It is an old maxim that “Hard cases make bad law.” But it may have a corollary: “Bad facts make hard law.” When a defendant clearly overreaches, the court may not let small details stand in its way. The decision in In re Xerox Corp. Consol. Shareholder Litigation by Justice Barry Ostrager of the New York Supreme Court may be such a case. Decided at the end of last month, the decision enjoined a shareholder vote on a merger-like transaction between Xerox Corporation and Fujifilm Holdings Corporation (“Fuji”) and required Xerox to waive its advance notice bylaw so that Carl Icahn and another shareholder could solicit proxies to elect a board majority. All this made perfect sense, but its treatment of the outside directors is raising concern in some quarters. As discussed below, it need not.
The case is fascinating on a variety of levels:
First, it tells a story with all the elements of a James Bond novel: foreign intrigue, disloyal agents, backroom deals, and big stakes. Many takeover contests involve pitched battles and Napoleonic egos, but here the key actor (Xerox’s CEO) resembled Napoleon less than Benedict Arnold.
Second, the New York case law on fiduciary duties in takeover contests was at best sparse, and the Xerox decision now suggests that New York will follow standards closely consistent (but perhaps not identical) with those of Delaware. Because the litigation has now settled, the Xerox decision will be the key precedent for deal planners considering New York-based transactions.
Third, the Xerox transaction shows some tactical innovations that enabled the parties to deny Xerox’s shareholders some statutory protections (such as an appraisal remedy) and in future transactions might even be manipulated to reduce shareholder voting rights.
This columnist is probably not the most objective observer of the decision, because he served as an expert witness for the successful plaintiffs (who were Xerox’s first and third largest shareholders – Carl Icahn and Darwin Deason). This column does not purport in any way to represent the plaintiffs’ views or the views of their counsel. Nor do I have any “inside” information about the case or its complicated settlement (which has now passed de facto control of Xerox to the two plaintiffs). Expert witnesses seldom play a more than marginal role in takeover litigation, but in this case our role, while still modest, may have been enhanced by the debatable decision of counsel for Fuji, the acquirer, to file a motion in limine to preclude our testimony. The net result may have been to cause the court, which denied this motion, to pay somewhat greater attention to our expert reports than would otherwise have been the case. Such a decision can backfire and may have here. The first lesson then is, only file a motion in limine if you are convinced you will win.
The Xerox-Fuji Transaction
In March 2017, the CEO of Fuji asked the CEO of Xerox whether Xerox would be amenable to an all-cash acquisition of Xerox by Fuji at around a 30 percent premium over Xerox’s market price. Although Xerox had no need for a deal, the premium was attractive (well above Xerox’s own projections for growth), and Xerox and Fuji had long been involved in a joint venture that accounted for 25 percent of Xerox’s revenues. The Xerox board indicated that it was prepared to approve an all-cash deal at a 30 percent premium.
But that deal never materialized. In May 2017, Fuji, beset by a major accounting scandal that also forced restatements of Xerox’s earnings, indicated that it was no longer in a position to make a major acquisition before that scandal was resolved. Next, Icahn, Xerox’s largest shareholder, bluntly informed Xerox’s CEO, Jeff Jacobson, that Xerox should be sold and that unless Jacobson could quickly arrange a sale, Icahn would have him fired. This threat was credible, because everyone at Xerox anticipated that Icahn would run a proxy contest once his standstill agreement expired in December 2017.
Even worse for Jacobson, the Xerox board hired a professional headhunting firm (Heidrick & Struggles) and formed a board committee to find possible replacements for him. Jacobson’s days seemed numbered. His only hope was to negotiate a deal with Fuji that left him in office. That he did, but at great cost to Xerox shareholders. The deal he proposed to Fuji dropped both the all cash condition and any control premium. Instead, under the deal designed by Jacobson and his investment bankers, Fuji would swap its 75 percent interest in the Fuji-Xerox joint venture for a 50.1 percent interest in Xerox. Were the pieces swapped of equal value? This depended on estimates of future synergies that the court termed “highly subjective.”
