ESG and Takeover Law: Unexpected Drivers of Governance
By Rolin Bissell, Guest Contributor
ESG and Takeover Law - Unexpected Drivers of Governance.
Well-crafted ESG principles may be helpful in guiding a board’s decision-making about the operation of the corporation, including what assets or companies to acquire, what technology to invest in, managing regulatory risk, and aligning the corporate policy with the expectations of its customers, employees, the communities it operates in, and other constituencies. But when making decisions about control or sale of the corporation, ESG principles have almost no space to operate and are mostly irrelevant to a board’s decision making process.
This issue was provocatively teed-up during a panel titled “"The ESG Pendulum Swings Back (or is it a Wrecking Ball?)" held at the Weinberg Center for Corporate Governance on October 12, 2023. Bloomberg reported that the panel’s moderator, Trevor Norwitz, a prominent M&A partner and corporate governance expert at Wachtell Lipton, repeatedly asked his fellow panelists to weigh in on the following proposition: “If ESG concerns weren’t powerful enough to stop Musk from destroying the world’s most important social media platform on a whim—if it’s ‘just a fact’ that Twitter’s directors would have lost their jobs for refusing Musk’s hugely overpriced offer—then what exactly is ESG good for?” He concluded with the cri de coeur that although the sale was “very good for the shareholders,” it “messed up the entire world. Everybody knew that the town square—such an important and powerful institution—was basically soon going to become just a cesspool of Russian propaganda and lies and hate speech.” To paraphrase country singer Jerry Reed: Why is it the Twitter stockholders get the goldmine even if it means the rest of the world gets the shaft?
Perhaps reflecting an understandable caution before biting down on a question tethered to the twin lightening rods of Musk and Twitter, none of the panelists obliged Norwitz with an answer. Another explanation for the panelists’ reticence is the conspicuously rhetorical nature of the question. Norwitz’s colleague at Wachtell and former Chief Justice of the Delaware Supreme Court, Leo E. Strine, is the author of Caremark and ESG, perfect Together: A Practical Approach to Implementing an integrated, Efficient, and Effective Caremark and EESG Strategy and other papers that set forth in detail what “ESG is good for” in managing enterprise risk. (hyperlink here). In addition, Wachtell represented Twitter in its successful suit to compel Musk to acquire Twitter in 2022. So it seems doubtful that the question was meant as a rebuke to the Twitter board for not deploying a defense based on the preservation of ESG principles to thwart Musk’s takeover bid.
Shorn of its rhetoric, the question Norwitz poses is: What is the role of ESG principles in takeover law? This question has a ready and clear answer, which has nothing to do with how one feels about the bona-fides of Musk as a moral agent or the social-utility of historical Twitter, or its metempsychosis into X. Under Delaware corporation law, ESG principles have infinitesimal space to operate in connection with a Board’s decision to sell or not the corporation. Thus, whatever value ESG principles have in helping directors act as good stewards of the corporation in guiding its affairs, ESG principles are largely irrelevant to board decisions about corporate control.
Fundamentals of Delaware corporation law teach this result. A bedrock principle under Delaware law is that directors owe fiduciary duties to “the corporation and its stockholders.” In carrying out their obligations to the corporation and its stockholders, directors can consider the interests non-stockholder constituencies, for example through paying employees higher salaries and benefits, or more general norms like promoting a particular corporate culture or the advancement and using corporate resources to support of other environmental, social or charitable causes. But in promoting, protecting, or pursuing non-stockholder considerations, the directors’ decisions must lead at some point to value for stockholders.
In connection with setting strategy or managing the operations of the business, the interests of the corporation, its stockholders and non-stockholder constituencies are typically aligned—what is good for the corporation’s non-stockholder constituencies is good for the corporation’s ability to create long term value, which in turn is good for the value of the stockholders’ investment. Reflecting this symbiosis, the courts apply the director friendly business judgment rule in assessing a stockholder challenge to board decision making that does not involve a conflict of interest. Under the business judgment rule, the courts generally defer to and do not second guess a board’s decision making unless so the decision is so irrational that it constitutes waste.
By contrast, Delaware law recognizes that long term interests of the corporation, its stockholders and non-stockholder constituencies can diverge when a board is deciding whether to sell the corporation or to resist an uninvited bid to be sold. When a corporation is sold, the selling stockholders lose any long term financial or legal interest in how the affairs of the corporation will be managed in the future. Their interest narrows to maximizing the amount of money they will receive for their stock in the sale. When a board decides to resist an unwanted bid to buy the corporation, there is the “omnipresent specter” that interests of the stockholders in receiving a favorable price for the stock can diverge from the board and officers desire to remain in control of the corporation. Reflecting this potential, but not inevitable, divergence of interests, judicial review of a board’s decision to sell or not sell the corporation often falls outside the board-protective business judgment rule. Instead, the courts, when reviewing the sell or no-sell decision, examine whether board’s decision-making was objectively reasonable, and not defer to a board decision because it meets some minimal level of rationality. Reasonableness review has expressed itself in two case law developed doctrines— Unocal-and Revlon--that arose during the height of takeover battles of the mid-1980’s. Both doctrines are designed to keep the board aligned with the interests of the corporation’s existing stockholders in maximizing the value of their stock.
