Kevin F. Brady of Connolly Bove Lodge & Hutz, LLP, who was present at many of the lengthy proceedings in this historic case, provides an insider’s perspective in his review of this decision by the Delaware Court of Chancery.
Chancellor William B. Chandler, III upheld the validity of Airgas’s poison pill as an appropriate anti-takeover defense where the Airgas board, in the face of a hostile tender offer from Air Products, found the price to be inadequate, in connection with the high-stakes battle for corporate control of Airgas, Inc. Air Products and Chemicals Inc. v. Airgas, Inc., et al., C.A. No. 5249-CC (Del. Ch. Feb. 15, 2011). At what turned out to be the end of an epic takeover battle involving highly skilled New York and Delaware lawyers going head-to-head, Chancellor Chandler, in his imposing 153-page opinion, carefully set out the factual twists and turns of the 16-month dispute and after a thorough review of the origin and the development of Delaware corporate takeover jurisprudence regarding the use of poison pills, he rendered a well-reasoned and thoughtful decision concluding that the power to defeat an inadequate hostile tender offer ultimately lies with the board of directors and not the shareholders. The Chancellor, not without reservation, ruled in favor Airgas’s right to use its poison pill as a defensive mechanism against the Air Products’ hostile tender offer. The entire opinion is available here.
Given the amount of attention this decision has garnered in the week or so since it was released, it will be by all accounts one of the “classic” Delaware corporate law opinions on mergers and acquisitions and a mainstay in corporate law textbooks for many years to come. The flurry of comments that this decision has generated in the short time since the decision was issued includes commentary on the following sites: The Deal Professor, ProfessorBainbridge.com, The Harvard Law School Forum on Corporate Governance and Financial Regulation (in a post authored by Martin Lipton), The Conglomerate, Lucian Bebchuck and the Dealpolitik, just to name a few. [In mentioning Mr. Lipton, it is only appropriate to pause here for a moment to note the recent passing of Joseph Flom, of Skadden Arps Slate Meagher & Flom. Mr. Flom, like Mr. Lipton, became one of the titans of the takeover world in the 1980s and their influence continues to resonate today. Wachtell and Skadden were never far from any big takeover battle and the Airgas case was no exception. Wachtell represented Airgas and Skadden was retained to represent three directors of the Airgas board nominated by Air Products. Mr. Flom will be missed by the many who were privileged to work with him.]
While the final result of this case is clear and concise, it is also evident that the Chancellor did not come to that conclusion without reservations. There is a not-so-subtle undercurrent throughout the opinion (which was also present in the questions the Chancellor asked of various witnesses during the supplemental evidentiary hearing on January 2011), that the Chancellor appeared to be pulled in different directions — between what he personally thought should be the result and what the Delaware Supreme Court precedent required him to do. Indeed, while the Chancellor said that he thought the Airgas poison pill had “served its legitimate purpose,” he also noted:
Trial judges are not free to ignore or rewrite appellate court decisions. Thus, I am constrained by Delaware Supreme Court precedent to conclude that defendants have met their burden under Unocal to articulate a sufficient threat that justifies the continued maintenance of Airgas’s poison pill. That is, assuming defendants have met their burden to articulate a legally cognizable threat (prong 1), Airgas’s defenses have been recognized by Delaware law as reasonable responses to the threat posed by an inadequate offer—even an all-shares, all-cash offer (prong 2).
Indeed, it was that “constrained” analysis that prompted one Delaware practitioner to characterize the decision as “ingenious” noting that if there was an appeal (which there won’t be), if the decision was either reversed or affirmed, the Chancellor could confidently say “I got it right.”
In reviewing a decision which is the product of a week-long trial, a three-day supplemental evidentiary hearing, several rounds of post-trial briefing and seven-plus hours of closing arguments, it is nearly impossible to fairly summarize in a blog post a decision of this magnitude and I will not attempt to do that in this post. The relevant facts, which take up 65 pages of the decision, include the facts and decision concerning the “bylaw” issue which has already been discussed in this blog so I will not address the “bylaw” issue.