Nor surprisingly, Fuji warmed to this proposal, because it was too good to be true. As its CEO later bragged to the Japanese press:
“This latest scheme will allow us to take control of Xerox without spending a penny.”
Unfortunately for Fuji, that line (in Japanese) was discovered by plaintiffs and was understandably viewed by the court as evidence that Fuji was knowingly helping Jacobson to breach his fiduciary duties.
Jacobson did not advise the Xerox board of the terms that he was offering to Fuji, and the Xerox board did not learn of his proposal until after it had been cleared with Fuji. Meanwhile, the Xerox board approved a replacement for Jacobson as CEO, and on November 10, 2017, Xerox Board Chairman Robert Keegan advised Jacobson that he was likely to be replaced and further instructed him “at the express and unanimous direction of the Xerox board to desist from further discussions with Fuji about a possible combination with Xerox.” Nonetheless, Jacobson persisted and convinced Fuji to advise Xerox, in his words, “that there is no deal without me.” Believing that Jacobson was its ally and that his dismissal as Xerox’s CEO implied Fuji’s “losing control of the [Xerox] board of directors,” Fuji insisted that a condition of the deal be Jacobson’s continuation as CEO.
Some Xerox directors objected to Jacobson’s two-sided role, and one Xerox director emailed a shocked critique of him as a “rogue executive” to Keegan. But the rest of the board saw a countervailing problem: Icahn had ended his truce and nominated four directors to the Xerox board just before the expiration of Xerox’s advance notice deadline for director nominations. To some, the choice was now between an inadequate Fuji deal and humiliation through ouster from the board at the hands of Icahn. Thus, they opted for inadequacy over humiliation and approved the transaction but did require Fuji to sweeten the special dividend that Xerox would pay to its shareholders (out of money borrowed by Xerox). As a final touch, Fuji asked Jacobson to hand pick the five Xerox directors who would continue to serve with him on the 12-person Xerox board for a five year effective term.
A last surprise emerged on the day Xerox announced its deal with Fuji: Xerox disclosed that, for over 17 years, it had hidden from the market and its shareholders a special provision in its joint venture and technology agreements with Fuji under which, if Xerox were to sell more than a 30 percent stake in itself to a competitor, Fuji could cancel the joint venture and appropriate the rights to Xerox’s brand and technology in Asia and the Pacific Rim. As plaintiffs argued and the court found, this was the equivalent of an undisclosed “asset lockup” over Xerox’s “crown jewels.”
The Court’s Decision
The court expressed itself succinctly:
“This transaction was largely negotiated by a massively conflicted CEO in breach of his fiduciary duties to further his self-interest and approved by a board, more than half of whom were perpetuating themselves in office for five years without properly supervising Xerox’s conflicted CEO.”
Possibly the most impressive features of Justice Ostrager’s decision were its speed and cogency. The court issued its decision within a few hours after the close of a highly contested two-day hearing. Put simply, the court had to work its butt off and master highly complicated facts to keep to this pace. For years, there has been speculation among practitioners about what would happen if a Delaware-style contested takeover battle came to New York, where the judicial pace in state court is often slower and the level of judicial experience substantially less developed. But Justice Ostrager is an extremely experienced and sophisticated veteran of the takeover wars, having represented Paramount Communications in some of its major battles in the late 1980s. For the future, he may become a one man New York Court of Chancery.
What most moved Justice Ostrager to enjoin the transaction? Of course, any answer is speculative, but the leading factor was probably not the expert witnesses or the eloquence of counsel. Rather, as the court emphasized, it just did not find Xerox’s key witnesses – Jacobson and Keegan – to be “credible.” This is a code word by which experienced judges express their view that they are being lied to. In their live testimony, Xerox’s directors disagreed with each other and raised unavoidable issues of credibility. Once a lack of credibility is found, the case is lost.
