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Lawsuits and Proxy Contests as Shareholder Activists Push for M&A Deals
Practical Law Article 2-554-6725 (Approx. 8 pages)
Lawsuits and Proxy Contests as Shareholder Activists Push for M&A Deals
by Practical Law Corporate & Securities
| Published on 30 Jan 2014 • USA (National/Federal) |
A discussion of recent actions taken by activist shareholders pursuing M&A deals.
Last October, Practical Law discussed several emergent hostile situations in which activist shareholders were not merely pushing for change on a target company's board, but advocating for an M&A transaction (see Legal Update, Unsolicited Offers and Shareholder Activism May Drive M&A Deals). This trend, a highlight of the 2013 public M&A landscape, has intensified in the beginning of 2014, with several shareholder activists launching proxy contests and even filing suit in efforts to cause their target companies to pursue an M&A deal.
This Article highlights recent developments in situations where activist shareholders are advocating for sale or spin-off transactions, with special attention paid to the successful complaint filed by the hedge fund Sandell Asset Management Corp. in the Delaware Court of Chancery against Bob Evans Farms, Inc. and its board of directors.
Sandell Asset Management/Bob Evans Farms
Sandell Asset Management, a 6.5% stockholder of the casual-dining chain restaurant Bob Evans, began its public campaign against the company with a letter to the board last September. In it, Sandell advised that the company separate its packaged-food business (by IPO, if necessary), enter into sale-leaseback transactions for its hundreds of locations, and apply the proceeds of those two steps toward conducting a self-tender for its own shares.
After being rebuffed, Sandell filed suit in the Delaware Court of Chancery against the company and its board of directors. The complaint did not ask the court to force the board to pursue Sandell's suggested transactions (a virtually inconceivable ruling). Rather, the complaint sought a declaratory judgment from the court that the board invalidly amended the company's by-laws to impose an 80% stockholder-approval requirement on any future amendments to the by-laws. According to Sandell, if the court were to rule in its favor, Sandell would then pursue a consent solicitation (requiring only majority approval) to amend the company's by-laws to de-stagger the board and elect Sandell's nominees.
On January 28, 2014, Bob Evans announced that its board had amended the by-laws, presumably in response to the complaint filed by Sandell (the announcement does not explicitly mention the lawsuit). On January 29, 2014, Sandell announced that it was satisfied with the board's actions and would drop its lawsuit. Because of its success, the complaint is instructive as both an example of the influence of activist shareholders and as a cautionary tale for the drafting and implementation of by-laws.
The Complaint
The complaint filed by Sandell begins with this assertion:
"It is a fundamental precept of the Delaware General Corporation Law (the 'DGCL') that the stockholders of a Company possess the right to amend the Company's By-Laws (the 'By-Laws')."
Though stated somewhat forthrightly, this statement is essentially true. Section 109(a) of the DGCL provides that "the power to adopt, amend or repeal bylaws shall be in the stockholders entitled to vote" (8 Del. C. § 109(a)). However, the DGCL goes on to say that any Delaware corporation can, in its certificate of corporation, confer the right to adopt, amend or repeal the by-laws on its board of directors, with the caveat that the stockholders can never have this right taken away from them.
Later in the introductory section of the complaint, Sandell makes another statement about the nature of Delaware law that is more open to debate. The complaint says:
"It is the stockholders—not the Board—who own Bob Evans and have ultimate control over the Company's governance, and a declaration is needed here to ensure that long-recognized dynamic."
The model of a firm being "owned" by its stockholders is strongly contested in corporate law and scholarship. In addition, DGCL Section 141(a) states that the business and affairs of every corporation are managed by the corporation's board of directors, which seemingly undermines the contention that it is the stockholders who have ultimate control over the corporation's governance (beyond their right to elect the directors and their other statutory rights) (8 Del. C. § 141(a)).
These opening statements by Sandell about the nature of corporate law at first create an impression that the complaint intended to make an argument against the board based on equitable grounds, predicated on theories of breach of fiduciary duties and lack of entitlement to the presumptions of the business judgment rule. But at its core, the complaint asserted a specific cause of action based on contractual interpretation. Sandell had sought a declaration from the Court of Chancery that the Bob Evans board misread the company's by-laws and, in so doing, wrongfully amended them.
The Amendments to the By-laws
As described in the complaint, certain (unnamed) stockholders had been engaged in a years-long effort to amend the company's by-laws. Until August 2011, the company's by-laws had provided for a staggered board and a requirement that any amendment to that section of the by-laws (Section 3.01), as well as the amendment section itself (Section 8.01), receive the approval of 80% of the stockholders. In particular, Section 8.01 read:
"Section 8.01. Amendments. These by-laws may be amended or repealed by the board of directors pursuant to the certificate of incorporation or by affirmative vote of the holders of record of shares entitling them to exercise a majority of the voting power on such proposal: provided, however, that the provisions set forth in this Article VIII, in Article II, Sections 2.05 and 2.08 and in Article III, Sections 3.01 and 3.13, herein may not be repealed or amended in any respect unless such action is approved by the affirmative vote of the holders of eighty percent (80%) of the stock issued and outstanding and entitled to vote thereon."
