Corporate Finance Outline – Mitchell – Spring 2011 I. Limited Liability’s Effect on Corporate Finance
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F: Preferred shares outstanding were non-cumulative dividends. The Board failed to declare dividends to preferred, and subsequently, years later, declared a dividend to the common shareholders. I: Can directors declare a dividend on common shares without paying non-cumulative dividend to preferred? R: 1. Non-Cumulative Preferred’s arrears expire when not paid A. Non-Cumulative preferred stock means that if directors decide, in their discretion not to pay it, it expires B. Arrears do not accumulate for payment later, but expire C. Directors have discretion to pay or not Π Argument: Π argued that non-cumulative dividend should be limited to if money is used to reinvest. And if not, should be accumulated and paid But this doesn’t work…because there are other plowbacks other than capital improvements that need to occur, which would, under π’s vew, cause accumulated dividends Goes back to historical view of dumping on Preferred—as here, Court distinguishes that Companies need to be able to reinvest in the corporation to maintain it, at detriment to preferred 2. Contract Controls: Similar to Debt in this manner Contract will control, and Court largely will not interject Courts will not revise contracts entered into by competent, sophisticated parties BOD Fiduciary Duty to Common Shareholders and Payment of Preferred Dividends 1. Contract will Control: When Non-Cumulative Dividends of Preferred There is an inherent conflict between common shareholders and preferred stock when non-cumulative dividends Effect: Board will likely not pay the non-cumulative Will most likely pay the common dividend Wants to avoid being voted out Wants to avoid fiduciary duty suit If they did pay it in addition to or instead of common stock dividend Duty of Care Question: Protected by Business Judgment Rule May bypass by arguing waste, uninformed decision Duty of Loyalty Question: If board is also preferred shareholder, or controlling shareholder has preferred shares Entire Fairness inquiry Much more heightened judicial scrutiny If they do not own, no duty of loyalty question When Cumulative The contract controls Meaning, by contractual obligation, the Board of Directors must pay preferred cumulative dividend before any goes to common shareholder Must pay arrearages before any goes to Common Shareholder Will be no fiduciary duty issue, as BOD is contractually obligated to pay Overall: Contract Controls, and Courts adhere to this notion (similar to debt) So contract for the protection and covenants you want Right of Election Clause, and Board of Directors Elected by Preferred Shareholder Baron v. Allied Artists Pictures Corp F: Allied was film company, having hard financial times. Needed capital, so amended AIC to allow 150K of preferred. Had Right of Election clause, to vote for majority of directors if 6 quarterly dividends missed. Default ensued, and preferred controlled board due to vote. Subsequently, had 2 hit movies and made lots of $ I: Whether the Directors, elected by preferred must pay off as soon as sufficient funds exist to return control to common shareholders, or whether they have discretion? R: 1. The Right to Election Clause: The right of election does not end once sufficient funds exist Not simple mathematical equation Directors still have discretion (unless clause provides otherwise) Purpose: Right to vote, and control to try new management due to the failure of previous management to meet contractually obliged payments When Terminates: Right of election continues until dividends can be made current, but once funds “clearly available” to satisfy cumulative dividend, Right of Election Terminates 2. Preferred elected Board owes Fiduciary Duty to Corporation / Business Judgment Rule Applies The boards duty, even elected by preferred, is fiduciary relationship to corporation and shareholders Must deal fairly with both While one of the reasons they are there is to repay it, repayment when sufficient funds is not sole reason they are there…in doing so, may not fulfill duty to others… The Board of Directors has Discretion in Acts, protected by Business Judgment Rule: One of these powers is discretion to declare dividend based on informed judgment Only avoided by showing of: 1. Fraud or 2. Uninformed Decision Making Here: Board acted within its discretion, as earnings were volatile, to not declare dividend to preferred shareholders…no fraud or abuse of discretion Within its informed discretion Note: Warns that, right of election is not indefinite, and Board does have fiduciary duty not to stay in forever, abdicating payment when it could clearly do so But: doesn’t limit it clearly, as Business Judgment Rule gives it discretion to repay when possible, while still prudent to corporation B. Repurchases, Redemptions, Recapitalizations, Liquidations: Generally: This is an inquiry into what effect these transactions have on the Preferred Shares What the Corporation may do to avoid preferred arrearages What protections the Preferred Shares have Corporate Actions: Merger/Recapitalization Asset Sale Repurchase of shares All avoiding the preferred share obligations Preferred Share Arguments: Implied Covenant of Good faith De-Facto Merger, etc… Contractual Interpretation Fiduciary Duty Delaware Court Tools used: Doctrine of Strict Construction of Special Rights, and Preferences Contractual provisions don’t have fiduciary duty Independent Legal Significance Doctrine Delaware does not accept the de facto merger doctrine No Fiduciary Duty to Contractual Provisions Fiduciary Duty owed to the non-contract portion of preferred shares (See Jebwab) The Doctrine of Independent Legal Significance: Rauch v. RCA: F: GE and its new subsidiary were merging with RCA. RCA would merge into the