Summary
addressing whether there was a change in control under a pension plan
Summary of this case from BASF CORPORATION v. POSM II PROPERTIES PART.Opinion
Civil Action No. 12051.
Date Submitted: May 13, 1991.
Date Decided: May 14, 1991.
Gregory V. Varallo, Esquire and Robert J. Stearn, Jr., Esquire, of RICHARDS, LAYTON FINGER, Wilmington, Delaware; Marc P. Cherno, Esquire, Debra M. Torres, Esquire, Terrence A. Corrigan, Esquire and Mary Liz Geffert, Esquire, of FRIED, FRANK, HARRIS, SHRIVER JACOBSON, New York, New York; Attorneys for Plaintiff.
Lawrence A. Hamermesh, Esquire and Jon E. Abramczyk, Esquire, of MORRIS, NICHOLS, ARSHT TUNNELL, Wilmington, Delaware; Of Counsel: FOLEY LARDNER, Milwaukee, Wisconsin, Chicago, Illinois; Attorneys for Defendants.
MEMORANDUM OPINION
Sutton Holding Corp. is a substantial (8.9%) shareholder of DeSoto, Inc. that is currently engaged in a proxy contest to elect a slate of directors at DeSoto's forthcoming May 20, 1991 annual meeting. It here claims that an effective and open election is being thwarted by the defendants, who constitute the majority of the current board of directors of the Company, and seeks a declaratory judgment that, it says, will have the effect of clarifying matters that may importantly affect the outcome of the voting contest.
The parties have a history. See Sutton Holding Corp. v. DeSoto, Inc., Del. Ch., Cons. C.A. Nos. 11221, 11222, Hartnett, V.C. (Feb. 5, 1990).
As the case is now structured it revolves around the question whether election of the challenger slate would constitute a "change in control" as that term is used in the Company's two pension plans.
On December 11, 1987, DeSoto amended its two existing pension plans to insert a "change in control" provision. This provision provides that for a period of five years following a "change in control" the Company may not terminate the plans, nor may it amend them in a manner that would reduce benefits to the beneficiaries under the plans. Section 10.4(d) of the plans reads as follows:
A "Change in Control" shall be deemed to have occurred at such time as (1) without the prior approval of two-thirds of the Whole Board and a majority of the Continuing Directors (but not less than one Continuing Director), any New Substantial Stockholder becomes a Beneficial Owner, directly or indirectly, of 35 percent or more of the voting power of the Voting Stock of the Company; or (2) one-third or more of the Board consists of members not nominated for membership by the Company or the Board . . . [F]or purposes of this subsection 10.4(d), a person shall be considered a Beneficial Owner of Voting Stock which such person has a proxy (other than a proxy solicited by or on behalf of the Company or the Board) to vote for the election of directors of the Company.
Provisions in corporate instruments that are intended principally to restrain or coerce the free exercise of the stockholder franchise are deeply suspect. Blasius Industries, Inc. v. Atlas Corp., Del. Ch., 564 A.2d 651 (1988). The shareholder vote is the basis upon which an individual serving as a corporate director must rest his or her claim to legitimacy. Absent quite extraordinary circumstances, in my opinion, it constitutes a fundamental offense to the dignity of this corporate office for a director to use corporate power to seek to coerce shareholders in the exercise of the vote. It is not surprising that the attempt to do so should be made. As long as there have been elections there have been those who seek to gain unfair advantage in them (and those, who like some lawyers today, can suggest and guide that effort). But courts must remain sensitive to the risk and alert to act when they legitimately can to thwart it. Thus, I suppose (but cannot on this record hold) that adoption of this 1987 provision constituted a breach of the duty of loyalty that the members of the DeSoto board at that time owed to the company and its shareholders.
Where the offense is to the shareholders right to vote in a fair contest, it probably is sensible to refer to the board's duty directly to shareholders.
