Airgas, Inc. v. Air Products: Staggered Boards Staggered (The Overstated Role of Proxy Advisory Firms)(Part 6)

The discussion below is based upon the Chancery Court decision in Airgas, Inc. v. Air Products.  The Supreme Court has reversed the decision.  The Supreme Court's opinion is here. 

One of the interesting factual asides in the case is the role of the investor advisory firm.  In Yucaipa, a decision on a poision pill, the Vice Chancellor gave what amounted to definitive weight to the firm's recommendation in making his decision. 

• The Rights Plan is not preclusive because, as Yucaipa's own experts indicated, there is good reason to believe that Yucaipa will succeed in a proxy contest if it puts together a platform and a slate of candidates that are attractive to Aletheia and the leading institutional proxy advisors, particularly Risk Metrics. . . . As will be discussed, Yucaipa admits that if it gets the support of Risk Metrics, it will likely win, as it is difficult to imagine a situation where Yucaipa gets Risk Metrics' support and does not also get Aletheia's. The policies of Risk Metrics about contests for a minority of the board help Yucaipa, as they make short slates easier to elect. Risk Metrics also makes plain that it looks at nominees' strategic plans and business expertise. For these reasons, it is plain that Yucaipa can win and is indeed perhaps a favorite in a proxy fight for three members of Barnes & Noble's board. Certainly, Yucaipa is not precluded by the Rights Plan from running a successful campaign -- rather, its merits case will be the key. In that light, it is also noteworthy that all of the experts in this case agreed that Risk Metrics was much more likely to support an insurgent slate than the management slate.

The prediction turned out to be wrong.  Risk Metrics in fact supported Yucaipa, the insurgent, but Yucaipa still lost.  In other words, the Delaware courts have used investor advisory firms and their purported power to justify decisions that are favorable to management in the proxy contest area.  Yet as Yucaipa demonstrates, they can reflect a serious overstatement of the power of investor advisory firms. 

This case is another example.  The Air Products bylaw was opposed by ISS because it would have the effect of “reducing Airgas’s negotiating leverage in the bidding process.”  Yet the bylaw still passed.

In short, a court's decision to uphold a poison pill or other defensive tactic that prevents shareholders from reaching agreement with each other cannot be justified just because the shareholders can still talk to, and negotiate with, the investor advisory firm.  Other shareholders have the power to determine the outcome of a contest; advisory firms often do not.  

Airgas, Inc. v. Air Products: Staggered Boards Staggered (A Possible Improvement in Majority Vote Provisions)(Part 5)

The discussion below is based upon the Chancery Court decision in Airgas, Inc. v. Air Products.  The Supreme Court has reversed the decision.  The Supreme Court's opinion is here.  

The case turned on the validity of a bylaw rescheduling the next annual meeting.  At the same meeting where the bylaw passed, two other bylaws were also adopted (overwhelmingly), with one in particular of note in the context of majority vote provisions. 

The bylaw addresses a problem that comes up in the context of proxy contests, particularly where the company has a staggered board.  When incumbents lose, it results in the defeat of only one third of the existing board.  Management continues to retain control and has the power to expand the size of the board (assuming its consistent with the range ordinarily set out in the articles).  The new vacancies can be filled with the very directors who just lost the proxy contest.   

Air Products submitted (and shareholders adopted) a bylaw that would prevent this from occurring.  The provision provides:

• “Section 11. Eligibility Requirements. Notwithstanding anything in these By-Laws to the contrary, any person who was nominated by the Board for election as a director at any annual meeting of stockholders and was not elected to the Board by the Corporation’s stockholders at such annual meeting shall be ineligible to serve on the Board (whether to fill any newly created directorship resulting from any increase in the number of Directors or any vacancy on the Board resulting from death, resignation, disqualification, removal or other cause) until after the third annual meeting of stockholders following such annual meeting; provided, however, that if the Chief Executive Officer of the Corporation is so nominated for election but not elected, he or she shall be eligible to serve on the Board (but in no event as Chairman) only if such service is approved by the affirmative vote of a majority of the Directors then serving on the Board who meet the applicable independence requirements of the New York Stock Exchange (such Directors, the “Independent Directors”), and the Board shall select another Director to serve as Chairman. In making such decision, the Independent Directors shall retain and consult with nationally recognized legal and financial advisors that have not represented and are not representing the Corporation in any other capacity. Neither the stockholders nor the Board shall amend, alter or repeal this Section 11, or adopt any provision inconsistent with or germane to the subject matter of this Section 11, without the approval of the affirmative vote of the holders of at least a majority of the voting power of all shares of the Corporation entitled to vote generally in the election of directors, voting together as a single class.”

The provision left open the possibility that the CEO could in fact be elected to the board, even if just defeated.

The bylaw also has some use in the majority vote context.  Majority vote provisions, as we have noted, typically required defeated directors to resign, with the board having the discretion to accept or reject the resignation.  Even assuming the resignation is accepted, nothing prevents the board from reappointing the losing director to the vacancy.  Indeed, the RMBCA provides that bylaws may require directors not receiving a majority to step down after 90 days but note in the comment that the defeated director can be appointed to the vacancy that he or she created.

This type of provision could be written to prevent the reappointment of a director who resigns or is required to step down after failing to receive the requisite majority support.  This would prevent reappointment in RMBCA jurisdiction and would prevent reappointment in Delaware if a letter of resignation was accepted.  It does not cure the problems with majority vote provisions but it does enhance the ability of shareholders to use the power to remove directors from the board. 

Airgas Reversed

We have been following Airgas v. Air Products, a Chancery Court decision that had given shareholders a rare victory.  The case, however, was (predictably) reversed by the Supreme Court. 

The case turned on the provision in the staggered board provision that gave directors a term that expired "at the annual meeting of stockholders held in the third year following the year of their election."  The only issue was whether year meant calendar year or had to mean something like 365 days.  The resolution mattered since shareholders passed a bylaw that would schedule the next annual meeting for January 2011, three calendar years for the directors elected in 2008 but not three durational years.  