subsidiary, and all RCA stock was converted to cash. Preferred shares were converted to ~$40. The shares had a liquidation preference of $100. The preferred shareholders argue that the merger was akin to a liquidation, and thus she should have gotten her $100 liquidation preference. R: 1. The Doctrine of Independent Legal Significance: Rule: When an action is taken under 1 section of the DGCL, is legally independent of, and will not be construed under another section of the DGCL. Both are legally independent of one another Reason and Purpose: 1. Equal Dignity: The DGCL provisions are equally created, by legislature to be independent 2. Pro-Corporation and Transaction: Predictability and Certainty 1. Allows corporations to choose an appropriate transaction for their needs, choose the appropriate provision and know that is what will occur 2. Ensures that what they planned is what will occur Price-Certainty 1. Price is based on transaction chosen 2. This rule allows for economic efficiency, and certainty that price is accurate for transaction 3. Otherwise: Prices for Business transactions, which are important, would be altered, discounted, for uncertainty, and this would be negative for markets Here: Was a §251 Merger, and not a liquidation—ILS Doctrine applies Repurchase of Shares Reason: Company repurchasing avoids having to pay arrearages as it now owns the stock; no need to pay itself In Re Sunstates Litigaiton: F: Clause in preferred share contract prohibited Sunstates from acquiring shares of itself, common and preferred, however the clause did not specifically say that its subsidiaries could not do the same. Sunstates was owned by a controlling shareholder. Subsidiaries ended up purchasing much of preferred. Π, a preferred shareholder argues that the contractual provision must mean Sunstates and its subsidiaries. I: Does the repurchase of shares clause include subsidiaries? R: 1. Doctrine of Strict Construction of Special Preferential Rights: The Rights and preferences of the preferred must be expressed clearly in contract Court will not broadly imply or impute any terms The Rights in Question were Contractual from Preferential ContractNo Fiduciary Duty Contract displaces any fiduciary duty, as terms were contracted for The Contract controls and is strictly construed The Board owes no Fiduciary duty to preferred on Contractual Provisions Issue: *So Fiduciary Duty will depend on whether argument involves preferred contractual provisions, or non-contract equity portion* Here, was clearly a duty of loyalty fiduciary duty issue, as controlling shareholder is self-interested…but no fiduciary duty is owed on the contractual portions, and that is what was being interpreted 2. Implied Covenant of Good Faith and Fair Dealing: Is it reasonable to infer that the parties would have proscribed the conduct in question had they negotiated it? Note: Identical Inquiry to Bond Doctrine No fiduciary rights in contract either, with respects to contractual portion IMCGF argued then Here: No, Contractual provisions were clear, and no inference could be drawn otherwise 3. The Doctrine of Independent Legal Significance: Applies from contractual provision to contractual provision Extends away from merely the Legislative purpose it was created for Now, a rule of contractual interpretation Here: Says that the contract says corporation, but subsidiaries did it Restricted to each clause provisions Note: This is redundant with the doctrine of strict construction of special rights Preferred Contract Right to Vote if AIC “Amended” And a Merger: Elliot Assoc. v. Avatex: F: Avatex formed a subsidiary—Xetava. It announced that it was merging into its subsidiary. Preferred Contract had a clause that said “Vote of Preferred required if amendment, alteration, or repeal, whether by merger, consolidation, or otherwise, of the Articles of Incorporation that materially adversely effects preferred rights.” Preferred argue that the merger amends, alters, or repeals the AIC, as they will be eliminated, and therefore—they should have a right to vote. Why Did Transaction Occur: Stock was almost worthless, and arrears owed to the preferred was essentially all Avatex was worth. By reorganizing, and issuing common stock to all, moved the arrears from preferred, and put it back in the equity. This by-passes the Absolute Priority Rule at bankruptcy: a junior claimaint is receving something, even though senior claimant is not fully compensated I: Does the K give right to vote, as merger constituting and amendment, repeal or alteration of AIC? R: 1. The merger caused the adverse effect, and was an amendment, alteration or repeal: The AIC being terminated fits into at least one of the three listed in K The merger is the cause of this, as the merger results in the AIC terminating 2. The rights meet the Doctrine of Strict Construction of preferential Rights: The rights were explicitly within the contract This is likely the consequence they had in mind Overall: This is boilerplate and must be construed consistently as a matter of Corporate Finance 1. When a certificate says “amendment, alteration, or repeal” The preferred have no vote in a merger A merger, per the Doctrine of Independent Legal Significance, is a merger In this scenario, the amendment may be caused by the merger, but it is the merger that causes the adverse effect, not the amendment…therefore, no vote in merger 2. When certificate adds “by merger, consolidation, or otherwise” If merger causes “amendment, alteration, or repeal” preferred vote 3. Broadest is “Preferred may vote in any merger or where preferred receive junior security” Note: This is a contractual portion of the Preferred Contract So, equitable power of the court is not as strong, as if common stock, fiduciary issue This is consistent with idea that Contract controls, and boilerplate will be construed consistently, that Delaware