line failed to prove that the publicly traded target company, Genesco, fraudulently induced Finish Line to enter into the merger agreement.

My colleague, Rick Climan, former Chair of the Committee on Mergers & Acquisitions, who acted as special advisor on the Deal Points Studies, points out that some of the targets involved in the 52% of the acquisition agreements in the Study sample that did not include a non-reliance clause may nonetheless have enjoyed the protection afforded by a non-reliance clause, in those cases where such a clause was included in the confidentiality agreement between the buyer and the target. In fact, in Genesco, the Court pointed to non-reliance clauses in both the confidentiality agreement and the merger agreement to support its decision.

It will interesting to see the results of our 2009 study on this issue.

In addition to Jim Griffin, Wilson Chu and Larry Glasgow, the former co-chairs of the M&A Market Trends Subcommittee, and more than 20 M&A lawyers from major law firms across North America, assisted in the Study. Their names are listed in the Study.

The Study is available here.

Last month I discussed the emerging importance of what I call “uncorporate” governance – that is governance characteristic of partnership-type firms – for large, publicly held firms. As elaborated in my Uncorporating the Large Firm, a critical aspect of these firms is that they substitute distributions, liquidation rights and high-powered managerial incentives for traditional corporate monitoring devices, particularly including fiduciary duties.

The Delaware legislature does effectuate this “substitution” by explicitly letting LLCs eliminate all duties except for “the implied contractual covenant of good faith and fair dealing” (6 Del. Code §18-1101; there are similar provisions for other unincorporated firms). By contrast, the Delaware provision on fiduciary duty modification in corporations (DGCL §102(b)(7)) prohibits waivers of the duty of loyalty and “for acts or omissions not in good faith or which involve intentional misconduct or a knowing violation of law.” And as I discussed in Uncorporation and Corporate Indeterminacy, Delaware courts have enforced waivers consistent with the statutes.

But will Delaware courts apply corporate restrictions on waivers to publicly held uncorporations. In particular, might they interpret the “good faith” qualifier in the uncorporation statutory waiver provisions as similar to corporate-type good faith, which has been interpreted as part of the fiduciary duty of loyalty (see Stone v. Ritter, 911 A.2d 362 (Del. 2006))? Until very recently, the Delaware Supreme Court had never held that fiduciary duties could be waived in any publicly held firm.

That has now changed thanks to the Delaware Supreme Court’s recent opinion in Wood v. Baum. The case involved Municipal Mortgage & Equity, LLC (“MME”), at the time of the case a NYSE-listed Delaware LLC with 2500 record holders (see MME 2006 10K). The question in the case was whether the plaintiff had adequately alleged facts justifying excusing demand in a derivative suit as futile. Under the controlling Aronson standard in Delaware, in a case like this one involving an independent board the plaintiff had to show that the directors had an incentive to protect themselves from a substantial risk of personal liability. The court noted that:

under the Operating Agreement and the [Delaware Limited Liability Company Act] the MME directors’ exposure to liability is limited to claims of “fraudulent or illegal conduct,” or “bad faith violation[s] of the implied contractual covenant of good faith and fair dealing.”

Where directors are contractually or otherwise exculpated from liability for certain conduct, “then a serious threat of liability may only be found to exist if the plaintiff pleads a non-exculpated claim against the directors based on particularized facts.” Where, as here, directors are exculpated from liability except for claims based on “fraudulent,” “illegal” or “bad faith” conduct, a plaintiff must also plead particularized facts that demonstrate that the directors acted with scienter, i.e., that they had “actual or constructive knowledge” that their conduct was legally improper. Therefore, the issue before us is whether the Complaint alleges particularized facts that, if proven, would show that a majority of the defendants knowingly engaged in “fraudulent” or “illegal” conduct or breached “in bad faith” the covenant of good faith and fair dealing. We conclude that the answer is no.

With respect to bad faith, the complaint alleged, among other things, that the defendants had “breached their Caremark duties by “fail[ing] properly to institute, administer and maintain adequate accounting and reporting controls, practices and procedures,” which resulted in a “massive restatement process, an SEC investigation, and loss of substantial access to financial markets.” (footnotes omitted). These allegations may have raised a good faith issue under Stone. Nevertheless, the court said:

the Complaint does not purport to allege a “bad faith violation of the implied contractual covenant of good faith and fair dealing.”The implied covenant of good faith and fair dealing is a creature of contract, distinct from the fiduciary duties that the plaintiff asserts here. The implied covenant functions to protect stockholders’ expectations that the company and its board will properly perform the contractual obligations they have under the operative organizational agreements. Here, the Complaint does not allege any contractual claims, let alone a “bad faith” breach of the implied contractual covenant of good faith and fair dealing. Nor, as discussed above, does the Complaint contain any particularized allegations that the defendants acted with the requisite scienter (in “bad faith”). (footnotes omitted)

The court concludes: “Given the broad exculpating provision contained in MME’s Operating Agreement, the plaintiff’s factual allegations are insufficient to establish demand futility. (emphasis added)”

In short, the directors had no fiduciary duties under the agreement, and no incentive to protect themselves from liability for breach of any such duties. Although this case did not involve particularized allegations of self-dealing, there is no apparent reason why the court’s reasoning should not cover such allegations as well.

If publicly held firms can waive fiduciary duties in the LLC form, why should they not be able to do so in the corporate form? Should the Delaware legislature take the next seemingly logical step and carry the complete exculpation approach over to corporations from uncorporations? Seventeen years ago, in the wake of Delaware’s initial adoption of broad fiduciary opt-out provisions for limited partnerships, I predicted that would happen, in my Unlimited Contracting in the Delaware Limited Partnership and its Implications for Corporate Law, 17 J. Corp. L. 299 (1991). I argued that the absence of other corporate-type protections made fiduciary duties even more important in unincorporated firms, so that if the latter could opt out, a fortiori corporations should be able to do so. Also, if publicly held corporations could opt out by simply disincorporating, why force them to take this procedural step? Perhaps, as discussed in Uncorporating the Large Firm, corporations should be distinguished from uncorporations on the basis that the latter offer disciplinary and incentive devices that make fiduciary duties less necessary in this context. There is also an argument for letting firms and investors choose between two distinct approaches to opting out of fiduciary duties.

In any event, it now seems clear that publicly held unincorporated firms can opt out of fiduciary duties in Delaware. It remains to be seen whether my initial prediction that this permission will extend to publicly held corporations ultimately will prove to be correct.

Martin Lipton’s speech last week in Miami, Shareholder Activism and the ‘Eclipse of the Public Corporation’, noted yesterday, got a strong reaction from the NYT‘s Gretchen Morgenson on Sunday – she called it a “rant,” as I discussed on my blog. But while Lipton is clearly angry, his speech is no mere rant, and I’m going to give it the attention it deserves.

Briefly, Lipton identifies alien forces that have besieged the modern corporation and are threatening the functionality of its key institution–the board of directors.  Among other things, Lipton indicts:

–Activist investors who pressure the board to “manage for the short-term”;

…continue reading: Why is the Public Corporation in “Eclipse”?