CHAPTER 11 HOSTILE TAKEOVERS IN THE MID-NINETIES: A BACKGROUND PRIMER

• Jurisdiction: United States

Mergers and Acquisitions of Natural Resources Companies
(Nov 1994)
CHAPTER 11
HOSTILE TAKEOVERS IN THE MID-NINETIES: A BACKGROUND PRIMER
Morris J. Kramer
Steven J. Rothschild
Skadden, Arps, Slate, Meagher & Flom ^*
New York, New York and Wilmington, Delaware
SYNOPSIS

I. FRIENDLY NEGOTIATED ACQUISITIONS v. HOSTILE UNSOLICITED ACQUISITIONS: AN OVERVIEW

II. FEDERAL SECURITIES LAWS

A. Duty to Disclose Acquisition Negotiations Under the Federal Securities Laws

B. Stock Purchases and Tender Offers

III. STATE TAKEOVER STATUTES

A. "Fair Price/Supermajority" Statutes

B. "Freezeout" or "Business Combination" Statutes

C. "Control Share Cash-Out" Statutes

D. "Control Share Acquisition" Statutes

E. Non-Shareholder Constituency Statutes

F. Disgorgement Statutes

G. Greenmail Statutes

H. Poison Pill Endorsement Statutes

I. Mandated Staggered Board Statutes

J. Succession of Labor Contracts/Severance Pay Statutes

K. Golden Parachute Statutes

IV. THE FIDUCIARY DUTIES OF DIRECTORS AND THE BUSINESS JUDGMENT RULE

A. The Basic Fiduciary Duties of Directors

B. The Business Judgment Rule

C. Enhanced Scrutiny of Defensive Actions

V. TAKEOVER DEFENSES

A. Structural Defenses ("Shark Repellents")

B. Responsive Defenses

Significant Cases

———————

[Page 11-1]

I. UNSOLICITED ACQUISITIONS: AN OVERVIEW FRIENDLY NEGOTIATED ACQUISITIONS v. HOSTILE

— Friendly transactions are the result of negotiations between managements of the target and the acquiror; since mergers or asset sales initially require approval of the target's board, an essential ingredient in any successful transaction is to obtain the requisite board approval. By contrast, hostile/unsolicited acquisition attempts are typically launched by the purchase of or offer to purchase shares directly from the target's shareholders; typically open market buying programs, "street sweeps" or tender offers are employed.

Recently, due to the efficacy of state takeover laws and the use of "poison pills," which significantly increase the costs of launching a hostile stock acquisition, there has been a significant increase in the utilization of proxy contests as a takeover technique.

— Most hostile offers, if they are ultimately successful, turn "friendly" in the end. This generally happens after the hostile bidder alters the terms of its original offer by doing such things as increasing the offer price or changing the form of consideration (perhaps from cash to securities).

— The presence of devices such as:

• charter or by-law provisions, including a classified board of directors, elimination of shareholder action by written consent, elimination of shareholders' ability to call special meetings, fair price/supermajority merger provisions and advance notice of shareholder proposal provisions;

• shareholder rights plans (i.e., "poison pills," which typically permit shareholders (other than a hostile acquiror who crosses a specified ownership threshold such as 20% or 30% of the target's common stock) to buy target stock at a 50% discount, unless such "poison pill" has been previously redeemed); and

• state anti-takeover statutes (e.g., Delaware statute that provides for a three year "freezeout" on business combinations with a

[Page 11-2]

15% or more shareholder, unless certain requirements, such as prior board approval, are met; or Oregon "control share" statute that eliminates the right of a 20% or more shareholder to vote additional shares unless prior shareholder approval is obtained),

make it more difficult for hostile/unsolicited bidders to acquire companies on a totally unfriendly basis. While such provisions will not stop a determined bidder, they will induce the parties to negotiate a transaction on terms that are generally more favorable to the target shareholders than the bidder's original offer.

In addition, targets can instigate legal action against a hostile bidder that has failed to comply with the myriad of federal and state regulations governing hostile takeovers. Defensive litigation serves both to insure that the target's shareholders receive the information required for them to make an informed decision and, by forcing the bidder to negotiate with the target and by giving the target sufficient time to evaluate alternative paths, helps assure that the shareholders receive the best price and terms possible.

