Banking & Capital Markets

States of Grace

The state with the toughest antitakeover statutes? It's not Delaware.
Roy HarrisJuly 1, 2002

Corporate raiders are hardly a company’s top worry these days, with the economy dampening acquisition activity of any kind and even the reemergent T. Boone Pickens sounding less threatening in recent interviews. But even without the barbarians storming the gates, it’s still vital to keep the antitakeover barricades manned.

In certain industries, acquisitive corporations are on the prowl, cautions Northeastern University finance professor Donald Margotta, who expects unsolicited bids to become a wider trend. Further, a change in economic conditions could foster new generations of individual raiders at any time.

“Companies should always be thinking about this,” says Margotta. “As a CFO or CEO you have a fiduciary duty, and it is in the company’s best interests to have a strong takeover defense.” Echoing the position of most defense-minded corporations, the professor thinks shareholders, on balance, benefit from poison pills and other “porcupine” measures–in part because their companies reap higher premiums if takeovers en-sue. (The standard shareholder- advocate position, of course, is that a well-defended firm commands a lower share price, reflecting less exposure to a possible bidding war.)

Where companies feel at all vulnerable, the use of state antitakeover laws can play an important defensive role. States nearly always seek to protect businesses by making hostile bids harder to mount (California and Texas, which have no antitakeover laws, are the major exceptions), and 90 percent of U.S. companies choose to incorporate in states that have antitakeover provisions. The nuances in each statute can affect a company’s ability to resist. Some states, including Ohio and Pennsylvania, install “control-share” clauses, creating obstacles to the purchase of large blocks of stock. Other states, including Delaware, have moratorium laws that infringe less on voting rights, while still presenting barriers to unfriendly offers.

The most obvious time to design defensive strategies is before going public, when choosing a state of incorporation is part of the normal process. But for companies already incorporated, understanding existing statutes, and coordinating the corporate bylaws with them, can improve the ability to counter unwanted advances. It’s best to do this before a firm becomes the target of a hostile bid, says Margotta. “You’re judged by a different standard when you act in the heat of a takeover battle,” he cautions, and courts may toss out your defenses.

Which state laws offer the strongest defenses? Experts usually put Pennsylvania, Ohio, Massachusetts, and Wisconsin on the list, ahead of Delaware, the state usually considered to be most responsive to director needs.

Mary Ann Jorgenson, of the Cleveland-based law firm Squire, Sanders & Dempsey, is especially high on the “Ohio model,” which also combines many stronger elements adopted in other states. “We’re not shy in seriously suggesting that when companies are ready to go public, they consider Ohio” as their state of incorporation, says Jorgenson.

For an illustration of the Ohio law’s effect on a hostile bid, Professor Margotta points to TRW Inc.’s ongoing effort to resist Northrop Grumman Corp. The battle has put both the Ohio statute and the entire hostile-takeover genre in the spotlight. Los Angeles-based Northrop has challenged the constitutionality of Ohio’s law, even while increasing its offering price from $47 to $53 a share since February. “Without that law, Northrop would currently be the proud owner of TRW at the price it originally offered,” says Margotta.

The British Were Coming

TRW’s battle has certainly been on the minds of other companies incorporated in Ohio or other states with particularly strong antitakeover protections. Consider Applied Industrial Technologies (AIT), a Cleveland-based industrial parts and services company that reincorporated from Delaware to Ohio back in the late 1980s, mainly to qualify for what were then brand-new Ohio takeover protections. “The whole idea is to be prepared,” says John R. Whitten, vice president, treasurer, and CFO, who was controller when the company reincorporated.

Like most states that toughened their statutes at that time, Ohio acted in response to a particular hostile bid–British corporate raider Sir James Goldsmith’s pursuit of The Goodyear Tire & Rubber Co. Around the same time, Pennsylvania adopted a strict new standard to help Armstrong Holdings Inc. fend off the Belzberg family of Canada.

The strong antitakeover provisions installed by Ohio may have been the attraction behind AIT’s reincorporation, says Whitten, but the company first sought feedback from consultants about the potential effect on its stock price; all advised that it wouldn’t be material. Shareholders approved the incorporation change with little debate.

