Time, Warner Armed for Fight in Delaware

The formidable legal teams of Time Inc. and Warner Communications head to court in Delaware this morning to wage what may be an uphill battle to defend their merger agreement against the takeover assault of Paramount Communications.

The Time and Warner lawyers must defend an anti-takeover feature of the deal before a court increasingly inclined toward letting shareholders choose between rival takeover bids.

Presiding will be Chancellor William T. Allen, who has jarred the takeover world with decisions favoring hostile bidders, but also recently was criticized by the Delaware Supreme Court for tilting toward defending management.

Not surprisingly, the court fight is expected to get ugly. The merger fight “may not be decided in the Delaware courts, but you’ll see it in all its fury there,” said a lawyer with a top takeover firm, who asked to remain unidentified.

Paramount, which offered $10.7 billion for Time on Tuesday, has asked the courts to block Time and Warner from putting into effect a stock-swap arrangement that would make the takeover more expensive by adding about $1 billion to its price.

The terms of the swap would give Time 8.7% of Warner’s shares and Warner 11.1% of Time’s if a bidder such as Paramount acquired more than 25% of Time before the merger was complete, or if the merger broke off for some other reason.

In a complaint filed Wednesday, Paramount called this an illegal “lock-up” that was intended to entrench Time’s management and benefit Warner, which gains a 60% voting stake in the new company if the deal goes through.

A key question is whether the signing of the Time-Warner deal opened a bidding process for Time.

Time and Warner contend that their deal represented a merger of equals and brought no change of control at Time. The stock-swap arrangement, while partly designed as an anti-takeover maneuver, “was as much a statement of intent (to merge) as anything else,” said a person familiar with the thinking of Time and Warner executives.

If the merger was not a transfer of control, then the stock-swap is judged under the so-called “business judgment rule,” which gives directors wide latitude to run their companies without second-guessing by the courts.

But if the deal put the company up for sale, then the courts apply a separate standard, under which directors are discouraged from taking defensive maneuvers that would keep shareholders from getting the best bid.

The Delaware courts have “made some pretty strong statements that say lock-ups or similar devices that preclude a true auction aren’t favored,” said John Coffee, professor of law at Columbia University.

Frown on ‘Poison Pills’

Paramount’s suit also challenges Time’s “poison pill” defense, a kind of maneuver that makes takeovers prohibitively expensive by issuing new stock rights to shareholders in the event of an unwelcome takeover offer.

The Delaware courts increasingly have frowned upon use of such “pills,” ruling that they are acceptable as means to delay unfair bids, but can’t be used to keep shareholders from choosing a takeover offer.

Late last year, the Delaware Chancery Court struck down the pill defense used by Pillsbury Co. to ward off Grand Metropolitan PLC, and another used by Interco in the face of a takeover threat from the Rales brothers of Washington.

“The Delaware Courts have favored responsible shareholder positions in a series of recent cases,” said Harvey Goldschmid, a professor of law at Columbia University.

Whatever the outcome, the case should be argued ably. Time is represented by the top firm of Cravath, Swaine & Moore and the firm of Skadden, Arps, Slate, Meagher & Flom. Warner will be represented by Paul, Weiss, Rifkind, Wharton & Garrison, and Paramount by Simpson, Thatcher & Bartlett. All are based in New York.

The case has ended up in Delaware courts because Time is incorporated there.

Chancellor Allen, 44, has been widely praised for his handling of a number of major takeover cases, including the Interco and Pillsbury-Grand Metropolitan suits.

But he was chastised by his superiors on the Delaware Supreme Court for an April ruling in an another case, Mills vs. Macmillan, in which he had sided with a defending management. The criticism of a chancellor was “absolutely extraordinary,” said one legal scholar.