Horwitz v. Southwest Forest Industries, Inc.

• Decision Date: 20 March 1985
• Docket Number: No. CV-R-84-467-ECR.,CV-R-84-467-ECR.
• Citation: 604 F. Supp. 1130
• Parties: Martin HORWITZ, Plaintiff, v. SOUTHWEST FOREST INDUSTRIES, INC., and William A. Franke, Defendants.
• Court: U.S. District Court — District of Nevada

604 F. Supp. 1130

Martin HORWITZ, Plaintiff, v. SOUTHWEST FOREST INDUSTRIES, INC., and William A. Franke, Defendants.

No. CV-R-84-467-ECR.

United States District Court, D. Nevada.

March 20, 1985.

John Frankovich, Reno, Nev., and Allan R. Tessler, Sheldon D. Camhy, Kurt Hunciker and John G. Nicolich, New York City, for plaintiff.

Albert F. Pagni, Reno, Nev., and Charles F. Richards, Jr., Donald A. Bussard, Jesse A. Finkelstein, Gregory P. Williams, Gregory V. Vallallo, C. Stephen Bigler, Allen M. Terrell, Jr., Wilington, Del., for Southwest Forest Industries, Inc. Peter D. Laxalt and Richard L. Davenport, Reno, Nev., for Franke.

MEMORANDUM DECISION AND ORDER

EDWARD C. REED, Jr., District Judge.

The plaintiff has moved for a preliminary injunction enjoining the defendants from taking any action in furtherance of certain stock purchase rights declared by the defendants, as a dividend to the common stockholders of Southwest Forest Industries (SFI or the Company), on October 22, 1984. SFI has opposed the motion. (Defendant Franke, who has pending a motion to dismiss or transfer for lack of personal jurisdiction, has not responded). Memoranda of points and authorities, affidavits and exhibits have been filed by both the plaintiff and SFI.

The gist of the plaintiff's contentions is as follows: About a year ago, SFI's Board of Directors approved an agreement in principle whereunder an insider group headed by the Company's president, defendant Franke, would take SFI private by buying all of its outstanding stock from the stockholders for $24 per share. The plan failed for lack of capital. However, an outside group then indicated willingness to buy all the stock at the same price. After some brief negotiations, the Board terminated consideration of the matter. It then announced the issuance of "poison pill" warrants. The effect of special features of the warrants is to make a tender offer for the Company's stock virtually impossible. This procedure was adopted for the purpose of thwarting any competitive offers by outsiders to obtain control of SFI. The stockholders have been told that the warrants were designed to enable present Management to pre-screen and veto tender offers that it deems unfair or inadequate. However, deciding whether to accept a tender offer or to vote in favor of a proposed merger are rights of stockholders that are usurped by the warrant provisions. The dominant motives of Management are self-perpetuation in office and the continued enjoyment of Management perquisites. The warrants also authorize Management to veto the acquisition by any person of a 20% interest in SFI's stock. This, in effect, will preclude mergers that are authorized by statutes of Nevada, the state of SFI's incorporation. Since a 20% interest may not be acquired by anyone without Management's acquiescence, any meaningful challenge to the Company's present control group is prevented. The result is impairment of the rights of stockholders to buy as much of the Company's stock as they wish and to sell their shares to anyone at the highest price in a free market. The plaintiff is an SFI stockholder. The Hearst Corporation is the owner of the largest bloc of Company stock, namely 17.5% of the stock outstanding. It has three representatives on SFI's Board of Directors. Certain officers and directors, including defendant Franke, own in the aggregate another 3.1% of the stock. The Board of Directors has authorized the Company to enter into "golden parachute" agreements with certain of its officers, thus providing them with windfall benefits if a change in control of the Company should result in a termination of their employment. The poison pill warrants are tied to the outstanding shares of Company stock, one warrant for each share. The warrants, when exercisable, entitle their holders to purchase the Company's common stock at a $50 per share price. At the time the Company announced its dividend of warrants, SFI's stock was trading at approximately $17 per share. The warrant rights are not exercisable until after public announcement that a person or group owns 20% of the Company's stock or the commencement of a tender offer for 30% or more of the stock. Until such time, the Company may recall or redeem the warrants for the nominal price of 25¢ each. In the case of a merger, each warrant entitles its holder to receive stock of the surviving company having a market value of $100 in return for the payment of $50. Alternatively, the acquiring company is permitted to buy the warrants at an exorbitant cash premium. In either event, the cost would be so high as to make any merger unfeasible. An injunction is needed because acquisition of a 20% interest by one person or group or the making of a tender offer for 30% or more of the Company's stock would set off a "spring-gun," making the warrants effective. The result would be the stifling of tender offers, the depression in value of the stock, and impairment of the stockholders' rights to buy stock, to sell stock and to seek a controlling voice in SFI.