The Court conceded that the language was ambiguous.  Moreover, the decision noted that in the case of ambiguity any doubt had to be "resolved in favor of stockholders' electoral rights."  Yet the decision then engaged in a fact finding exercise to conclude that the term meant a durational year because the "intent of the parties" resolved the ambiguity.

The basis for the determination of the intent of the parties?  That companies with similar provisions typically stated in their proxy statements that the staggered board provision provides for three year terms. 

• Of the eighty-nine Fortune 500 Delaware corporations that have staggered boards, fifty-eight corporations use the Annual Meeting Term Alternative. More important, forty-six of those fifty-eight Delaware corporations, or 79%, expressly represent in their proxy statements that their staggered-board directors serve three year terms. 
• Ninety-nine of the Fortune 500 Delaware corporations have de-staggered their boards over the last decade. Of those ninety nine corporations, sixty-four used the Annual Meeting Term Alternative, and an overwhelming majority -- sixty-two, or 97% -- represented in their proxy
  statements that their directors served three year terms.

In other words, the Court was making a factual determination about a common understanding.  The Court did so despite the fact that 31 of the 89 companies used other, presumably less ambiguous langauge in their articles.  

Moreover, even had Airgas intended a three year term computed on durational time periods (a high likelihood, notwithstanding the absence of any evidence cited by the Court in this case), it doesn't change the fact that the language was ambiguous and susceptible to two reasonable interpretations.  What the lower court did was apply the interpretation that comported most with promoting the shareholder franchise.  The Supreme Court did not.  

Airgas, Inc. v. Air Products: Staggered Boards Staggered (A Prediction)(Part 7)

The Supreme Court in Delaware issued an opinion today reversing the Chancery Court's decision in Airgas.  This post had been scheduled for Friday but was written last week.  In it we predicted this very result.  We will have more to say about this in subsquent posts. 

We are discussing Airgas, Inc. v. Air Products, a recent decision out of the Delaware Chancery involving staggered boards.  This case is on appeal.  It will likely be reversed. 

Despite the accuracy of the reasoning, it puts public companies with staggered boards in a bind.  To prevent what happened in this case, they will need to amend their staggered board provision.  Assuming it is in the articles, this will require approval of shareholders.  Given the dislike by many shareholders of staggered board provisions, putting the matter to a vote will likely result in a contentious exchange and, at least in some cases, a defeat of the amendment. 

Of course, many companies will likely ignore the possible concern.  With most public companies having their annual meeting during the first six months of the year, any attempt by shareholders to adopt a bylaw that would reschedule the meeting for shortly after the next calendar year still results in a delay of six to eight months.  The risk of an Air Products type bylaw may not be particularly serious.

For the smaller number of companies with annual meetings towards the end of the calendar year, the problem may be more acute.  To the extent that the company has a controlling shareholder (a more likely possibility for smaller public companies), there will be no need to change the staggered board provision.  The controlling shareholder will already have the voting power to block any Air Products style bylaw (and frankly to win any election for directors, whenever the meeting is held).

So, for companies with staggered boards that have meetings late in the calendar year and do not have controlling shareholders, there will likely be pressure to change the staggered board provision.  This will at least in some cases result in contentious exchanges between management and shareholders. 

The Supreme Court has an easy way out.  It can affirm all of the legal analysis in Airgas but find that the actual language of the bylaw/charter for the staggered board contemplated a three fiscal rather than calendar year period.  And with an easy way out, its this Blog's opinion that the Court will take it. 

Airgas, Inc. v. Air Products: Staggered Boards Staggered (What About Those Special Interest Directors)(Part 4)

We are discussing Airgas, Inc. v. Air Products, a recent decision out of the Delaware Chancery that validated a bylaw shortening the time between annual meetings to three months.

In the world of shareholder access, one of the most significant concerns has been the use of the authority to elect “special interest” directors, candidates that will act in the interests of the nominating shareholder rather than all shareholders.   The usual response is to assert that directors must be elected by all shareholders and that special interest directors will not be elected.  The battle is one of assertion.  Only with experience will a definitive answer emerge.

Nonetheless, anecdotal evidence suggests that shareholders wanting to win contests must nominate highly qualified persons to the board. 

This was apparently the case in Airgas.  Although the case centered around a bylaw, shareholders at the same meeting elected three insurgent directors to the board.  Who were these "special interest" directors?  They included:

John P. Clancey

Mr. Clancey, 65, has more than 22 years of experience as both CEO and Chairman of complex international businesses, and 16 years of experience serving on the boards of large public companies across a range of industries.  He is currently Chairman Emeritus of Maersk Inc. and Maersk Line Limited, a division of the A.P. Moller - Maersk Group, one of the world’s largest shipping companies.  Mr. Clancey previously served as Chairman of Maersk Inc., where he managed the company’s ocean transportation, truck and rail, logistics and warehousing and distribution businesses, and as Chief Executive Officer and President of Sea-Land Service, Inc.  Mr. Clancey is currently a Principal and founder of Hospitality Logistics, International, a furniture, fixtures and equipment logistics services provider serving customers in the hotel industry, and a member of the Board of Directors of Livingston International Inc., a major international customs house and freight forwarding company.  He has served as a member of the board of directors of UST Inc., Foster Wheeler AG, and AT&T Capital.  Mr. Clancey, a former Captain in the United States Marine Corps, received a B.A. in Economics and Political Science from Emporia State College.

Robert L. Lumpkins

Mr. Lumpkins, 66, has more than 40 years of significant operational, management, financial and governance experience from a variety of positions in major international corporations, covering both developed and emerging countries, and service on public company boards in a wide range of industries.  He is currently the Chairman of the board of directors of The Mosaic Company, a producer and marketer of crop and animal nutrition products and services, a position he has held since the creation of the company in October 2004.  He previously served as Vice Chairman of Cargill Inc., a commodity trading and processing company, until his retirement in 2006, and as Cargill’s Chief Financial Officer from 1989 until 2005.  Mr. Lumpkins currently serves as a director of Ecolab, Inc., a cleaning and sanitation products and services provider; a Senior Advisor to Varde Partners, Inc., an asset management company specializing in alternative investments; and a member of the Advisory Board of Metalmark Capital, a private equity investment firm.  He also serves as a Trustee of Howard University.  He received an M.B.A. from the Stanford Graduate School of Business and a B.S. in Mathematics from the University of Notre Dame.

