Two courts recently issued significant corporate law decisions that are meaningful for corporations and investors navigating an M&A transaction or a proxy contest. Interestingly, both decisions arose outside of Delaware, whose courts handle more corporate law disputes than other states because Delaware is the corporate domicile for many corporations. The first decision, In re Xerox Corporation Consolidated Shareholder Litigation, was issued by the Supreme Court of the State of New York1 and involved a two-part injunction by the court. In particular, the court enjoined Xerox from: (i) proceeding with a business combination with Fujifilm; and (ii) enforcing its advance notice bylaw, with the result that a large stockholder who initiated a proxy contest after the corporation's advance notice deadline could proceed with making director nominations. The second decision, Blue Lion Opportunity Master Fund, L.P. v. HomeStreet, Inc.,2 was issued by the Superior Court of the State of Washington for King County. That decision upheld a board's decision to reject a stockholder's nomination of a competing slate of directors on the basis that the nomination failed to comply with the company's advance notice bylaw.
The Xerox case comes at a time when very few public company deals have been enjoined and serves as a useful reminder for participants in M&A transactions as to potential risks relating to conflicts of interest and process issues. Meanwhile, both the Xerox and HomeStreet decisions will likely serve as important precedents when companies and investors navigate disputes relating to advance notice bylaws.
The Xerox Decision
The Xerox case arose out of a deal that would give Fujifilm Holdings Corp. (Fuji) a 50.1 percent controlling interest in Xerox Corporation (Xerox), a New York corporation. The New York court, after holding a two-day evidentiary hearing, characterized the facts as follows: Xerox and Fuji had a long-term joint venture agreement that made it difficult, but not impossible, for Xerox to engage in a value-maximizing transaction with a party other than Fuji. In early 2017, Xerox and Fuji began discussing a possible transaction involving the acquisition by Fuji of all of Xerox's shares in exchange for cash at a premium. At such time, Xerox conveyed that it expected 100 percent cash consideration for its stockholders. Around the same time, Carl Icahn, Xerox's largest stockholder, expressed dissatisfaction with Xerox's chief executive officer and threatened to seek the termination of the CEO if he didn't produce a sale of the company. Shortly thereafter, Fuji momentarily suspended deal discussions for its own internal business reasons.
Meanwhile, the Xerox board began to express its own dissatisfaction with the CEO and launched a search for a new CEO, ultimately deciding on a leading candidate. Xerox's current CEO, who eventually became aware of the threats to his job, then quickly negotiated a deal with Fuji that would involve the CEO continuing on as the chief executive of the combined company, five of the nine Xerox directors remaining on the board of the combined company for five years, and Xerox stockholders receiving a large cash dividend but no premium in the deal. The court found that the CEO had, at times, continued to conduct negotiations even though the board had instructed him to cease doing so. When Xerox's financial advisor raised concerns regarding the diligence and value of the deal, Fuji threatened to walk from the deal. At that point, the financial advisor did provide a fairness opinion, and the sale of 50.1 percent of Xerox was unanimously approved by Xerox's board and announced in January 2018 (along with the restrictions imposed by the joint venture agreement). These disclosures occurred after the December 2017 deadline for stockholder nominations of directors under Xerox's advance notice bylaw. Before the advance notice deadline, Icahn nominated a short slate of four directors; after announcement of the transaction, another significant stockholder, Darwin Deason, requested that the Xerox board waive the advance notice deadline to allow for his nomination of a full slate of directors. The Xerox board rejected Deason's request, and the two stockholders joined forces.
At the preliminary injunction phase in the case, the court found that the CEO was "massively conflicted" given the court's assessment of the facts. The court held that, in breach of their fiduciary duties, the CEO negotiated and the Xerox board approved a transaction that was disproportionately favorable to Fuji to further the interests of the CEO and those directors continuing on the board. Meanwhile, the court found that Fuji aided and abetted that breach. Among other things, the court focused on text messages between the CEO and a Fuji executive that appeared focused on helping the CEO retain his job and allowing Fuji to have control over the Xerox board. The court also drew upon a letter from a member of the board to the chairman of the board expressing concern over the chairman permitting the CEO to lead the sale process and ultimately the combined company, given the board's dissatisfaction with him and his apparent violation of the board's instructions to cease negations with Fuji.
