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Relational Investors LLC v. Sovereign Bancorp

March 2, 2006

RELATIONAL INVESTORS LLC, PLAINTIFF,
v.
SOVEREIGN BANCORP, INC. AND, BANCO SANTANDER CENTRAL HISPANO, S.A., DEFENDANTS.



The opinion of the court was delivered by: Alvin K. Hellerstein, U.S.D.J.

OPINION GRANTING AND DENYING MOTIONS FOR JUDGMENT ON THE PLEADINGS

This case centers on a recurring debate in corporate governance, namely the balance of power between a corporation and its shareholders. Sovereign Bancorp Inc., a banking corporation incorporated under Pennsylvania law ("Sovereign"), finds itself locked in a battle for control with its largest shareholder, Relational Investors, LLC ("Relational"), incorporated under Delaware law. Dissatisfied with Sovereign's management and with its recent decision to sell a portion of its outstanding common stock to Santander Central Hispano, S.A. ("Santander"), a bank incorporated under the laws of Spain, Relational asserts its rights as a shareholder to persuade a majority of shareholders to oust Sovereign's directors from power. Sovereign counters that Relational's real interest is to aggrandize its own equity position, and contends that it and other shareholders may remove directors only upon a showing of cause. If directors could be removed without cause, Sovereign warns, important principles of corporate stability and continuity would be undermined, particularly where, as here, the Board of Sovereign is staggered, so that only two of its six directors stand for election at each annual meeting.

I hold, in response to the parties' motions for judgment on the pleadings, Fed. R. Civ. P. 12(c), in favor of Relational's position. Under Pennsylvania law and Sovereign's own Articles of Incorporation, I hold that Sovereign's shareholders, upon majority vote, have the right to remove directors without cause.

I. PROCEDURAL AND FACTUAL BACKGROUND

In June of 2004, Relational and its affiliates began acquiring a significant equity stake in Sovereign, accumulating approximately eight percent of Sovereign's issued and outstanding common stock, and becoming Sovereign's largest shareholder. In late 2004 and early 2005, Relational began to express dissatisfaction about Sovereign's management and, in May 2005, disclosed that it would seek representation on Sovereign's board at the 2006 annual meeting scheduled to be held in April. Under the terms of Sovereign's classified board structure, two of the six incumbent directors are to stand for re-election at the 2006 annual meeting; a second two, at the 2007 annual meeting; and the third two at the 2008 annual meeting. Seeking initially to replace just two directors, Relational filed preliminary proxy materials with the SEC on October 20, 2005, in connection with its proposed nomination of two directors for election to the Sovereign Board.

In the immediate wake of Relational's announcement, Sovereign announced, on October 24, 2005, that it had reached a definitive agreement with Independence Community Bank of Brooklyn, New York. Under the terms of this agreement, Sovereign is to acquire 100% of the outstanding shares of Independence for approximately $3.6 billion. Contemporaneous to the announcement of its agreement with Independence, Sovereign announced that it had reached a companion agreement with Santander pursuant to which Santander is scheduled to purchase 19.8% of Sovereign's common stock for approximately $2.4 billion.

Expressing concern about the potential implications of Sovereign's agreement with Santander, and contending that the transaction was not in the best interests of Sovereign or its shareholders, Relational brought suit, and filed its initial complaint on December 12, 2005 (05 Civ. 10394). By its complaint, Relational sought a declaratory judgment that the transaction contemplated by the agreement between Santander and Sovereign would result in Santander owning between 19.8% and 24.99% of the outstanding shares of Sovereign common stock and thus would constitute a "control transaction" as defined by Subchapter E of the Pennsylvania Business Corporation Law ("PaBCL"). 15 Pa. Cons. Stat. Ann. §§ 2541 et seq. Under Subchapter E of the PaBCL, upon the occurrence of a "control transaction" wherein an individual or group acquires voting power over at least 20% of all voting shares of a corporation, any holder of the voting shares of said corporation is entitled to payment of fair value for their shares upon demand. 15 Pa. Cons. Stat. Ann. §§ 2541 et seq. Thus, Relational sought a judicial declaration that, upon closing of the transaction with Santander, Sovereign's shareholders would be entitled to receive fair value for their shares.