A summary of the Delaware Supreme Court’s decision regarding the Airgas bylaws, and links to review and commentary of several other Airgas decisions, are available here. And with respect to the remainder of the facts, I will take the 3,000 foot approach (which is low enough to see The Circle in Georgetown but not close enough to see who is standing on the porch of the Brick Hotel).
Air Products’ Interest in Airgas
Air Products first became interested in Airgas in 2007 but it did not pursue a transaction because supposedly the stock price was too high. In October 2009, the president and CEO of Air Products, John McGlade, approached the founder and CEO of Airgas, Peter McCausland, about a potential acquisition or combination, however, nothing came of it. Not long thereafter, Air Products proposed a $60 per share all equity deal to Airgas. Airgas responded that it was not interested in a transaction. In December 2009, Air Products revised its offer to $62 per share in a cash-and-stock deal. Again, Airgas rejected the offer on the grounds that it grossly undervalued Airgas.
The $60 Per Share Offer
In January 2010, Air Products changed tactics and sent a public letter to the Airgas board announcing its intention “to proceed with a fully-financed, all cash offer to acquire all outstanding shares of Airgas for $60 per share.” The Airgas board felt that Air Products had timed its offer to take advantage of Airgas’s depressed stock price based on the recession. The Airgas board unanimously agreed that the $60 price was too low. On February 11, 2010, Air Products launched a tender offer conditioned on a number of things, including: (i) a majority of the total outstanding shares tendering into the offer; (ii) redemption of the poison pill; (iii) approval under §203 and the charter. Airgas responded accordingly with 14D-9 filings explaining its position that the offer was inadequate.
The Airgas Anti-Takeover Measures
By way of background, in addition to a staggered three-class board structure, Airgas: (i) had a shareholder rights plan or “poison pill” with a 15% triggering threshold; (ii) had not opted out of 8 Del. C. § 203, which prohibits business combinations with any interested stockholder for a period of three years following the time that such stockholder became an interested stockholder, unless certain conditions are met; and (iii) had a Certificate of Incorporation which included a supermajority merger approval provision for certain business combinations for any merger with an “Interested Stockholder” (one who beneficially owns 20% or more of the voting power of Airgas’s outstanding voting stock) which would require the approval of 67% or more of the voting power of the then-outstanding stock entitled to vote unless approved by a majority of disinterested directors or certain fair price and procedure requirements were met.
The Proxy Contest and the Three Air Products’ Nominees
On March 13, 2010, Air Products nominated a slate of three “independent” directors for election at the Airgas 2010 annual meeting. By all accounts, the three Air Products’ nominees were not only very experienced business people, they also had a significant amount of experience as board members. Air Products made public statements that its nominees were independent and “would act in the Airgas stockholders’ best interests.”
Air Products Continues to Raise Its Offer
On July 8, 2010, Air Products raised its offer to $63.50 per share (all other terms remained the same.) The Airgas board continued to view that amount as inadequate and amended its 14D-9 filings rejecting that offer as “grossly inadequate” and recommending that Airgas shareholders not tender their shares. On September 6, 2010, just weeks before the annual meeting, Air Products increased its offer to $65.50 per share (the rest of the terms remained the same.) Again, the Airgas board rejected the offer as inadequate and said so in its 14D-9 filing. However, at this point in time, the Airgas board was starting to hear from shareholders (mostly arbs, hedge funds and institutional holders) that they wanted Airgas to negotiate with Air Products.
