Takeaways:
- Disgorgement, or the repayment of ill-gotten gains, is an “unusual defense” for a proxy contest because the requirement only falls under Pennsylvania and Ohio law, one lawyer said.
- Pennsylvania’s statute is vague enough that Hudson’s nomination announcement might trigger the disgorgement period, four lawyers said.
- A source familiar said USA Technologies possibly invoked the disgorgement statute so it can later claim Hudson is not supportive of a potential deal because the activist would be forced to surrender its profits in the event of a sale.
USA Technologies’ (USAT) claim that activist investor Hudson Executive Capital has initiated an 18-month disgorgement period as a result of its proxy contest threat has sparked a debate regarding shareholders’ rights to prompt board shakeups and whether this means activists are “seeking to acquire control” of companies, four lawyers said.
Interim CEO and Executive Chairman Donald Layden said on a Feb. 19 earnings call that Hudson is “required to disgorge, or surrender to USAT, any profits” from the sale of company shares over an 18-month period following the activist’s Nov. 4 board nominations. Layden noted this includes selling shares in connection with an M&A transaction. The activist nominated eight directors to replace the incumbent board at USAT’s 2020 annual general meeting on April 30.
Shares in USAT have risen 30.27% since Hudson’s nomination announcement. The Malvern, Pa.-based cashless payments and software services company noted on Feb. 21 that it believes Hudson has an unrealized profit of over $35 million in its USAT investment. Hudson, a 17.3% shareholder, said that same day that USAT’s statements regarding disgorgement are “inaccurate and misleading.”
USAT and Hudson declined requests for comment.
Disgorgement, or the repayment of ill-gotten gains, is an “unusual defense” for a proxy contest because the requirement only falls under Pennsylvania and Ohio law, said Aneliya Crawford, a partner at Schulte Roth & Zabel. There has never been litigation over the Pennsylvania provision and the situation between USAT and Hudson might be the first, said a source familiar with the matter. Several corporations, including Glatfelter, PNC Financial Services and Aetna, which is now part of CVS, have opted out of the statute.
USAT said it believes the “words and intent” of the Pennsylvania statute are meant to protect corporations from “attempts to take control of the board.”
However, Derek Bork, a partner at Thompson Hine, said USAT “mischaracterizes” the law in its statement, noting that the real purpose is to protect corporations from investors threatening or waging a proxy contest “with the effect of reaping short-term speculative profits.”
Bork explained that Pennsylvania and Ohio adopted these statutes in 1990 to protect corporations from the more egregious practices of corporate raiders in the 1980s, including greenmailing, or threatening a takeover through a hostile acquisition or proxy contest and subsequently forcing management to repurchase shares at a higher price to retain control.
The Pennsylvania statute specifically states that it is not intended to “curtail proxy contests on matters properly submitted for shareholder action under applicable state or other law,” Bork said.
Question of Control
Bork said he believed Hudson still triggered the disgorgement period with its nomination announcement, clarifying that this will only affect Hudson’s potential trading of USAT’s stock and not the actual proxy contest.
The statute states that the disgorgement period is triggered when a shareholder announces its intention to put a company “in play” or seek to acquire control of the corporation.
Hudson on Feb. 21 argued that it believes now is an “inopportune time” for a sale of USAT and its effort to elect a new board to “facilitate necessary and meaningful changes in company governance” does not mean it is seeking control of the firm.
Regardless, Pennsylvania’s statute is vague enough that Hudson’s announcement might still trigger the disgorgement period, all four lawyers said. “Statutes like the one in Pennsylvania and regulations that aim to limit the control of an activist are not nuanced enough to make that distinction,” Crawford said. A controlling person includes whoever engages in a proxy contest to replace a majority of the board, according to draftsmen's comments on the 1990 Anti-Takeover Provisions.
“It's entirely unfair and reflects an archaic, outmoded statute that shouldn't even be applicable to a proxy contest,” said Andrew Freedman, a partner at Olshan Frome Wolosky, adding that he believes the incumbent board’s “attempt to hide behind this statute is entrenchment at its very core.”
Yet Patrick Gadson, a partner at Vinson & Elkins, said USAT’s response is “reasonable” if it believes a majority of Hudson’s directors are not independent from the activist and might be detrimental to long-term shareholder value creation.
Crawford said this issue raises a broader debate within regulated industries - where shareholders are limited on the number of candidates they can nominate due to control provisions - about whether activists gain control or can influence management when nominating independent board candidates.
Doug Braunstein, Hudson’s founder, is the only non-independent candidate on the activist’s slate. However, USAT highlighted potential conflicts of interests with some nominees, including three who formerly worked at JPMorgan Chase with Braunstein and two Hudson investors.
Unhappy Shareholders
Nearly 61% of USAT’s shareholders have already voted for Hudson’s full slate, the activist said on Jan 15. However, shareholder sentiment is “irrelevant” to the disgorgement statute and will not be considered by a court, Bork said.
Hudson also accused the board of considering a sale, prompting other shareholders to publicly question the company. USAT has yet to respond to the allegation.
22NW, a 1% shareholder, urged the incumbent board to resign, while Fisher Park Capital, a 3% shareholder, implored management to move up the AGM to the earliest possible date. A second source familiar with the matter said 22NW thinks the board’s refusal to resign corroborates Hudson’s suspicion of an impending sale.
The first source familiar said USAT possibly invoked the disgorgement statute so it can later claim Hudson is not supportive of a potential deal because the activist would be forced to surrender its profits in the event of a sale. Gadson speculated the statute was invoked by USAT as leverage in any potential settlement talks. However, a third source familiar noted that even if USAT chooses not to enforce disgorgement, a shareholder of USAT could enforce it on behalf of the company.
A top-10 shareholder said USAT delisting from Nasdaq in October following “significant” accounting problems is reason enough for change. Another top investor, which has since exited its position, said USAT’s capital raise shortly after delisting was another red flag, which is something Hudson also criticized. The investor said USAT could have received better terms if it did the financing after relisting.
Antara Capital, USAT’s financing partner and an 8.6% shareholder, did not respond to various requests for comment.
The first shareholder said a newly elected board should focus on the company’s network, development team and sales force.
Yet, USAT said it tried to reach a “constructive path forward” with Hudson on the ongoing board refreshment process, adding that the current directors are taking the “necessary actions” to deliver value for shareholders.
The company generated $44.1 million of revenue for the second quarter of fiscal 2020, a 27.7% increase from the same period in 2019. Yet its non-GAAP net loss also increased to $4 million, compared with $1.6 million a year earlier.
Shares in USAT closed at $8.35 on Feb. 27 on the OTC Market, giving it a market cap of $535.83 million.
--Elana Duré