Ted B. Miller, Jr.

Mr. Miller, 58, has extensive executive, financial and governance experience as a founder, significant shareholder, executive officer and director of both start-up companies and large public companies.  He is the former Chairman and Chief Executive Officer of Crown Castle International Corp., a wireless communications company he founded in 1995 that currently has an equity market capitalization in excess of $10 billion.  He currently serves as President of 4M Investments, LLC, an international private investment company.  He is also the founder, Chairman and majority shareholder of M7 Aerospace LP, a privately held aerospace service, manufacturing and technology company; the founder, Chairman and majority shareholder of Intercomp Technologies, LLC, a privately held business process outsourcing company; and the founder, Chairman and majority shareholder of Visual Intelligence, a privately held imaging technologies company.  Mr. Miller previously served as a member of the board of directors of Affiliated Computer Services, Inc., from November 2008 until its acquisition by Xerox Corporation in February 2010.  He received a J.D. from Louisiana State University and a B.B.A. from the University of Texas.

In short, from all appearances, highly qualified candidates that would appeal to a majority of shareholders.

Airgas, Inc. v. Air Products: Staggered Boards Staggered (A Drafting Tutorial by the Chancery Court)(Part 3)

We are discussing Airgas, Inc. v. Air Products, a recent decision out of the Delaware Chancery that validated a bylaw shortening the time between annual meetings to three months. 

In responding to the argument that its holding would “destabilize the staggered boards of Delaware companies,” the Chancery Court made clear that the problem was inartful drafting.  See Id. ("If corporate charters and bylaws have been written in a non-specific, open-ended fashion, it is not for this Court to twist their plain words to achieve a purported intent of the drafters.  The solution is for drafters to employ clear and simple language to provide clarity and avoid ambiguity.").   

But more than criticize, the Chancery Court engaged in a writing tutorial.  The opinion included the precise language for any bylaw/article provision that would prevent advancements in the meeting date for staggered board provisions. 

• This could easily be accomplished by corporate planners and draftsmen through such simple language as:  "The annual shareholder meeting shall be held as closely as practicable in the same month of each year so as to ensure that the terms of office of directors shall approximate a complete year in length."  In short, this is not the end of the world of staggered boards; it is an easy fix if it needs fixing.

It was a clear and cost effective approach.  The opinion probably shaved off an hour of billing time for every transactional lawyer considering the drafting issues raised by this opinion. 

Airgas, Inc. v. Air Products: Staggered Boards Staggered (The Holding)(Part 2)

We are discussing Airgas, Inc. v. Air Products, a recent decision out of the Delaware Chancery involving staggered boards. 

The legal issue was whether a bylaw scheduling the next annual meeting for three months after the prior annual meeting violated the Company's staggered board provision and/or the Delaware statute.  Airgas had in place both a bylaw and article provision that mandated a staggered board.  Airgas asserted that the change in the annual meeting conflicted with the requirement that directors “hold office for a term expiring at the annual meeting of stockholders held in the third year following the year of their election.” 

The court viewed the language as ambiguous and relied on the interpretation that favored “the shareholder franchise.”  Because the directors at issue had been elected in calendar 2008 and would be subject to election in calendar 2011 (albeit in January), the court concluded that the bylaw was not inconsistent with the staggered board provision. 

As for a challenge under the Delaware statute, Airgas asserted that the bylaw violated the staggered board provision, Section 141(k), which provided that directors would be elected at annual meetings and for a full term.  The analysis shifted to Section 211(c) which provided that “an annual meeting of stockholders shall be held for the election of directors on a date and at a time designated by or in the manner provided by the bylaws.”  The provision contains only one express timing requirement:  Annual meetings cannot be separated by more than 13 months. 

• "Annual meeting” [as the term is used in Section 211] is not defined.  Corporations are free to draft their governing documents to specify when their annual meetings shall take place.  They can do this explicitly in the bylaws.  They can also define the term of their staggered board in their charter or bylaws, should they decide to have a classified board.  To the extent they do not unambiguously make these terms clear in their governing documents, though, the default rules in Delaware do not require a “year,” or “twelve months” or any set amount of time from one annual meeting to the next.

As for the argument that “annual” meetings could be held only days apart, the court conceded the possibility but noted that there were “practical constraints,” not the least of which was the need to file proxy materials.  Id. at n. 63. 

Moreover, there was always equity.  “If, once in office, the insurgents engage in musical meeting games advancing or delaying meetings for entrenchment, disenfranchisement, or other improper purposes, this Court’s broad equitable powers would have bite, as would the thirteen month limit under Section 211(c).  Equity stands ready to thwart misuse or abuse by directors or by insurgents.”

The decision and its interpretation of "annual" is reasonable.  Moreover, in the long run, it accedes greater discretion to management since the board, rather than shareholders, usually sets the date for the annual meeting.  Moreover, to the extent "annual" must mean fiscal or calendar, most efforts to shorten the time period between meetings wouldn't be all that effective.  Public companies usually have their meetings in the first half of the year.  While a bylaw could require that the meeting be early in the next calendar year, it would still provide six-eight months between meetings in most cases.

Airgas, Inc. v. Air Products: Staggered Boards Staggered (Introduction and Facts)(Part 1)

Even Delaware can occasionally issue a decision that surprises and Airgas, Inc. v. Air Products certainly qualifies.  After Selectica and Yucaipa validated poison pills in the context of proxy contests at companies with staggered boards, it would have been reasonable to predict that the Delaware courts would do little to interfere with the use of staggered boards or adopt positions that would allow for their circumvention.   On that basis, Airgas should have won its challenge to the bylaw proposed by Air Products and adopted by shareholders that effectively circumvented the Airgas staggered board.  Yet it did not.