Additionally, the court enjoined Xerox from enforcing its advance notice bylaw against Icahn and Deason. In doing so, the court drew upon prior case law requiring companies to waive their advance notice deadline where, among other things, a material change in circumstances occurs after the nomination deadline has passed. In this case, the court determined that the disclosures relating to the joint venture with Fuji and the announcement of the change of control transaction were material to a stockholder's decision to nominate a competing slate of directors and that the defendant directors likely breached their fiduciary duty of loyalty in refusing a request to waive the advance notice deadline. The court noted its belief that the nomination process is integral to the stockholders' right to vote and is a "fundamental and outcome-determinative step" in the director election process. The court ordered that the plaintiffs, and any other stockholders, would have 30 days to nominate a competing slate.
The HomeStreet Decision
In the Washington case, stockholder plaintiff Blue Lion Opportunity Master Fund, L.P. (Blue Lion) attempted to nominate a competing slate of directors for the board of directors of HomeStreet, Inc. (HomeStreet), a Washington corporation. Although the court's decision was brief, the facts of the case from the litigation filings appear to be as follows: HomeStreet had a classified board with three directors up for election, two of whom were members of the audit committee. There was a pending U.S. Securities and Exchange Commission (SEC) investigation into alleged improper accounting at the company. HomeStreet's advance notice bylaw required stockholder nominations to comply with certain timing requirements and to provide extensive information about each candidate, including a detailed questionnaire and other information required to be disclosed in a proxy statement under SEC rules.
Within the period specified by the bylaws, Blue Lion attempted to nominate two independent director candidates to run against the incumbent directors. HomeStreet rejected Blue Lion's nomination notice for failure to comply with the advance notice bylaw. In the ensuing litigation, Blue Lion maintained that its submission, which was more than one hundred pages in length, substantially and materially complied with HomeStreet's bylaws and that the company's rejection was based on immaterial and purely technical grounds. HomeStreet, meanwhile, argued that advance notice bylaws should be strictly enforced. Among the deficiencies that HomeStreet cited were the following: Blue Lion's failure to disclose the precise HomeStreet shares owned beneficially and of record by various entities within Blue Lion's corporate family; the failure to provide information, as required by the bylaws, that would have to be disclosed in a proxy statement under SEC rules; and a representation as to how Blue Lion intended to vote its stock at the meeting.
Both sides looked to Delaware case law to support their respective arguments: Blue Lion for purposes of demonstrating the importance of stockholder voting and the application of enhanced scrutiny when directors attempt to thwart stockholder voting rights (as Blue Lion argued happened here), and HomeStreet for purposes of establishing that bylaws are presumptively valid and part of a binding contract that, if unambiguous, are to be construed as written and enforced absent certain equitable circumstances. According to HomeStreet, the advance notice bylaw was adopted on a "clear day" many years ago in connection with the company's initial public offering and not in response to a threat, or perceived threat, from any stockholders; the circumstances were not such that it was impossible for Blue Lion to comply; and there had not been a material change since the deadline (as in the Xerox case).
The court agreed with HomeStreet, finding that the advance notice bylaw was valid, that Blue Lion failed to comply with its requirements, and that the HomeStreet board had acted within its business judgment in rejecting the nomination.
Takeaway Points
As both stockholder activism and M&A activity continue to surge, these two decisions serve as important reference points. The HomeStreet decision stands for the proposition that advance notice bylaws can provide meaningful protections for corporations and that courts may choose to enforce them fairly strictly in various circumstances. At the same time, the Xerox decision illustrates that advance notice bylaws are not always impenetrable. The Xerox decision also illustrates that, in M&A events, courts maintain the ability to issue powerful injunctions where a judge perceives that conflicts of interest may have meaningfully tainted a sales process. These decisions also add to the growing list of litigation over complex corporate issues occurring outside of Delaware courts but with continued reference to Delaware case law.