Shortly thereafter, on December 22, 2005, Relational announced that it intended to seek to remove Sovereign's entire board at the next shareholder meeting. Following Relational's December 22 announcement, Sovereign filed its complaint (05 Civ. 10736), seeking a declaration that its board could be removed only for cause and that the transaction would not constitute a control transaction. One week later, Sovereign's board postponed the April 2006 meeting until an unspecified date after August 31, 2006.

The parties then appeared before me for a conference on January 31, 2006. By Summary Order of January 31, 2006, I directed that the cases be consolidated into 05 Civ. 10394 and set a schedule for filing dispositive motions, and for discovery. Sovereign filed a motion to dismiss pursuant to Rule 12(c), Fed. R. Civ. P., and Rule 12(b)(1), Fed. R. Civ. P., seeking declarations that Relational's claim concerning the effect of the Santander transaction should be dismissed because there was no case or controversy, that Relational's claims based on Sovereign's alleged breach of duties and alleged violations of Section 14(a) of the Securities Exchange Act of 1934 should be dismissed for lack of standing and capacity to sue, and that Relational's claims asserting a right to remove Sovereign's directors without cause should be dismissed because both Pennsylvania law and Sovereign's Articles of Incorporation establish that such removal may only be with cause. Relational filed its opposition to Sovereign's motion to dismiss, and filed its own motion for judgment declaring that removal of Sovereign's directors could be effected without cause.

Contemporaneous with the instant litigation, Sovereign petitioned the Pennsylvania legislature to amend those provisions of the Pennsylvania Business and Corporation Law (the "PaBCL") implicated by the instant litigation. On January 31, 2006, the Pennsylvania legislature passed revisions to § 1726(a)(1), requiring a specific and unambiguous statement in the articles to permit removal of directors without cause. The amendment also included changes to Subchapter E, providing that "[s]hares acquired directly from the corporation in a transaction exempt from the registration requirements of the Securities Act of 1933" are not to be counted when determining whether a person or group has acquired a control position. The amendments were subsequently signed into law by Pennsylvania Governor Edward Rendell on February 10, 2006.

The parties then appeared before me for oral argument on February 16, 2006, to address the various issues of law presented by the motions to dismiss. Prior to oral argument, and in light of the recent statutory amendments, Sovereign voluntarily withdrew its claim as to the applicability of Subchapter E to the Santander transaction. For the reasons stated on the record, I denied Sovereign's motion to dismiss Relational's claims of alleged breach of duties and alleged violations of Section 14(a) for lack of standing and capacity to sue. Thus, remaining for decision is the question of whether Sovereign's directors may be removed without cause, and it is to this question that I now turn.

II. STANDARD OF REVIEW

The standard employed in reviewing a motion for judgment on the pleadings pursuant to Rule 12(c), Fed. R. Civ. P., is the same as that employed for motions brought pursuant to Rule 12(b)(6), Fed. R. Civ. P. A Rule 12(b)(6) motion requires the court to determine whether plaintiff has stated a legally sufficient claim. A motion to dismiss under Rule 12(b)(6) may be granted only if "it appears beyond doubt that the plaintiff can prove no set of facts in support of his claim which would entitle him to relief." Conley v. Gibson, 355 U.S. 41, 45-46 (1957); Branum v. Clark, 927 F.2d 698,705 (2d Cir. 1991). The court's function is "not to assay the weight of the evidence which might be offered in support" of the complaint, but "merely to assess the legal feasibility" of the complaint. Geisler v. Petrocelli, 616 F.2d 636, 639 (2d Cir. 1980). In evaluating whether plaintiff may ultimately prevail, the court must take the facts alleged in the complaint as true and draw all reasonable inferences in favor of the plaintiff. See Jackson Nat'l Life Ins. Co. v. Merrill Lynch & Co., 32 F.3d 697, 699-700 (2d Cir. 1994).

III. DISCUSSION

A. The Right of Removal under Pennsylvania Law

At the time of Sovereign's incorporation in 1987, Pennsylvania law expressly provided for the removal of directors without cause. Pennsylvania Business Corporation Law ("PaBCL"), as enacted in 1933, provided that "the entire board of directors, or a class of the board, where the board is classified with respect to the power to elect directors, or any individual director may be removed from office without ...


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