Augmenting the Duties of Directors to Protect Minority Shareholders in the Context of Going-Private Transactions: The Case for Obligating Directors to Express a Valuation Opinion in Unilateral Tender Offers After Siliconix, Aquila and Pure Resources

Wednesday, January 1st, 2003 at 12:00 am by Kimble Charles Cannon
Kimble Charles Cannon, Augmenting the Duties of Directors to Protect Minority Shareholders in the Context of Going-Private Transactions: The Case for Obligating Directors to Express a Valuation Opinion in Unilateral Tender Offers After Siliconix, Aquila and Pure Resources, 2003 Colum. Bus. L. Rev. 191

Much has been written, both by commentators and the courts, about the need to protect shareholders in the context of third-party offers to acquire a company. Third-party offers in general, and hostile acquisitions in particular, have led to the development of many of the central concepts that define appropriate directorial behavior, including the classic duties of loyalty and due care that directors owe to the company generally and shareholders specifically. The requirement that directors ensure shareholders receive maximum value for their shares when the company is for sale, as articulated in the Delaware Supreme Court’s Revlon, Inc. v. MacAndrew & Forbes Holdings, Inc., decision, likewise arises most prominently in the third-party acquisition context. However, today it is not an entrenched board’s opposition to a third-party transaction that raises the greatest concern with respect to protecting shareholder interests, but rather board inaction in the face of an unfairly priced related-party acquisition, particularly where the acquisition is structured as a unilateral tender offer.

While related-party acquisitions can make strong economic sense to all of the parties involved, especially where the objective is taking the company private and avoiding the costs of remaining a publicly traded entity, transactions in which the controlling shareholder is the acquirer represent an opportunity for abuse. Controlling shareholders often have significant influence over the board of directors as well as over management; they may also have substantial nonpublic information regarding the company’s operations. The risk that a controlling shareholder will use this control and informational advantage to the detriment of minority shareholders in the context of acquiring the shares that it does not already own is significant. The danger to minority shareholders should be of particular concern considering that the current economic and political climate increasingly incentivizes controlling shareholders to privatize public companies that have depressed stock valuations.

The precipitous drop in share prices that has occurred between March 2000 and the end of the first fiscal quarter 2003 has created a particularly compelling reason for controlling shareholders to seek to acquire the portion of a company’s shares they do not own where the underlying fundamentals of the company remain sound. Such transactions can be structured either as mergers that are negotiated with the target’s board of directors acting as an intermediary between the acquisition group and shareholders, or as tender offers made by acquirers directly to the other shareholders. In either case, such transactions threaten shareholders because they offer both the risk that a captive board will take no action to derail a below fair-value offer and the reality that no third party can, as a practical matter, make a more reasonable competing bid.

Delaware law addresses the risks posed to minority shareholders in companies controlled by large shareholders with a considerable degree of success where the transaction is structured as a negotiated merger. However, where the acquirer chooses a tender offer structure, Delaware law has, until quite recently, left minority shareholders largely exposed to the risk that corporate directors will act in collusion with the controlling shareholder to the detriment of minority stockholders. During the past two years, the Delaware Chancery Court has issued rulings articulating a legal framework that generally accepts target board inaction in the face of an unfairly priced tender offer launched by a controlling shareholder. While these recent decisions are arguably based on Delaware legal precedent distinguishing directorial duties in a merger context from those in a tender offer context, the decisions nevertheless illuminate a gap in the general duties of directors to protect minority shareholders when a tender offer structure is encountered.

At the same time, the line of Delaware cases permitting director inaction in connection with unilateral tender offers also legitimizes as non-coercive a class of tender offer transaction that leaves shareholders no practical choice but to accept an offer’s terms. Permitting director inaction while accepting coercive tender offer structures leads to an environment in which increasing numbers of shareholders in controlled companies will see their ownership interests eliminated at unfair prices. This phenomenon will initiate a cycle in which the value of the shares in companies controlled by a majority shareholders will become ever more depressed due to the perceived risk that minority shareholders will be eliminated at an unfair price through a related-party tender offer.

This article addresses the threat posed by unilateral tender offers initiated by controlling shareholders. First, the article will examine why it is particularly compelling today for majority shareholders to acquire the remaining stock in the public companies they control. Second, the article will address the process for taking a company private and the various deal structures that can be employed. Third, the article will review the standard of conduct governing directors in various related-party transactions. Fourth, the article will discuss both recent Delaware judicial decisions making it easier for directors to sit on the sidelines while controlling shareholders use the inherently coercive tender offer process to force minority shareholders into accepting below-value offers for their shares, and recent Delaware case law rejecting this trend. Finally, the article concludes by proposing significant changes to the rules governing directorial duties to minority shareholders in the context of controlling-shareholder initiated unilateral tender offers.

Author Information

Kimble Cannon is a 1994 graduate of CLS and has previously published articles on corporate and securities law in publications including the Securities Regulation Law Journal and the CBLR.