In early February, activist hedge fund investor Darwin Deason filed a lawsuit against the well-known company Xerox1 The basis of the lawsuit stems from Xerox’s proposed merger with Fujifilm, which would lead to the creation of a new entity called, Fuji Xerox, and give Fujifilm a 50.1% stake in the created entity.2. Deason filed the complaint alleging that the merger was approved without a fair sale process and that the decision would not be in the best interest of the company’s shareholders.3. Deason claims that the merger undervalues the US company, favors Fujifilm, and benefits the existing Board of Directors rather than shareholders.4
The suit raises larger issues concerning the role and place of activist, majority investors within the larger shareholder landscape in large, public companies. Corporate law imposes certain fiduciary duties that companies owe to shareholders, which include the duties of care, loyalty, and good faith.5 Importantly, no such duty exists to act in the interest of the board of directors, and instead the duty solely runs to the shareholders.6 Decisions of the Board of Directors are critiqued with reference to these fiduciary duties, and although the business judgment rule protects directors through a rebuttable presumption that directors are acting on an informed and good faith basis, there are examples of courts determining that directors breached their fiduciary duties.7
Smith v. Van Gorkom represents a seminal and exemplary case explicating corporate fiduciary duties demonstrating directors breaching those duties.8 Courts were previously waryof ruling against directors and finding that directors had breached their fiduciary duties. The facts of the Smith case are somewhat similar to the Xerox case at issue here, and revolved around a merger that shareholders claimed undervalued the company and left them in an undesirable situation.9. Shareholders claimed that the directors did not fulfill their duty of care by their failure to fully inform themselves prior to agreeing to the merger, and the court agreed.10.
Whether the Xerox case reflects a situation like Van Gorkom, where the directors failed to properly inform themselves before agreeing to a major merger, remains to be seen. However, the Xerox cases reflects a complication to the classic idea of directors acting in the best interest of shareholders. Xerox is emblematic of the growing trend of hedge funds or other types of institutional investors asserting power through their status as majority shareholders. The issue involves the question of whether directors should act in the best interest of these large, institutional investors, who often times do not share the same motivations as ordinary retail investors. Often times, the role played by activist investors leads them to pressure managers to pursue a decision-making path that may benefit them, but may fail to benefit the minority shareholders.11
Such issues have arisen with rising frequency within recent decades. In 1950, 8% of shares in public corporations were owned by institutional investors, compared with approximately 67% today.12 The growing trend complicates the assumed landscape that shareholders are dispersed and powerless.13 Activist hedge funds add another complication to the shareholder landscape, as they take large positions in companies for the purpose of reorganizing the company or forcing the disbursement of stock buybacks or dividends.14. The salient question is whether directors should favor such activist and institutional investors, or instead that their fiduciary duties extend solely to minority shareholders who represent the classic “class” of the shareholding landscape.
It remains to be seen what will occur with the Xerox and Fujifilm merger. However, the pressure from Deason clearly represents an activist hedge fund and institutional investor displeased with the decision of the directors. It will be up to the courts to determine whether the merger truly undervalued the company, and thus whether the directors breached their fiduciary duties. However, an alternative explanation exists. Perhaps the directors did uphold their fiduciary duties, the minority shareholders would benefit from the merger, and the activist hedge fund merely filed suit as a way to make more money.
James Fontanella-Khan, Hedge Fund Activist Sues Xerox over Fujifilm Merger, Fin. Times (Feb. 13, 2018), https://www.ft.com/content/8abe5afa-10d0-11e8-940e-08320fc2a277. ↩
Corporate Law: What is Fiduciary Duty, Rocket Lawyer, https://www.rocketlawyer.com/article/corporate-law-what-is-fiduciary-duty-cb.rl (last visited Feb. 28, 2018). ↩
Lindsay C. Llewellyn, Breaking Down the Business-Judgment Rule, Winston & Strawn LLP (2013), https://www.winston.com/images/content/1/5/1535.pdf. ↩
488 A.2d 858 (Del. 1985). ↩
See Bernard S. Sharfman, The Enduring Legacy of Smith v. Van Gorkom, 33 Del. J. of Corp. Law 287, 288 (2008). ↩
Iman Anabtawi and Lynn Stout, Fiduciary Duties for Activist Shareholders, 66 Stan. L. Rev. 1256, 1257-58 (2008). ↩
Id. at 1275. ↩
See id. ↩