Yearly Archives: 2012

Warning to Lenders that Do Business with Distressed Companies

Posted by Noam Noked, co-editor, HLS Forum on Corporate Governance and Financial Regulation, on
Wednesday, June 6, 2012
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The following post comes to us from Harold S. Novikoff, partner in the Restructuring and Finance Department at Wachtell, Lipton, Rosen & Katz, and is based on a Wachtell Lipton memorandum by Mr. Novikoff, David C. Bryan, and Emil A. Kleinhaus.

In a significant decision for lenders to distressed companies, the United States Court of Appeals for the Eleventh Circuit has reinstated a decision by the Bankruptcy Court for the Southern District of Florida to unwind a secured loan transaction on fraudulent transfer grounds. In re TOUSA Inc., No. 11-11071 (11th Cir. May 15, 2012).

As discussed in our prior memos (Bankruptcy Court Voids Subsidiary Guaranties and Liens as Fraudulent Transfers, November 2, 2009, and Controversial Fraudulent Transfer Ruling Reversed on Appeal, February 18, 2011), TOUSA involved a parent company that in July of 2007 caused certain of its subsidiaries to guarantee and secure $500 million in new secured debt, which was used to fund a litigation settlement with a pre-existing unsecured lender group to which the parent had been obligated but the subsidiaries had not. The bankruptcy court determined that the transaction was a fraudulent transfer as to both the new lenders and the lenders who were repaid, concluding that the subsidiaries had not received “reasonably equivalent value” for securing and guaranteeing loans used to repay parent company debt. In the view of the bankruptcy court, because the challenged transaction made it “inevitable” that the subsidiaries would file for bankruptcy, as they ultimately did in January 2008, the subsidiaries did not receive value from the transaction, even though it permitted them to forestall an immediate bankruptcy that would have resulted from an adverse judgment against the parent company triggering defaults on over $1 billion of debt that the subsidiaries had guaranteed. See In re TOUSA, Inc., 422 B.R. 783 (Bankr. S.D. Fla. 2009).

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Local Investors and Corporate Governance

Posted by R. Christopher Small, Co-editor, HLS Forum on Corporate Governance and Financial Regulation, on
Wednesday, June 6, 2012
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The following post comes to us from Vidhi Chhaochharia and Alok Kumar, both of the Department of Finance at the University of Miami, and Alexandra Niessen-Ruenzi of the Department of Finance at the University of Mannheim.

An emerging literature in accounting and finance demonstrates the economic benefits of geographical proximity. Another distinct strand of literature on shareholder activism shows that large institutional investors may influence corporate policies. In our paper, Local Investors and Corporate Governance, forthcoming in the Journal of Accounting and Economics, we link these two strands of research and examine whether physical proximity between firms and investors allows large institutions to monitor corporate activities more effectively. Specifically, we examine whether firms with more local shareholders are better governed and are less likely to engage in corporate misbehavior. We also investigate whether monitoring activities of local investors affect the profitability of local firms. Although there is an obvious free-riding problem associated with the monitoring of geographically proximate firms, the potential benefits from monitoring can outweigh the monitoring costs, especially for large shareholders (e.g., Grossman and Hart (1980), Shleifer and Vishny (1986)).

Our key conjecture is that in an economic setting where monitoring costs vary inversely with distance, firms with high local institutional ownership would have better governance characteristics. In particular, firms with more proximate shareholders would exhibit a lower propensity to engage in undesirable corporate behavior like option backdating or aggressive earnings management. As a result of better monitoring, firms with high local institutional ownership would have a lower propensity to be a target of class action lawsuits. Further, because of geographical proximity, local institutions are more likely to attend shareholder meetings and introduce shareholder proposals, facilitate CEO turnover, or limit excess CEO pay. This form of local activism could also have an indirect influence on the selection of board members and the structure of compensation contracts.

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Using Confidential Information in a Hostile Offer

Posted by Victor I. Lewkow, Cleary Gottlieb Steen & Hamilton LLP, on
Tuesday, June 5, 2012
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Victor Lewkow is a partner at Cleary Gottlieb Steen & Hamilton LLP. This post is based on a Cleary Gottlieb memorandum by Neil Whoriskey. This post is part of the Delaware law series, which is cosponsored by the Forum and Corporation Service Company; links to other posts in the series are available here.

