Delaware must fix state takeover law now, law professor warns

A corporate law professor has advised Delaware lawyers to fix what he says are flaws in the state’s anti-takeover law because companies incorporated there will soon have to rely on it as their main defense against unwanted merger offers.

Harvard Law School professor Guhan Subramanian, this year’s speaker at the Pileggi Distinguished Lecture in Law, warned attorneys and judges at a Nov. 22 breakfast lecture at Wilmington’s Hotel DuPont that Delaware’s anti-takeover law isn’t a reliable defense and won’t withstand a constitutional challenge.

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Harvard Law School professor Guhan Subramanian speaks at the Pileggi Distinguished Lecture in Law on Nov. 22 at the Hotel Dupont in Wilmington, Del.

Harvard Law School professor Guhan Subramanian speaks at the Pileggi Distinguished Lecture in Law on Nov. 22 at the Hotel Dupont in Wilmington, Del.

His thesis drew substantial criticism from the assembled corporate lawyers, some of whom had helped to craft the statute.

The anti-takeover law, Del. Gen. Corp. Law § 203, was enacted in 1988 to deter corporate raiders from using borrowed funds to quickly get control of companies and sell off their assets in the merger wars of the late 1980s.

It passed its first court challenges in takeover battles but then directors began to rely more on other defenses such as poison pills and staggered boards that could be incorporated into company bylaws.

The anti-takeover law was on the sidelines in later litigation over hostile offers.

Back in the lineup?

Subramanian predicted that the anti-takeover law will soon be back in play as a defense again now that corporate boards are quickly dropping the staggered board and poison pill because of pressure from shareholder activist groups.

The staggered board puts only a fraction of the directors up for re-election in any given year, preventing hostile suitors from quickly replacing a majority of the board with friendly directors in one election proxy fight.

The poison pill makes the target company too expensive by exploding into thousands of discount-priced new shares for all stockholders of a target company except for the suitor who triggered it when he bought a certain percentage of the company’s shares.

The anti-takeover law slows down a hostile bidder if he triggers it by acquiring more than a set percentage of the target company without getting the board’s permission.  It prevents the unwanted suitor from consummating the deal for three years, by which time his financing for the offer would have run out.

The next shoe to drop

“Will Delaware get out in front of this problem” and fix the statute before it’s challenged, or “will it wait and react” and try to fix it afterward, the professor asked.  “This is the shoe that hasn’t dropped,” he said.

He said in the 1990s, 57 percent of the nation’s major companies had staggered boards, but that’s dropped to 8 percent to 10 percent today because studies have shown they deliver lower stock value for shareholders than those that put all directors up for election each year.

Similarly the use of poison pills — also very unpopular with shareholders — has dropped from a high of 62 percent of major U.S. companies in the 1980s to 12 percent today, he said.

“Shareholder activists like Institutional Shareholder Services have campaigned against (the re-election of) officers and directors who have kept poison pills and staggered boards,” Submarian noted.

Since few companies with have those defenses to rely on, that means the next big takeover battle will probably test the constitutionality of the anti-takeover law, and it isn’t likely to pass this time because it rests on faulty data and suppositions, he said.

The federal Williams Act of 1968, which amended the Securities Exchange Act of 1934, 15 U.S.C.A. § 78a, involving tender offers, bars states from passing laws that make it virtually impossible for an investor to acquire control of a company.

Could the anti-takeover law pass again?

Originally, the anti-takeover law passed its court challenges because the judges accepted faulty data that showed investors could acquire at least 85 percent of the target corporation and satisfy the Williams Act, Subramanian said.

But none of the cases used to support the anti-takeover law actually allowed hostile suitors to acquire a controlling 85 percent of a target company, he said, and plaintiffs using research from new studies would be able to convince a judge that the statute is unconstitutionally restrictive.

However, Subramanian’s contentions that the anti-takeover law is flawed and vulnerable drew critical responses from both lawyers and jurists in the audience.

A. Gilchrist Sparks III, a partner in the Wilmington defense firm Morris Nichols Arsht & Tunnell and a designer of the law, took the podium for a rebuttal.

He predicted that an attorney representing a hostile suitor challenging the anti-takeover law would have a hard time proving the law was unconstitutional when it had functioned well for more than a quarter century in restricting, but not preventing, hostile takeovers.

“(The law) hasn’t stopped all takeovers even with the (aid of) poison pills,” Sparks said.

Subramanian noted that most takeovers happened because the target company threw in the towel when it realized the hostile suitor would eventually win by means other than obtaining a controlling interest.

But the Delaware Chancery Court’s chief judge, Chancellor Leo E. Strine, said even though many takeovers happened without the hostile suitor acquiring more than the 85 percent controlling interest that let them complete the deal, “the courts have viewed Section 203 as an anti-takeover law” and it has survived.

Other corporate lawyers in the audience warned that taking the anti-takeover law back into the state Legislature to revise it in this age of shareholder activism and powerful special interest lobbyists could open up a problematic, time-consuming and expensive can of worms.