The 2010 Annual Meeting
Up until September 2010, Airgas had a nine-member staggered three-class board made up of Mr. McCausland and eight independent directors. At the annual meeting on September 15, 2010, Airgas increased that number to ten. In addition, the Airgas stockholders elected all three of the Air Products’ nominees to the board: Messrs. Clancey, Lumpkins and Miller. While this was only the first step in replacing the Airgas board, it would later prove to play a critical role in how the Court analyzed the dispute. This was also the time the Court noted that the Airgas stockholders “had all of the information they needed to evaluate Air Products’ $65.50 offer.” The Court also noted that “the evidence at trial also incontrovertibly demonstrated that $65.50 was not as high as Air Products was willing to go.” It was not Air Products “best and final offer.” After the annual meeting, while Airgas indicated that $65.50 was grossly inadequate, it stated for the first time that it believed that the value of Airgas was in excess of $70 per share and at least $78 per share. Air Products responded that it was not willing to pay $78 per share.
The Spotlight Turns to the Three Air Products’ Nominees
In December, 2010, the three new Air Product nominees to the Airgas board requested authorization to retain their own legal counsel and financial advisors (which would be the third one the board used) to assist them in evaluating the Air Products offer. Credit Suisse and Skadden were soon hired to assist in the process and by December 21, 2010, the three new board members fully supported the Airgas view that the company was worth at least $78 per share.
The $70 Per Share “Best and Final” Offer
On December 9, 2010, Air Products made its ‘best and final” offer of $70 per share (all other terms remained the same). Not surprisingly, the Airgas board unanimously rejected the offer with the Air Products’ nominees being some of the most vocal opponents of the $70 per share offer. Airgas filed another amendment to the 14D-9 announcing the board’s rejection of the offer and recommended that the Airgas shareholders not tender their shares. The reasons for their opposition included:
The Airgas board’s knowledge and experience in the industry; the board’s knowledge of Airgas’s financial condition and strategic plans, including current trends in the business and the expected future benefits of SAP and returns on other substantial capital investments that have yet to be realized; Airgas’s historical trading prices and strong position in the industry; the potential benefits of the transaction for Air Products, including synergies and accretion; the board’s consideration of views expressed by various stockholders; and the inadequacy opinions of its financial advisors.
The Unocal Standard and the “Omnipresent Specter”
With the number of cases involving poison pills in Delaware in the past twelve months — eBay, Yucaipa (which is currently on appeal before the Delaware Supreme Court) and Selectica, much has been written about the Unocal/Unitrin standard as the centerpiece of the judicial analysis in reviewing a board’s defensive actions taken in response to a hostile takeover. Not surprisingly, Chancellor Chandler stated:
Because of the ‘omnipresent specter’ of entrenchment in takeover situations, it is well-settled that when a poison pill is being maintained as a defensive measure and a board is faced with a request to redeem the rights, the Unocal standard of enhanced judicial scrutiny applies. Under Unocal, to justify its defensive measures, the target board must show (1) that it had ‘reasonable grounds for believing a danger to corporate policy and effectiveness existed’ (i.e., the board must articulate a legally cognizable threat); and (2) that any board action taken in response to that threat is ’reasonable in relation to the threat posed.
The first hurdle under Unocal is essentially a process-based review: ‘Directors satisfy the first part of the Unocal test by demonstrating good faith and reasonable investigation.’ Proof of good faith and reasonable investigation is ‘materially enhanced, as here, by the approval of a board comprised of a majority of outside independent directors.’ But the inquiry does not end there; process alone is not sufficient to satisfy the first part of Unocal review—‘under Unocal and Unitrin the defendants have the burden of showing the reasonableness of their investigation, the reasonableness of their process and also of the result that they reached.’ That is, the ‘process’ has to lead to the finding of a threat. Put differently, no matter how exemplary the board’s process, or how independent the board, or how reasonable its investigation, to meet their burden under the first prong of Unocal defendants must actually articulate some legitimate threat to corporate policy and effectiveness. Once the board has reasonably perceived a legitimate threat, Unocal prong 2 engages the Court in a substantive review of the board’s defensive actions: Is the board’s action taken in response to that threat proportional to the threat posed? In other words, ‘[b]ecause of the omnipresent specter that directors could use a rights plan improperly, even when acting subjectively in good faith, Unocal and its progeny require that this Court also review the use of a rights plan objectively.’ This proportionality review asks first whether the board’s actions were ‘draconian, by being either preclusive or coercive.’ If the board’s response was not draconian, the Court must then determine whether it fell ‘within a range of reasonable responses to the threat’ posed. (citations omitted).