Of the court’s various legal conclusions, its safest and least contestable is that a New York corporation is required to waive its advance notice bylaw for nominating directors “when there is a material change in circumstances after the nomination deadline.” The court relied on Delaware decisions, but the facts virtually speak for themselves. The advance notice bylaw expired on December 11, 2017, a month before the first rumors of a deal reached the press and at least six weeks before Xerox announced the deal on January 31, 2018. Although Icahn was already running a slate of four directors, this minority slate would not have been able to rescind the transaction or open negotiations with other bidders. To be sure, the Xerox shareholders could still vote against the transaction, but voting the transaction down was neither their goal nor the plaintiffs’. All wanted a superior deal – either by seeking a new bidder or reopening negotiations with Fuji. And that goal was best facilitated by allowing the plaintiffs to contest a majority of the Xerox board (which required a waiver of the advance notice bylaw).
More controversy may surround the court’s decision to enjoin the Fuji-Xerox transaction. The court found that directors lose the presumptions of the business judgment rule if their decision is the product of self-dealing or bad faith. Although the record is stuffed with evidence concerning Jacobson’s bad faith (and the court found him “hopelessly conflicted”), the evidence about the other directors was less clear-cut. Only in the case of Xerox Board Chairman Keegan could the court point to a real failure, finding that “it was a breach of fiduciary duty for Keegan to authorize Jacobson to continue to be the primary interface with Fuji after Keegan both told Jacobson he could be imminently terminated and, for that reason, he should cease communications with Fuji about any transaction.” This may alarm some board chairs about their duty to monitor their CEO, but on these facts more oversight was clearly needed.
Still, the other directors were hardly subject to any domination by Jacobson. After all, they had determined to remove Jacobson. As to these directors, the court emphasized that a majority of them, who would serve for five years “on the board of the combined entity, acted in bad faith in structuring and negotiating the proposed transaction.” If that is “bad faith,” directors of an acquired firm need to worry about continuing on the combined entity’s board, as it might give them a conflict of interest. Possibly, it would have been wiser to analogize the Xerox board to the Trans Union Corp. board in Smith v. Van Gorkom, where the board was found to have passively deferred to its CEO when he sought to push through a less than value-maximizing merger. Under New York law, there is precedent that board negligence also suspends the application of the business judgment rule. Although New York law permits exculpatory charter provisions eliminating monetary liability for breach of the duty of care (just like Delaware law), these provisions do not bar injunctive relief. Thus, the merger could have been enjoined, at least preliminarily, on this alternative ground.
Some will argue, however, that the merger should not have been enjoined at all and that shareholders should have been permitted to vote it up or down. Arguably, one Delaware decision, involving very different facts, may point in this direction. But Xerox was a case in which the board never knew, at the time it voted, how much of a turncoat Jacobson had become, obtaining long-term employment by structuring a premium-less deal that left Xerox shareholders in an exposed, minority position. Would Delaware disagree? I emailed the opinion on the date it was released to a distinguished Delaware jurist (who has decided multiple major takeover cases), and he responded in an email the next day, saying that he thought the decision was “spot on.”
In any event, the court’s preliminary injunction would have had little long-term impact. It only barred consummation of the January 31 proposed transaction, not variants and improvements on it. Because the Xerox board election would have come first, the insurgents (Icahn and Deason), if they had won, could have sought new bidders or to re-open negotiations with Fuji. If the incumbent board had won, it may still have sought to improve the deal (in order to obtain a majority vote in favor of the transaction). Even if the incumbent board did not seek a sweetened transaction, the incumbent directors could have asked the court to lift its injunction in light of the shareholder support that they received in the board election. The court’s injunction was preliminary and sought only to preserve the status quo.
Now that the case has settled, plaintiffs’ nominees have been added to the Xerox board, and Jacobson has been replaced, what happens next? Fuji may claim that it is owed a $183 million termination fee, and Xerox can counter that Fuji’s auditing scandal entitled it to cancel the transaction. Xerox will predictably be on the auction block. Although a sale to a competitor would be difficult under Xerox’s agreements with Fuji, Xerox’s new board could seek a financial buyer for Xerox (such as a private equity firm). Under the Fuji-Xerox joint venture and technology agreements, Xerox is restricted only from selling more than 30 percent of its stock to defined “competitors.” Private equity firms do not fall within the scope of this restriction, and they may view an iconic name, such as Xerox, as an attractive target.