has continuously demonstrated Fiduciary Duties owed to Preferred Shareholders: Generally: While there may be a duty of loyalty issue, or duty of care issue, it must be preceded by the existence of a Fiduciary Duty Determine if the K is silent or not, to determine Fiduciary Duty Then apply scrutiny level Jedwab v. MGM Hotels F: MGM had bad fire, killing many people. Suits for wrongful death sought $2.65B. The stock price tumbled, and in response, company sought to exchange 1 share of common for 1 share of preferred. Kerkorian owend Tracinda Corporation, which owned >50% of MGM. Preferred was cumulative, and right of election, with liquidation preference of $20. Kerkorian exchanged 5M shares, and in total 9.3M tendered into exchange. Kerkorian announced tender for all remaining shares at 18, but then Bally’s offered 18-CS and 14-PS. Because this combination was >440M, the value agreed to in total, Kerkorian took a cut on his shares—getting 12.29/common + property like rights to MGM name. ∏: argues that apportionment of 18 for common and 14 for preferred was unfair, in breach of Fiduciry duty owed to common, and breach of duty of loyalty by Kerkorian, a controlling shareholder. Why did Transaction Occur: Kerkorian entered into because of financial difficulties The dividends are cumulative, so he will have to be paid, unlike common stock holders, on back dividends Liquidation preference was response to common stock price it used to trade at Preferred tried to resemble common as much as possible with same dividend and similar trading price Like stock buy back, raising market price of common Defers dividend payments to future, when more money may be available I: Whether a fiduciary duty is owed to the Preferred Shareholders? R: 1. Fiduciary Duty is owed to Preferred Non-Contractual Provisions: Generally: All stock, common and preferred begin as common stock with same attributes Contractual provisions may create additional preferences, above and beyond the common equity The Preferred shares “crawl out of” the ooze, or to put it into other words, are ratcheted above the common stock with preferential, contractual rights 1. Matters relating to Contract, preferences, or limits in preferred stock The Contract Controls and No Fiduciary Duty Exists Solely defined by contract portion Contract supersedes the common equity characteristics, and fiduciary duty 2. Matters relating to Silent, Non-Contractual portion, shared by all equity: Fiduciary Duty exists Issues with Jedwab Rule: 1. Contract is ambiguous Must interpret it, and therefore, it will not be clear what exactly the provisions include or don’t 2. Unclear provisions, then, lead to fiduciary duty Will not owe fiduciary duty to those things clearly stated Ambiguous terms may be owed fiduciary duty 3. How do you advise the Board The board will be interpreting the contract If it is clear, they must interpret as a fiduciary in aspects contracted for the preferred shareholders But, if ambiguous, creates issues of how they are interpreting the contract May breach their fiduciary duty Creates a default of Fiduciary Duty owed unless contract supersedes Here: Preferred Contract was silent on Mergers Therefore, preferred shareholders owed a fiduciary duty in mergers 2. What Standard of Review Applies, if Fiduciary Duty Exists : Fiduciary Duty Owed by Directors, and Controlling Shareholders Business Judgment Rule Presumption: Rebutted by Uninformed Decision or Interested transaction in breach of Duty of Loyalty Burden on the ∆ to prove Entire Fairness Duty of Loyalty: Is transaction interested: Interested: Does the fiduciary receive something to detriment of shareholders /do not If Transaction is interested Rebuts Business Judgment Rule Not per se liability, as simply alters scrutiny, and burden Entire Fairness Test utilized Shifts burden to ∆ to prove fairness Here: Controlling Shareholder received less share value, but added property Invokes Entire Fairness Test But, although unequal, it is fair: Here, he gets paid less, and thus is giving up $ allocated to the stockholders The difference between the common and preferred then, is out of his pocket So not unfair to preferred as the greater value to the common was out of his own pocket No right to “equal” Treatment if fair Issue: Preferred shares at the outset had the economic reality of being almost identical to the common That was the intended consequence of the preferred shares So unequal treatment was unfair treatment perhaps, based on what they had agreed to In re FLS Holdings, Inc. Shareholders Litigation: F: Preferred bring claim against Directors that price in merger was unfairly apportioned and allocated, breaching fiduciary duty to them. In merger negotiations, eventually agreed to a merger, which gave preferred 62% of its value and common 54% of its value. Why Done: Another transaction done to avoid bankruptcy and the absolute priority rule Could have reorganized, or gone bankrupt….by reorganizing, it avoided bankruptcy The Common, a junior claimant to preferred were paid, avoiding absolute priority rule Directory: outlines outlines -> Chabot College Fall 2010 Course Outline for Computer Application Systems 60 business software applications/general accounting outlines -> Adil Khan Contracts Midterm outline- waldron outlines -> Remedies for breach of promise (1) The Interests Protected outlines -> Basic Process for Assessing Damages: 97 Select interest that deserves vindication 97 a. Restitution 97 outlines -> Chapter Five: Written Documents 1 Unsigned Documents 1 outlines -> Cases and Materials on Contracts outlines -> College of Science and Health outlines -> Evidence outline outlines -> 2. Act, Omission, Status or Circumstances 4 Consequences and Causation 8 Introduction to Mens Rea and Intent 10 Levels of Fault 11 Download 0.63 Mb. Share with your friends:
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