Dual-class voting structures can lead to duels. The Xerox/Affiliated Computer Services merger agreement brought to light the legal rifts that can arise between different classes of shareholders – and yet companies from Google to the New York Times Co. to Ford Motor Co. all have dual-class voting structures. Special voting shares can be either a stabilizing factor that ensures the independence of a company or a device that relegates some shareholders to second-class corporate citizenship. With the recent surge in IPOs bringing the issue to the forefront, lawyers are reminded to carefully review the benefits and potential pitfalls of setting up a duel-class stock structure.

Inserting a duel-class stock structure into a company’s capital structure may come with consequences. There are oft-bandied about studies that link these two-tiered ownership structures to lower stock prices. There are, however, real legal consequences to organizing a company with a duel-class stock structure, as Xerox, ACS, and Darwin Deason (founder and chairmen of ACS), might soon learn. These structures can either help facilitate deals or may produce legal side-effects during those very same offerings and registrations, M&A transactions, proxy contests, and restructurings.

As background, dual-class stock structures are sometimes thought of as the providence of a few family-owned businesses, but a quick review shows that is simply not the case. Companies as varied as Google, Dynegy, and Visa all have special voting shares. And pending IPOs for Imperial Capital Group, Baltic Trading Limited, and National Beef have all been recently filed with the hope of instituting dual-class stock structures.

While two-tiered structures are not limited to family-held companies, these businesses aren’t renowned for dual-class voting structures for nothing. Companies as disparate as the New York Times, Viacom/CBS, and Dillard’s are controlled by families that own more voting clout in the company than their economic exposure alone warrants. Furthermore, Hyatt Hotels and its royal family, the Pritzkers, are about to join the ranks of public companies controlled by families through duel-stock structures.

Hyatt’s pending IPO is a particularly notable case study in the usual issues that arise with duel-class share structures. Hyatt is offering to sell close to 48 share of Class A common stock. Following the offering, Hyatt will have two classes of authorized common stock, Class A common stock and Class B common stock. The rights of the holders of Class A common stock and Class B common stock are identical, except with respect to voting and conversion. The Class A common stock is entitled to one vote per share. The Class B common stock is entitled to ten votes per share. The Class B shares can also be converted into Class A shares on a one-to-one basis. Hence, according to the registration, “Because of our dual class ownership structure, Pritzker family business interests will continue to exert a significant degree of influence or actual control over matters requiring stockholder approval, even if they own less than 50% of the outstanding shares of our common stock.”

Hyatt’s capital structure could be troubling to investors. The registration statement was recently amended to add, among other things, a disclosure warning that bickering among the Pritzker clan could depress the value of Class A common shares. Furthermore, the infighting has been in regards to the duel-class structure. According to the most recent registration amendment, “In particular, certain beneficiaries of Pritzker family trusts expressed concern that there could be a value differential between our Class A and Class B common stock based on the difference in voting rights between those two classes of stock.” The same registration contains the rather ominous disclosure that, “The interests of Pritzker family business interests may not always coincide with our interests or your interests. As a result, we may take actions that you do not believe to be in our interests or your interests that could depress our stock price.”

Special voting shares can also lead to conflicts in M&A transactions. Recently, Xerox agreed to acquire ACS for $ $6.4 billion. Darwin Deason, the chairman and founder of ACS, is slated to receive a total of a mix of cash and Xerox securities worth $889 million. According to court documents, Deason’s payout represents a premium of 50% over the amount paid to the public Class A shareholders. Deason owns less than 10% of the Company’s economic equity interests, but his “super-voting” Class B shares garner a 43.6% voting interest in the company. Deason is being paid a premium locking-up merger via a voting agreement covering Deason’s voting securities in ACS.

Class A shareholders are not pleased with the merger agreement or Deason’s premium. The recently-filed Delaware Court of Chancery cases Sheet Metal Workers Local 28 v. Affiliated Computer Services and Orleans Employees’ Retirement System v. Darwin Deason both allege that the merger agreement as currently structured represents a breach of ACS’s board’s fiduciary duties. Both cases mention Deason’s alleged and particularly conflicted position caused by the company’s dual-class voting structure, lock-up, and previous voting agreements with Deason. Orleans Employees’ Retirement System v. Darwin Deason, meanwhile, places more emphasis on the Deason-specific dynamic and asserts a class action claim for breaches of fiduciary duties against Deason as controlling or dominating shareholder. It remains to be seen if the Xerox/ACS transaction, as currently structured will pass muster with the court.