Implications and Innovations
Some innovations in the Fuji-Xerox transaction raise issues for the future. Although the transaction was clearly a strategic acquisition by Fuji of Xerox, no merger transaction was proposed. Instead, the two sides entered, on January 31, 2018, into (i) a Redemption Agreement pursuant to which their joint venture (Fuji-Xerox Co., Ltd, a Japanese company) redeemed for cash Fuji’s 75 percent stake in it, thereby making it a wholly owned subsidiary of Xerox, and (ii) a Subscription Agreement pursuant to which Fuji purchased 50.1 percent of the outstanding shares of Xerox for the same cash price paid by Xerox under the Redemption Agreement.
Why was this complex approach used instead of a simple merger agreement? Any answer is speculative, but one reason may be that this structure denied Xerox shareholders any appraisal remedy (which they would have possessed had a merger been used). It was predictable that a deal without any control premium paid by the acquirer would leave many Xerox shareholders dissatisfied, and large holders, such as Icahn and Deason, could certainly afford to exercise any appraisal right that they possessed. In a time of appraisal arbitrage, other transaction planners may consider this route.
Another possible consequence of avoiding a merger involves the minimum shareholder vote required. Under New York law, a merger must be approved by at least a majority of the outstanding shares (and not simply a majority of a quorum present at the shareholders’ meeting). But if no merger is used, this higher vote is not needed. Still, to issue 50.1 percent of its stock to Fuji, Xerox would need a shareholder vote (either to authorize additional shares or to comply with the New York Stock Exchange’s rules, which require shareholder approval of any issuance of 20 percent or more of the issuer’s outstanding shares). But if only the NYSE rule were applicable, it would not require a majority of all outstanding shares but only a majority of the quorum represented at the meeting. This distinction may have made no difference on the actual facts of the Xerox transaction, but it could be important in future transactions.
Transaction planners will also need to consider carefully the Xerox decision’s focus on the board’s duty to monitor the managers negotiating a deal. Although a disloyal CEO will be a rarity, M&A transactions often stumble over “social issues,” such as which executives will occupy which positions in the combined entity. If such a social issue seemingly blocked an attractive deal, would the board be responsible for failing to monitor and control the self-interest of its managers? Arguably, Xerox contains such a hint, but the decision is best read more narrowly as holding only that egregious treachery will not be tolerated. Hopefully, that is true in both New York and Delaware.
 ___N.Y.S. 3d___ (2018); 2018 N.Y. Slip Op. 28137; 2018 WL 2054280.
 Id. at *8.
 Id. at *10 (quoting Fuji CEO Komori).
 Id. at *5.
 Id. at *5.
 Id. at *7.
 Id. at *6.
 Id. at *7.
 Id. at *11.
 See Hubbard v. Hollywood Park Realty Enterprises, Inc., 1991 WL 3151 at *12 (Del. Ch. January 14, 1991); Icahn Partners LP v. Amylin Pharm., Inc., 2012 WL 1526814 at *3 (Del Ch. April 20, 2012).
 In re Xerox Corp. Consol. Shareholder Litigation, supra note 1, at *9 (citing Patrick v. Allen, 355 F. Supp. 2d 704.711 (S.D. N.Y. 2005).
 Id. at *6.
 Id. at *9.
 488 A. 2d 858 (Del. 1985).
 See Casey v. Woodruff, 49 N.Y.S. 2d 625 (N.Y. Sup. Ct. 1944).
 See In re CNX Gas Corp. Shareholders Litig., 4 A. 3d 397 (Del Ch. May 4, 2010) (denying preliminary injunction despite procedural irregularities). However, this decision relies on the availability of post-closing relief through damages litigation and also involved a very protective majority of the minority provision.
This post comes to us from John C. Coffee, Jr., the Adolf A. Berle Professor of Law at Columbia University Law School and Director of its Center on Corporate Governance.