How Would Shareholders of Bear Fare in Delaware?

[WSJ_law_blog]

At the markets’ close today, Bear Stearns shares were trading at $5.33. It’s not much compared to where the stock was trading early last year, but it’s a significant premium over the $2.34 per share recently offered by J.P. Morgan Chase.

As the WSJ reported this morning, Bear bondholders were partly responsible for the stock’s rise yesterday. Some are eager to see the deal get done and avoid a bankruptcy, so they’re buying up shares to increase their voting position on the deal. That said, the story hinted at the possibility of disgruntled shareholders rejecting the deal outright.

An up or down vote isn’t shareholders’ only recourse. They could — drum roll please — sue to enjoin the deal.

But would would such a suit look like? Could Bear shareholders possibly mount a winning challenge? We here at the Law Blog are too many years removed from our second-year corporations class to come up with a cogent analysis on our own. (All we remember from corporations — or Enterprise Organizations, as it was called at Michigan back in the day — is the phrase ultra vires. But we haven’t the foggiest idea what it means.)

So we checked in with an expert to help us out, this time Gordon Smith, a professor at BYU Law School and contributor to the Conglomerate blog. Smith didn’t have a lot of time — he was rushing out to teach class, but did give us a stellar overview. Let’s put it in his own words:

Okay, professor Smith, so what would a lawsuit look like? We’re presuming it would be filed under Delaware law, right?
In all likelihood. The shareholders might first argue that the Bear Stearns board breached its fiduciary duty to shareholders. But here’s the thing: With stock-for-stock transactions, which the Bear-J.P. Morgan deal is, Delaware courts generally apply the business judgment rule, which allows for broad deference to board rulings. In cash-for-stock deals, under the old Revlon case, the courts apply an enhanced level of scrutiny. But all-stock deals are harder to challenge.

Huh. Why the difference?
Well, I’m not sure it’s a rationale that makes perfect sense — and it’s been criticized widely. But the theory is that in a stock-for-stock deal, the market is essentially setting the price, and courts are typically reluctant to second-guess the wisdom of the market. But when you have a cash-for-stock deal, there’s a greater likelihood that shareholders will be taken advantage of.

Okay, so in this instance, it’d be a losing case for Bear shareholders?
Probably, if the court held that Revlon didn’t apply and went with the business judgment rule.

Any other lines of attack for shareholders?
Well, the most likely course of attack for shareholders would be a Unocal attack. I’m sure you guys studied the Unocal case in your corporations class. Unocal is another seminal Delaware case. It addresses the validity of defensive mechanisms, which are provisions the parties embed in a deal to keep it from falling apart. They include termination fees, no shop provisions, and a host of others.

Is there one in the Bear-J.P. Morgan deal?
There is. It’s very interesting. It’s provision 6.10, and it says that if shareholders reject the deal, JP Morgan can go back and renegotiate and Bear shareholders can’t accept a different deal until a year from now.

Have you ever seen a provision like that?
I haven’t. It’s probably a Wachtell innovation and it’s very clever. Under Unocal, if a court finds that a provision does, in fact, qualify as a “defensive mechanism,” then they apply a heightened standard of scrutiny to the deal. It’s my guess that that’s probably what would happen.

And under this enhanced level of scrutiny, what would a court look at?
The court would look at whether Bear directors had interests other than the shareholders’ in mind when they made the deal. It’s often hard to tell what a board’s interests might have been. A situation which sometimes comes up under Unocal is that the board wanted to avoid being sued by someone else, like bondholders, and figured that a sale would assuage them.
In the course of this review, a court could look at whether the defensive mechanism precludes someone else from coming in and proposing a better deal.

Well, that sounds exactly like what the provision does!
I’m not sure it’s so easy a case. There’s a lot of case law out there, and analogies to be drawn by either side. But it does appear to me that this provision has some preclusive effect.

So shareholders would at least have a colorable claim here, right?
Making predictions like this is always dicey, but I’d say yes, they’d have a colorable claim.

Thanks for taking the time.
No problem.