II. FEDERAL SECURITIES LAWS

A. Duty to Disclose Acquisition Negotiations Under the Federal Securities Laws

— Once a company that is subject to the disclosure requirements of the Securities Exchange Act of 1934, as amended (the "Exchange Act"), engages in acquisition negotiations, the question often arises "when must a public announcement be made?" If a duty to disclose exists and there is a material misstatement or omission, liability may result under Section 10(b) of the Exchange Act and Rule 10b-5 promulgated thereunder.

— Often there are conflicting considerations:

• The bidder may insist that negotiations remain secret so that its bid is not "shopped;" also, the target may fear that more confusion

[Page 11-3]

and uncertainty will result if discussions are disclosed prematurely.

• Alternatively, unusual market activity or rumors, as well as stock exchange inquiries, may pressure public companies to disclose the existence of acquisition discussions.

— Application of a two-step test, which is consistent with current case law, will aid in the determination of whether disclosure of acquisition discussions is required:

• First, is there an affirmative duty to make a disclosure? Three broad "duty to disclose" categories exist:

— a person with "inside information" has a duty to disclose such information prior to trading in securities;

— a person may have a statutory duty to make disclosures (e.g., disclosures required in 10-Ks, 14D-1s, 14D-9s); and

— a person may have a duty to make disclosures in order to correct prior disclosures that have become inaccurate or were incorrect or to correct leaks attributable to it.

• Second, even if an affirmative "duty to disclose" exists, liability will not ensue unless the omitted disclosure is deemed material (viz., there is a substantial likelihood that a reasonable investor would consider it significant).

— In 1988, the U.S. Supreme Court addressed the question of disclosure of preliminary merger negotiations in Basic, Inc. v. Levinson:¹

[Page 11-4]

• In the Basic decision, the Court noted that Basic had denied the existence of merger negotiations on three occasions and had also stated that it knew of no present or pending corporate developments to explain the unusual trading activity in Basic stock.

• In view of Basic's statements a "duty to correct" untrue statements implicitly existed. The Supreme Court, however, did not focus on the first part of the disclosure equation and instead focused on the second part of the disclosure equation, the materiality issue. The Court adopted a "probability/magnitude" test holding that the question of when preliminary merger negotiations are material must be decided on a case-by-case basis, taking into account such factors as the probability that the transaction will be consummated and the significance a reasonable investor would place on the withheld or misrepresented information.

• Since Basic, lower courts have continued to apply the two-part test and, indeed, have held that failures to disclose material merger negotiations would not violate Rule 10b-5 if an affirmative "duty to disclose" otherwise did not exist.

— "No Comment" Position

• The question of whether to "disclose" or "not to disclose" is highly dependent on facts and circumstances at any given time (including the latest case law developments) and, therefore, guidance by experienced counsel is essential.

• Many companies have adopted a consistent practice of issuing "no comment" statements in response to inquiries regarding merger negotiations, such as "the company has a policy of neither confirming nor denying market rumors," or simply "no comment."

• Companies should consider whether "no corporate development" continues to be an appropriate response because it may be inaccurate and, even if true when made, may become inaccurate

[Page 11-5]

and therefore trigger a "duty to disclose" at a time when the company is engaged in sensitive discussions and does not want to make a disclosure. The Securities and Exchange Commission ("SEC") has taken the position that a "no corporate development" statement made while the issuer is engaged in acquisition discussions may be materially false and misleading.

B. Stock Purchases and Tender Offers

— Section 13(d) of the Exchange Act and the rules promulgated thereunder require that a person acquiring beneficial ownership of 5% of any class of equity securities registered under Section 12 of the Exchange Act must file a Schedule 13D within 10 calendar days of crossing such 5% ownership threshold.

• Significantly, the Schedule 13D requires the acquiror to disclose, among other things, the "purpose" of his acquisition (i.e., intent to acquire control), the source of his financing and information about the acquiror's background.

• The 10-day window between crossing the 5% threshold and disclosure often affords a hostile bidder the opportunity to accumulate a substantial block of stock over the 5% filing threshold. However, if a filing² under the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended ("Hart-Scott-Rodino"), is required, disclosure that a bidder is interested in a particular target might occur when such bidder owns as little as $15 million of the target's shares.

• Amendments to a Schedule 13D must be filed "promptly" after any "material" change in the facts set forth therein. Acquisitions or dispositions of 1% of a company's shares are deemed "material."

[Page 11-6]

— The tender offer rules, which are set forth in Regulation 14D of the Exchange Act (Rules 14d-1 to 14d-10) impose a...