In the primer section on poison pills, the case of TW Services, Inc. v. SWT Acquisition, piqued the Chancellor’s interest because it raised (but did not answer) the same question confronting the Court in Airgas – when, if ever, must a board abandon its long-run strategy in the face of a hostile tender offer. The Chancellor highlighted the most famous quote from TW Services in considering whether the duty of loyalty could force a board into Revlon mode, where the Court in TW Services stated “directors, not shareholders, have responsibilities to manage the business and affairs of the corporation.” He went on to note that “the Chancellor [in TW Services] endorsed the view that so long as a corporation is not for sale, it is not in Revlon mode and is free to pursue its long run goals. In essence, TW Services appeared to support the view that a well-informed board acting in good faith in response to a reasonably perceived threat may, in fact, be able to “just say no” to a hostile tender offer.
Where is the Perceived Threat?
In addressing the good faith and reasonable investigation components of the first prong of Unocal, the Court found that Airgas easily met that part of the test. The independence of the board was never in doubt. The board used three outside independent financial advisors and they all came to the same conclusion about the inadequacy of the price.
So the real question became “what was the “threat”? After a great deal of discussion regarding the state of the record concerning a threat, the answer came down to:
The only threat that the board discussed—the threat that has been the central issue since the beginning of this case—is the inadequate price of Air Products’ offer. Thus, inadequate price, coupled with the fact that a majority of Airgas’s stock is held by merger arbitrageurs who might be willing to tender into such an inadequate offer, is the only real ‘threat’ alleged.
The focus then shifted to: “was that enough of a threat” to satisfy the first prong of Unocal. The short answer was yes. The Court noted:
The Delaware Supreme Court has defined substantive coercion, as …‘the risk that [Airgas’s] stockholders might accept [Air Products’] inadequate Offer because of ‘ignorance or mistaken belief’ regarding the Board’s assessment of the long-term value of [Airgas’s] stock.’ In other words, if management advises stockholders, in good faith, that it believes Air Products’ hostile offer is inadequate because in its view the future earnings potential of the company is greater than the price offered, Airgas’s stockholders might nevertheless reject the board’s advice and tender.
The Court then asked if a majority of stockholders want to tender into an inadequately priced offer, is that substantive coercion? The record showed that type of threat to be real because a large number of arbitrageurs bought into the stock at prices significantly below $70 per share offer price so they would be happy to get out at that price.
The Chancellor concluded that:
Ultimately, it all seems to come down to the Supreme Court’s holdings in Paramount and Unitrin. In Unitrin, the Court held: ‘[T]he directors of a Delaware corporation have the prerogative to determine that the market undervalues its stock and to protect its stockholders from offers that do not reflect the long-term value of the corporation under its present management plan.’ When a company is not in Revlon mode, a board of directors ‘is not under any per se duty to maximize shareholder value in the short term, even in the context of a takeover.’ The Supreme Court has unequivocally ‘endorse[d the] conclusion that it is not a breach of faith for directors to determine that the present stock market price of shares is not representative of true value or that there may indeed be several market values for any corporation’s stock.’ As noted above, based on all of the facts presented to me, I find that the Airgas board acted in good faith and relied on the advice of its financial and legal advisors in coming to the conclusion that Air Products’ offer is inadequate. And as the Supreme Court has held, a board that in good faith believes that a hostile offer is inadequate may ‘properly employ a poison pill as a proportionate defensive response to protect its stockholders from a low ball bid.’
