36. What is a “hostile takeover” and what effect does it have upon corporate governance?
A hostile takeover is where a third-party acquirer seeks to purchase a controlling number of outstanding shares without the endorsement or approval of the target company’s board of directors. Prospective shareholders can carry out their objectives through a number of methods.
• Strategies for a Hostile Takeover – Acquirers often employ numerous methods to circumvent the board and affect the intended acquisition.
⁃ Tender Offer – The primary method of acquiring a controlling share of a corporation’s stock without the approval of the board is done through an open offer to shareholders to purchase shares at a given price. This is known as a “tender offer”. Once the acquirer obtains a sufficient number of shares, it will begin to elect new directors to the board of directors. The new directors will represent the interests of the acquirer. This effectively puts the acquiring shareholder in control of the corporation.
⁃ Note: Tender offers are regulated by federal law. The Williams Act requires that an attempted tender offer be registered with the SEC.
⁃ Example: 123 Corp wants to buy ABC Corp. 123 Corp registers with the SEC and makes an open offer to all ABC Corp shareholders to purchase their shares at $72 per share. The offer is contingent upon 123 Corp receiving a commitment from a certain number of shareholders to sell their shares. If 123 Corp is successful in acquiring a majority of outstanding corporate shares, it will then begin electing directors who will approve 123 Corp’s acquisition plan.
⁃ Proxy Contest – A potential acquirer may attempt to convince existing shareholders to replace the current directors with directors that support the acquirer’s objectives. This is done by placing the name of the acquirer’s proposed director nominee in the shareholder proxy material. If the proxy material is successful, a majority of shareholders will elect the acquirer’s director(s), who will then work to effectuate the takeover plans.
⁃ Note: Acquirers must often initiate litigation to enforce shareholder proxy right provisions. As previously discussed, these provisions effectively strengthen shareholder access to proxy material. It allows the acquirer to provide shareholders with the option of approving the acquirer’s objectives.
⁃ Example: 123 Corp makes an offer to ABC Corp’s board to purchase all outstanding shares of ABC Corp at $23 per share. ABC Corp refuses the offer. 123 Corp purchases a large block of shares of ABC Corp and thereby has shareholder rights. 123 Corp then exercises its right to add its recommended directors to the corporate proxy material. This allows shareholders to vote for 123 Corp’s proposed directors. If successful, the 123 Corp proposed directors will vote to approve 123 Corp’s acquisition plan.
⁃ Creeping Tender Offer – In some cases, an acquirer may begin to slowly acquire corporate shares on the public market. Once the shareholder reaches a sufficient number, it can begin the process of replacing existing directors with directors who will support the acquirer’s objectives.
⁃ Note: Depending upon the amount and how quickly a potential acquirer purchases shares, it may have to register its intent with the SEC. In any event, acquisition of a certain percentage of corporate shares triggers a number of disclosure requirements.
⁃ Bear Hug – In some cases, a takeover can appear to be friendly but is really hostile. For example, a “bear hug” is a situation where an acquirer offers a purchase price to the board that is far above expected value. The board may be required to accept or endorse the offer in order to meet its obligations to represent the best interest of shareholders.
⁃ Example: ABC Corp wishes to purchase 123 Corp and merge operations. ABC Corp realizes that the board of 123 Corp is not interested in a merger or acquisition. As such, ABC Corp offers a very high purchase price for the 123 Corp shares. The board must consider this proposal. If 123 Corp rejects the offer, shareholders who are unhappy with the decision may bring a derivative action against shareholders or vote against them in future director elections.