For that reason alone the case warrants a serious examination.  But there are other reasons.  It provides a road map for circumventing staggered boards and also provides shareholders with a rare devise that could be used to subject a board to greater shareholder oversight.  Finally, and  most importantly,  the opinion triggers the application of the Delaware failsafe mechanism for ensuring management friendly mechanism – the Delaware Supreme Court.

Airgas has a staggered board.  On Sept. 15, 2010, the company held its annual meeting.  Air Products ran a competing slate (one third of the board) and succeeded in elected all of them.  The election was to some degree a blow out, with the insurgent candidates receiving almost twice the number of votes as the incumbent directors. 

Ordinarily, Air Products would need to wait until the following year to run enough directors to obtain control.  But not willing to accept the delay, Air Products proposed a number of bylaws, one of which would advance the next annual meeting of shareholders to January, only a few months away.  In effect, Air Products would have an opportunity to elect a second tranche of directors (and obtain a majority) only three months after the first.  The bylaw passed with 51% of the votes cast (and 45.8% of the outstanding shares). 

Litigation ensued and the parties turned to the Delaware Chancery Court to determine whether the bylaw was valid. 

Say on Pay and SEC Rulemaking (Mandatory Proxy Solicitations)

The SEC has put out a rule proposal designed to implement the say on pay provisions in Dodd-Frank.  See Exchange Act Release No. 63124 (Oct. 18, 2010).

The provision contains a number of new requirements, most noticeably the adoption of Rule 14a-21.  The rule proposal covers the requirement of shareholder approval, the need for a vote at least every three years, the requirement that shareholders vote at least every six years on frequency of "say on pay" proposals, and the approval of golden parachutes in any solicitation for approval of an acquisition.  A note to the proposed rule specifies that the approval process does not apply to director compensation required by Item 402(k).

There are a number of observations that arise out of this proposal.  First, say on pay was voluntarily implemented by some companies and required for TARP recipients.  This provision (as was mandated by Dodd-Frank) extends say on pay to all public companies (those registered under Section 12 of the Exchange Act, a requirement that applies to companies with 500 shareholders of record and $10 million in assets; see Rule 12g-1).   

What Dodd-Frank left open but the SEC has apparently resolved is whether say on pay requires companies to engage in a proxy solicitation.  State law does not impose the requirement; nor does the federal securities laws.   Proxy solicitations are either discretionary acts or done pursuant to the requirements of the stock exchange.  Non-exchange traded companies, therefore, are not required to solict proxies (but still must distribute an information statement under Section 14(c) of the Exchange Act).  For those companies, the application of the say on pay requirements was murky.

The SEC has resolved the issue by providing that once a company engages in a solicitation for an annual meeting, the say on pay requirements attach.  See Proposed Rule 14a-21(a).  In other words, as long as a company not required to engage in a solicitation does not, say on pay does not apply.  Once the company engages in a solicitation, it will then lose future discretion over the right to engage in solicitations.  Thereafter, a say on pay vote must be held no less frequently than every three years and a vote must occur at least every six years on frequency.

Said another way, non-exchange traded companies that do not ordinarily solicit proxies will gradually find themselves required to do so.  Over time, most public companies will, as a result of say on pay, be required to solicit proxies. 

Selectica, the Delaware Supreme Court, and the Effort to Limit Access (The Impact on Access)

We are examining the Delaware Supreme Court's recent decision in Selectica.  The opinion affirmed the validity of a poison pill with a 5% trigger.  

As we have suggested, the true significance of this decision can be seen with respect to shareholder access.  Selectica (and Yucaipa) are beginning to develop a line of cases that put into the hands of the board the ability to prevent the election of insurgent directors.  Under Moran and Unocal, the board has long had that authority with respect to insurgents seeking control of the board.  But the more recent jurisprudence is designed to allow directors to stop the election of a minority of directors on the board.

This case illustrates exactly how poison pills can be designed to interfere with access.  Access provides that nominations must be submitted by those shareholders holding more than 3% of the outstanding shares.  In Selectica, the insurgent had a 5% block but would have needed to hold at least 3% of the outstanding shares for at least three years.  In other words, to the extent not owning 3% for at least three years, Trilogy would have needed to form a group with other shareholders meeting the holding period requirement.  Yet had Trilogy tried to do so, it would have triggered the poison pill since it would have entailed an agreement with shareholders that collectively exceeded the 5% threshold.  As a result, the pill would have potentially prevented access nominees from Trilogy.

To the extent 5% poison pills (or pills with even lower triggers) become common, a federal response may be necessary.  One possibility would be to lower the 3% threshold in the access rule dramatically, at least for companies with poison pills that have low thresholds.  This is only a partial solution.  There should be no restrictions on the right of shareholders who have held their shares for more than three years to collectively decide on a common slate of access candidates.  The SEC removed restrictions in Rule 14a-2.  Poison pills, however, will interfere with any agreement to the extent the collective ownership of the shareholders approaches the poison pill trigger.

Perhaps more dramatically the SEC ought to give consideration to a provision in the rule that provides explicitly that 3% shareholders will not trigger a rights plan solely as a result of negotiations over access nominees.

Finally, the approach in Delaware puts greater pressure on the need for corporate law reform.  In truth, shareholders ought to have the right to propose changes to the articles, at least where they interfere with the voting process.  In other words, shareholders ought to have the right to propose the elimination of staggered boards, provisions usually in the articles.  Likewise they ought to have the direct authority to repeal a poison pill.  This would be a change but it would ensure that corporate governance remained a matter of private ordering.   

For materials from the lower court proceeding, access the DU Corporate Governance web site.

Selectica, the Delaware Supreme Court, and the Effort to Limit Access (Absolutely Not Absolute)

We are examining the Delaware Supreme Court's recent decision in Selectica.  The opinion affirmed the validity of a poison pill with a 5% trigger.  

