Dynamics Corp. of America v. CTS Corp.

• Decision Date: 17 April 1986
• Docket Number: No. 86 C 1624.,86 C 1624.
• Citation: 637 F. Supp. 406
• Parties: DYNAMICS CORPORATION OF AMERICA, Plaintiff, v. CTS CORPORATION, Robert D. Hostetler, Gary B. Erekson, Joseph DiGirolamo, George F. Sommer, Gerald H. Frieling, Jr., Don J. Kacek, Ted Ross, and Richard M. Ringoen, Defendants.
• Court: U.S. District Court — Northern District of Illinois

637 F. Supp. 406

DYNAMICS CORPORATION OF AMERICA, Plaintiff, v. CTS CORPORATION, Robert D. Hostetler, Gary B. Erekson, Joseph DiGirolamo, George F. Sommer, Gerald H. Frieling, Jr., Don J. Kacek, Ted Ross, and Richard M. Ringoen, Defendants.

No. 86 C 1624.

United States District Court, N.D. Illinois, E.D.

April 17, 1986.

Lowell Sachnoff, Dean A. Dickie, Sarah R. Wolff, Jeffrey E. Stone, Michael J. Kaufman and Thomas J. Bamonte, Sachnoff, Weaver & Rubenstein, Ltd., Chicago, Ill., for plaintiff.

Stephen C. Sandels, Gary L. Prior, Mark L. Yeager, J. Craig Busey, William P. Schuman and David Marx, McDermott, Will & Emery, Chicago, Ill., for defendants.

MEMORANDUM OPINION AND ORDER

GETZENDANNER, District Judge:

Plaintiff Dynamics Corporation of America ("DCA") filed the present action on March 10, 1986, seeking injunctive relief under Section 14(a) of the Securities Exchange Act of 1934, 15 U.S.C. § 78n(a), in connection with what it alleged to be gun-jumping and unlawful proxy solicitations communicated by defendant CTS Corporation ("CTS") and its management to CTS shareholders. The same day it filed this action, DCA, a 9.7% shareholder in CTS (554,600 shares) announced a tender offer for up to 1,000,000 CTS shares at $43 a share, a premium of $8 over market, and announced an intention to wage a proxy contest to elect its own slate of directors to the CTS board. The offer, if successful, would increase DCA's interest to approximately 27.7% of CTS.

The stated purpose of the tender, as set forth in DCA's Schedule 14d-1 and the Offer to Purchase, is 1) to increase DCA's equity in CTS, and 2) to enhance DCA's ability to obtain control of the company. The offer further states that DCA intends to seek control "by causing its nominees to be elected to the Board of Directors ... at the April 25, 1986 Annual Meeting of the Company's stockholders."

DCA's announcement of the tender led to certain defensive reactions of CTS management and a consequent expansion of the claims before this court. The matter at issue in this opinion is DCA's motion to preliminarily enjoin a shareholder rights plan adopted by the CTS Board on March 22, 1986 for the admitted purpose of warding off DCA's hostile tender offer. Under this plan, CTS shareholders received a dividend distribution of one "right" per share at the close of business on April 3, 1986. The rights are worth nothing unless and until certain "triggering events" occur. The first of these triggering events, or "flip-in" provision, occurs when any person or group acquires 15% or more of CTS's common stock. At that time, the rights become nonredeemable and entitle all holders of CTS stock other than the acquiror (whose rights become null and void) to purchase a unit of CTS securities, consisting of a fractional share of CTS common stock and debentures, at a price equal to 25% of the then current market value (i.e., pre-trigger value) of such securities. The object of this "flip-in" is to inflict on the acquiror an immediate economic loss, and thereby to force all such hostile bidders to negotiate with management before making an unsolicited acquisition.

The second trigger, or "flip-over" provision, occurs upon the acquisition of CTS in a merger, business combination, or the sale of all or the majority of its assets. Upon this "flip-over" event, the right entitles the holder, for an exercise price of $75, to purchase common stock of the company acquiring CTS having a market value of $150.

The heart of this controversy revolves around the "flip-in" provision of the CTS plan. DCA's tender offer is currently oversubscribed, and, under its terms, DCA must purchase the full 1,000,000 shares. Upon so doing, DCA will hold 1,554,600 of the 5,650,800 outstanding shares of CTS stock, or 27.5%. After the flip-in provisions are triggered, however, 1,849,000 flipin shares (all of CTS's authorized but unissued stock) and up to $80,000 in debentures will be issued to all the other CTS shareholders. Assuming that all other CTS shareholders exercise their rights, DCA will then own 1,554,600 of 7,499,800 shares, or 20.7% of CTS, whose own value will decrease because of the new debt issued. According to CTS's own calculations in adopting the plan, this dilution would impose an economic loss of approximately $24 million on DCA should it complete its acquisition.