By these terms, Section 3.01 of the by-laws could only be amended by the stockholders if 80% of the voting stock elected to amend it. The provisions of the by-laws not enumerated in Section 8.01, however, could be amended by a simple majority of the holders of the voting stock.
Annual proposals to change the threshold for amending the staggered-board provision to a simple majority repeatedly passed, but only with simple majorities, not enough to amend the 80% threshold. Eventually, at the 2011 annual meeting, a proposal passed with enough support to amend and restate the by-laws. The new by-laws provided for an unclassified board under Section 3.01 and for a new stockholder-approval threshold for amendments to this by-law. The new Section 8.01 stated:
"Section 8.01. Amendments. These by-laws may be amended or repealed by the board of directors pursuant to the certificate of incorporation or by affirmative vote of the holders of record of shares entitling them to exercise a majority of the voting power on such proposal: provided, however, that the provisions set forth in this Article VIII, in Article II, Sections 2.05 and 2.08 and in Article III, Section 3.13, herein may not be repealed or amended in any respect unless such action is approved by the affirmative vote of the holders of eighty percent (80%) of the stock issued and outstanding and entitled to vote thereon."
With Section 3.01 removed from the enumerated sections, a simple majority of the voting power of Bob Evans could elect to amend the staggered-board provision (which in any event had been changed to provide for a non-staggered board).
As Sandell explained in the complaint, three months later the board of Bob Evans unilaterally amended the by-laws. The new by-laws did not immediately reclassify the board, but did apply the 80%-approval threshold for stockholder amendments to all provisions of the by-laws, not just those that had previously been enumerated. As the new Section 8.01 provided:
"Section 8.01. Amendments. These by-laws may be amended or repealed by the board of directors pursuant to the certificate of incorporation or by affirmative vote of the holders of eighty percent (80%) of the stock issued and outstanding and entitled to vote thereon."
The Allegations by Sandell
Sandell asserted that the November 2011 amendment by the board of Bob Evans was improper. This assertion assumed one, exclusive way of reading the pre-November 2011 by-laws: that the proviso in Section 8.01 applied to the entire sentence preceding it and captured even board-approved amendments.
Section 8.01 had always begun with the same initial statement: the by-laws can be amended by the board of directors or by the affirmative vote of the stockholders. The proviso that followed added an 80%-approval requirement for the amendment of the enumerated sections. It does not seem unreasonable to read this proviso as applying only to the second half of the clause that preceded it, which dealt with amendments by the stockholders. Although the phrase "in any respect" in the pre-November 2011 by-laws might be read to capture amendments approved by the board, this concept could have been drafted more clearly by explicitly stating that the enumerated sections can only be amended with 80% stockholder approval, notwithstanding the approval of the board.
If the by-laws were read as providing for two possible paths for amendment, a section enumerated in the proviso to Section 8.01 could have been amended either by the board or by the stockholders with approval of 80% of the voting stock. But Sandell maintained that this is not the correct way of reading the pre-November 2011 by-laws. According to Sandell, the proviso applied to the entire Section 8.01, meaning that the sections enumerated in the proviso could only be amended with the approval of 80% of the voting stock. By this reading, the board had no authority in November 2011 to amend Section 8.01 without obtaining the consent of 80% of the stockholders.
To support its position, Sandell pointed out that in the company's proxy statement for the 2006 annual meeting, the board itself explained to the stockholders that an amendment to Section 3.01 needed "action by the board, and subsequently the stockholders." Sandell added that in the company's ensuing proxy statements before August 2011, when the board recommended the amendment to the by-laws, the board did not state that it could act unilaterally to make the desired amendments. These references to the board's previous statements amount to an argument for estoppel: that regardless of how the old by-laws can be read in isolation, the board cannot claim it had a right to amend the by-laws unilaterally when it had disclosed to the stockholders that it could not. Sandell also voiced a concern that the previous disclosures by the board would likely create a "chilling effect" on the stockholders, many of whom might have assumed that 80% approval was required for Sandell's desired amendments. Sandell therefore asked that as a matter of equity, the court should declare the November 2011 by-laws invalid.
Sandell added in its complaint that the November 2011 version of Section 8.01 was improper as a legal matter under Section 109(a) of the DGCL. Section 109(a) provides that even when the company confers on the directors the right to amend the by-laws, the stockholders can never lose that right. In Sandell's view, the board's version of Section 8.01, which requires 80% approval for an amendment to any section of the by-laws, by definition contravened that statute. This argument, however, seems harder to make, as it would mean that there is a legal distinction between raising the approval threshold for amending some sections (which the stockholders of Sandell never objected to) and amending all of them.
Response by Bob Evans
Although it does not credit the Sandell lawsuit by name, the board of Bob Evans announced on January 28, 2014, that it had once again amended and restated the by-laws. The new by-laws restore the version of Section 8.01 that had been approved by the stockholders in August 2011. The announcement also states that the board intends to propose to the stockholders to eliminate even the enumerated exceptions, which would allow for a simple majority to approve any amendment to the by-laws.