The Court at some level understood the extraordinary nature of the opinion.  Pills with 5% thresholds when coupled with staggered boards would in fact have a signficant impact on proxy contests.  The opinion provided a roadmap for companies, particularly smaller ones, in the appropriate array of defensive tactics that are likely to minimize or eliminate the risk of proxy contests. 

At the end of the analysis of the pill, the Court inserted some analysis that suggested the case may be limited in its reach. 

• As we held in Moran, the adoption of a Rights Plan is not absolute.  In other cases, we have upheld the adoption of Rights Plans in specific defensive circumstances while simultaneously holding that it may be inappropriate for a Rights Plan to remain in place when those specific
  circumstances change dramatically. The fact that the NOL Poison Pill was reasonable under the specific facts and circumstances of this case, should not be construed as generally approving the reasonableness of a 4.99% trigger in the Rights Plan of a corporation with or without NOLs.
  To reiterate Moran, “the ultimate response to an actual takeover bid must be judged by the Directors’ actions at that time.” If and when the Selectica Board “is faced with a tender offer and a request to redeem the [Reloaded NOL Poison Pill], they will not be able to arbitrarily reject the
  offer. They will be held to the same fiduciary standards any other board of directors would be held to in deciding to adopt a defensive mechanism.” 

Yet the analysis in the opinion does not provide any meaningful support for a limited reading of Selectica or the hope that the Court will be more exacting if and when a tender offer surfaces. 

There is a burden on the company to justify a 5% trigger.  But the Court makes clear that anything reasonable (reasonable having a very broad spectrum) will suffice.  Once an explanation for the 5% trigger has been provided, that will meet the "threat" element required by Unocal.  The Court made it clear that so long as a 5% limit on purchases can be justified, it will not separately examine the 5% limit on agreements in the context of a proxy contest.

Likewise the proportionality analysis in the opinion provides little basis for challenging pills with low triggers, despite the obvious and severe impact on proxy contests. There the court indicated that a pill that did not preclude a proxy contest would be upheld even if it made one impractical.

The Court admonishes that in the event of a tender offer, the board cannot arbitrarily leave the pill in place.  But that will again depend upon the circumstances and so far this Court has not seen circumstances that warrant the overturning of a poison pill with a lower trigger.  

Despite the admonition about the importance of the circumstances tacked on by the Court in this case, the circumstances are in fact not that important.  It remains to be seen what subsequent courts will do but one thing is clear:  Poison pills with much lower triggers will become far more common.

For materials from the lower court proceedings, access the DU Corporate Governance web site.

We are examining the Delaware Supreme Court's recent decision in Selectica.  The opinion affirmed the validity of a poison pill with a 5% trigger.  

Unitrin also prohibited poison pills that had a preclusive effect on proxy contests.  Preclusive meant that success was "realistically unattainable."  As the Court described:

• A defensive measure is preclusive where it “makes a bidder’s ability to wage a successful proxy contest and gain control either ‘mathematically impossible’ or ‘realistically unattainable.’” A successful proxy contest that is mathematically impossible is, ipso facto, realistically unattainable. Because the “mathematically impossible” formulation in Unitrin is subsumed within the category of preclusivity described as “realistically unattainable,” there is, analytically speaking, only one test of preclusivity: “realistically unattainable.”

Selectica, the Delaware Supreme Court, and the Effort to Limit Access (The Impact of the Staggered Board)

We are examining the Delaware Supreme Court's recent decision in Selectica.  The opinion affirmed the validity of a poison pill with a 5% trigger.  

The low trigger for the poison pill in this case had to be considered in light of the company's staggered board.  The pill made any proxy contest difficult.  But with only one-third of the directors up for election, the company made a proxy contest even more unappealing.  

Insurgents would have to engage in a proxy context with no more than 5% of the shares, pay all of the expenses, and have the possibility of only electing a minority of the board.  Because they cannot come to agreement on a common slate of directors with any other sharehodlers (at least any shareholders that would result in the crossing of the 5% threshold), they come into the contest with markedly less support than otherwise woudl be the case.  As a result, the low threshold likely increases the costs of a contest.

It also makes certain that insurgents will never be reimbursed.  To the extent an insurgent succeeds in obtaining a majority of the board, the new board will likely agree to reimburse the costs expended by the insurgent.  By limiting insurgents to a minority of the board, the company is in effect ensuring that shareholders will not be compensated for the expenses even if they win. 

None of this was acknowledged by the Supreme Court.  The Court simply opined that staggered board were legal. 

• Classified boards are authorized by statute and are adopted for a variety of business purposes. Any classified board also operates as an antitakeover defense by preventing an insurgent from obtaining control of the board in one election.  More than a decade ago, in Carmody, the Court of Chancery noted “because only one third of a classified board would stand for election each year, a classified board would delay-but not prevent-a hostile acquiror from obtaining control of the board, since a determined acquiror could wage a proxy contest and obtain control of two thirds of the target board over a two year period, as opposed to seizing control in a single election.” The fact that a combination of defensive measures makes it more difficult for an acquirer to obtain control of a board does not make such measures realistically unattainable, i.e., preclusive. 

The statement is merely a repeat of the justification of a staggered board.  The problem with the analysis is that it does not take into account the staggered board and a poison pill with a 5% threshold.  The two combined do more than limit an insurgent from acquiring control in two years.  They collectively discourage anyone from engaging in a proxy contest. 

None of this was acknowledged in any meaningful way.  In considering both tactics together, the Court simply said that they weren't preclusive.  "In this case, we hold that the combination of a classified board and a Rights Plan do not constitute a preclusive defense."

For materials from the lower court proceeding, access the DU Corporate Governance web site.

Selectica, the Delaware Supreme Court, and the Effort to Limit Access (The Impossibility Standard)

We are examining the Delaware Supreme Court's recent decision in Selectica.  The opinion affirmed the validity of a poison pill with a 5% trigger.  

