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Companies often establish committees of independent directors to handle conflicts. But what happens when the rest of the board ignores the committee’s advice — especially if a sale of the interested directors’ company hangs on that decision? The Delaware Court of Chancery will take up that question next month and could provide the first case law on the matter, one lawyer familiar with the litigation said. The case was brought by minority shareholders of Digex Inc., a Beltsville, Md.-based company controlled by Intermedia Communications Inc., a Tampa, Fla.-based communications services company. Intermedia announced its sale to telecom giant WorldCom Inc. on Sept. 5. Intermedia has a 55 percent economic stake and a 92.5 percent voting stake in Digex, a Web hosting service provider. In taking Digex public last year, Intermedia failed to exempt the company from Section 203 of the Delaware General Corporation Law. That statute bans owners of between 15 percent and 85 percent of a company’s equity from merging with the company for three years, unless the target’s board approves. Designed as an anti-takeover provision, Section 203 often makes it difficult to structure mergers in which the target has partially owned subsidiaries. The statute proved critical when Intermedia began to consider a sale of itself, Digex, or both. Santa Clara, Calif.-based Exodus Communications Inc. offered $120 per share for Digex alone. Global Crossing Ltd. prepared a bid for both targets. But WorldCom swooped in and agreed to buy Intermedia for $5.9 billion in assumed debt and WorldCom stock. The $39 per share offer represents a 70 percent premium to Intermedia’s pre-announcement price of $22.63 a share. While WorldCom acquired Intermedia, it lusted after Digex. “First and foremost, the deal is about Digex,” said WorldCom CEO Bernard Ebbers when the deal was announced. Ebbers said his company planned to divest itself of Intermedia’s assets. The deal would allow WorldCom to control Digex without paying the steep premium its investors normally would have demanded. On the Friday before the deal was announced, Digex’s market capitalization stood at $5.3 billion, compared with $1.24 billion for Intermedia. WorldCom’s offer was conditioned on the Digex board’s decision to make Section 203 inapplicable to the stake in Digex that WorldCom would acquire. Independent Digex directors Richard Jalkut and Jack Reich recommended against the proposal, but the six directors at Digex with ties to Intermedia voted for the deal, according to plaintiffs’ complaints. Delaware Chancellor William Chandler will hear the plaintiffs’ motion on Nov. 29 for an expedited hearing. Lawrence Hamermesh, a professor at Wilmington’s Widener University School of Law, believes Intermedia has little to worry about. “The Digex shareholders run up across a very difficult legal obstacle in that, as a 55 percent shareholder, Intermedia has the right to do what it wants with its shares,” Hamermesh said. Delaware courts have ruled that majority shareholders, when selling their shares, do not owe a duty to minority shareholders. Chandler noted this point in his bench ruling. “[Defendants] insist that Digex did not, and will not, have a corporate opportunity to offer itself for sale without Intermedia’s approval and that Intermedia cannot be compelled to agree to a Digex sale. Defendants thus argue, and not without force, that Digex’s minority public stockholders have no legal right to a control premium for their stock, as they do not have control,” he wrote. The more significant legal question is whether Digex’s board violated Delaware law in opting out of Section 203, especially because the board ignored the advice of outside directors. Intermedia counsel Potter Anderson & Corroon claimed in a brief that Section 203 shouldn’t apply to the deal because Intermedia owns 92.5 percent of Digex’s voting stock – well above the 85 percent mandated by the statute. Moreover, Potter claimed, the Section 203 issue is premature because WorldCom had yet to propose a transaction with Digex. It’s difficult to believe Chandler would have decided to hear the suit if it was obvious to him that a company can waive Section 203 against the advice of independent directors. The Digex board had to act to avoid having the company fall under Section 203 regarding WorldCom. That board action may allow Chandler to distinguish the case from those in which majority owners of a company have been found not to have duties to other shareholders. Copyright (c)2000 TDD, LLC. All rights reserved.

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