Of interest, the new by-laws also remove a "golden leash" provision that had prohibited directors from receiving compensation for their service as directors from anyone other than the company itself (note the removal in the new by-laws of Section 2.07(x) from the previous version). This topic has been fiercely debated, with proxy-advisor company Institutional Shareholder Services recently taking the position that directors should not adopt prohibitory golden-leash by-laws without putting them to a vote of the stockholders (see Legal Update, ISS Releases FAQs on Director Qualification By-laws).
The entire episode stands as an example of the legal sophistication of activist shareholders, while also highlighting the need for clarity when drafting any contractual provision that contains a disjunctive statement ("the board or the stockholders may amend the by-laws") followed by a proviso. For a form of by-laws for a Delaware corporation, see Standard Document, Private Company By-Laws (Delaware Corporation) .
Icahn Partners/eBay
On January 22, 2014, eBay Inc. disclosed that it had received a notice from investor Carl Icahn indicating that he has nominated two of his employees to eBay's board of directors and submitted a non-binding proposal for a spin-off of eBay's PayPal business into a separate company. The company responded with an explanation of why it believes the PayPal business should stay within eBay. The company has also disclosed several conversations that its directors have had over Twitter on the subject, bringing to mind the issues that can arise when a reporting company is active in social media. For a checklist of best practices in this area, see Social Media and the Securities Laws: Best Practices Checklist.
eBay's by-laws contain an advance-notice provision for stockholder proposals of business to be discussed at the annual meeting (see Section 1.14). The provision requires 90 days' advance notice for stockholder proposals, which is a typical time frame. For a form of advance-notice by-law for Delaware public corporations, see Standard Clause, By-laws (DE Public Corporation): Advance Notice.
Eminence Capital/Jos. A. Bank
The takeover battle between The Men's Wearhouse, Inc. and its smaller rival, Jos. A. Bank Clothiers, Inc. (see Legal Update, Unsolicited Offers and Shareholder Activism May Drive M&A Deals), has gone through several more iterations since October 2013. The counteroffer made by Men's Wearhouse, a spin on the old "Pac-Man" takeover defense in which the target of a hostile bid attempts to acquire its own bidder, may have been prompted in part by the public encouragement of Eminence Capital, a hedge fund with significant holdings in both Men's Wearhouse and Jos. A. Bank.
Going beyond this advocacy, Eminence Capital announced on January 14, 2014, that it intends to nominate two individuals for election as directors to the board of Jos. A. Bank. The announcement explains that Eminence Capital intends to support Men's Wearhouse's own nominees to the Jos. A. Bank board and would withdraw its nominees if those proposed by Men's Wearhouse are still running at the time of the Jos. A. Bank annual meeting.
The board of Jos. A. Bank has since announced its rejection of Men's Wearhouse's latest offer, which prompted a response on January 30, 2014, from Men's Wearhouse. In its response, the board of Men's Wearhouse indicates that it is prepared to raise its offer if discussions with, or due diligence of, Jos. A. Bank uncovers additional sources of value.
Elliott Management/Riverbed Technology
On January 8, 2014, an affiliate of hedge fund Elliott Management Corp. disclosed its proposal to acquire Riverbed Technology, Inc. The proposal's true aim is apparently to prompt an auction by Riverbed, as reflected in part by the 45-day go-shop included in the draft merger agreement provided by Elliott. The proposal is also conditioned on due diligence and does not contain details of Elliott's financing (though the proposal does state that it is not conditioned on financing).
The proposal does not make any explicit threat to pursue a hostile transaction, nor announce any intention by Elliott to nominate its own directors to the board of Riverbed. Riverbed has a staggered board under its certificate of incorporation (see Article VI) and by-laws (see Section 3.2).
On January 15, 2014, Riverbed announced its rejection of the proposal.
Barington Capital/Darden Restaurants
The October legal update discussed the reports that hedge fund Barington Capital Group LP, along with other investors, had proposed to Darden Restaurants, Inc. that it form two separate companies, one to house the Olive Garden and Red Lobster chains, the other to own Darden Restaurants' other, higher-growth chains.
On December 19, 2013, Darden Restaurants announced that it intended to spin off its Red Lobster chain and take other actions to enhance shareholder value. But on January 13, 2014, Barington Capital called this plan inadequate and advised that it planned to give a presentation on January 30 in which it would further discuss its recommendations. Barington Capital has since been joined by Starboard Value, which urged Darden Restaurants in a letter to delay the Red Lobster spin-off until it undertakes a fuller review of its available options.
Engaged Capital/Abercrombie & Fitch
- Separate its chairman and CEO roles.
- Add three new independent directors and declassify its board.
- Eliminate its poison pill.
These changes effectively lower the company's defenses against hostile bids, although the announcement says nothing about actively pursuing a sale transaction. Engaged Capital responded that it was pleased with these steps, but that the board should continue to "evaluate value‐maximizing strategic and organizational changes."