A Bear swimming in the murky waters of corporate law

Gordon Smith has a nice summary of the issues in the Delaware lawsuits challenging Bear’s 39.5% lockup share sale to Morgan. 

Basically, as we all know by now, it comes down to Omnicare. The transaction effectively forces the Bear shareholders to accept the deal because the managers and Morgan will own 45% of the stock and the board has no effective way to embrace a superior transaction if it should come along.

Gordon also says the plaintiffs seem to be arguing that the threat to the shareholder franchise justifies application of the Blasius “compelling justification” standard. Gordon notes that this standard is generally applied in board elections and, anyway, is probably met in this case.

Then Gordon asks rhetorically:

Which board of directors was more faithful to its obligations: the board that allowed existing majority shareholders to commit themselves to a transaction that they viewed as favorable (Omnicare), or the board that is planning to issue stock to the acquiring company to make approval of the transaction over the objections of the existing shareholders much more likely (Bear Stearns)?

However, as Gordon notes, "[t]he lawyers have structured the Bear Stearns-JP Morgan transaction in a manner that elides the obvious pitfalls in Omnicare."

In my view, in both cases the essential issue should be whether the board exercised its fiduciary obligations to preserve shareholder value, which is what the shareholders as a whole wanted them to do. And in both cases it arguably did, because the deal protection move secured the only promising deal in sight – in Omnicare, the Genesis bid, and in Bear, the quintupling of the Morgan bid.

As dissenting Justice (now Chief Justice) Steele observed in Omnicare:

We should not encourage proscriptive rules that invalidate or render unenforceable precommitment strategies negotiated between two parties to a contract who will presumably, in the absence of conflicted interest, bargain intensely over every meaningful provision of a contract after a careful cost benefit analysis.

I criticized Omnicare in Why Corporations? as exemplifying the excessive rigidity of the corporate structure:

The courts. . . engage in a rigid structural analysis that applies equally to all corporations. They have been said to be creating a “sacred space” in which shareholders exercise inviolate rights to vote and sell [referring here to Gordon’s article with Bob Thompson, Toward a New Theory of the Shareholder Role: “Sacred Space” in Corporate Takeovers, 80 Tex. L. Rev. 261(2001)] The term aptly conveys the courts’ disregard of mundane day-to-day realities and specific governance terms.

I would add that it’s questionable whether the shareholders really deserve this “sacred space.” It’s not just about Hanging Chads and Empty Voting (e.g., Hu & Black, The New Vote Buying: Empty Voting and Hidden (Morphable) Ownership, 79 S.Cal. L. REV. 811 (2006)). Who are the “shareholders” anyway? The 19% employee ownership concerned about their jobs, the arbs, long-term investors, or what?

In any event, my guess is that the Chancery Court will not block or invalidate the transaction, finding some kind of exception to Omnicare. Some years later the Supreme Court will give us a Bear Stearns “save the firm” exception to the Omnicare qualification of the Unitrin application of Unocal. [Keep in mind that the Omnicare court was closely divided, and the dissenters included the current CJ.] In other words, if this case gets adjudicated, it will lead to still more indeterminacy in Delaware corporate law.

I’ve been writing for years that there is a way out of the corporate mess: partnership-type structures that, among other things, limit shareholder voting and fiduciary rights while improving managerial incentives to maximize value. See Why Corporations?, above, and more recently The Rise of the Uncorporation.

A revised version of the latter is forthcoming. I will also soon be posting my take on how partnership-type firms address the indeterminacy of corporate law, previewed here.

Comments

[mark mkelly]

I believe the facts are vastly different and will beome more different as events unfold. Odyessey involved an organization which was equitably insolvent, in the sense that its assets were greater than its liabilities.Bear Sterns was most certainly solvent and could have waited for bids above $10 after the first agreement. The SEC has officially stated that it held in excess of $2 billion in capital.The board duties still ran to the shareholders, not the creditors.