In effect, the Court in Selectica adopted an impossibility standard.  A poison pill would not be deemed preclusive unless it was impossible to win an election contest.  The opinion described testimony indicating that to win, an insurgent would need to obtain 43.2% (a percentage apparently assuming that some shareholders would not vote).  The court noted that twenty-two shareholders controlled 62% and citing testimony that “if you have a compelling platform, which is critical, it would be easy from a logistical perspective; and from a cost perspective, it would be de minimis expense to communicate with those investors, among others.”

Yet buried in a footnote was an acknowledgement that 23.5% of the shares were owned by Steel Partners, the company's largest shareholder, and two directors.  Trilogy asserted that "their opposition would result in having to conduct a traditional proxy contest."  The Court, however, disagreed.  Doing some quick math, it noted that by subtracting 23.5% from 62%, the remaining large shareholders owned 38.5%.  This left Trilogy with enough outstanding shares to still win the proxy contest.

• "Those nineteen shareholders plus the 4.99% amount allowed before triggering the pill would equal 43.49% of Selectica’s shares, an amount slightly in excess of what Harkins testified would be needed to win a proxy contest."

 In other words, Trilogy had to win the support of every single large shareholder.  Moreover, it had to do so with a poison pill in place that prevented it from reaching agreement with any of the other large shareholders.  For example, some of the other large shareholders might have supported Trilogy had Triology been willing to include one of their candidates in its slate.  But the poison pill prevented this from occurring.

The Court was willing to find that a pill did not have a preclusive effect on a proxy contest in circumstances where the insurgent shareholder had to obtain the support of all 19 other large shareholders and could not negotiate with them in advance of the vote.

The limitation is not preclusive if by preclusive you mean impossible.  But if it means “realistically unattainable” as the courts pretend that it does, the poison pill, in this context, meets that standard.

For materials from the lower court proceeding, access the DU Corporate Governance web site.

Selectica, the Delaware Supreme Court, and the Effort to Limit Access

We are examining the Delaware Supreme Court's recent decision in Selectica.  The opinion affirmed the validity of a poison pill with a 5% trigger.  

Unitrin also prohibited poison pills that had a preclusive effect on proxy contests.  Preclusive meant that success was "realistically unattainable."  As the Court described:

• A defensive measure is preclusive where it “makes a bidder’s ability to wage a successful proxy contest and gain control either ‘mathematically impossible’ or ‘realistically unattainable.’” A successful proxy contest that is mathematically impossible is, ipso facto, realistically unattainable. Because the “mathematically impossible” formulation in Unitrin is subsumed within the category of preclusivity described as “realistically unattainable,” there is, analytically speaking, only one test of preclusivity: “realistically unattainable.”

Yet as we will show in the next post, the Court did not apply a "realistically unattainable" standard.  As long as a proxy contest is mathematically possible, Selectica indicates that the Court will find the that the pill does not make a proxy contest "realistically unattainable."

For materials from the lower court proceedings, access the DU Corporate Governance web site.

Selectica, the Delaware Supreme Court, and the Effort to Limit Access (The Import of the Poison Pill)

We are examining the Delaware Supreme Court's recent decision in Selectica.  The opinion affirmed the validity of a poison pill with a 5% trigger. 

Selectica put in place a poison pill with a 5% threshold in order to prevent the loss of NOLs (net operating loss carryforwards).  The board understood that the NOLs could be lost should ownership of the company change during any three year period.  As the Court described:

• At its most basic, an ownership change occurs when more than 50% of a firm’s stock ownership changes over a three-year period.  Specific provisions in Section 382 define the precise manner by which this determination is made. Most importantly for purposes of this case, the only shareholders considered when calculating an ownership change under Section 382 are those who hold, or have obtained during the testing period, a 5% or greater block of the corporation’s shares outstanding.

Given that only 5% shareholders could cause an ownership change that would result in the loss of the NOLs, the pill's attempt to prevent the creation of additional 5% thresholds more than met the standard in Unocal that imposed on management a prima facie case of establishing a threat to the company.  Indeed, as the Court noted:  "The Court of Chancery found the record “replete with evidence” that, based upon the expert advice it received, the Board was reasonable in concluding that Selectica’s NOLs were worth preserving and that Trilogy’s actions presented a serious threat of their impairment."

But the poison pill did more than restrict purchases.  It also prevented shareholders in a proxy contest from reaching agreement on a common slate of directors and a sharing of expenses.  The threat to the NOLs may have justified a 5% threshold on purchases but it did not justify a restriction on agreements in proxy contests.  Moreover, given the existence of a staggered board, it was difficult to see how the insurgents could pose any threat to the company.  Moreover, the pill could have preserved the 5% threshold for purchases but put in place a higher one applicable to proxy contests. 

The decision suggests that a low trigger, if justified for any reason, will be allowed to remain in place during a proxy contest, even where the poxy contest poses no threat to the company.  

For materials from the lower court proceeding, access the DU Corporate Governance web site.

Selectica, the Delaware Supreme Court, and the Effort to Limit Access (Introduction)

It was no big surprise that the Delaware Supreme Court affirmed the trial court's decision in Selectica.  Selectica involved a poision pill with a 5% trigger.  Plaintiffs bought through the pill and saw their holdings undergo significant dilution.  They challenged the poison pill in Delaware courts, arguing that the pill, with its 5% threshold, violated Unocal. 

As a means of stopping hostile takeovers or creeping tender offers, no defensive tactic violates Unocal, or so it seems.  Certainly poison pills do not.  In a sub silentio fashion, the Delaware courts have adopted a version of the "just say no" defense.  Pills can be used and will be upheld irrespective of the "threat" posed or the proportionality of the response.

The focus has therefore shifted to the impact of poison pills on proxy contests.  The pills impose substantial limitations on insurgents.  Shareholders seeking to negotiate a common slate of directors and an expense sharing arrangement will trigger the pill if, collectively, the own more than the triggering percentage.  As in the takeover context, courts have little trouble affirming the use of the poison pills, even when (or perhaps because) they tilt the playing field decidedly in the direction of management.

