Can PeopleSoft’s Defense Survive a Challenge?

The long-running takeover battle between software producers Oracle Corp. and PeopleSoft Inc. has generated a novel defensive ploy that attempts to use PeopleSoft’s customer base as a barrier to Oracle’s unsolicited bid. Under the plan, following an acquisition by Oracle or any other company, PeopleSoft could be required to pay large sums of money to PeopleSoft customers and in effect exact a hefty monetary penalty on the acquirer. Unlike most traditional antitakeover devices embedded in a company’s charter or bylaws (e.g., classified board, fair price provisions, supermajority votes, or supervoting share classes), or a shareholder rights plan, PeopleSoft’s “Customer Assurance Program” utilizes the target’s own business operations to create an economic disincentive to fend off an unwanted buyer. As a result, the program straddles the line between legitimate concerns for customer care and generation of new business and a bold, potentially unlawful attempt to make a hostile acquisition prohibitively expensive. PeopleSoft stockholders and Oracle have challenged the Customer Assurance Program and a Delaware court is likely to adjudge this spring which side of that line this program falls. The determination could have broad ramifications because it will address the extent to which other unwilling targets may entwine ordinary business practices – care and feeding of customers – with defenses against hostile bids. As described by PeopleSoft, the Customer Assurance Program generally would require PeopleSoft, under certain defined circumstances, to make payments to customers ranging from two to five times the value of the respective customers’ contracts. In general, the program provides that if PeopleSoft is “acquired” within a two-year period after a customer contract is signed, the payments would be due if PeopleSoft products are not adequately “supported” during a four-year period after the contract date. The stated purpose of the program is to allay concerns of potential PeopleSoft customers that, following a takeover, Oracle may attempt to migrate PeopleSoft customers to its own competing products, and would not support PeopleSoft products in which the customers had invested. (Oracle has announced a 10-year commitment to support the PeopleSoft product line after initially suggesting it might phase out PeopleSoft’s offerings). Of course, the program also could function as a “poison pill” to deter a takeover. At the very least, the program introduces risk and limits the flexibility of a potential acquirer in running the business. Moreover, the support obligations are complex and would be an invitation to litigation even if a good-faith effort to comply were made, particularly given the amount of money involved. This represents a clear distinction from a rights plan, which threatens the potential acquirer with dilution and generally has no impact on the target’s financial condition. More importantly, in profound contrast with typical rights plans, which may be modified following their adoption to permit a transaction supported by the target’s board, the program exposes PeopleSoft to potentially crippling liabilities in the event of any acquisition. A long line of Delaware Supreme Court cases provide instructive guidance in considering reasonable and unreasonable responses to acquisition offers (see sidebar). Under the Delaware Supreme Court’s famous Unocal decision in the 1980s, board adoption of defensive measures in the face of a hostile bid is subject to “heightened scrutiny” of the basis for and reasonableness of the action. Under the Unocal test, assuming PeopleSoft’s board reasonably determined that the Oracle offer constituted a threat to PeopleSoft, the question is whether the program is reasonable in relation to the threat posed. The answer is less clear. On the one hand, it appears plausible that prospective customers may be concerned that support for PeopleSoft products might be reduced following a takeover, and that their inclination to purchase products might be enhanced by the protections. Moreover, significant business contracts commonly contain provisions relating to assignments and changes in control that commonly trigger the customer’s rights to consent to a new business relationship or to terminate the contract. Debt instruments routinely provide for acceleration under similar circumstances. On the other hand, the financial impact of the program could effectively preclude any acquisition of PeopleSoft for at least two years. As of mid-January 2004, the aggregate value of PeopleSoft’s outstanding shares was less than $8 billion. Analysts estimate that, based on contracts entered into through that date, an acquirer of PeopleSoft could be obligated to pay customers in excess of $1 billion if payments under the program were triggered. Moreover, the PeopleSoft program ensures continued product support only in the event of a takeover, though customers presumably would be concerned about a withdrawal of support under any circumstance. The program would have been almost unassailable if it had been adopted essentially as a warranty – a four-year guaranty of support without regard to a takeover. However, PeopleSoft did not commit itself to the policy absent a takeover, presumably because it would not make sense to make a four-year support commitment in the rapidly evolving software industry. Moreover, the potential