Corporate Governance Group. Client Alert

Transcription

1 April 6, 2010 Corporate Governance Group Client Alert Bei j i n g Fr a n k f u r t Ho n g Ko n g Lo n d o n Lo s An g e l e s Mu n i c h Ne w Yo r k Si n g a p o r e To k y o Wa s h i n g t o n, DC Delaware Court Entertains Third-Party Vote Buying Claim in Connection with Director Election Contest Opines that Vote Buying, Even When Not Involving the Use of Corporate Assets or Inside Information, Should be Examined Closely Historically, Delaware courts have closely scrutinized transactions in which corporate assets are used to buy stockholder votes. 1 Yet, so-called third-party vote buying vote buying not involving the use of corporate resources or inside information has not been examined under Delaware law; that is, until now. In Kurz v. Holbrook, 2 the Delaware Court of Chancery recently opined that when third-party vote buying proves deleterious to stockholder voting, this Court can and should provide a remedy. Even though the Court ultimately rejected charges of illegal vote buying in Kurz because voting rights appropriately followed the economic interest in the shares in question, the fact that the Court was willing to entertain this argument is instructive for anyone planning to engage in, or who may become subject to, a battle for control of a corporate board of directors. Background EMAK Worldwide, Inc., a Delaware corporation based in Los Angeles, has two classes of stock: common stock and Series AA preferred stock. In late 2009, EMAK found itself the target of dueling consent solicitations seeking control of its board of Please feel free to discuss any aspect of this Client Alert with your regular Milbank contacts or with any of the members of our Corporate Governance Group, whose names and contact information are provided at the end of this alert. In addition, if you would like copies of our other Client Alerts, please visit our website at and choose the Client Alerts & Newsletters link under Newsroom/Events. This Client Alert is a source of general information for clients and friends of Milbank, Tweed, Hadley & McCloy LLP. Its content should not be construed as legal advice, and readers should not act upon the information in this Client Alert without consulting counsel Milbank, Tweed, Hadley & McCloy LLP. All rights reserved. Attorney Advertising, prior results do not guarantee a similar outcome. 1 See Portnoy v. Cryo-Cell International, Inc., 940 A.2d 43 (Del. Ch. 2008). For a discussion of this decision, please see our Client Alert entitled Delaware Court Sets Aside Election of Directors and Orders New Shareholder Vote (February 6, 2008). 2 C.A. No VCL (Del. Ch. Feb. 9, 2010). An appeal from this decision was recently filed with the Delaware Supreme Court and, given the novel issues discussed in the opinion, may be heard on an expedited basis.

2 directors. At the time, EMAK s board consisted of five sitting directors two of whom were designated by Crown EMAK Partners, LLC through its ownership of the Series AA preferred stock, and three of whom were elected by the holders of common stock and two vacant seats. One of the competing groups, Take Back EMAK, LLC ( TBE ), included Donald Kurz, a sitting director elected by the common stockholders. TBE proposed to take over a majority of the board by seeking a vote of the common stockholders to remove the other two EMAK directors previously elected by the common stockholders, without cause, and to fill the resulting vacancies with directors nominated by TBE. In response, the other group, led by Crown, proposed a series of bylaw amendments that would reduce the size of the board to three and thereby give Crown the ability, as the sole owner of the preferred stock, to elect a majority of directors in any given election. Approximately four days before the consent delivery deadline, the TBE group realized it was 116,325 votes short. s among members of the group warned that [w]e need to buy someone[ s] shares this weekend. To accomplish this, Kurz turned to Peter Boutros, a former employee and current consultant of EMAK who owned 175,000 shares. After some haggling, Boutros entered into a purchase agreement providing for the sale of 150,000 of his shares to Kurz, at a price of $1.50 per share, 3 and the grant to Kurz of an irrevocable proxy to vote those shares in his discretion. The proxy was necessary because Boutros s shares were subject to certain transfer restrictions and, therefore, legal title to those shares could not be transferred to Kurz at that time. Believing that Kurz s arrangements with Boutros had put it over the top, TBE claimed victory. Crown, which was not entitled to vote its preferred stock in connection with TBE s consent solicitation but was entitled to vote those shares in favor of its own proposed bylaw amendments, also believed that it had gathered sufficient consents to adopt its bylaws and take control of the board. Not surprisingly, each group challenged the other s consents, seeking relief under Section 225 of the Delaware General Corporation Law, which gives the Court of Chancery the power to resolve election disputes. TBE challenged Crown s consents on the basis that the bylaw amendments they sought to promote violated Delaware law. 4 For its part, Crown argued that TBE had, among other things, engaged in illegal vote buying in connection with Kurz s purchase agreement for Boutros s shares. 5 Following a thoughtful analysis of these issues, the Court declared TBE the winner. The Court s Analysis The Court prefaced its analysis of Crown s claim that TBE had engaged in illegal vote buying by noting that [v]ote buying is an incendiary phrase that carries connotations of bribery and corruption. At the same time, however, the Court pointed out that the principles that make vote buying anathema in the political context do not translate well into the corporate realm. 3 The then-current market price of EMAK stock was $0.95 per share. Boutros originally asked Kurz for $2.25 per share. 4 The Court sided with TBE on this issue and disallowed Crown s consent solicitation. For a discussion of this aspect of the Kurz decision, please see our Client Alert entitled Delaware Court Rejects Bylaw Amendment Seeking to Unseat Directors by Reducing Size of Board (March 19, 2010). 5 Crown also argued that TBE failed to acquire the requisite consents because it did not obtain an omnibus proxy from the Depository Trust Company in order to vote street name shares. The Court sided with TBE on this novel issue as well. For a discussion of this portion of the Court s ruling, please see our Client Alert entitled Delaware Court Clarifies Process for Holders of Street Name Shares to Cast Votes and Sign Consents (March 30, 2010). 2