SFI's papers filed in opposition to the plaintiff's motion for a preliminary injunction present its side of the story as follows: The purpose of the issuance of the warrants is to protect the Company's shareholders from unfair two-tier tender offers. Under such an offer, the acquiror makes a cash offer for a controlling position. After gaining control, the acquiror then offers a lesser consideration (often including securities rather than all cash) for the remaining stock. Alternatively, the remaining stockholders may be ignored by the acquiror, who already possesses a controlling interest. A front-end loaded, two-tier tender offer thus is coercive and unfair to the shareholders. Even if the initial cash offer is inadequate, a shareholder is under pressure to tender his stock because of the realization that he figures to receive even less in the second tier of the transaction. As to the agreement in principle for acquisition of SFI by a group of investors which included members of the Company's Management, the deal fell apart when certain banks that had agreed to finance the transaction withdrew from participation because of rising interest rates and other factors. The outside group, which in May 1984 indicated it was interested in acquiring control at the same per share price offered by the Management group, failed to make a formal offer and would not or could not demonstrate the availability of adequate financing. Therefore, in July 1984 the Company's Board of Directors directed Management to terminate negotiations. Following these two unsuccessful acquisition episodes, the Board instructed Management to concentrate on business operations. Effort then was devoted to an already-commenced five-year plan to develop and expand the Company. The plan was submitted for review to The First Boston Corporation, an investment banking firm that had been serving for several years as a financial adviser to SFI. In connection with the Company's expressed concern over its vulnerability to any coercive takeover attempt, First Boston worked with outside legal counsel and Management in developing the rights or warrant plan with which the plaintiff takes umbrage. A three-hour discussion of said plan took place at a Board meeting on October 22, 1984. First Boston, outside counsel and the Company's Nevada counsel explained the plan and its pros and cons. Its utility in protecting SFI and its stockholders from unfair or coercive takeovers while the five-year plan was being implemented was an important factor. If expectations are met, the Company stock will have a market value of $50 per share by the end of the five years; hence, the use of that price in the warrants. The warrant plan serves to encourage a potential acquiror to negotiate with the Board, in light of the Board's right to redeem the warrants for a mere 25¢ each. The Board thus would serve as the bargaining agent for all the shareholders, who individually have little negotiating leverage. The Board's negotiations would be exercised in the light of its fiduciary duties. The fact that other major corporations had adopted similar plans was made known to the Board. The Company's Nevada attorneys advised the Board that research indicated that the warrant plan appeared legal under Nevada law. The plan was adopted unanimously by the directors in the exercise of their business judgment. Eleven of the twelve directors are non-Management. The rights were issued November 1, 1984.

The Complaint was filed herein on November 8, 1984.

Discussion

An injunction may issue only after the plaintiff has established that the conduct sought to be enjoined is illegal and the defendants, if not enjoined, will engage in such conduct. United Transportation Union v. State Bar of Michigan, 401 U.S. 576, 584, 91 S.Ct. 1076, 1081, 28 L.Ed.2d 339 (1971); Memphis Light, Gas & Water Division v. Craft, 436 U.S. 1, 8, 98 S.Ct. 1554, 1559, 56 L.Ed.2d 30 (1978). Therefore the conduct of SFI's Board of Directors must be the focus of attention here.

The powers of corporate directors is determined by state law. Burks v. Lasker, 441 U.S. 471, 478, 99 S.Ct. 1831, 1837, 60 L.Ed.2d 404 (1979). It is the law of the state of incorporation that is controlling. Lewis v. Anderson, 615 F.2d 778, 781 (9th Cir.1979). SFI is incorporated in Nevada. To the extent that any issues raised have not yet been confronted by the Nevada Supreme Court, this federal court must predict how the State Supreme Court would decide them. Amfac Mortgage Corp. v. Arizona Mall of Tempe, Inc., 583 F.2d 426, 434-5 (9th Cir.1978). Guidance may be sought from other jurisdictions that have considered those issues. Matter of Charles D. Stapp of Nevada, Inc., 641 F.2d 737, 738 (9th Cir.1981).

A director is a fiduciary. Foster v. Arata, 74 Nev. 143, 325 P.2d 759, 765 (1958). Since the value of and rights incident to outstanding shares of stock are affected by the...