If you happen to control a public company and want to buy out the remaining shareholders, avoid the mistakes made by the American Financial Group in its attempt to squeeze out the minority at the National Interstate Corporation.
The American Financial Group owns 51.7 percent of the National Interstate Corporation, a specialty property-casualty insurer. On Feb. 5, the American Financial Group, known in the Midwest by its Great American Insurance brand, started a tender offer at $28 a share to acquire the remaining shares in National Interstate that it does not already own.
These types of buyouts are perilous for minority shareholders, because the majority can use its control to force minority shareholders to receive a lower price. Because of this, there is now a well-worn procedure for tender offers of this type dictated by Delaware laws designed to protect minority shareholders from being coerced.
Typically, a controlling company will begin the tender offer and condition it on getting the majority of the minority of shareholders to agree to sell their shares. The controlling company is also required to make no threats that it will use its control to harm the minority shareholders, since such threats would otherwise be seen as pushing minority shareholders into accepting the offer.
In addition, the board of the target company sets up an independent committee with independent advisers who will make a recommendation as to whether the tender offer should be accepted. If the controlling firm does this, then the courts in Delaware - where many publicly traded companies are incorporated â€" will not interfere with the tender offer since it will be viewed as being noncoercive toward minority shareholders.
None of this was done in the case of American Financial’s buyout offer.
Instead, American Financial began its offer without a majority of minority condition. To boot, the group has arguably made those troublesome threats, including stating that it might buy shares at a lower price, change its dividend policy or remove protections for minority shareholders. These are threats that appear specifically designed to push National Interstate shareholders into tendering.
As for the National Interstate board, six of the 10 members are affiliated with American Financial and therefore not independent. These directors control the National Interstate board, and they have refused to set up an independent committee.
Instead, the National Interstate board voted to arrange to have management hire an investment banker: Duff & Phelps (another no-no, this should be done by the independent directors to ensure there is no conflict).
What happened next can only be put in the bizarre realm of corporate shenanigans. At a Feb. 17 board meeting, Duff & Phelps told the board that it could not provide a fairness opinion at the original offer of $28 a share, and that the price was indeed too low.
According to The Wall Street Journal, a board member, Jeff Consolino, who is also the chief financial officer of American Financial, then offered $30 a share. He then asked Duff & Phelps if that higher price was appropriate. When the investment bank declined to opine on that, the meeting ended.
Duff & Phelps subsequently resigned. Thereafter American Financial raised its offer to $30 a share calling it its “best and final†offer. On Feb. 18, the board â€" without Duff & Phelps’s opinion â€" voted 6 to 4 to remain neutral with respect to the offer. I should note that before the tender offer was made public, National Interstate was trading at $22 to $23 a share. Today, its stock is above $30 a share.
There was no response to a request to National Interstate for comment.
Let’s be clear: if this were litigated in Delaware, the lawyers would be having a field day. At a minimum, the board’s actions in considering the offer from American Financial appear deeply flawed. In particular, the failure of the board to receive proper financial advice would not only cause Delaware judges to halt the transaction in its tracks, but also subject the directors to liability.
More telling, in Delaware, the board would arguably have a duty to fend off this “hostile†tender offer since it appears underpriced as Duff & Phelps determined (albeit at $28 a share).
In a number of cases Delaware courts have implied that boards have an affirmative duty to adopt a poison pill to ward off an offer by a controlling shareholder who undervalues the company. The board in iBasis did just such a thing back in 2009 to fight off a squeeze-out offer by the Dutch telecom company KPN.
But National Interstate is an Ohio company. The law is different there (full disclosure, I’m a professor at Ohio State University and love Ohio for all its good and bad corporate law).
For starters, it’s unclear whether controlling companies have any special duties in squeeze-out transactions under Ohio law. There are a few lower court cases from more than a decade ago, which ruled that there are none.
More specifically, the cases state that where the injury is to all shareholders and is solely over an unfair price, there are always appraisal rights, the right of a shareholder to have the court determine the value of their shares. It’s also unclear whether the Ohio Supreme Court would rule in the same manner, but there is law sustaining this at the lower court level.
In addition, American Financial has stated it may close its offer even if it does not get to the 90 percent threshold at which it can squeeze out the minority in a merger automatically without a vote, triggering appraisal rights. If American Financial only reaches 89 percent for example, then appraisal rights wouldn’t be available.
As for the board’s obligations, there is not a lot of Ohio law on this either. But Ohio sets forth the duties of directors in its corporate law. The statute specifically states that a director has not breached these duties unless “the director has not acted in good faith, in a manner the director reasonably believes to be in or not opposed to the best interests of the corporation.â€
A breach of these duties should be grounds for an injunction, an order by the court halting American Financial’s offer. Given the facts here, there appears to be a possible claim for an injunction.
This type of conduct - acting in the interest of the controlling entity rather than the public shareholders â€" is exactly the type of conduct meant to be addressed. Particularly problematic is the failure of the directors to act to defend the company, something Ohio law is quite clear on.
Given the uncertainties, you would have thought that the board here would have done a better job in setting up the buyout procedures, and American Financial Group would have been more careful to at least appear neutral. No doubt they are relying on Ohio law to get them through, but there is a sloppiness and amateurism here.
Building on this, the mutual fund firm T. Rowe Price, which owns about 8 percent of the company, filed an open letter to the six directors on Tuesday, complaining that the process here was “appalling†and that it would not participate in the offer. Without that support, it looks as though there is no way that American Financial will reach that 90 percent threshold.
Despite all of the problems with this deal, the intricacies and lack of certainty have scared away the plaintiffs’ lawyers. While you normally see oodles of suits around this, to date there are only two actions in local Ohio courts in two different counties: Summit and Hamilton counties (Hamilton is Cincinnati. Summit is Akron).
There was a hearing Tuesday morning in Ohio state court in Summit County. The judge ordered further briefing on a jurisdictional issue, namely whether this case should be dismissed in favor of the first-filed Hamilton County case.
If that occurs, then the action will shift to Cincinnati. We’ll then hopefully see what Ohio law really says about these actions. But before that happens, given T. Rowe Price’s actions, it may be that shareholders push this to a head first.
