Corporate Finance Outline – Mitchell – Spring 2011 I. Limited Liability’s Effect on Corporate Finance
R: 1. Was an interested transaction by the Board of Directors—Duty of Loyalty Issue
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R: 1. Was an interested transaction by the Board of Directors—Duty of Loyalty Issue There were no procedural safe guards of independent committee No preferred vote Ex-Post Fairness Opinion was inadequate No comparable size of the investments in comparable transactions Rights may not have been comparable Other transactions may not have been interested ones Because Duty of Loyalty Implicated The Contract must have been silent on mergers Therefore, the common portion must still exist, and fiduciary duty must still exist Overall Preferred Shareholder Fiduciary Duties: Generally: Jedwab is clear that fiduciary duty exists when Contract is silent When not silent, specifically dealing with something, contract supersedes fiduciary duty and common attributes Question becomes: What does the contract consist of Has only been applied, however, in few contexts: When there is Silent Contract and: 1. Interested Board of Directors/Controlling Shareholder-Duty of Loyalty Question 2. Allocation of $ from 3. An organic transaction (merger, reorganization, asset sale) Horizontal and Vertical Conflict: Horizontal: There is always a horizontal conflict between the common and preferred shareholders as both are competing for pieces of the corporate pie Vertical: When corporate directors conflict with corporate shareholders/constituency Duty of Care and Loyalty Implicated When Independent Board Business Judgment Presumption Preferred must rely on their contract If the 3P is the allocating party of capital 3P owes no fiduciary duty Probably ok If the Board is Interested and Allocates Fiduciary Duty Issue if the contract is silent, or can be read not to discuss a particular transaction VI. Convertible Securities: General Attributes: Convertible securities permit a holder, while remaining in the outstanding position, to exercise a conversion option into another security of the issuer corporation Specified Number of Shares and Prices **Key Concern is protection of the conversion right Conversion Right: Converts to shares at pre-set price Issues more shares into the market, with dilutive effects (like a warrant) Effect of Conversion Right: 1. Lower interest rate than paid on bond Because the conversion right has value 2. Subordinated 3. Indenture for Conversion is less restrictive Benefit to Purchaser: 1. Downside Protection: Benefit of debt protection at bankruptcy Fixed, legally mandated interest rate payment 2. Upside Potential of Stock: If shares appreciate in value, you may exercise conversion Benefit to Issuer: 1. May use when stock is undervalued IPO of shares would be less then optimal/undervalued financing 2. Poor Credit If you are unable to borrow, convertible securities give another option to access method of financing Redeemable/Callable: Issuer will call: As method of avoiding dilution to existing shareholders, limiting the costs of conversion 1. Lessens dilutive impact 2. Eliminates interest payments or dividends that would have been paid if outstanding still For Instance: Convertible Bond at 1,000 and Conversion price of $50/share, FMV stock = 60, callable at 1050 1,000/50=20 Value = 20 x 60=1,200 If bond is called at 1050 In the best interest of convertible security holders to convert at higher price then call price Issues: 1. Dilution Exercising the conversion rights dilutes the existing shares outstanding 2. Destruction If the underlying shares that may be converted into are merged, reorganizd, etc…the conversion right is destroyed Conversion Ratio: Issue: If outstanding shares are split, reverse split, or take dive in value otherwise, the conversion right can be eradicated Adjustments needed: Must contract for and draft adjustment protection If no adjustment Stock split could wipe out value of shares, well below conversion value—eradicates value of conversion Anti-Destruction: If merger occurs, or other transaction that the shares cease to exist, without contracted for protection Conversion right ceases to be of value Contract for and draft protection Example of Conversion Calculation: Convertible Debenture: Convertible Bond with Face Value of $1,000, and conversion price of $36/share Total Shares convertible into = 1,000/36=27.7 shares Or: Conversion Price= Face Value/Shares Convertible into Value of Conversion= Shares convertible into x Market Value Convertible Preferred: Conversion Price = Price of Preferred/Shares Convertible into Value of Conversion = Shares convertible into x market price For instance: Convertible preferred at $100, convertible into 6.5 shares, FMV of $10 100/6.5 = $15.38 conversion price Conversion value = 6.5 x 10 = $65 Overall: Contract controls for convertible security Holders Fiduciary Duty owed to Convertible Debenture Security Holders: Debt Simons v. Cogan: R: 1. No equitable interest in conversion exists Expecting to gain the equitable interest of stock is not having that interest Contract Controls No Fiduciary Duty owed to Convertible Debt holders Convertible Preferred: Jedwab: R: 1. Same Jedwab bifurcated duties approach applies Fiduciary Duty owed on silent portions No Fiduciary duty owed on contractual provisions Notice of Redemption Provision: Generally: The convertible contract will give an optional right to redeem by the company, after which the convertible security holders may not convert If the conversion value is greater than the redemption price Security holder loses $ Notice of redemption is essential Van Gemert v. Boeing: F: Convertible debentures were offered. They were convertible into 2 shares per $100. Indenture K had provisions of notice and debentures referred to this indenture. Within the indenture, it required “publication at least twice in newspaper.” If registered bondholders, they could receive mail notice. A call/redemption occurred, and news release in 2 newspapers was given. Both parties stipulate the K was met. R: 1. Debenture holders must know what type of notice of the redemption: must be adequate: The type of notice that a debenture holder will receive must be adequate Must tell the debenture holders in some way what type of notice they will get in event of redemption Here: Notice was inadequate and knowledge of the type of notice was inadequate Referring to a 113 page debenture was not adequate Breach of Implied Covenant of Good Faith Implications of Case: Per Katz, the notice of a debenture redemption, if provided should be sufficient and should end the inquiry…Contract Controls There, newspaper notice was adequate Here: More Expansive view of Contractual Good Faith: Court stands for proposition that the notice in contract was inadequate Violated Implied Covenant of Good faith with method of notice chosen Test: The Courts will patrol the outskirts of acceptable behavior in contract, or impute a floor It is implied that the parties may assume certain risks in a contract But, the risk of the contracting party acting opportunistically, to the detriment of the other party is unacceptable Extremes of behavior will not be tolerated Contrast with Katz (Neo-classical): Narrower test, of what parties would have agreed to proscribe had they negotiated it Evaluates the economically efficient outcome of a decision, and implies it Ignores the fact that debenture holders don’t really negotiate themselves Assumes that if the parties contracted for something, and contract is not silent, contract controls Reason for Narrow Construction: Certainty in debt markets, Capital Markets Interpretation of Contract by law This maximizes overall societal wealth even though particular litigants may lose Overall: While notice is acceptable, for the most part, under a Katz view of narrow good faith and the contract controlling There is jurisprudence that may require more in the contract to be “fair” to the debenture holders Anti-Dilution and Anti-Destruction: Generally: These provisions protect the conversion holder from companies behavior with the underlying stock If the stock is diluted (Stock Split, Reverse Split, Stock Dividends), the conversion must be adjusted to reflect the value the conversion holder had prior to the split Changes price Changes number of shares Forward Stock Split: Splits, in general, add no value, but merely adjust number of the shares you own in the company The total value is still the same Everyone’s shares go up proportionally Increases number of shares Decreases price per share Purpose: Adds liquidity to the market Signals company’s confidence in a stock by encouraging ownership More affordable on per share basis Why may not do it: From managerial standpoint, no split encourages stagnant ownership Less liquidity means more predictable stock holder base—easier to manage EG: 2:1 Forward Split Pre-Split shares x 2 Pre-split price ÷ 2 3:2 Forward Split Pre-Split shares ÷ 2, then x 3 Pre-Split price x 2, then ÷ 3 Reverse Stock Split: Decreases number of shares proportionately Price increases per share Purpose: If you feel price is too low/under representative May create attraction to a higher share price Preserve an NYSE listing requirement May be a negative sign from management as stock isn’t at appropriate price EG: 1:2 Reverse Split Pre-Split shares ÷ 2 Pre-Split price x 2 2:3 Reverse Split Pre-split shares ÷ 3, x 2 Pre-split price x 3, ÷ 2 Overall: The Conversion Price/Ratio of the convertible securities must be adjusted appropriately Pre-Slit Conversion Ratio/Price must be multiplied or divided per split ratio calculation Example of Anti-dilution provision in Convertible Contract Reiss v. Financial Performance Corp. F: ∆ authorized issuance of warrants to π, enabling them to purchase up to 1.2M shares at .10. Neither of the warrant contracts required an adjustment to price or amount of