that the program might commit PeopleSoft to make payments of up to five times the value of a contract has a punitive character typically disfavored by the courts. Unlike a rights plan, the customer assurance program cannot be disarmed and would apply to other acquisition offers, arguably precluding consideration of a sale of the company for two years. While the board of a Delaware corporation generally does not have a duty to accept an offer to purchase the company, it does have a duty of care to be informed about the affairs of the company, including possible m&a transactions. Impairing PeopleSoft’s ability to enter into a sale transaction that the board might otherwise find in the corporation’s best interests for at least two years could be found to violate this duty of care obligation. Finally, while long-term support may be of particular importance in the software industry, many, if not most, businesses value long-term relationships with groups such as customers, suppliers, employees, the community, etc. Thus, a policy similar to the assurance program likely could be justified by almost every Delaware corporation, providing for a huge liability following an acquisition in the event some vague standard of support were not satisfied. It is also noteworthy that while a number of states have adopted so-called constituency statutes that authorize a corporate board to weigh the interests of such parties against the interests of stockholders, Delaware has not done so. A degree of PeopleSoft’s own discomfort with the legality of the program may be seen in the fact that at least three versions have been employed over time. Based on SEC filings, contracts implementing the program initially defined “acquired” to include not only an acquisition of shares but also replacement of a majority of the PeopleSoft directors within a two-year period, which would occur if an Oracle proxy contest to replace incumbent directors succeeded. Delaware courts are extremely protective of the stockholder franchise in election of directors and the foregoing standard appears to conflict almost directly with relevant precedent. PeopleSoft later issued a letter to customers purporting to change the definition, stating that PeopleSoft would be deemed acquired following the change in board composition only if a change in control of a majority of the shares occurred as well. Subsequently, the reference to the change in board composition was deleted, presumably as superfluous, and definitions related to support obligations were heavily revised. It is always hazardous to predict the outcome of a case involving such complex facts and difficult issues of law. However, absent precedent supporting such a policy, I would counsel great caution to any board considering the adoption of a policy such as the Customer Assurance Program in its current form. Given the efficacy of a rights plan against a hostile tender offer, such a policy might be characterized as a scorched earth strategy, unreasonable under the Unocal decision in relation to the threat posed by a premium cash offer for all shares. Under such circumstances, the adoption of the program would not be entitled to deference under the business judgment rule, and the board would bear responsibility for establishing that the program was entirely fair to the corporation and its stockholders. Moreover, directors are subject to a duty of loyalty – an obligation to act in the best interests of stockholders, and not to use the office for their own benefit. If a court found that the program was not a reasonable response to Oracle’s offer, it might find further that the program was adopted to entrench the board and management in violation of this duty of loyalty. Under such circumstances, the directors could be personally liable to the corporation for any damages suffered as a result. Donald Leo Toker Jr. is a Corporate and Securities Partner in the Washington office of the law firm of Crowell & Moring LLP and an adjunct professor at George Mason University School of Law. Key Delaware Supreme Court Takeover Decisions on Director Responsibilities Smith vs. Van Gorkum (1985) – As part of the duty of care, directors have an affirmative obligation to be informed “of all material information reasonable available to them.” Unocal vs. Mesa Petroleum (1985) – In adopting takeover defenses, a board must have a reasonable basis for finding a danger to corporate policy, and the action taken must be reasonable in relation to the threat posed. The board “does not have unbridled discretion to defeat any perceived threat by any draconian means available.” Moran vs. Household International (1985) – Adoption of a poison pill was upheld based on findings that it would not impair the corporation’s value, prevent all tender offers, or materially affect proxy contests, and that a board would not have “unfettered discretion” to refuse to redeem rights. Revlon vs. MacAndrews & Forbes (1986) – Defensive measures adopted in breach of duty of loyalty are invalid. Blasius Industries vs. Atlas (1988) – Board adoption of a defensive measure that disenfranchises shareholders will not be upheld absent “compelling justification.” Quickturn Design vs. Mentor Graphics (1998) – A provision that would prevent new directors from redeeming a rights pan (so-called “dead-hand pill”) is invalid. Copyright 2004 Thomson Media Inc. All Rights Reserved. http://www.thomsonmedia.com http://www.majournal.com