“But, upon a close review of these model [confidentiality] agreements and other leading treatises, I cannot conclude that the use of a standard structure has led to a corresponding lack of ambiguity about important issues.” Martin Marietta Materials, Inc., v. Vulcan Materials Company. [1]

On December 12, 2011, Martin Marietta Materials, Inc. sued Vulcan Materials Company in Delaware Chancery Court, seeking declaratory judgment that the non-disclosure agreement between them (the “NDA”) did not prohibit Martin Marietta from making a hostile offer for the shares of Vulcan. The initial reaction of many deal professionals at the time was – well, if the parties wanted to agree to a standstill preventing a hostile offer, the firms involved certainly knew how to draft one. [2] However, it seems as if the idea of a standstill was not even discussed by the parties – leading perhaps to the several ambiguities found by the court in its opinion. The ambiguities, of course, required that the court resort to extrinsic evidence to determine the intent of the contracting parties. The court found that virtually all of the extrinsic evidence supported Vulcan’s contention that the parties intended the NDA to serve as a back-door standstill.

The two most significant questions examined by the court, both resulting from contractual ambiguities, were the following:

  • 1. Whether restricting the use of confidential information to evaluation of a “Transaction” effectively prohibited the use of the confidential information for the purpose of evaluating an unsolicited transaction?
  • 2. Whether the exception to confidentiality, permitting the disclosure of confidential information as “legally required,” permitted disclosure of confidential information “legally required” to be disclosed solely as a result of Martin Marietta’s own decision to launch a hostile offer?

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Surviving the Global Financial Crisis

Posted by R. Christopher Small, Co-editor, HLS Forum on Corporate Governance and Financial Regulation, on
Monday, June 4, 2012
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The following paper comes to us from Laura Alfaro of the Business, Government, and the International Economic Unit at Harvard Business School, and Maggie Xiaoyang Chen of the Department of Economics at George Washington University.

In our paper, Surviving the Global Financial Crisis: Foreign Ownership and Establishment Performance, forthcoming in the AEJ: Economic Policy, we examine the differential response of establishments to the recent global financial crisis with particular emphasis on the role of foreign ownership. In 2007-2008, the world economy entered the deepest financial crisis since World War II. Countries around the globe witnessed major declines in output, employment, and trade. GDP in industrial countries fell by 4.5 percent while average GDP growth in emerging economies dropped from 8.8 percent in 2007 to 0.4 percent. The unemployment rate rose to 9 percent across OECD economies, and reached double digits in a mix of industrial and developing nations. World trade volume plummeted by over 40 percent in the second half of 2008, collapsing at a rate that outpaced the fall of total output.

The severity of what has been labeled as the Global Financial Crisis led many economists to explore its macro patterns and causes. Rose and Spiegel (2010), for example, investigate the potential causes for the differential extent of the crisis across countries. Using a large country-level dataset, they do not find international trade and financial linkages and other major economic indicators to be clearly associated with incidences of the crisis. Eaton et al. (2009), Levchenko, Lewis and Tesar (2010), and Chor and Manova (2011), among others, examine the potential causes of the great trade collapse, a phenomenon that received particular attention, and find, respectively, manufacturing demand, vertical specialization, and credit conditions to play important roles.

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Board Oversight of Strategic Risk

Posted by Jeffrey Stein, King & Spalding LLP, on
Sunday, June 3, 2012
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Jeffrey Stein is a partner in the Corporate Practice Group at King & Spalding LLP. This post comes to us from Mr. Stein, Bill Baxley, and Rob Leclerc, and is based on a report from the Lead Director Network, available here.

Strategic risk — which may be defined as the risk to the achievement of a company’s strategic plan — is at the forefront of any board’s agenda. While boards have always focused on the oversight of strategic risk, the recent financial and economic crisis has led companies and boards to refine, and in some cases change, their approaches to this function.

The Lead Director Network (the “LDN”), a group of lead directors, presiding directors and non-executive chairmen from many of America’s leading companies, met on April 3, 2012 to discuss board oversight of strategic risk. Following this meeting, King & Spalding and Tapestry Networks have published a ViewPoints report here to present highlights of the discussion that occurred at the meeting and to stimulate further consideration of this subject.

The following provides highlights from the LDN meeting, as described in the ViewPoints report.

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Women on Boards: Review & Outlook

Posted by Noam Noked, co-editor, HLS Forum on Corporate Governance and Financial Regulation, on
Saturday, June 2, 2012
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The following post comes to us from Julie C. Norris, partner with CTPartners, and is based on a CTPartners report. The complete report, including exhibits and footnotes, is available here.