stock based on underlying stock being diluted/increased. However, a similar warrant contract with another party entered into did have price-adjustment. When reverse split was announced, π sought to exchange their warrant for 5x value it was before. ∆ denied it. I: Should the court impute a term that is missing? R: 1. A contingency’s omission does not automatically lead to a Court implying a term: Here: parties agreed to contract without adjustment Had a forward split occurred Warrant would be eviscerated Price would have gone extremely low, killing value Had a Reverse split occurred Warrant price would increase Court refused to imply the term: The Company entered into this agreement Evidence existed that company had price adjustment in other agreements, but not this Company decided to perform the reverse split knowing of this warrant Court disagreed with “Implying Essential Term that is missing” A term can be supplied if by logical deduction from agreed terms, if Essential Term Court may supply a term that is reasonable if essential term is missing to define parties rights and duties Overall: The reason the clause was not in the Contract is probably mistake CAREFULLY Draft to assure the desired outcome is reached and do not simply take form contracts and use them Cheap Stock: Anti-dilution provisions also cover issuance of stock below market value (Cheap Stock) Effect: Dilutes the value of the company’s existing common stock So, Convertible security holders deserve to receive more shares to compensate/make them whole Forumla: Adjusted Conversion Price= CP x [OCS + ((NCSxOP)/CMP)] OCS+NCS Where: OCS=Number of outstanding shares of common NCS=Number of new shares of common (cheap stock issued) OP=Offering price of new cheap stock issued CMP= Current market price per share of common CP= Conversion price in effect at time of adjustment Distribution of Assets and Indebtedness: Generally: Adjustments will be made to the conversion price when the company distributes assets For instance: Spin-off shares distributed as a dividend Excluded: Cash dividends Warrants Formula: Adjusted Conversion Price= CP x (CMP-D/CMP) Where: CP=Conversion price at time of adjustment CMP=Current Market price per share of common D= Per share value of the distribution being received by common shareholders HB Koreneveas v. Marriot Corporation: F: Marriot was hotel and food concession business. It had 200M Preferred Convertible, 2B in Common and 2B in Debt. Marriot announced it would restructure. It would create a subsidiary of Marriot International, and would spin off shares to common shareholders. It would put most profitable assets (hotels, properties generating cash) in International. Then, remaining assets (tollway road conessions restaurants/rest stops) in Host Marriot. Host would be burdened with most of the debt. Host would lost 44M/Year based on the transaction. Host had a subsidiary of HMH. Bondholders sued, and settled for exchange of debt and new debentures in HMH, with higher interest rate. Preferred Shareholders were told their dividend would not be paid. Plaintiffs bring suit, arguing that the transaction was coercive, and done so that they would convert prior to record date of special dividend, not getting spin-off. Argue coerciveness, fiduciary duty, and that anti-dilution provision applies. R: 1. Court may step in to abate coercive action when fiduciary duty exists However, fiduciary duty must exist to do so Here: Contract of preferred controls Many protections exist (cumulative, right to vote in certain situations) So, per Jedwab, no Fiduciary duty exists as contract supersedes 2. Implied Covenant of Good Faith: The contract was performed in good faith The postponement of dividend was for a business reason as subsidiary would have no income to pay dividend with So, under either view of good faith—this was within acceptable behaviors 3. Anti-Dilution Provisions which require “Sufficient value of net assets remain” Purpose: Protect against dilution of the conversion component, by adjusting conversion price Certain dividends of property, or assets may be so large that following the distribution, the firm may not have sufficient value to preserve the pre-dividend conversion right Interpretation: Refrain from declaring dividend of assets so large that leaves the company worth less than pre-distribution value of assets Value Judged: At the time the Board declares the special dividend If, when declared, corporation will have sufficient assets to preserve the conversion value, satisfies clause Conversion Value: Shares Convertible into x FMV Contract has Clause saying that “As determined by Board of Directors” Therefore, the Board’s calculation and valuation formula it decides to use, the Court holds, is controlling in this circumstance Anti-Destruction: When the stock that is convertible into is impaired, something must occur to fulfill convertible security holder’s value If eliminated, the “anti-destruction