(Reuters) - We will never know if consolidated shareholder litigation to block Fujifilm’s $6.1 billion acquisition of Xerox Corp would have turned out differently had it taken place in Delaware Chancery Court instead of New York State Supreme Court. But a dramatic decision in the Xerox case has spurred lawyers and academics to ask whether Delaware has become too deferential to corporate boards.
On Friday, Manhattan State Supreme Court Justice Barry Ostrager issued a preliminary injunction barring Xerox from holding a shareholder vote on the proposed Fuji merger at its annual meeting in June. After a two-day evidentiary hearing in which Justice Ostrager heard live testimony from eight witnesses, including Xerox’s CEO and the chairman of its board, the judge concluded the Fuji deal was so tainted with conflict that it was likely the CEO and the board, abetted by Fuji, had breached their duty to Xerox shareholders. The judge also ruled that Xerox must allow activist shareholder Darwin Deason to nominate an alternative slate of directors at the meeting in June.
Ostrager blocked the deal even though a highly credentialed board unanimously approved the Fuji offer and no bidder has emerged with better terms than the complex, no-cash transaction Fuji proposed. Xerox’s lawyers at Paul Weiss Rifkind Wharton & Garrison had argued that the board’s fully-informed approval, which came after 10 months of board-supervised negotiations and some heated internal debate, showed independent directors acting carefully to decide what’s best for shareholders.
Justice Ostrager found that depiction to be not credible, adopting instead the account of events proffered by Deason’s lawyers at King & Spalding and lead shareholder class action counsel from Grant & Eisenhofer and Bernstein Litowitz Berger & Grossmann. In their depiction, Xerox’s CEO, Jeff Jacobson, was on the verge of losing his job under pressure from activist Carl Icahn, who, along with Deason, controls about 15 percent of Xerox shares. As Xerox’s board was searched for Jacobson’s replacement, Jacobson stepped up desultory talks with Fuji, a Xerox joint venture partner, proposing a deal structure that would minimize Fuji’s cash outlay. Fuji executives, sensing an opportunity to take advantage of Jacobson’s precarious state, promised to keep him in charge. And the board, despite some early opposition, went along with the deal because Fuji pledged to retain five Xerox directors after the merger.
The judge agreed Jacobson’s priority in the Fuji deal was his own job – and the board didn’t give enough weight to Jacobson’s conflict. “Once Jacobson learned that he had been targeted for replacement by Xerox’s largest shareholder and eventually the board itself, he abandoned the board’s request to obtain a value-maximizing all-cash transaction and engineered the framework for a one-sided deal that includes Jacobson retaining his position as CEO post-transaction,” wrote Justice Ostrager (who was formerly an ace corporate defense litigator at Simpson Thacher & Bartlett). “There is ample evidence that he collaborated with Fuji to make himself indispensable to the transaction.”
One of the most damning documents, which Ostrager said would have been sufficient by itself to prove the board’s likely breach of its fiduciary duty, was a text message, witnessed by board chairman Robert Keegan and another director, in which Jacobson told a high-ranking Fuji executive that he and Fuji were a “team” aligned against Icahn, their “mutual enemy.”
From nearly the beginning of the litigation, said Deason lawyer Richard Marooney of K&S and shareholder class action lawyer James Sabella of G&E, Ostrager was determined to hear from Xerox witnesses, not just lawyers on both sides. Last month he set a punishing pre-trial schedule, including a pair of depositions in Japan of Fuji witnesses. “He did it right,” said Marooney, who credited his firm’s New York litigators for running at the judge’s fast pace. He wanted to understand the facts, and not just on paper. He wanted to get to the truth.”
That hearing probably wouldn’t have happened, said shareholder lawyer Sabella, if this case had been litigated in Delaware. As recently as 2012, Delaware judges would, in rare instances, enjoin transactions. In 2011, Vice-Chancellor Travis Laster blocked a shareholder vote on a $3.5 billion leveraged buyout of Del Monte because of its financial advisor’s alleged conflicts. The following year, Chancellor Leo Strine (now Chief Justice of the Delaware Supreme Court) enjoined Martin Marietta’s hostile tender offer for Vulcan Materials.
But in 2014’s C&J Energy Services v. City of Miami General Employees’ and Sanitation Employees’ Retirement Trust, the Delaware Supreme Court reversed an injunction against C&J’s merger with Nabors Industries. The state justices essentially said that when independent boards exercise their business judgment to approve strategic mergers – and give shareholders a right to vote on the deals – Chancery Court should not stand in the way, particularly if there’s no competing bid for the company.
Since then, said Harvard law school professor Guhan Subramanian, the trajectory in Delaware Chancery Court has been away from scrutiny of deal processes. Subramanian, who was an expert witness for shareholders in the Xerox case, said he was impressed that, in contrast to Delaware courts in recent years, Justice Ostrager was willing “to engage in a meaningful way” with details of the deal.
Even if Delaware judges were deciding the Xerox case based on the record developed before Justice Ostrager, said Brooklyn Law professor Minor Myers, they might well have rejected shareholder attempts to block the deal. “You could easily image a Chancery judge, with all the factual findings, nevertheless saying, ‘I’m going to let shareholders vote,’” said Myers, who was not involved in the Xerox case but read Friday’s ruling.
It’s going to be interesting, said shareholder lawyer Sabella, to track whether shareholders who suspect deals were tainted by real conflicts try to find a way to bring their cases in New York after the Xerox decision. Xerox is incorporated in New York, so filing in state court in Manhattan was an easy call for its shareholders. But for shareholders of Delaware-incorporated companies headquartered in New York, “this decision is going to make New York a more attractive jurisdiction,” Sabella said.
I emailed Xerox counsel Jay Cohen of Paul Weiss and Fuji lawyers Erik Olson and James Hough of Morrison & Foerster but didn’t hear back. Xerox told Reuters on Friday that it will appeal Justice Ostrager’s ruling. “The company strongly believes that its shareholders should be allowed to exercise their right to vote on the transaction and decide for themselves,” Xerox said. “The Xerox board undertook a rigorous process to reach its decision to approve the proposed transaction, including a comprehensive review of the company’s strategic and financial alternatives, as well as potential transaction structures in its negotiations with Fujifilm.”