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There Is No Such 40% Rule In DelawareAnd It’s a Good Thing For Bear Shareholders Too

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Despite reports to the contrary on CNBC and the New York Times, there is no precedent in Delaware law that allows a company to sell up to 40 percent of their shares without shareholder approval. Rather, there is a rule-of-thumb employed by lawyers advising clients incorporated in Delaware that tells them deals shouldn’t lock-up a sale of more than 40% of the shares if they don’t want to risk the wrath of the courts. But the rule is cobbled together from reading a variety of Delaware cases, and it has never been tested in the courts.
At issue, as Gordon Smith explains on The Conglomerate, is whether a deal will be seen as coercive or precluding minority shareholders from exercising their franchise. In one early case, the Delaware Supreme Court struck down a deal in which 65 percent of the shareholders agreed to vote for a transaction in advance of the shareholder vote. In a later case, a lock-up deal was upheld by the courts when it required the final approval by a majority of the outside shareholders to approve the deal. Lawyers put the two together and came up with the rough-and-ready rule of thumb that if you didn’t lock-up more than 40% of the shares before the shareholder vote, you’d probably be okay.
“The bottom line is that JP Morgan is trying to lock up the acquisition of Bear, but it can't be too aggressive without triggering the wrath of the Delaware courts,” Smith writes. “39.5% plus the shares of the Bear directors who ‘have indicated that they intend’ to vote for the revised deal should get them to about 45%, and that may be enough to bring the deal home.”
This has important implications for Bear shareholders and may explain why the deal has progressed the way it has. Bear’s board had promised to sell JP Morgan 20% of the company, even if Bear’s shareholders rejected the deal. The fact that they didn’t promise more may well indicate that they didn’t feel comfortable with going as high as the 40% rule would presumably allow.
With a much higher bid in their pocket, however, they now have a better story to sell to shareholders—we got $1 billion more by just promising another 20% of the company—and, if necessary, to the Delaware courts. The board no doubt hopes that these facts will make it look as if it was acting in the interests of shareholders throughout the negotiations.
39.5%? [The Conglomerate]