To the extent that there was any meaningful limitation on the use of poison pills, it would have been in the context of contests centering around a minority of the directors on the board.  Even if an insurgent elected minority directors to the board,  it would have no power to implement any policies or otherwise change the direction of the company.  This would be the case in any contest involving a minority of the board but it would be most clearly the case in those companies with a staggered board.  In those circumstances, insurgents could not elect more than a minority of the board even if they wanted to. 

The Supreme Court in Selectica made absolutely clear that poison pills with small thresholds were valid, even when the company had a staggered board and, as a result, only a minority of the directors were up for election.  The Delaware Supreme Court has more or less signaled that it will decide cases in a manner that is designed to discourage the election of non-management nominated directors, even if only representing a minority of directors on the board.  In short, the decisions are paving the way with legal limitations on shareholder access. 

For materials from the lower court proceedings, access the DU Corporate Governance web site.

Gentile v. Rossette: Even 95% Majority Shareholders Must Be Entirely Fair

In Gentile v. Rossette, C.A. No. 20213-VCN, 2010 WL 2171613 (Del. Ch. May 28, 2010), the Delaware Chancery court declared that defendant P. David Rossette, the largest shareholder of the now defunct company SinglePoint Financial, Inc. and one of two directors, had engaged in self-dealing through a debt conversion plan that benefitted him at the expense of fellow shareholders.

Rossette was the largest shareholder in SinglePoint. He had lent the company considerable sums, causing the court to observe that the "balance sheet reflected a staggering (for an entity of its size) amount of debt--virtually all of it owed to Rossette."  To reduce the amount of debt on the company's balance sheet, Rossette opted to convert some of the loans to equity.  The Debt Conversion Agreement provided that debt of $2,220,951 would be converted into shares of the Company at $0.05 per share.  The result was that Rossette's percentage increased from 61% to 95% of the Company's equity. 

Plainitiff challenged the agreement.  The court first had to determine the standard of review.  The board contained two directors, with one of them independent.  As a result, plaintiffs had the burden of showing the unfairness of the transaction.  The court, however, disagreed. 

• "Bachelor [the independent director] had no experience as a director. He was intensely familiar with the Company's technical matters and was aware of its financial difficulties. However, he had no firm basis for determining what a fair conversion price would have been. More importantly, he had no help. He received no independent legal or financial guidance." 

Instead, the burden of establishing fairness rested with the board.  According to the court, “[f]air dealing ‘embraces questions of when the transaction was timed, how it was initiated, structured, negotiated, disclosed to the directors, and how the approvals of the directors and the stockholders were obtained.’ Fair price ‘relates to the economic and financial considerations of the proposed merger, including all relevant factors: assets, market value, earnings, future prospects, and any other elements that affect the intrinsic or inherent value of a company’s stock.’” Boyer v. Wilmington Materials, Inc., 754 A.2d 881, 898-99 (Del. Ch. 1999).

The court found that the process used to determine the debt conversion price was not "fair." 

• Rossette set the conversion rate with limited or no pushback from Bachelor, who was in no position to bargain effectively on behalf of the minority stockholders. Although the Company's financial condition  may have afforded Bachelor little leverage, the lack of any independent assistance--legal or financial--precluded a material effort on behalf of the constituency he represented. Furthermore, as set forth above, the so-called fairness opinion obtained by Rossette is not a substitute for a thoughtful and helpful analysis.

As the court noted, "[f]rom a tainted process, one should not be surprised if a tainted price emerges."  The court examined evidence on value provided by both plaintiffs and defendants and opined that there "is no reliable way to 'calculate' a 'fair value'" for the shares at the time of conversion.  Nonetheless, weighing all of the evidence, the court concluded that the value was "a number in the mid-range between $ 0.10 per share and something a little less than $ 0.75 per share is as accurate as one can be."  As a result, the court selected a value of $.40 per share.

As for damages, the court found that Bachelor was not liable.  The waiver of liability provision in the articles eliminated monetary damages in the absence of personal benefit.

• Bachelor is entitled to the protection of this exculpatory provision. He received no personal benefit from the Debt Conversion. Indeed, as the holder of the largest block of Company stock other than Rossette, its dilutive effects affected him more than anyone else. He thought for himself and attempted to do the best that he could in difficult circumstances. His ability to discharge his duties effectively was crimped by his lack of experience as a director and the lack of resources to advise him separately and independently of Rossette. At most, Bachelor breached his fiduciary duty of care. He has demonstrated that otherwise he acted loyally and in good faith. Accordingly, he may not be held liable for any money damages.

The primary materials for this case may be found on the DU Corporate Governance Website.

A subsequent related decision was made in Gentile v. Rossette, C.A. No. 20213-VCN, 2010 WL 3582453 (Del. Ch. Sept. 10, 2010).

Barnes & Noble Proxy Fight After Delaware Ruling

The Delaware Court of Chancery, in Yucaipa Am. Alliance Fund II, L.P. v. Leonard Riggio, et. al., No. 5465-VCS, 2010 WL 3170806 (Del. Ch. Aug. 11, 2010), previously upheld a poison pill adopted by Barnes & Noble’s Board of Directors to prevent Yucaipa American Alliance Fund (“Yucaipa”) from purchasing more than a 20% stake in the company, which is discussed here, here, and here.  The fight, however, was not over. 

Ron Burkle, on behalf of Yucaipa, filed a Proxy Statement with the Securities and Exchange Commission challenging the current Barnes & Noble Board in a proxy contest.  The Statement nominated Burkle, Stephen F. Bollenbach, and Michael S. McQuary for the Board of Directors. Additionally, the Statement asked shareholders to amend the poison pill by raising the threshold trigger to 30%, approximately Leonard Riggo’s ownership stake.  

Thereafter, Barnes & Noble sent a letter to shareholders urging them to vote for the Board’s nominations, which included Barnes & Noble founder Leonard Riggio, as well as David Golden, and Dr. David Wilson.  The letter suggested shareholders vote against Yucaipa’s nominations and presented reasons in support. 