provision” will allow convertible holder to convert into The same consideration paid to the common May be stock, cash, etc… Whatever it is, convertible security holders get to convert into it Note: This is where “flip over” poison pill provisions stem from Wood v. Coastal States: F: Coastal was reorganizing its business, and spinning off its subsidiary. The shareholders would be the sole party to get the spun-off shares. The preferred were not entitled to this spun off dividend. The preferred argue that the “spin off” is a recapitalization, within the meaning of the anti-destruction clause. I: What is a recapitalization R: The Contract failed to define recapitalization: Drafter error Define it the way you want it to be defined Court held a spin off is not a recapitalization: A recapitalization does not occur if the same shares were available after event After this event, he may not receive what was available to him before, but instead, is given something “in lieu of” common Alternative Arguments to bring: Could have argued that Contract did not address a “spin off” specifically Based on the doctrine of independent legal significance, and a fiduciary duty—because k is silent—preferred may have been able to bring a breach of fiduciary duty claim Other Court’s Interpretations: Lohnes v. Level 3: A Stock split did not constitute a “substantial change” in the corporate structure Merely a different proportional representation of the same aggregate amount VII. Ownership Claimants: Redemptions and Repurchases: Generally: These two methods are methods to return to shareholders, value they may participate in Redemption: Typically based on a preexisting agreement, which is set forth in the Articles of Incorporation Repurchases: Typically made upon the decision of the board of directors Purpose: Generally: Arguably, repurchases serve the same purpose as a dividend, distributing value to shareholders by purchasing their stock above value, raising the overall value of the corporations stock Gives Corporation Flexibility Unlike Dividends: Once a company begins doing so, must continute, as shareholders will see the end of a dividend policy as a negative sign Long Term Dividends are viewed as a long term, permanent commitment by the corporation Once corporation reaches mature business cycle, may undertake dividend policy Has cash flow to payout Steady and reliable revenue stream A Repurchase: Can be a one time occurrence Is not viewed as permanent Done to raise value of shares seen as undervalued As this is seen as a “bullish” sentiment, price may increase further Reduces number of shares in the market, increasing EPS Negative Effect: While both dividends and repurchases deplete cash Repurchases reduce equity in corporation Increases D/E ratio Kayn v. US Sugar: F: π is class of common stock, alleges a breach of the duty of candor. That in a Tender Offer by company, the company failed to disclose that an independent bank did not conduct its own analysis, but merely approved its selected price, and that representations to shareholders were coercive. R: The Duty of Candor Requires that when shareholder action is sought: Must disclose all material facts relevant to the shareholders Stems from Duty of Loyalty: If pleaded, Entire Fairness Analysis ensues Katzowitz v. Sidler: Preemptive rights in close corporation Meant to protect voting and dilution Gives you ability to buy proportion of shares offered, if shares offered Frantz v. EAC: Courts will protect voting rights, requiring a “compelling justification” to infringe on them This is shareholder’s right, and the board has no right to infringe on their ability to vote Director, whose imminent retirement is known to other members of board does not violate fiduciary duties in corporation by tendering his resignation at time he sells stock to corporation Jones v. Ahmanson: Controlling shareholders have a fiduciary duty owed to the corporation and shareholders Entire Fairness Analysis Applies When majority receives premium over market for its shares: If reflects payment for corporate asset, all shareholders may demand share proportionately Not Widely Followed, as holds sale of corporate governance/control is corporate asset More Equitable Opinion Absent inequitable behavior, or freeze out behavior, Controlling shareholder may sell at premium without issue Leader v. Hycor: Fiduciary Duty is owed in a close-corporation Controlling shareholder/Director must act “utmost good faith and loyalty” Framework: 1. Can controlling shareholder demonstrate legitimate business purpose? If yes π bears burden to establish that objective could have occurred with legitimate alternative with less harm to minority Reverse Stock Split as freeze out: Reverse split in such a proportion that minority shares are left with fractional shares Cash out the fractional shares, freezing them out 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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