Yucaipa American Alliance Fund II, LP v. Riggio: The Growing Use of Poison Pills to Preclude a Proxy Contest (The Impact on Access)
We have talked enough about Yucaipa. There is plenty more to say in the 80 plus page opinion. We stop more from exhaustion than completion. In any event, the case is on appeal and will be resolved by the Delaware Supreme Court. Because this case is not highly visible and does not raise the same risks of federal preemption as cases such as Axcelis, we predict that the Court will affirm the reasoning of the Vice Chancellor.
Yucaipa permits the use of poison pills to interfere with and even discourage proxy contests from taking place. But the real impact is in building a set of precedents that can be used to limit the federal right to shareholder access. With the SEC just adopting a rule that permits 3% shareholders from submitting nominees for inclusion in the company's proxy statement over the adamant opposition of the issuer community, focus has shifted on practical limitations on the use of the authority. JW Verrett at George Mason has done a good job in pointing out ways to do so.
The Delaware courts are now providing an assist, pointing out the possibility of using poison pills to limit the use of access. Yucaipa stands for the proposition that poison pills triggered by shareholder agreements on a common slate of directors will be upheld even if involving a minority of directors on the board (something that access requires). Selectica demonstrates that courts will affirm poison pills with a 5% threshold.
Access allows for shareholders to submit nominations if they own 3% or more of the company's voting shares. For many large companies, there will either not be a 3% shareholder or the 3% shareholder will not be interested in nominating directors. Other shareholders will need to organize and put together a group. Indeed, in recognition of this, the SEC amended Rule 14a-2 to permit this type of organization without triggering the requirement of a proxy statement.
Only under state law, a meeting with a group of shareholders that exceeds 5% may well trigger a poison pill, at least where the group comes to agreement on a common slate of nominees. Any real risk of this occurring will rightfully result in shareholders refusing to participate, making the 3% block much harder (if not impossible) to form. Moreover, even if the group is formed one shareholder at a time, as soon as the shares supporting the slate exceed 5%, the pill may be triggered. At a minimum, it provides a nice threat and litigation issue anytime a group of shareholders put together a block of stock to trigger the access requirements.
In short, Yucaipa and Selectica provide a road map for companies wanting to increase the risks associated with access. Moreover, there is no evidence that the courts in Delaware will stop at 5% triggers. The analysis in Selectica was not very refined. By finding that a 5% threshold did not interfere excessively with a proxy contest, the logic of the court's analysis does not stop there. It is possible that Delaware could uphold poison pills with triggers that are below the access threshold.
Time will tell. But in a battle between state and federal law, the feds have an advantage. Our federal system allows agencies, if acting within their rulemaking authority, to preempt state law. With Dodd-Frank giving the SEC extraordinarily broad authority in this area, the Agency has room to take corrective actions should state courts effectively limit the use of access. The SEC could, for example, dramatically drop the percentage thresholds for submitting nominees, making organization among other shareholders unnecessary.
Time will tell but the judicial direction in Delaware seems clear.