Delaware's Top Five Worst Shareholder Decisions for 2011 (#4: The Poison Pill Cases: Airgas and Yucaipa)
Delaware, as we have noted on this Blog, is a management friendly jurisdiction. Yet in academia, many favor the approach taken by Delaware because they believe that it promotes efficiency. By allowing maximum discretion in the management of the company, private ordering can flourish and companies can select the most efficient structure that meets their particular needs. To the extent they operate in an inefficient manner, the market is there to exact a penalty.
We have questioned this analysis. The dynamics of corporate law do not permit meaningful private ordering. Shareholders, for example, cannot initiate amendments to the articles of incorporation. As such, management has a negotiating advantage, acting as the drafter for any amendment and is able to determine the timing of the approval process. The problems with private ordering are discussed in Opting Only in: Contractarians, Waiver of Liability Provisions, and the Race to the Bottom.
The management friendly approach and the goal of efficiency often overlap in outcome, but not always. One place where they do not is with respect to hostile takeovers. Delaware cases permit the use of defensive tactics to restrict hostile acquisitions even when inconsistent with efficiency goals. Not all of the jurists in Delaware agree with this approach but they do not control the law in Delaware. When it comes to a conflict between efficiency and the management friendly approach, it is the Delaware Supreme Court that resolves the outcome and efficiency that is the loser.
This can be seen from the decision in Airgas. The case invovled a poison pill issued by Airgas in an effort to stop an acquisition by Air Products. Given the law in Delaware, poison pills are difficult to strike down. Under Unocal, the board has an initial obligation to show that the poison pill was adopted in response to a threat. Threat includes an inadequate price. As long as an informed board considers the price inadequate, the requisite threat will be present.
Airgas, however, involved some unique facts. The poison pill had been in place for a year. It prevented consumation of a "structurally non-coercive, all-cash, fully financed tender offer directed to the stockholders of the corporation". Moreover, the extended time period provided Airgas with "more time than any litigated poison pill in Delaware history." The year long period pesumably provided Airgas with time to find alternative suitors or to convince shareholders it had a better vision for the future than Air Products. This sentiment was echoed by the Chancellor charged with assessing the validity of the pill.
- Air Products' advances have been ongoing for over sixteen months, and Airgas's use of its poison pill—particularly in combination with its staggered board—has given the Airgas board over a full year to inform its stockholders about its view of Airgas's intrinsic value and Airgas's value in a sale transaction. It has also given the Airgas board a full year to express its views to its stockholders on the purported opportunistic timing of Air Products' repeated advances and to educate its stockholders on the inadequacy of Air Products' offer. . . . . In short, there seems to be no threat here—the stockholders know what they need to know (about both the offer and the Airgas board's opinion of the offer) to make an informed decision.
In other words, the poison pill had outlived its usefulness. The time had arrived to remove the poison pill and allow shareholders to make the final decision. Or, as the Chancellor indicated, in his "personal view, Airgas's poison pill has served its legitimate purpose." That, it would seem, was the most efficient outcome.
But his view and the law of Delaware, as established by the Supreme Court, diverged. As the Chancellor noted, he was hemmed in by a different approach emanating from the state's highest court.
- That being said, however, as I understand binding Delaware precedent, I may not substitute my business judgment for that of the Airgas board. The Delaware Supreme Court has recognized inadequate price as a valid threat to corporate policy and effectiveness. The Delaware Supreme Court has also made clear that the "selection of a time frame for achievement of corporate goals . . . may not be delegated to the stockholders." Furthermore, in powerful dictum, the Supreme Court has stated that "[d]irectors are not obliged to abandon a deliberately conceived corporate plan for a short-term shareholder profit unless there is clearly no basis to sustain the corporate strategy." Although I do not read that dictum as eliminating the applicability of heightened Unocal scrutiny to a board's decision to block a non-coercive bid as underpriced, I do read it, along with the actual holding in Unitrin, as indicating that a board that has a good faith, reasonable basis to believe a bid is inadequate may block that bid using a poison pill, irrespective of stockholders' desire to accept it.
Said another way, the relevant issue was not market efficiency but deference to management. Because a trial court was "not free to ignore or rewrite appellate court decisions," the Chancellor declined to overturn the poison pill.
As if to reiterate this approach, the Supreme Court affirmed the decision in Yucaipa. See Yucaipa Am. Alliance Fund II, L.P. v. Riggio, 15 A.3d 218 (Del. 2011). Yucaipa involved a poison pill that limited shareholders ability to form groups in a proxy contest. The Chancery Court found that the proxy contest amounted to a "threat" justifying the pill even though, because of the presence of a staggered board, the insurgent shareholder had no chance of obtaining control. As the trial court reasoned: "For starters, the argument ignores the reality that the election of three directors to a classified board is not a trifling event, which gives the prevailing party no influence."
The case illustrated that poison pills would be upheld even if they significantly impeded the ability of insurgents to elect even a minority of directors through a proxy contest.
These cases collectively reiterate that when efficiency and the management friendly approach are in conflict, it is efficiency that must give way.