When the DeSoto board injected this provision in the Company's pension plans, its dominant motivation was doubtlessly not to create a valuable economic right in plan beneficiaries. Provisions of this sort — like so-called poison pill stock rights plans — are designed to deter a change in control not to create useful rights in the event they are triggered. But by inserting this provision, even if its creation constituted a violation of the loyalty that the board owed to the corporation and its shareholders, the directors, at the least, created litigable claims by plan beneficiaries to rights governed by federal law, i.e., the Employee Retirement Income Security Act of 1974, as amended, 29 U.S.C. §§ 1001, et seq. ("ERISA"). Thus, it appears to me, that even if, as I suppose, this provision represents a breach of director loyalty, one cannot as a matter of corporation law alone say it is invalid.
The obvious purpose of this sort of provision is to foreclose a "raider" from financing any part of a "takeover" by resorting to the Company's excess pension funding while permitting that fund to be available to directors approved by the incumbents ("continuing directors") for any corporate purpose. The most critical defect, in my opinion, is the fact that the "enemy" here, the raider, includes anyone that the shareholders elect but that the board has not nominated.
The provision is critically important now. At the moment, the excess funding of the Company's pension plans (on a per share basis) equals about 50% of the Company's share price on the New York Stock Exchange. The existing board has resolved to terminate the pension plans and to distribute that excess funding to the Company's shareholders. It has been delayed in doing so.
That is, excess of what ERISA regulations require given the circumstances or characteristics of the Company's covered employees. See 29 U.S.C. § 1341(b)(1)(D) (single employer may terminate plan only if sufficient funds to cover "benefits liability"); see also 29 U.S.C. § 1301(a)(16) (defining "benefits liability"); 26 U.S.C. § 401(a)(2) (same).
In a federal class action under ERISA representatives of the plan beneficiaries claimed that an earlier recapitalization of the Company constituted a "termination" of the pension plans, entitling beneficiaries to payment of the funds excess funding. That matter has apparently been settled in principle, but an injunction pendente lite restrains termination of the plans and distribution to shareholders of the excess funds in the plans until that litigation is resolved.
The challenger slate has announced a similar intention, but the presence of the pension plans' "change in control" provisions created certain complexities in their case. Specifically, at the time the complaint was filed, those provisions gave rise to the argument that since two-thirds of the board had not approved Sutton's acquisition of 35% of the Company's voting power (by proxy or otherwise) and since the board had not "nominated [the challenger slate] for membership," the election of that slate might constitute a "change in control" under the plans. The occurrence of a change in control would mean that the pension plans could not be terminated (and the excess funding distributed to shareholders) for a period of five years, (unless of course plan beneficiaries agreed, which presumably they would do for a price).
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According to the complaint this suit was originally brought, among other things, to preliminarily enjoin the application of the change in control provisions with respect to Sutton's proxy solicitation, to require the board to amend the change in control provisions or to otherwise render them inapplicable to Sutton, and to order DeSoto to adjourn the meeting date.
Promptly upon filing of the complaint, the defendants, however, announced that they had no wish to impede the free choice of the shareholders in the election and that they did not oppose the relief sought. Indeed, after the action was filed, the DeSoto board on April 26th, adopted a resolution that provided as follows:
RESOLVED, that to the fullest extent permitted by the DeSoto Salaried Employees' Pension Plan and the DeSoto Hourly Employees' Pension Plan, and to the fullest extent consistent with applicable law, including without limitation all applicable fiduciary conduct rules, any election of Sutton Holding Corp. nominees to the DeSoto Inc. Board of Directors at 1991 annual meeting of the stockholders of the Company and/or the accumulation of proxies for the purpose of such election shall not be deemed to constitute a "Change in Control" for purposes of the plans.
In adopting this resolution the Board declined to actually "nominate for membership" (Plan § 10.4) the challenger slate (emphasis added).
The defendants do not contend that this resolution is not effective. They have nevertheless, in effect, asserted that voting for the challenger slate constitutes a somewhat risky proposition. Specifically, in its most recent communication to shareholders, the Company states:
The Company further believes that, notwithstanding the Board's resolution of April 26, 1991, there remains a material issue under ERISA and the terms of the pension plans as to whether the election of Sutton's nominees will constitute a change in control under the pension plans.