The Unocal doctrine applies when a board wishes to rebuff an unwanted offer to buy a corporation. (hyperlink here). It permits a board to take defensive measures in response to a takeover threat that are reasonable and proportional to the threat the unwanted bidder presents. Although Unocal involves the board’s ability to resist an unwanted bidder and permits the board to “just say no” to the unwanted bidder, the board needs good reasons to support that decision. Unocal’s underlying rationale is that the board needs leeway to avoid getting steamrolled into a coercive transaction that undervalues the corporation and therefore shortchanges the stockholders.
Air Products and Chemicals, Inc.’s year-long takeover attempt of Airgas Inc. in 2010 shows how the proper use of defensive measures can work. (hyperlink here). Air Products offered $70 per Airgas share, a significant premium over what Airgas shares were trading for at the time. Airgas believing it was worth significantly more, rejected the offer and indicated it would not accept a bid of less than $78 per share. The court found that various defensive measures Airgas was using to hold Air Products at bay were a reasonable attempt to get full value of the Airgas stockholders and were not for the purpose of entrenchment. As a result, Air Products abandoned its takeover bid in 2011. Of course, the court could not predict the future when deciding the case. As it turned out, however, the judgment of Airgas’s board was vindicated in 2016 when Airgas sold itself to Air Liquide for $143 per share, roughly double what Air Products offered five years before.
If Twitter’s board wanted to “just say no” to Musk’s bid, the Twitter board’s use of defensive measures would have to be based on a good faith and reasonable belief that through negotiation it could obtain a higher value for Twitter stockholders. This could be by extracting a higher bid from Musk, or some other buyer in the future, or by current management running and growing the corporation. It seems beyond dispute that Musk was overpaying Twitter’s existing stockholders so that he could own all of Twitter and thus manage it as he thought best. Given the whopping premium that Musk offered to Twitter’s stockholders, it is difficult to see how the Twitter board could have credibly formed the belief that it could capture more value for Twitter’s stockholders by continuing to run Twitter themselves or finding a bidder who would pay more. Any qualms the Twitter board had about how Musk would adhere to Twitter’s existing ESG principles after he took control of Twitter would not provide a sufficient justification for the board to deploy defensive measures to block Twitter’s stockholders from considering and accepting Musk’s bounty.
Revion followed Unocal and emphasizes the stockholder value maximization norm that underpins both doctrines. (hyperlink here). Revlon review applies when a board has decided to sell or agree to a change in control of the corporation, and it requires that the board act to obtain the highest reasonable attainable value for the stockholders’ shares. Revlon does not require the board to auction a company to the highest bidder, but the board must have a good reason for turning down the buyer who is willing to pay the stockholders the most.
Under Revlon, it is doubtful that the Twitter board could have rejected Musk’s bid because they believed that post-acquisition Musk would not share the same concerns they did concerning Twitter’s non-stockholder constituencies. Revlon held that “concern for non-stockholder interests is inappropriate when an auction among active bidders is in progress, and the object no longer is to protect or maintain the corporate enterprise but to sell it to the highest bidder.”
Similarly, the Twitter board could not reject Musk’s bid because they found Musk or his management style unwise, personally distasteful, or troubling. The Delaware Supreme Court criticized the Revlon’s board for letting the “personal antipathy” that Revlon’s Chairman and CEO Michael Bergerac felt for Revlon’s unwanted suitor, Ronald Perelman, infect its thinking. Bergerac, who had aristocratic tastes, regarded Perelman, then a young and brash raider, as uncouth and uncultured and thus unworthy to run the Revlon brand, whose success was based on the projection of elegance and glamour. The Delaware Supreme Court held that it was a breach of fiduciary duty for the Revlon board to shut Perelman out and channel the sale to a bidder it found more acceptable.
Putting the facts of the Musk-Twitter circus aside, consideration of the cases in which the courts have been asked to permit the preservation of corporate culture to serve as a justification for defensive tactics suggest that the circumstances under which the protection of ESG principles can function effectively as a justification of a takeover defense are hypothetically rare and practically non-existent.