The world has changed in the past 10 years. Companies can go from obscurity to an estimated $100 billion market cap (Facebook) or from zero to $1 billion in revenue very quickly (Groupon did it in two years), or from near collapse in the late ‘90s to become one of the world’s most valuable companies (Apple). To succeed today, companies need to embrace change, in ways that include learning to market and sell using digital channels, pursuing global customers, leveraging technology, and relentlessly streamlining operations to remain competitive.

CTPartners is starting to see changes in the boardroom that mirror these macro changes. There are more than 1,100 directors currently serving on Fortune 1000 boards who are over 70 years old. With these impending vacancies, demand is emerging for a new generation of directors, one which will include individuals capable of contributing new insights into customers, technology, distribution channels, and international markets. The goal is to create a boardroom with diverse perspectives, which leads to better-informed discussions and more effective decision making. With this new generation comes the opportunity to include more women directors. The onus is on boards, management teams, and search firms to ensure that qualified women are given consideration in the director recruitment process.

Among the Fortune 1000, there are 139 boards that have no women directors; and, women comprise fewer than fifteen percent of all directors. Beyond the Fortune 1000, representation by women is even less. CTPartners looked at an additional 1,000 midcap companies with revenue ranging from $500mm to $3 billion and found that 300 still had no female directors. Perhaps most startling is the fact that, among these companies with no women directors, there are many that sell directly to consumers. Women control nearly 75 percent of consumer purchasing decisions, yet there are still 29 Fortune 1000 consumer companies with no women on their boards. On a positive note, there are 54 Fortune 1000 consumer companies with three or more women on their boards. This raises a pressing question: Why is it that some consumer companies embrace women directors and others do not?

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2012 Proxy Season Political Spending Shareholder Resolutions

Posted by Bruce F. Freed, Center for Political Accountability, on
Friday, June 1, 2012
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Bruce F. Freed is president and a founder of the Center for Political Accountability. Work from the Program on Corporate Governance about corporate political spending includes Corporate Political Speech: Who Decides? by Lucian Bebchuk and Robert Jackson, discussed on the Forum here. A committee of law professors co-chaired by Bebchuk and Jackson submitted a rulemaking petition to the SEC concerning corporate political spending; that petition is discussed here.

Companies are once again being engaged on political sending, and preliminary results for this proxy season show strong, if not stronger, support. Coordinated by the Center for Political Accountability (CPA), the shareholder resolution focuses on disclosure of political spending from corporate funds, including payments to trade associations and 501c4 organizations; disclosure of management decision making policies; and board oversight of the spending. Through increased oversight and disclosure, shareholders proponents seek to more effectively manage and lessen the risks associated with corporate political spending especially in the post-Citizens United world. (See CPA’s website for a model resolution.)

Shareholders working with CPA have filed a total of 51 resolutions this year, 13 of which have already resulted in an agreement with the company. The New York State Pension Funds successfully engaged six companies: Safeway, Kroger, CSX Corp., Sempra Energy, R.R. Donnelley & Sons, and Reynolds American. Trillium Asset Management reached agreements with Halliburton, Chubb Corp, and State Street Corp.; individual shareholders affiliated with the Responsible Wealth Coalition successfully withdrew their resolutions with Hershey Co. and Aflac, Inc. after agreements. The Miami Firefighters worked successfully with Southwestern Energy Co., and the Nathan Cummings Foundation reached an agreement with Tenet Healthcare.

Several agreements have followed previous strong votes for political disclosure resolutions. Last year, almost 47 percent of shareholders supported the resolution at Halliburton, almost 49 percent at R.R. Donnelley, and more than 44 percent at State Street Corp.

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The Need for Both Strong Regulators and Strong Laws

Posted by R. Christopher Small, Co-editor, HLS Forum on Corporate Governance and Financial Regulation, on
Friday, June 1, 2012
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The following paper comes to us from Mark Humphery-Jenner of the Australian School of Business at the University of New South Wales.

In the paper, The Need for Both Strong Regulators and Strong Laws: Evidence from a Natural Experiment, which was recently made publicly available on SSRN, I analyze whether strong law is effective in the presence of weak regulatory institutions. This is a live-issue for policy setters as they attempt to reform the financial system to prevent future market misconduct. This has become particularly relevant as the EU has attempted to reform securities laws under the Markets in Financial Instruments Directive (MiFID), and the regulation of financial markets in the US has sustained recent criticism. I use a difference-in-difference methodology to disentangle the effects of the design of news laws from their actual implementation, and I find that strong law in the presence of weak regulations might actually worsen market conditions. This provides additional empirical support for the prediction in Bhattacharya and Daouk (2009) that ‘no law’ can sometimes be better than ‘good law’. This also suggests that empirical law and finance work should carefully distinguish between the mere presence of laws, and their enforcement.

