Change of Control Board: Federal Preemption of the Law Governing A Target's Directors

Abstract

This article sets out a proposed federal uniform standard governing the actions by the board of directors of a publicly held corporation that is the target of a change of control transaction. This proposal would apply in each of the following four merger and acquisition transactions: (1) the acquisition of a target in an arm's length negotiated merger or acquisition; (2) the acquisition of a target in a management buyout; (3) the proposed acquisition of a target in a hostile tender offer; and (4) the acquisition by a target's controlling shareholder of the minority interests in such target in a freezeout merger. Under this proposal, an independent and knowledgeable change of control board would be appointed for the target, and this board would have complete authority over the acquisition process. Because of the board's obvious independence, a uniform governance standard, the business judgment rule, would apply in determining if the board acted properly. Thus, this article proposes that federal law preempt state law rules governing the actions of a publicly held target's board in each of these transactions. However, this is only a default rule because a corporation's shareholders could elect not to have the provision apply or could elect to have it apply only in certain circumstances, such as in a hostile tender offer. The adoption of this provision would enhance the competition for corporate governance rules in change of control transactions. This proposal would replace the four separate governance rules generally applicable to a target's directors under Delaware and other state law in arm's length transactions, management buyouts, tender offers, and freezeouts. This article also rejects the four sets of rules proposed for these transactions in the American Law Institute's PRINCIPLES OF CORPORATE GOVERNANCE: ANALYSIS AND RECOMMENDATION. This proposal would also override all state takeover laws, such as control share statutes, business combination statutes and disgorgement statutes, which generally have the purpose or effect of protecting incumbent management. By placing the control of the change of control process in the hands of truly disinterested directors and applying the business judgment rule in all cases in which a change of control board acts, this proposal should cure the problem of unpredictability and vagueness, should result in a substantial decrease in litigation in change of control situations, and should enhance the efficiency of the change of control market.