Governing Law

The parties agree that Indiana law governs the validity of the CTS directors' actions in this case. CTS has further advised the court that Indiana courts generally look to Delaware decisions in matters of corporate law. See, e.g., Shaffer v. General Grain, Inc., 133 Ind.App. 598, 182 N.E.2d 461, 468 (1962); Dotlich v. Dotlich, 475 N.E.2d 331, 343 (Ind.App.1985); Dynamics Corp. of America v. CTS Corp., 479 N.E.2d 1352, 1355 (Ind.App.1985). The parties have both cited and argued controlling Delaware Supreme Court opinions, and the court accepts this characterization of Indiana law as accurate.

Standards for Injunctive Relief

A preliminary injunction should issue upon the following showings: 1) the movant must show a probability of success on the merits; 2) that it has no adequate remedy at law and will suffer immediate and irreparable injury if injunctive relief is not granted; 3) that the harm of not granting an injunction outweighs the irreparable harm that defendants may suffer if the relief is granted; and 4) that an injunction will not harm the public interest. Roland Machinery Co. v. Dresser Industries, Inc., 749 F.2d 380, 386-88 (7th Cir.1984). Although the Seventh Circuit has on occasion engrafted certain formalisms onto this traditional test, see, e.g., American Hospital Supply Corp. v. Hospital Products Ltd., 780 F.2d 589 (7th Cir.1986), the traditional formulation of the test still governs. Lawson Products, Inc. v. Avnet, Inc., 782 F.2d 1429, 1432-36 (7th Cir.1986).

Legal Discussion

Because of time pressures, the court will not relate a separate narrative of facts, but simply discuss the facts as they bear on the court's ultimate determination. DCA has alleged that CTS's shareholder rights plan, a variant of what has commonly come to be known as a "poison pill," is illegal and should be invalidated. In particular, DCA argues that the rights plan unlawfully establishes two classes of stock and unlawfully discriminates among shareholders, and that Indiana law, which governs this claim, prohibits its implementation. Alternatively, DCA argues that defendants breached their fiduciary duties to CTS and its shareholders by adopting the plan in response to the DCA tender offer.

To support the first of these arguments, DCA notes that the CTS Articles of Incorporation do not authorize the board to issue classes of shares with different "relative rights, limitations, preferences and qualifications" and that CTS shareholders have a statutory right to vote on any amendment to those Articles which would create a new class of shares. Ind.Stat. Ann. § 23-1-4-4(a)(8). Because the rights plan effectively creates one class of shares with enhanced voting power and dividend rights based on whether the stockholder owns in excess of 15%, DCA claims that the CTS rights plan violates these statutory restrictions.

The court disagrees. Corporations organized under Indiana law are empowered both to pay dividends and to create and issue rights and options. Ind.Code § 23-1-2-7 (pre-April 1, 1986); Ind.Code. § 23-1-26-5 (governing CTS as of April 1, 1986). The plan makes clear that what is involved are the issuance of rights, which at present trade with the common, and not a second class of stock. Moreover, the rights at present are attached to all shares, including DCA's. That DCA might subsequently take actions which will cause it to forfeit those rights does not make the rights themselves a new class of stock. As provided in Providence & Worcester Co. v. Baker, 378 A.2d 121, 123 (Del.1977), restrictions upon stockholders are distinguishable from restrictions on the stock itself.

The cases cited by DCA do not convince the court otherwise. In Unilever Acquisition Corp. v. Richardson-Vicks, Inc., 618 F.Supp. 407 (S.D.N.Y.1985), the court invalidated a new class of stock which provided for different voting rights within the same class of stock, depending on when the stock was acquired. In Asarco, Inc. v. Court, 611 F.Supp. 468 (D.N.J.1985), the district judge concluded that New Jersey law does not permit amendments which would redistribute voting power within a class or series of stock, and invalidated a board of directors' attempt to achieve that result. In Minstar Acquiring Corp. v. AMF, Inc., 621 F.Supp. 1252 (S.D.N.Y.1985), the court specifically declined to follow Delaware law, and the rights were nontransferable, a fact on which the court relied.

In Unilever and Asarco, the rights plan constituted a pure vote altering scheme with no economic consequences; the cases stressed that the plans directly altered voting power of stock depending on when it was transferred. The court does not think that the rationale of those cases should be extended to a poison pill dividend of the sort issued here. In Telvest, Inc. v. Olson, Slip Op. No. 5798 (Del.Ch. March 8, 1979) available on WESTLAW, Allstates database (available on LEXIS), the Delaware chancery court similarly held that direct alteration of voting rights cannot be accomplished without shareholder approval. Yet the Delaware Supreme Court in dicta recently confirmed the statutory authority of a board to issue a discriminatory note purchase rights plan in response to a coercive two-tier tender offer. Revlon, Inc. v. MacAndrews & Forbes Holdings, Inc., 506 A.2d 173, 180 & n. 11 (Del.1986). The court specifically relied on that portion of the Delaware Code which allows corporations to issue rights or options. Id. DCA has therefore failed to establish probability of success on its claim that the rights plan was unauthorized under Indiana law.

DCA secondly argues that the rights...