Managing leadership succession in the misnomered “merger of equals” or the more common combination of two large public companies of different sizes can often be tricky. To the extent that both the buyer and the target agree that one or more members of a target’s management team are to transition to management positions in the combined company, merger contracts often specify who shall become what.
But such provisions are rarely drafted to be effective for any period of time beyond the closing. Further, buyers are loath to have a target’s stockholders become third-party beneficiaries to a merger contract between the buyer and the target and thereby give individual target stockholders, and the plaintiff law firms who may eagerly seek out such individual stockholders, standing in court to sue.
As a result, if management positions are not apportioned as contemplated in the merger contract, there is not necessarily anyone left following the closing to pursue the buyer. Buyers are equally hesitant to delegate authority over future management decisions to some sub-set of legacy target directors, an act which would thereby cede outsized power over management selection to a minority of the merged company’s board.
The circumstances in the merger of Duke Energy and Progress Energy – titans in the Southeastern energy production market – illustrate the awkwardness of such arrangements. On January 10, 2011, Duke and Progress announced their proposed marriage with an all-stock dowry for Progress valued just shy of US$14 billion. Two eminently reputable law firms were involved: Wachtell, Lipton Rosen & Katz represented Duke, while Hunton & Williams represented Progress.
Section 1.07(b) of the merger contract stipulated that:
Duke’s Board of Directors shall cause the current Chief Executive Officer of Progress (the “Progress CEO”) to be appointed as the President and Chief Executive Officer of Duke, and cause the current Chief Executive Officer of Duke (the “Duke CEO”) to be appointed as the Chairman of the Board of Directors of Duke, in each case, effective as of, and conditioned upon the occurrence of, the Effective Time, and subject to such individuals’ ability and willingness to serve.
The CEO of smaller Progress thus was to become CEO of the combined company. The combined board of 18 consisted of 11 directors from Duke and 7 from Progress.
Following a lengthy regulatory approval process, the merger closed on July 2, 2012. In the corporate equivalent of a nanosecond after the closing – reportedly about 20 actual minutes – the Duke directors unanimously voted on a conference call to oust the “current” CEO (from Progress) and bring back Duke’s CEO. As best understood from media reports, all five legacy Progress directors present on the call voted against this change, but to no avail. The Progress CEO officially ”resigned” from the combined company effective midnight on July 3 and was sent packing, with a not-too-shabby total severance package worth US$44 million.
Progress was based in Raleigh and Duke in Charlotte. Following the deal, the members of the North Carolina Public Utilities Commission publicly decried what they believed was an outcome different from what had been presented to them. They quickly hauled in the parties to explain, thereby granting deal observers a rare expedited view of the boardroom tactics in this transaction.
Accusations from Duke (of a supposedly dictatorial but also hands-off Progress CEO) who purportedly fumbled with issues at the company’s nuclear plants – cracked containment structures can be a costly thing as Duke continues to discover) and counter-accusations from the CEO of Progress (that Duke got cold feet about the deal price, leading to eagerness to avoid a closing and sudden antagonism toward the leadership at Progress) have flown. While it remains hard to separate the wheat from the chaff, ultimately, absent a giant, and unjustified, governmental intervention from the North Carolina PUC, it seems likely the ouster will stand. Two legacy Progress directors have already resigned in a huff.
One cannot really fault Duke. As buyer, it lived up to the Spartan terms of the merger contract. And, as Duke’s old (er, new) CEO was quick to point out, the post-closing board had a fiduciary duty to change leadership if they believed in good faith that the Progress CEO was no longer the best leader.
Could anything have been drafted contractually by Progress pre-signing to avoid this predicament? In private company mergers, the answer is simple. A voting agreement could have been executed as a condition to closing under which large stockholders would agree to vote in favor of board nominees who support a particular management member or team, or at least allow legacy stockholders a blocking right (probably with the usual ”reasonableness” proviso). That voting agreement could not be amended without the consent of the stockholders or board members from the smaller target company.
However, because of the large turnover in a public company’s stockholder base, public company voting agreements (absent a large majority holder or the like) are not feasible, just the same as with public company escrow distributions. There are other exotic potential ways to address this issue. One could hypothetically connive a dual-class structure with separate voting or blocking rights for management. But that is impractical as well as unrealistic – the complexity far outweighs the potential problem.
What about the actual merger contract? To prescribe a given minimum time (six months? A year?) for the new CEO to have an essentially unfettered right to remain in place is thorny in and of itself. If anything, it creates the ideal conditions for a lame-duck CEO who can operate with impugnity. More important remains the issue of standing. Any buyer almost certainly would reject such a third-party beneficiary clause outright.
An interesting example of another path that could be taken is the combination of United Airlines and Continental Airlines, first announced in May 2010. Its merger contract specified that the CEO of United would become chairman of the board of the combined airline for two years, while the CEO of Continental would become CEO of the combined company and eventually chairman of the board. In contrast to the Duke/Progress transaction, and despite size inequalities in the two companies, the board of the combined company was much more evenly drawn – seven members came from each company and two were union representatives. There is no indication that United regretted this setup – in fact, to the contrary, commentators indicated that United viewed a pivotal part of the Continental deal as the ability to tap the talent of a dynamic and young Continental CEO to help chart the troubled waters of commercial aviation. One wonders: if Progress had the leverage (or fortitude) to insist on a more evenly cleaved successor board for its deal, à la United/Continental – and if it had, whether the same leadership outcome would have ensued. We have no way of knowing (at least as of yet) how much the dueling sets of counsel and business principals negotiated the CEO provision and the board composition pre-signing.
Lest the Duke/Progress situation seem one of a heavy-handed Goliath adhering to a narrow and strict legal duty under the merger contract with nary a second thought, it is worth considering the practical, non-legal disincentives that would dissuade a buyer from casually ejecting a CEO immediately post-closing. Specifically: (a) no board wants a public food fight immediately following closing, thereby inviting intense scrutiny from both media and regulators; (b) the Progress CEO’s US$44 million severance package, while dwarfed by the roughly US$30 billion market capitalization of the combined company, was a hefty payout; and (c) any level of enmity and mistrust among the remaining directors (even if two of them quickly bid their indignant farewells) is clearly sub-optimal.
So, what happened in Duke/Progress? A public company buyer is a buyer. A “merger of equals” or a “partnership” are wonderful terms for branding and employee morale post-integration, but unfortunately a bit feckless from a purely legal leverage analysis. The Duke/Progress deal highlights yet again the benefits of the control premium. Legacy Duke directors controlled the board and did what they thought best. The Progress board had every opportunity to alter the board balance as part of its pre-signing contractual negotiations. But any pre-signing reassurances from the buyer, no matter if made in entirely good faith at the time, should not dissuade a target’s board from the reality that control means control. And rightfully, the sanctity of a contract is most often unimpeachable.