For starters, Delaware courts are highly reluctant to accept the protection of a specific corporate culture as a reasonable basis for a board to take defensive action in the face of an unwanted acquirer. In 1989, the Delaware courts accepted Time, Inc.’s desire to protect its “corporate culture” of “journalistic independence of an iconic American institution” as “distinctive and advantageous” and thus a justification of defensive action Time took to ward off an unwanted advance by an entertainment company, Paramount Communications, Inc. (hyperlink here) But as later decisions have noted, the courts’ embrace of corporate culture as a justification for a takeover defense in the Time/Paramount case was “conditional,” “limited,” “muted,” and “did not escape criticism.”
The difficulties of using protection of corporate culture as the basis of a takeover defense are explored in depth in the Court of Chancery’s 2010 decision invalidating a poison pill the founders of Craigslist put in place to protect Craigslist’s corporate culture following a significant investment in Craiglist by eBay. (hyperlink here) Using the protection of ESG principles as a justification for defensive action would have similar hurdles.
First, the Time/Paramount case did not hold that “corporate culture, standing alone, is worthy of protection as an end in itself.” Again the protection of the corporate culture must relate to advancing stockholder value. Similarly, there would need to be some showing that the board’s use of defensive measures the protect ESG principles “translates into increased profitability for stockholders.” An argument that ESG principles deserve protection because they advance societal welfare or protect non-stockholder constituencies would be insufficient.
Second, there must be a well thought-out connection between the corporate culture and the defensive action taken to protect it. This includes considering alternative business strategies or tactics to protect the culture and a determination how the defensive measure “affects the value of the entity for its stockholders” and not just how the measures reflect the board’s “own personal preferences.” To use ESG principles as the justification for defensive action, there would need to be some record of board deliberation of why preservation of the ESG principles promote the value of the entity. In the Craigslist/eBay case the court cautioned that merely labeling a set of business practices as a “corporate culture” will not constitute “a palpable, distinctive, and advantageous culture.” Similarly, for the protection of ESG principles to serve as credible premise for defensive action, the ESG principles would need to be identified well in advance of the need to use them as a justification for defensive action and enshrined as an important corporate policy. A previously unidentified set of ESG principles that nimbly spring to life in the heat of a takeover battle will seem like an excuse of convenience and will not pass muster.
Third, attempts to maintain corporate culture or a group of ESG principles for an indefinite period into the future will be deemed as unreasonable under Unocal. The Craigslist founders adopted a poison pill “so that their vision of craigslist's culture can bind future fiduciaries and stockholders from beyond the grave.” “Dead-hand” defensive devices that seek to “shape the future of the space-time continuum” by sterilizing future director or stockholder action indefinitely will be found to be unreasonable.
Fourth, it is worth noting that using ESG principles as takeover defense would be odd pairing for reasons that go beyond legal doctrine. The G in ESG stands for governance. For the last two decades, it has been close to an article of faith in the pro-ESG community that takeover defenses weaken the accountability of the board to stockholders and should be narrowly tailored if not outright eliminated. As a result, proxy advisors such as ISS and Glass Lewis typically recommend that staggered boards be eliminated, dual-class stock should be avoided or have sunsets, and that defensive measures such as poison pills be limited in their scope, duration and potency. A defensive device meant to protect a corporation’s environmental or social policies from the market for corporate control would be dissonant with what has become good governance policy. One suspects that were a corporation to announce the intent to adopt a poison-pill or other defensive device that is triggered by threats to corporate culture, social policy, or ESG principles that the outcry by the proxy advisors and major stockholders against it would be deafening.
To be clear, this analysis pertains to a cash buyout offer like Musk’s to Twitter’s stockholders. There are other transaction structures, for example stock for stock exchanges, through which stockholders of both the target and the acquirer will continue as stockholders in the combined corporation. In general, Revlon does not apply to stock for stock transactions and the target and acquirer boards negotiating those transactions consider an array of post merger governance factors. For example, so-called mergers of equals in which two similar sized companies in the same industry merge looking to mutually capture synergies they often involve intense negotiations about future board and officer management and the cultural and other principles under which the combined company will operate. In the stock for stock transaction the target and acquires stockholders interest of the corporation will continuing post-merger and consideration of their future interests in the combine corporation post merger is appropriate.
That being said, ESG principles and law governing takeovers don’t have a lot to say to each other. This is not a criticism of ESG principles or a board’s decision to employ them as part of its risk management function. Having and disclosing a policy on where a corporation stands on environmental, social and governance issues can provide an important star map for the directors and officers in managing and operating the corporation and can help stockholders better understand corporate policy toward risks. Put simply, no matter how useful a corporation’s ESG principles are to the day-today management of the corporation, they have little use to the board in deciding to sell the corporation for cash or defend it from an unwanted bid. In those situations, Revlon and Unocal keep the board’s focus on maximizing stockholder value and the interest of non-stockholder constituencies are sidelined.