3 Next, the Court explained that the Delaware cases in which vote buying has been at issue generally have involved insiders using corporate resources to buy votes and/or a fiduciary [who] receives inside information about how a vote is trending and then acts on the information to swing a close vote. As described below, these circumstances were absent in Kurz. Nevertheless, in confronting this undeveloped area of our law, the Court reasoned that the concept of vote buying is broad enough to encompass the purchase of votes without using corporate assets or taking advantage of inside information. Vice Chancellor Laster labeled this variation on vote buying as third-party vote buying. On this basis, the Vice Chancellor proceeded with an examination of the arrangements between Kurz and Boutros. Although Kurz was an EMAK director, he used his own resources to acquire Boutros s shares, and did not take advantage of any inside information or have any inside information from EMAK about the likely voting results. With EMAK s corporate assets untouched, and in the absence of the misuse of any inside information, traditional vote buying precedent did not apply. On the other hand, because Kurz s arrangements with Boutros provided TBE with the votes they needed to prevail, the Court considered the arrangements potentially disenfranchising and therefore subjected them to a vote buying analysis. While acknowledging that the full measure of principles that will govern third-party vote buying must await case-by-case development, the Court articulated several broad concepts to guide its analysis. First, third-party vote buying will merit review only if it is disenfranchising, in the sense of actually affecting the outcome of the vote. This includes vote buying that delivers the swing votes or alters the voting pattern in a critical way. Second, a third-party vote buying arrangement must not be the product of fraud. Fraud might be indicated by informational disparities or inadequate disclosures between buyers and sellers. Third, a stockholder s underlying economic interest should accompany the sale of voting rights to avoid Delaware law s close scrutiny of those who divorce[] property interest from voting interest[]. Although the first of these elements, the delivery of swing votes, was present, the other two were not: With respect to the second element, the Court found no evidence of fraud in the transaction. In reaching this conclusion, the Court noted that Boutros was fully informed about the ongoing consent solicitations, must have been cognizant that his shares were the swing shares, and was advised by counsel, all hallmarks of a transaction in which Boutros understood what he was selling, the circumstances under which he was selling it, and what he was getting in return. With respect to the third element, the Court viewed the economic and voting interests in Boutros s shares as being properly aligned. Even though Kurz did not (and could not) take title to the shares at that time due to the transfer restrictions, because he now bears 100% of the economic risk under the purchase agreement, Delaware law presumes that he should and will exercise the right to vote. The Court also noted that Kurz did not have any competing economic or personal interests that might create an overall negative economic ownership in EMAK; he was overwhelming long EMAK s stock with no countervailing short interest, and his EMAK holdings represented a sizable portion of his personal wealth. 3

4 While conceding that Kurz primarily wanted the voting rights carried by the shares, not the shares themselves, the Court could not perceive anything illicit in that fact given the nature of the transaction as a whole. In short, the Court did not believe that Kurz has any reason to vote other than in the manner he thinks would best maximize the value of EMAK as a corporation, and concluded that [t]he proxy granted to Kurz under the Purchase Agreement comports with what our law expects. Conclusion Kurz v. Holbrook expands upon Delaware s traditional vote buying jurisprudence, applying it to so-called third-party vote buying the purchase of votes not involving the use of corporate assets or inside information. In light of the still-strong market in derivatives, structured products and other forms of financial risk management that seek to separate voting rights and/or legal title from economic risk, this is an important development that could impact strategies and outcomes of future contests for corporate control. 4

5 Please feel free to discuss any aspect of this Client Alert with your regular Milbank contacts or with any of the members of our Corporate Governance Group, whose names and contact information are provided below. Beijing Units 05-06, 15th Floor, Tower 2 China Central Place, 79 Jianguo Road, Chaoyang District Beijing , China Anthony Root aroot@milbank.com Edward Sun esun@milbank.com Frankfurt Taunusanlage Frankfurt am Main, Germany Norbert Rieger nrieger@milbank.com Hong Kong 3007 Alexandra House, 18 Chater Road Central, Hong Kong Anthony Root aroot@milbank.com Joshua Zimmerman jzimmerman@milbank.com London 10 Gresham Street London EC2V 7JD, England Stuart Harray sharray@milbank.com Thomas Siebens tsiebens@milbank.com Los Angeles 601 South Figueroa Street Los Angeles, CA Ken Baronsky kbaronsky@milbank.com Neil Wertlieb nwertlieb@milbank.com Munich Maximilianstrasse 15 (Maximilianhoefe) Munich, Germany Peter Nussbaum pnussbaum@milbank.com New York One Chase Manhattan Plaza New York, NY Scott Edelman sedelman@milbank.com Roland Hlawaty rhlawaty@milbank.com Thomas Janson tjanson@milbank.com Robert Reder rreder@milbank.com Alan Stone astone@milbank.com Douglas Tanner dtanner@milbank.com Singapore 30 Raffles Place, #14-00 Chevron House Singapore David Zemans dzemans@milbank.com Naomi Ishikawa nishikawa@milbank.com Tokyo 21F Midtown Tower, Akasaka, Minato-ku Tokyo Japan Darrel Holstein dholstein@milbank.com Washington, DC International Square Building, 1850 K Street Washington, DC Glenn Gerstell gerstell@milbank.com 5