Apr 29, 2016 @ 11:15
Fighting The Conventional Board Standing
Jeroen van Kwawegen is a partner at
Bernstein Litowitz Berger & Grossmann LLP, where he specializes in
representing investors in disputes with boards of directors and senior
management. BLB&G’s “governance department” has a remarkable track
record and reputation representing institutional investors and
activist funds in breach of fiduciary duty actions and appraisals.
These actions may involve mergers & acquisitions, corporate misconduct
, and the protection of shareholder franchise rights, including the
fundamental right of shareholders to elect their representatives on
the board of directors.
Christopher P. Skroupa: How do
you define your mission in regard to shareholders’ rights?
Jeroen van Kwawegen: My job is to
protect shareholders’ three fundamental rights: the right to sell
shares, the right to effectively vote shares, and the right to hold
fiduciaries managing investor money accountable for misconduct.
Protecting those rights is essential for ensuring the integrity of
boards and management. From our perspective, most boards and
management act in good faith and do a good job. However, in some
circumstances, there is an inherent conflict between the personal
interest of directors versus the interests of shareholders. We become
involved if directors favor their personal desires over the interests
of shareholders. For example, there is an inherent conflict of
interest between directors who want to maintain their office and
shareholders who may want to vote them out. We will become involved if
directors use their corporate powers to, for example, change bylaws or
enter into significant credit agreements with dead hand proxy put
provisions to protect their board seats at the expense of shareholder
Skroupa: What corporate
governance trends and issues are driving your current work on behalf
of your institutional clients?
Kwawegen: Our work often concerns
basic human impulses, such as greed, vanity, and self-preservation.
That will never change. The most recent manifestations of those
impulses have led us to focus on protecting shareholder voting rights.
For example, we have challenged “dead-hand” proxy put provisions in
corporate credit agreements that would put the company in default of
its credit obligations if shareholders ousted a majority of the board.
Such provisions were widespread and served no purpose other than
insulating boards from accountability to their shareholders.
Similarly, we have challenged boards who rewrote election rules in the
corporate bylaws in order to hinder or undermine activist investors.
Skroupa: How do companies respond
when shareholder voting rights are utilized?
Kwawegen: Boards of directors are
given broad powers, subject to their fiduciary duties. Part of that
power is to adopt and change bylaws that provide the administrative
rules for the company’s internal governance. The board of directors
might use its power to amend bylaws to fight off an activist by making
it more difficult for the views of all shareholders to be heard and
for all shareholders to nominate directors. In other words, some
boards abuse their corporate powers to entrench themselves in a fight
with an activist by impairing the fundamental voting rights of all
shareholders. This of course, is improper. If a board believes that
its strategy is better than the strategy proposed by an activist, it
should communicate its views (using corporate funds) and trust that
shareholders will agree and vote the activist proposal down.
Darden Restaurants is a good example. A
few years ago, Darden owned a number of restaurant chains, including
Red Lobster, Olive Garden, Capital Grille, and a couple of others. An
activist investor made a detailed proposal to unlock shareholder value
by placing the mature restaurant chains such as Red Lobster and Olive
Garden in one company and the newer, higher growth restaurants such as
Capital Grille in a separate company – each with their own specialized
management – while Darden’s significant real estate holdings would be
sold to a Real Estate Investment Trust. Darden’s board disagreed with
the proposal and informed shareholders that they instead planned to
sell Olive Garden. This is a perfectly legitimate dispute over the
strategy of the company and from a legal perspective there was no
“right” answer. Another activist investor then informed the Board
that it would call a special meeting of shareholders to solicit their
views and that if those views were ignored it would run a proxy
contest to oust the Board. In response, the Board changed the bylaws
to give the chairman extraordinary powers to suspend shareholder
meetings and to make it more difficult for shareholders to hold
meetings and nominate directors.
Skroupa: What type of jousting
goes on behind the scenes to get the bylaws fixed? How does that
process go when the shareholders don’t see things going their way?
Kwawegen: If there is already a
conflict between one or more shareholders and a Board that is
entrenching itself, it will usually take a credible threat of a
lawsuit to get the bylaws fixed. That is also what happened in Darden,
where we filed a lawsuit and ultimately, after the old board was
ousted, were able to undo the bylaw amendments that harmed the voting
rights of all shareholders.
Skroupa: How important a role
does litigation play in shareholder engagement?
Kwawegen: In my experience,
litigation is an arrow in the quiver of shareholder engagement that
should typically be used as a last resort. The threat of litigation to
enforce investor rights positively affects the balance of power
between boards and the shareholders whose interests they are supposed
to protect. When we do bring a lawsuit, the stakes are high and the
potential impact on shareholder rights is significant. For example, we
just brought a lawsuit challenging a $50 million loan facility that a
financially distressed controlling stockholder Navios Maritime
Holdings (“Holdings”) imposed on its healthy subsidiary, Navios
Maritime Acquisition (“Acquisition”). The loan was on absurd terms and
served no purpose other than to transfer value from Acquisition up to
Holdings at the expense of Acquisition’s stockholders. After we filed
a complaint and injunction papers and the Court scheduled a hearing,
Holdings capitulated, terminating the loan. Smart litigation preserved
$50 million for Acquisition’s stockholders.
Skroupa: How often are companies
open to working with you and making the process less adversarial? How
does your work differ from and overlap with the established
Kwawegen: The majority of
companies fairly engage with their shareholders. And in those cases,
my firm does not become involved. We become involved if the process
breaks down and Boards decide to use their corporate powers to
insulate and entrench themselves for their personal benefit or to
benefit the interests of a dominant stockholder over the interests of
public stockholders. That is the exception not the rule. But in those
exceptional circumstances, Boards are usually not inclined to make the
process less adversarial–at least initially–because they are already
in an adversarial situation. After we explain the basis for a
potential lawsuit, they often understand that we are not taking sides
in the underlying business dispute and are merely seeking to protect
the interest of all shareholders. That understanding can form the
basis for discussion to resolve the dispute, but the company and its
advisors have to get over their instinct to fight us no matter what we
Skroupa: How can shareholders
defend their voting rights when boards use entrenchment devices to
Kwawegen: First they need to
object. Having effective voting rights is fundamental to being a
shareholder. But if objecting does not work, they should consider
hiring counsel to increase the pressure, especially if the
entrenchment devices are implemented while there is a dispute between
shareholders and the board. Boards cannot insulate themselves from
accountability by impairing fundamental shareholder rights.