Hyatt’s incorporation documents seem to anticipate issues surrounding voting and mergers. Hyatt’s amended and restated certificate of incorporation requires that the consideration to be received per share by the holder’s two classes of common stock receive identical consideration. The voting rights, however, of any stock consideration may differ to the same extent that the voting rights of Hyatt’s Class A and Class B currently differ. Furthermore, a premium for special voting shares isn’t necessarily a “market" expectation. The Bancroft family did without a premium when it sold Dow Jones & Company to News Corp. in a $5 billion deal.

Shareholder claims of the inequity of two-tiered structures are not limited to M&A situations. Sometimes shareholders simply cannot take it when duel-class share structures depress stock prices or allow some shareholders to be treated as second-class corporate citizens. Morgan Stanley Investment Management, led by the fund’s manager, Hassan Elmasry, conducted a long campaign though through a series of disclosures and other correspondence with directors, management and Arthur O. Sulzberger Jr., the publisher and chairman, in an attempt to get the New York Times change its dual-class share structure. Morgan Stanley Investment Management’s efforts got it nowhere and it eventually sold off its shares.

Activist investors sometime hunt in packs and apply serious pressure to companies, even those insulated by special voting shares. A wolf pack composed of Barington Capital Group, the Clinton Group, and other hedge funds launched a proxy fight against Dillard’s, which widely disparaged the already downtrodden retailer. Dillard’s is controlled with special voting shares and operated by the Dillard family. Barington and Clinton wrote a letter stating in part, “We are convinced that each of the other members of the Dillard family (with the exception of William Dillard, III) is overpaid and under-qualified for the positions they hold and can be readily replaced with more talented retailers.” The hedge funds further alleged that the Dillard family availed itself of entirely too many corporate perks and advocated for unwinding the dual-class stock structure to increase the company’s value. The hedge funds had previously pressured the retailer into accepting one their nominees on the board, but its efforts on dissolving the dual-class stock structure have, so far, been unsuccessful.

Dual-class stock structures can also play important roles in restructurings. For example, Sumner Redstone in recent years has been known primarily for his far flung media holdings in companies like Viacom, CBS, and Midway Games. He also periodically makes headlines for being involved in seemingly internecine court room battles with members of his immediate family for control of the family’s business, movie theater chain, National Amusements Inc (NAI). Redstone controls his media empire by controlling NAI, which in turn owns, for example, Class A “super-voting” shares in CBS and Viacom. The entire empire, however, teetered on default recently and was nearly crushed by the $1.46 billion load a NAI. Redstone recently announced that he is planning to raise up to $1billion to retire debt at NAI by selling shares in CBS and Viacom, but according to disclosures NAI will still control in excess of 79% of voting control in both companies.

Redstone is managing this nifty feat by selling only Class B shares, which carry just one vote (i.e. not the Class A voting shares). It would seem upon first inspection that NAI doesn’t have enough Class B shares to do this. Class A shares, however, are convertible into Class B shares, as long as several preconditions are in place, shares on a one-to-one basis. The conversion allows NAI to raise capital and not dilute its voting control to what Redstone seems to feel would be an unacceptable level. The conversion of voting shares to normal shares is not unusual. Companies from Hyatt to VMware, a virtualization software company, have this convertibility provision within in their dual-class voting structures.

With the recent surge in IPOs, lawyers need to carefully review the benefits and potential pitfalls of setting up a duel-class stock structure. These structures can have legal side-effects during offerings and registrations, M&A transactions, proxy contests, and restructurings. Nonetheless, some are companies have recently done away with their special voting shares: Tecumseh Products Co, Kaman Corp, and several large companies have at least considered it. With all the legal controversy swirling around dual-class structures, the benefits and draw backs of any offering shares with dual-class structures or special voting already existing in the capital structure should be carefully reviewed with counsel.