In particular, the pension plans prohibit certain amendments which would reduce the effect of the plans' change in control provisions; the Internal Revenue Code prohibits reduction of accrued benefits of participants; and ERISA prohibits certain amendments increasing the employer's potential rights to surplus pension plan assets from being effective for five years after adoption. If the Board's resolution is found to have violated any of these prohibitions, it may be determined to be ineffective to prevent the election of Sutton's nominees from constituting a change in control.
Additional Proxy Statement Information (May 13, 1991) (emphasis added).
In this action Sutton now seeks a declaratory judgment that the April 26th DeSoto resolution is "valid, binding and effective" and that, contrary to defendants' statement, there is now no "material issue . . . as to whether the election of [its] nominees will constitute a change in control. . . ." In its view it clearly will not.
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Sutton's position, most basically, is that defendants are engaged in patent manipulation of the election. First, they created an illicit impediment to the shareholder's right to elect the board and now they are, Sutton says, attempting to create and exaggerate risks in voting for Sutton's slate. It claims that only a judicial determination of the valid, binding and effective nature of the board's April 26 resolution that it here seeks will permit shareholders to exercise a vote that has not been unfairly constrained; that is free and fair.
I agree that resolution of the doubts that the board's prior (1987) actions have created, and from which its present members now benefit, is important and perhaps essential if the forthcoming corporate election is to truly confer the legitimacy that presents the underlying reason for shareholder elections. The threats posed in these circumstances are particularly clear and palpable. The asset "overfunded pension funds" constitutes a huge proportion of this firm's equity and, on a per share basis, of the market value of its stock. A risk of any proportion that election of a particular slate would threaten the early realization of that asset is obviously material. Defendants appear, at least recently, to have acted prudently in taking steps to reduce that risk. But the possible effects of the remaining risk on shareholders may be powerful.
For this court to purport to determine that the resolution of April 26 is "valid, effective and binding," however, would do little good if the determination did not "bind" the plan beneficiaries, for it is they who might arguably assert rights arising out of "change in control." Plaintiff's urging that such a determination be made is premised in part on the view that defendant does not resist it (which is not itself enough here to justify entry of a judgment); in part on the notion that it is quite unlikely that any such claim will be made, and that in all events it would be rejected if made (a proposition that I cannot authoritatively express a view on); and, in part, on the notion that it would be helpful to get an adjudication now.
It surely would be helpful to get an authoritative resolution of the question whether the April 26th resolution was effective to render the election of the challenger slate not a "change in control" which creates rights in pension plan beneficiaries.
From a corporate governance perspective it would be regrettable were the shareholder franchise in this instance to be impaired by a construction of federal law that held, in these circumstances, that an exercise of corporate power that deemed the challengers to be on the same footing as the incumbents, violated federal rights of plan beneficiaries. I suppose that is an unlikely outcome. Federal law, too, is concerned that stockholder elections be fair so that their outcomes deserve respect and confer legitimacy. See J.I. Case Co. v. Borak, 377 U.S. 426, 431, 84 S. Ct. 1555, 1559 (1964) Equally important, it would appear that no legitimate interest of plan beneficiaries is implicated by a corporate resolution that removes the distinction whether corporate directors were nominated by the existing board or not. Obviously the interests of plan beneficiaries in the funding of the plan is substantial and deserves great respect. But those interests are not rationally intertwined with the question who nominated a director. Witness the fact that the incumbent directors plan to terminate the Plan in exactly the way the challengers propose to do.
The United States Supreme Court noted in Borak that:
[t]he purpose of § 14(a) [of the Securities Exchange Act] is to prevent management or others from obtaining authorization for corporate actions by means of deceptive or inadequate disclosure in proxy solicitation. That section stemmed from the congressional belief that "[f]air corporate suffrage is an important right that should attach to every equity security bought on a public exchange."Borak, 377 U.S. at 431, 84 S. Ct. at 1559 (citing H.R. Rep. No. 1383, 73d Cong., 2d Sess., 13).