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Can JP Morgan Transparently Police Itself?

Posted by the Harvard Law School Forum on Corporate Governance & Financial Regulation, on
Thursday, May 31, 2012
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Editor’s Note: Ben W. Heineman, Jr. is a former GE senior vice president for law and public affairs and a senior fellow at Harvard University’s schools of law and government. This post is based on an article that appeared in the Harvard Business Review online.

In the wake of its significant trading losses (now reportedly rising from $2 to $3 billion or more), JP Morgan can win back some of its lost reputation by transparently holding those responsible to account.

These individuals could include (but not be limited to) the London trader, Bruno Iksil (“The London Whale”); his London boss, Achilles Macris; their U.S. boss, Ina Drew, the former head of the bank’s Chief Investment Office (CIO); and CEO Jamie Dimon, who oversaw the CIO. Drew quickly retired after the losses, and Iksil and Macris are, according to news reports, leaving the bank.

Although the media has spoken loosely about a company “clawing back” pay, there are, in fact, different ways to hold responsible individuals to financial account. A “claw-back” seeks cash or equity already transferred to an individual. A “hold-back” cancels financial benefits which have been awarded but have not yet vested. A future compensation action would reduce 2012 variable benefits (bonus or equity awards) in absolute terms (or through a much slower rate of increase). Claw-backs or hold-backs of past awards could be appropriate for the departed employees. They could be appropriate for Dimon, but so could a compensation action about future variable comp.

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Delaware Decisions: Data Points, Not Doctrine

Posted by David Fox, Kirkland & Ellis LLP, on
Thursday, May 31, 2012
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David Fox is a partner at Kirkland & Ellis LLP, focusing on complex mergers and acquisitions as a member of the firm’s Corporate Practice Group. This post is based on a Kirkland & Ellis M&A Update by Mr. Fox, Yosef J. Riemer, and Daniel E. Wolf. This post is part of the Delaware law series, which is cosponsored by the Forum and Corporation Service Company; links to other posts in the series are available here.

Delaware courts often take an expansive approach to decision-making, offering detailed commentary on the facts and the underlying law in many key M&A cases. While these lengthy opinions can offer market participants useful insights into best practices for future deals, it is equally important that dealmakers not overreact to observations that should, and no doubt are intended to, be read within the context of the specific circumstances before the court. In seeking guidance from court decisions, readers should be mindful that, more often than not, it is only the cases with the worst, or at least most complicated, facts that make it to a final court decision, exacerbating the risk reflected in the old legal adage that “hard cases make bad law”. A few examples may be useful.

Stapled Financing In his 2005 Toys “R” Us, Inc. decision, then VC Strine was critical of the decision to allow one of the target board’s financial advisers to offer financing to the winning bidder after the merger agreement was signed. Some commentators interpreted the court’s comments as blanket discouragement of the practice of “stapled financing” being offered to bidders by a target adviser. However, VC Strine himself later publicly commented that such a reading “misconstrued” his opinion and that there were situations where it would be appropriate for a seller, through its banker, to offer financing to potential bidders (for example, in order to stimulate interest among buyers, to reduce the risk of leaks or to set a valuation floor for an auction). His criticism in Toys was directed at the risk of appearance of conflict generated by the request of the adviser (and agreement by the board) to offer financing once the deal was already signed, meaning the financing role served to only generate fees for the lending bank as opposed to any useful function for the target. A similar nuanced reading is required of VC Laster’s recent commentary on stapled financing that played a significant role in the fairly scathing Del Monte decision. Rather than suggesting that stapled financing is per se problematic, VC Laster implied that the court will seek evidence that allowing a sell-side adviser to offer a buyer financing had “some justification reasonably relating to advancing stockholder interests”. Instead of the reflexive avoidance of stapled financing that occurred in the aftermath of each of these two decisions, a more refined reaction requires principals and their advisers to critically assess whether such financing could in fact advance the target’s interests and, if such financing is in fact offered, to ensure that it is done with the full knowledge of the board with appropriate protections in place to address any resulting potential conflicts (e.g., by early engagement of a second, non-financing adviser).

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