Can takeover target force thwarted acquirer to pay costs?

March 26, 2012

Tenet Healthcare brought a gun to its knife fight with Community Health Systems. At the end of 2010, Community Health, the second-largest hospital operator in the United States, offered to acquire Tenet in what ended up as a $4.1 billion, all-cash bid. Tenet made the typical moves of hostile takeover targets, enacting a phalanx of defenses that included a bylaw amendment postponing its annual meeting by six months so shareholders couldn’t vote on Community’s proposed slate of directors. But that wasn’t all Tenet, the third-largest U.S. hospital operator, did. Its lawyers at Gibson, Dunn & Crutcher also filed a suit in federal court in Dallas that accused Community of bilking Medicaid and private insurers through unwarranted hospital admissions.

Community eventually gave up and walked away from its bid for Tenet. Tenet, however, wasn’t done fighting. In an amended complaint filed last May, it demanded that Community repay Tenet for the cost (including attorneys’ fees) of investigating Community’s allegedly fraudulent hospital admission policies. Tenet’s theory: Community was liable for materially false and misleading statements to Tenet shareholders. “But for these material misstatements from CHS during its proxy solicitation efforts,” the complaint said, “Tenet never would have been forced to expend considerable sums investigating CHS and uncovering troubling facts about CHS’s business.”

Interesting, right? And outrageous, according to Community and its lawyers at Kirkland & Ellis and Andrews Kurth. “It is the height of corporate hubris that Tenet now seeks to present CHS with the bill of costs for Tenet’s scorched-earth battle tactics,” Community said in a motion to dismiss. Community asserted that it actually filed no preliminary or definitive proxy statement on the Tenet takeover with the Securities and Exchange Commission and sent no definitive proxy statement to Tenet shareholders. More fundamentally, according to Community, Tenet didn’t have standing to sue under the proxy provisions of the Exchange Act of 1934.

The question of whether a corporation can sue for alleged proxy violations on behalf of its shareholders is surprisingly unsettled. Congress wasn’t terribly specific about private causes of action in the Securities Act or the Exchange Act, so courts have had to interpret who can sue and for what kind of relief. Community asserted that the 5th Circuit Court of Appeals has limited the right to sue to voting shareholders. Tenet countered in a reply brief that it’s “well-established that targets of hostile takeover attempts have standing to sue on behalf of their shareholders,” citing a 2nd Circuit case from 1966. According to U.S. District Judge Barbara Lynn, who’s overseeing Tenet’s case against Community, two other district courts have reached contrary conclusions on the exact standing issue posed in the Tenet case. A Delaware federal district judge said that extending standing to the corporation itself was contrary to Congress’ intent, but a Chicago court said that when corporations spend money to expose improper proxy solicitations, shareholders are harmed, so the corporations can sue. Neither case, however, was tested on appeal, leaving the standing question unresolved.

In a six-page ruling Wednesday, Lynn sided with Community, concluding that Tenet does not have standing to sue for costs. The judge pointed to a 1991 U.S. Supreme Court case, Virginia Bankshares v. Sandberg, which held that minority shareholders didn’t have standing to bring a proxy violation case. That case, Lynn said, stood for the proposition that courts shouldn’t assume Congress intended to extend private causes of action. She said that under Virginia Bankshares, she could not infer Tenet’s right to sue, “especially (for) the type of damages Tenet seeks here.” Lynn dismissed Tenet’s case with prejudice.

Kirkland’s Peter Duffy Doyle, who argued for Community Health at a three-hour hearing on the standing issue last September, told me that if Lynn had ruled for Tenet, the balance of power in hostile takeovers would have tilted toward targets. “This decision,” he said, “confirms that target corporations will not be permitted to use the proxy rules to shift their due diligence costs to the potential acquirer, which would have served as a significant deterrent to challenges for corporate control.”

Robert Walters of Gibson, Dunn didn’t return my call for comment.

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