This post is from Steven M. Haas of Hunton & Williams LLP.
Historically, merger proposals have almost always been approved by target-company shareholders. In fact, the Wall Street Journal recently reported that, since 2003, only 7 of 1,200 transactions have been voted down at shareholder meetings.
Yet the M&A world has now seen this happen twice in the past four months. First, Carl Icahn’s proposal to acquire Lear was rejected in July, even after a last-minute increase in price. Then, on October 24, the Dolan family’s go-private proposal was rejected by Cablevision’s minority shareholders. There have also been several close calls this year, including the Inter-Tel merger, which was headed for defeat until quick maneuvering by the board gave shareholders more time to consider, and ultimately approve, the transaction. Other deals, such as the acquisitions of OSI Restaurant Partners and Clear Channel Communications were delayed, and their terms improved, to help gain shareholder support.
Shareholder opposition seems to reflect a growing sentiment that many of the deals over the past two years were undervalued–particularly private equity-sponsored transactions. It also demonstrates increased coordination among shareholders, including investors who are not traditionally considered “activists.”
Finally, these events provide evidence of the increased power of proxy-advisory firms such as Institutional Shareholder Services. ISS recommended against the Lear and Cablevision proposals. It also heavily influenced voting on the Inter-Tel merger, initially recommending against the deal and then changing its position–but only after the shareholders’ meeting had been postponed.
The failed Cablevision transaction, however, is in a league of its own, because it involved a proposal initiated by a large controlling shareholder. Through a dual-class stock structure, the Dolan family controls about 74% of the company’s voting power; and, beginning in 2005, the Dolans began trying to acquire the outstanding minority shares to take the company private. Cablevision then formed a two-member special committee, and in May the Dolans signed a merger agreement that offered a 51% premium to Cablevision shareholders and required a majority of the minority shareholders to approve the deal.
Cablevision is a Delaware corporation, so the deal was subject to entire-fairness review under Kahn v. Lynch Communications Systems. In that case, the Delaware Supreme Court held that freeze-outs are subject to entire-fairness review because minority shareholders are inherently coerced by the majority and may vote in favor of a freeze-out simply to avoid retaliation. Under Kahn, the use of a special committee and a majority-of-the-minority provision can shift the burden of proof to the plaintiff, but neither affects the standard of review. And Delaware law offers no added benefit to controlling shareholders if, as in Cablevision’s case, both procedures are employed–although this would presumably be a factor in the court’s analysis.
In a 2005 article in The Business Lawyer entitled The Dilemma That Should Never Have Been: Minority Freeze-Outs in Delaware, Peter Letsou and I argued that Delaware’s per se rule of entire-fairness review of freeze-outs should not apply in many cases. There, we rejected the notion that minority shareholders are inherently coerced by a majority stockholder, and concluded that a freeze-out should be reviewed under the business-judgment rule if:
(1) The freeze-out has been approved by a properly functioning special committee of independent directors;
(2) The freeze-out has been effectively approved by a majority of the minority; and
(3) The controlling stockholder has fulfilled its disclosure obligations and has abstained from abusive or otherwise illegal conduct.
Guhan Subramanian advanced similar arguments in his 2005 article Fixing Freezeouts. Vice Chancellor Leo Strine has also addressed the issue, offering thoughtful analysis and a proposal for reform in his opinion in the Cox Communications shareholder litigation. I also advanced a similar argument in a 2004 piece in the Virginia Law Review entitled Toward a Controlling Shareholder Safe Harbor.
The Cablevision deal is additional evidence against the needlessly broad standard of review required under Kahn, and demonstrates the ability of minority shareholders to “say no” to a controlling stockholder. It also illustrates the effectiveness of majority-of-the-minority shareholder approval conditions, particularly where there are several large minority shareholders who can work together to increase the likelihood that an undervalued proposal will be rejected.
In Cablevision, the minority shareholders got the last word–for now, at least. Delaware law would be well-served if the Delaware Supreme Court revisited Kahn in light of this evidence, easing the standard of review for freeze-outs so long as certain procedural conditions are met. This would give controlling shareholders a real incentive to utilize a majority-of-the-minority approval condition, which seems to have worked rather well in Cablevision’s case.