But to speculate upon the thrust of federal law on this question, or even to express a considered opinion on the question, is of little real utility in resolving such uncertainty as may be ambient in the present situation. Such view as this court may present to the parties could not, given the absence as a party of any plan beneficiary, afford to shareholder dependable relief from such ambiguity. That might only be done in an action in which plan beneficiaries are parties.
This does not mean that our federal system is necessarily incapable of addressing a problem that appears to be real, pressing and of concern to both federal and state law. But it does mean that this is an instance in which the exercise of jurisdiction by our federal and state courts should be consciously coordinated. This court, in attempting to meet its obligations to supervise the exercise of corporate power dealing with the internal affairs of a Delaware corporation, is capable of affording a part, but only a part, of the judicial process necessary to address the problem of uncertainty that threatens the integrity of the forthcoming election of directors of DeSoto. It could do so by requiring the defendants to postpone for a short period, say sixty to ninety days, the forthcoming annual meeting of DeSoto shareholders. Such a delay could only be justified if plaintiff (derivatively) undertakes to commence and promptly requests expedited treatment of a defendant class declaratory judgment action against plan beneficiaries, seeking an adjudication of the questions necessary to determine whether the DeSoto board has, consistently with federal law, exempted the plaintiff's slate of candidates from the change in control provisions of the Company's pension plans.
Such a postponement would not be based merely upon the judicial perception that a delay of that length would be justified because it might produce a fairer election. Compare Hubbard v. Hollywood Park Operating Co., Del. Ch., C.A. No. 11779, Jacobs, V.C. (Jan. 14, 1991); with Alabama By-Products Corp. v. Neal, Del. Supr., 588 A.2d 255 n. 1 (Mar. 8, 1991). Rather, here the impediment to the election arises from board action (the 1987 adoption of the change in control provision) that I suppose for present purposes was an equitable wrong.
I assume that defendants who are interested in removing uncertainties affecting the election would cooperate in such an effort.
While there is a split among the federal Courts of Appeals on the question whether a defendant-class action is available under Rule 23(b)(2) (Compare e.g., Henson v. East Lincoln Township, 814 F.2d 410 (7th Cir. 1987) with Marcera v. Chinlund, 595 F.2d 1231 (2d Cir. 1979)) a declaratory suit by DeSoto, or by Sutton derivatively on behalf of DeSoto and its stockholders, would appear to qualify as a proper class action under subparagraph (b)(1)(A) of Rule 23. The Advisory Committees' Notes to the 1966 amendment to the federal rules that reconfigured Rule 23 appear to confirm that defendant class actions are contemplated under Rule 23(b)(1)(A). See also Leon N. Weiner Assoc. v. Krapf, Del. Supr., 584 A.2d 1220, 1226 (1991).
Should plaintiff seek to adjudicate such questions of law in an action in which pension plan beneficiaries would be bound by the judgments entered, then it would appear to me that an order requiring the board to postpone the annual meeting for the period mentioned might be justified. The board could have little objection to such a procedure as it has taken the position that it desires to do all that it can do legally to remove the "coercive" features of the present situation; it would, of course, remain in control of the enterprise in the meantime and to proceed in this way would not appear itself to require delay in the existing board's terminating the pension plans, if the United States District Court should lift its present order. (See n. 5 above). Indeed the pendency of that unrelated action provides some basis to hope that expedited treatment of a declaratory action might be possible.
In all events, whether the present circumstances exist by happenstance or design is essentially irrelevant to the fundamental point that the question that plaintiff presents (whether the April 26 resolution is valid, effective and binding) involves questions of federal law in which absent parties have an interest. While recognizing the possible importance of this question to the outcome of the election contest, I must acknowledge that to purport to resolve that problem in this action would risk (at least to some extent) creating in the minds of the shareholders a false belief that the present uncertainty has been authoritatively resolved.
Plaintiff's pending motion for summary judgment will be denied.