The Second Prong of Unocal and Proportionality
The Court noted that Airgas had the burden of showing that its defenses were not preclusive or coercive, and if neither, that they fell within a “range of reasonableness”. The Court found that the Airgas response was not preclusive because Air Products still had the ability to wage a successful proxy contest and gain control of the Airgas board. Also, the mere fact that the Airgas board had a classified board and a poison pill was not enough to constitute a preclusive defense. In keeping with the theme of “judicial constraint,” the Chancellor noted: “I am thus bound by this clear precedent to proceed on the assumption that Airgas’s defensive measures are not preclusive if they delay Air Products from obtaining control of the Airgas board (even if that delay is significant) so long as obtaining control at some point in the future is realistically attainable.” The Court also noted that the Air Products still had two options to pursue: (i) it could call a special meeting and remove the entire board with a 67%, vote or (ii) it could wait until the 2011 annual meeting and elect another slate of its own nominees.
The Range of Reasonableness
Under Unocal/Unitrin, if a defensive measure is neither coercive nor preclusive, the focus of enhanced judicial scrutiny shifts to the reasonableness of a board’s response in the context of the specific threat identified. The Airgas board, composed of a majority of outside, independent directors, acting in good faith and with numerous outside advisors concluded that Air Products’ offer was clearly inadequate. The board believed in good faith that the offer price was inadequate by at least $8 per share. Thus, the Court found that the board was responding to a legitimately articulated threat.
The Tipping Point – The Level of Independence
Some of the most striking testimony in this dispute came from the Air Products’ nominees during the supplemental evidentiary hearing. The Court spends a significant amount of time in its opinion discussing the fact that the directors selected by Air Products for the Airgas board testified that after their own due diligence: (i) they had no reason to believe that the Airgas directors had breached their fiduciary duties, (ii) even though plenty of information had been made available to the stockholders, they agreed that Airgas management was “in the best position to understand the intrinsic value of the company,” and (iii) “if the shoe were on the other foot, they would act in the same way as Airgas’s directors have.” The Court also pointed out that Air Products made the tactical decision to launch a proxy contest and replace the directors with “three independent directors who promised to take a fresh look.” Moreover, Air Products campaigned for its nominees on the promise that its nominees would “consider without any bias [the Air Products] Offer” and that they would be outspoken in the boardroom about their views…” Air Products got what it wanted and it had to live with the result.
The Chancellor started his legal analysis regarding the board behavior in defending against a hostile takeover by referencing the “omnipresent specter” that a board may be acting primarily in its own interest rather than those of the corporation or its owners. Indeed, this theme is the foundation of the Delaware Supreme Court’s decision that there is an enhanced duty which calls for judicial examination before the business judgment rule can be conferred on the board. In this case, there was never any doubt that the Airgas board was independent from the beginning of the battle for control. However, in the second prong of the Unocal/Unitrin test, where the court has to examine whether the defensive measure was reasonable in relation to the threat posed, the proof is materially enhanced where a majority of the board favoring the proposal is independent. In this case, the independence needle appeared to move sharply when the Court factored in the surprising actions of the three Air Products nominees. The fact that they retained their own legal counsel and financial experts, had those experts perform another analysis which came to the same conclusion that the other Airgas board members came to speaks volumes for proving independence. How influential was that behavior in the Chancellor’s decision? Was it the tipping point? We may never know, but one could make an argument that at the point in time the Air Products nominees became the cheerleaders for protecting the pill and demanding at least $78 per share, that probably marked the beginning of the end for Air Products’ chances for successfully attacking the Airgas poison pill.
In the end, the Chancellor found that the Airgas board met its burden under Unocal/Unitrin to articulate a legally cognizable threat (the allegedly inadequate price of Air Products’ offer, coupled with the fact that a majority of Airgas’s stockholders would likely tender into that inadequate offer) and took defensive measures that fall within a range of reasonable responses proportionate to that threat. To quote Mr. Lipton, “[t]he poison pill lives.” Whether you like the result or not, you have to marvel at the process. And while the “air” might be a little lighter in Georgetown these days, the Chancellor (along with his law clerk and his long-time assistant Mary Ellen) deserves a hat-tip for the monumental effort to “get it right.”
Postscript: Professor Stephen Bainbridge links to "Brady on Airgas" here.