The fight is finally over.  Barnes & Noble shareholders voted at the Annual Shareholder’s Meeting on September 28, 2010 in favor of the Board’s nominations electing Mr. Riggio, Mr. Golden, and Dr. Wilson to the Board.  The voting results were close, as was expected, with each of the Board’s nominees receiving approximately 2 to 3 million more votes (out of the nearly 50 million shares that voted) than Yucaipa’s nominees.  Additionally, the proposed amendment to the poison pill was rejected by a similar margin.  The preliminary voting results can be found here in the Form 8-K filing.

The primary materials for this case may be found on the DU Corporate Governance website.  

Barnes & Noble Poison Pill Upheld [Yucaipa American Alliance Fund II, LP v. Riggio]

In Yucaipa Am. Alliance Fund II, L.P. v. Leonard Riggio, et. al., No. 5465-VCS, 2010 WL 3170806 (Del. Ch. Aug. 11, 2010), the Delaware Court of Chancery dismissed Yucaipa’s claim for breach of fiduciary duties by the Barnes & Noble Board of Directors.  Applying the Unocal standard, the court upheld a poison pill by finding the Board acted reasonable in relation to the potential threat, and the adoption was not preclusive to shareholders running an effective proxy contest.  We have previously discussed poison pills in Selectica v. Versata.  

Ronald Burkle runs plaintiff Yucaipa American Alliance Fund II, L.P. (“Yucaipa”) an investment fund.  Burkle contacted Leonard Riggio, the Barnes & Noble founder and 28% owner, to indicate interest in investing in the company.  Riggio and Burkle have a strained relationship because a previous joint investment went wrong.  Yucaipa began investing in Barnes & Noble in 2008, accumulating an 8% stake in the company. 

In 2009, Burkle objected to Barnes & Noble’s acquisition of Barnes & Noble College Booksellers, a separate company owned solely by Riggio.  Yucaipa then increased its holding in Barnes & Noble to approximately 18% and indicated in its 13D filings a concern with the “corporate governance policies and practices” of the company.  Also, Yucaipa reserved the right to take further actions in the future to affect the governance of Barnes & Noble.  Furthermore, Aletheia Research and Management, Inc. (“Aletheia”), which has a history of following Burkle’s investments, began increasing its stake in Barnes & Noble to approximately 17%. 

In response to Yucaipa and Burkle, the Barnes & Noble Board adopted a Poison Pill Rights Plan that prevents a single holder of accumulating more than 20% of Barnes & Noble stock.  In addition, the plan prevents two or more shareholders who will collectively own 20% or more of the company from joining in an attempt to control the company.  Burkle requested to increase the threshold for triggering the poison pill to 37%, above the 32% owned by Riggio and other board members.  This request was denied.

Under the Unocal standard, the business judgment rule shields directors if “(1) the board that adopts the measure in question had reasonable grounds for believing that a danger to corporate policy and effectiveness existed: and (2) the defensive response was reasonable in relation to the threat posed.”  Additionally, under Unitrin, a court must examine “whether the company’s defensive arsenal as a whole, including the pill, was preclusive in the precise sense of making it unrealistic for an insurgent to win a proxy contest.” 

Here, the court held the Board acted reasonably in response to the threat posed by Yucaipa, and the poison pill did not preclude Yucaipa from running an effective proxy contest. 

Initially, the court found the Board acted reasonably in response to the Yucaipa threat because it was trying to advance the best interests of shareholders by preventing Yucaipa from taking control of the company without paying a premium to existing shareholders.  The court recognized the Board could have excluded Riggio from the discussions considering he is the largest shareholder, but ultimately concluded the board was acting independently of Riggio’s interest, even if it was a “bare independent board.”  Furthermore, the court rejected Yucaipa’s argument that its actions posed a threat at all because of the swiftness with which Yucaipa began buying shares and the tensions between Burkle and Riggio.  Based on Yucaipa’s threat, the Board’s defensive response was reasonable because it protected shareholders by disallowing Yucaipa from taking control of the company without current management’s involvement.

Second, the court determined the poison pill did not preclude Yucaipa from winning a proxy contest because Aletheia could vote for the proxy challenge without an agreement that would trigger the poison pill.  The court stated that the effectiveness of a proxy contest relies on the qualifications of the nominees rather than an agreement between shareholders that would violate the poison pill provision.

The court, therefore, dismissed the claims alleging the Board breached fiduciary duties.

The primary materials for this case may be found on the DU Corporate Governance website.  

Staying Access

The SEC granted the stay requested by the Chamber of Commerce on the implementation of the access rule.  The Chamber (and the Business Roundtable) have filed a legal challenge in the DC Circuit seeking to strike down the rule, mostly alleging that the Commission's decision was arbitrary and capricious under Section 706 of the APA.

The decision was quick (the Chamber's petition was only filed last week; the stay issued this Monday).  What reason did the Commission give for the stay?

• The Commission finds that, under all of the circumstances of this matter, a stay of Rule 14a-11 and related rule amendments is consistent with what justice requires. Among other things, a stay avoids potentially unnecessary costs, regulatory uncertainty, and disruption that could occur if the rules were to become effective during the pendency of a challenge to their validity. Because the Commission and petitioners will seek expedited review of petitioners’ challenge, questions about the rules’ validity will be resolved as quickly as possible. 

The stay is not based upon the merits of the claims.  The case for an arbitrary exercise of authority by the Commission is at best modest.  The stay is, however, justified based upon a broader policy ground.

As we have noted, access is the beginning of a paradigm shift in corporate governance.  Opposition to the provision has been powerful and unabated, particularly from the issuer community.  The opposition is understandable.  It will ultimately contribute to a more shareholder centric approach to governance, altering the way things are done inside the boardroom.

The SEC is ushering in access in a very careful and deliberate way.  The rule was not adopted until Congress clarified the Agency's authority.  The rule ultimately put in place included a three year holding period, a time period that reduced the viability of access.  Now the SEC is staying application pending the outcome of the legal challenge raised by the Chamber.

We are confident of the outcome of the legal challenge.  At the same time, for such an important step, implementation can wait until all legal doubts have been eliminated.