Central to the Ohio law is the control-share provision, which blocks the purchase of more than a 20 percent interest in a firm unless the acquirer first wins majority approval from holders of the other shares. The Ohio control-share statute is still considered among the nation’s strongest, even though half of U.S. states now have adopted similar provisions. A restriction on arbitrageurs, however, set Ohio apart from other states. This law limits voting power for those who purchase shares for short-term gains, and requires them to disgorge to the target firm any short-term deal profits over $250,000.

Ohio also includes an “expanded constituency” section describing a director’s duty as being to “the long-term as well as short-term interests of the corporation and its shareholders,” and to a range of other stakeholders, including employees, suppliers, creditors, and customers. “This fits in well with [J.M.] Smucker’s values and philosophy, and we think that it is an important and appropriate thing for a state to encourage,” says Steven J. Ellcessor, vice president, finance and administration, and CFO of the Orrville, Ohio-based food-products concern. The Ohio statutes, under which Smucker is incorporated, “help keep control of the company in the hands of the directors,” which is where shareholders want it, he says.

Ohio further helps companies by applying a favorable “business judgment rule,” says attorney Jorgenson, who also is chairman of the American Bar Association’s committee on corporate laws. Ohio law says that “if directors act with care, decisions will not be second-guessed by judges, including decisions regarding takeovers.” In Delaware, on the other hand, directors have, on occasion, been second-guessed by judges.

“Just Say No”

For all their various benefits, the Ohio statutes distill down to one big advantage for AIT’s Whitten: “Basically, we can just say no,” if the board finds fault with a hostile offer. AIT and Smucker both merit high takeover-resistance scores–9.25 and 9.5, respectively, on a 10-point scale–from, a New York-based research firm specializing in “takeover defense intelligence.” The applicable state law, however, is one of many elements in the rating, says company president James Sussmann.

AIT’s defenses don’t rest entirely on the strong Ohio law, points out Jorgenson, who counts the company as a client. In fact, as part of a plan to increase its takeover defenses, AIT “opted out” of Ohio’s control-share provision , she notes. As strong as the current state law is, “in the statute there’s no remedy if a hostile bidder abuses the control-share provision,” she explains. After opting out, AIT wrote the original statute provision into its own articles of incorporation, then established that a hostile bidder can lose its voting rights if it acts improperly. Further, AIT’s articles require potential acquirers to promise that they intend to complete an acquisition, and have the capacity to do so.

“Many states have protective provisions,” says Jorgenson, “and they can be tailored in the way we’ve tailored these.” Companies may also opt out of particular state statutes to avoid what they see as harsher elements of various state provisions. Some companies, for example, may exclude themselves from laws they believe go too far in inhibiting shareholder voting rights, or that they fear could discourage interest from potential acquirers, friendly or unfriendly. After Massachusetts passed a law requiring firms to have staggered boards, a number of companies opted out of that provision.

In general, a company like AIT designs its blend of defensive measures to make sure that its corporate directors have the final say in sorting the good deals from the bad, according to Jorgenson. “When somebody just throws an offer over the transom with a 50 percent premium,” she says, it is the board alone that should be able to determine if that’s “not a significant number.”

Roy Harris ([email protected]) is a senior editor at CFO.

Discouraging Hostilities

Some state-based defenses to make unfriendly bids less tempting.

Control-Share Laws (25 states)*

Let other holders vote on whether they want hostile acquirers in control. In Massachusetts, acquirers seeking more than a 20% holding must win a majority approval before they can vote their shares. Ohio requires acquirers to win the majority vote before they can purchase shares beyond 20%.

Merger-Moratorium Laws (25 states)*

Prevent acquirers from completing a merger quickly. Some provide “exception levels,” granting earlier mergers if a tender offer wins certain degrees of shareholder support. Delaware’s is 3 years, unless 85% of shares are tendered. Georgia provides for 5 years and 90%, and Wisconsin 3 years, with no exception level.

Expanded Fiduciary Laws (30 states)*

Use language to say corporate boards “may” or, in some cases, “must” consider constituencies, including communities, customers, employees, and shareholders. In Pennsylvania, directors need not consider any one constituency as dominant.


Source: Prof. Donald Margotta