If you want to see one possible dystopian future for takeovers, you should take a gander at what is going on in the takeover bid for CommonWealth REIT, a real estate investment trust that owns more than 500 office buildings. It’s not pretty, and it’s all a result of  CommonWealth’s clam that all its disputes with shareholders must be arbitrated.
In some ways, the contest for CommonWealth is a fairly normal hostile bid with heated rhetoric, lots of litigation and managers who have grown rich from operating the company and who do not appear to want to go quietly.
In February, Corvex Management, a hedge fund headed by a former employee of Carl C. Icahn, and the Related Companies announced the acquisition of 9.8 percent of CommonWealth and an offer for the REIT at $25 per share, threatening to go hostile if CommonWealth failed to enter into negotiations to sell to the two new shareholders. The two shareholders also demanded that CommonWealth halt a stock offering of 27 million shares.
CommonWealth ignored the demand. Corvex and Related responded as you would expect. They sued in Federal District Court in Boston to stop the offering, but failed to persuade a judge to halt the sale.
Corvex and Related, meanwhile, also raised the ante by starting a hostile offer and a consent solicitation to remove the board. The consent solicitation requires that two-thirds of Commonwealth’s shareholders agree.
This is a high threshold, though, and there are lots of other barriers to the takeover bid.
CommonWealth has stiff takeover defenses, including a poison pill that limits Corvex and Related to acquiring no more than 10 percent of its shares. The company also has a staggered board. Ordinarily, that would mean that all the directors couldn’t be unseated at once, because only roughly a third are up for election in any given year.
The two provisions would ordinarily make a takeover of Commonwealth quite difficult because it would take two years to replace a majority of the board’s directors and force the redemption of the poison pill.
But there is a flaw in CommonWealth’s organizational documents.
CommonWealth directors can still all be removed and replaced at any time by written consent without cause outside the company’s annual meeting. This is a way around the poison pill. Corvex and Related can simply remove these directors and replace them with new people who will redeem the pill.
CommonWealth is led by  Adam Portnoy, the president, and his father, Barry Portnoy, who founded the company. They are two of the five trustees on CommonWealth’s board. CommonWealth itself has no employee managers. And so the Portnoys also lead the management company that runs CommonWealth for a fee. The Portnoy’s management company was paid $77.3 million last year to operate CommonWealth.
But while the fee appears to be lucrative, CommonWealth’s returns are not. From Jan.  1, 2007, to Jan. 15, 2013, its stock price  declined almost 68 percent.
Perhaps not surprisingly, given the money at stake, CommonWealth, whose ticker is CWH, has fought a vicious defense. Its board had rejected the funds’ offer and the company has stated that Corvex and Related’s bid would allow the funds “ to seize control of CWH for their own benefit, or, alternatively, to realize a quick profit by forcing a sale of CWH before the full benefits of CWH’s current business plan are realized.â€
CommonWealth has also fought this bid not on the merits but through legal machinations.
On March 1, CommonWealth’s board passed a bylaw amendment that purports to require that any shareholder wishing to undertake a consent solicitation must, among other things, own 3 percent of the company’s shares for three years. This is an extremely aggressive position that if upheld would stop Corvex and Related in their tracks.
Not satisfied with this attempted knockout blow, CommonWealth appears to have lobbied the Maryland Legislature to amend the Maryland Unsolicited Takeover Act. This law allows companies to have a mandatory staggered board.
CommonWealth already has such a board, but the company has also reportedly lobbied the legislature to make a change that companies opting into this statute would now be unable to have their directors removed by written consent. Again, this would kill Corvex and Related’s campaign. When the two funds got wind of this, they fought back, and the Maryland legislature adjourned without adopting CommonWealth’s proposal.
CommonWealth still announced this week that it had opted into the act. The REIT is claiming that even though the Maryland Legislature did not adopt any amendment, the law still implicitly has this requirement. The funds will now have to sue CommonWealth to force them to change their interpretation.
So, let’s just start by acknowledging that this a particularly nasty contest, but that legislative maneuvers and extreme bylaws are not unusual in these situations. Just recently, Iowa adopted a mandatory staggered board requirement after Iowa-based Casey’s General Stores was subject to a hostile bid.
Still, shareholder governance experts are likely to view CommonWealth’s actions as over the top. And we can probably all agree that they are not the most shareholder-friendly actions.
Not only that, but if CommonWealth were a Delaware company, where most public corporations are incorporated, the judges in that state would have a field day with CommonWealth’s actions. The bylaw amendment would be struck down almost immediately.
But CommonWealth is a Maryland REIT.
This does not end the matter. CommonWealth’s acts are also likely to be viewed as extreme by a Maryland court, and Related and Corvex are suing in Maryland State Court to obtain this determination.
The problem is not Maryland law, but that CommonWealth has a bylaw provision that requires all shareholder disputes to be arbitrated. When CommonWealth filed for an initial public offering, it included a provision requiring arbitration of all shareholder disputes in its charter.
The Securities and Exchange Commission frowns on these provisions and forced the REIT to remove it.
But CommonWealth refused to give up, and after its initial public offering,  the  board on its own and without shareholder approval adopted a requirement that all shareholder disputes be arbitrated.
CommonWealth is now claiming that the dispute in the Maryland court should go to arbitration. Corvex and Related are protesting, claiming that the shareholders never consented to arbitration and that moreover the requirement is illusory because it puts CommonWealth in control of the arbitration.
In defense, the REIT Â asserts that by buying shares with knowledge of the bylaw, shareholders implicitly accepted this bylaw.
CommonWealth is again taking an aggressive position, but the courts have been trending toward increasing acceptance of arbitration even with these types of consents. Still, no court has yet to go this far.
But while they are protesting, Corvex and Related are hedging their bets and proceeding with arbitration on a parallel track. You can get an idea of each parties’ attitude from their choice of arbitrators. The funds have picked William B. Chandler III, the former chief of the Delaware Chancery Court, the nation’s preeminent corporate law court, as their arbitrator.
CommonWealth, meanwhile, has selected a person whom Corvex and Related allege is a friend of the Portnoys and sometime business partner (CommonWealth’s bylaw specifically allows for the arbitrators to have a relationship with the parties). The two arbitrators will now select a third arbitrator. And when will a decision be rendered? Who knows - this could take years.
And this is the problem. No matter if they are wrong under the law, CommonWealth can use the arbitration process to delay this for years. And any arbitration is likely to be done in secret with no real right of appeal.
And this is why this case is so important. If the Maryland court upholds CommonWealth’s arbitration provision, more companies like Commonwealth can simply adopt these bylaws. They can then take aggressive positions to resist a takeover, and the results will be sent to the black hole of an arbitration conducted in secret and with no timeline for an outcome.
So the real question is what the Maryland court does and whether it upholds the arbitration provision. To my knowledge, no court has ever ruled on whether shareholders are required to arbitrate their claims through a bylaw amendment passed by a board but not shareholders. But with no compromise in sight, we’re about to get our first ruling with real consequences for the takeover market.
