Poison Puts and Fiduciary Obligations and the Irrelevance of the Delaware Courts: Pontiac General Employees Retirement v. Healthways (Part 1)
Debt instruments, at least in the past, commonly included poison puts. These are clauses that define, as an event of default, the replacement of a majority of the board. The clauses often have a provision that alleviates the event of default if the incumbent board approves the new directors. The provisions can also, however, have a dead hand provision that provides for immediate acceleration of the loan principal by the company, with no discretion by the board to avoid the consequences.
Needless to say, these provisions can have a significant impact on the shareholder franchise. Shareholders may be unwilling to support an insurgent slate of directors to the extent doing so will result in an event of default and cause financial hardship (even insolvency) for the company.
Poison puts were challenged in San Antonio Fire & Police Pension Fund v. Amylin, 983 A.2d 304 (Del. Ch.), aff'd, 981 A.2d 1173 (Del. 2009). In a case we ranked as one of the five worst shareholder decisions in 2009, the court expressed concerned over the use of the provisions but declined to find that a board's approval of the debt agreement without awareness of the poison puts violated its fiduciary obligations. Nonetheless, the Chancery Court had this to say:
- This case does highlight the troubling reality that corporations and their counsel routinely negotiate contract terms that may, in some circumstances, impinge on the free exercise of the stockholder franchise. . . . Outside counsel advising a board in such circumstances should be especially mindful of the board’s continuing duties to the stockholders to protect their interests. Specifically, terms which may affect the stockholders’ range of discretion in exercising the franchise should, even if considered customary, be highlighted to the board. In this way, the board will be able to exercise its fully informed business judgment.
Moreover, the court essentially served a warning to companies that these provisions were highly problematic and required a substantial (essentially impossible) showing to justify.
- The court would want, at a minimum, to see evidence that the board believed in good faith that, in accepting [a Proxy Put], it was obtaining in return extraordinarily valuable economic benefits for the corporation that would not otherwise be available to it.
We posted the primary materials in the case here. The court, therefore, gave the Amylin board a pass but seemed to put counsel and companies on notice that the provisions were not favored. What affect did this "guidance" have on Delaware corporations?
Fast forward to 2012. In Pontiac General Employees Retirement v. Healthways, the Complaint alleges the following:
- Numerous times prior to 2012, Healthways had entered into credit agreements and amendments to those agreements. Those agreements did not include a “Dead Hand Proxy Put” that would prevent the Board from approving directors initially nominated in connection with a proxy context or threatened
proxy contest. But in 2012, the New York State Common Retirement Fund (“NYSCRF”), one of Healthways large institutional investors, submitted a stockholder proposal to declassify the Board. The Healthways Board opposed the proposal, but the stockholders nonetheless voted by a ten-to-one margin in support of the proposal. On June 8, 2012, barely a week after stockholders voted to destagger the Board, Healthways entered into a new amended revolving credit and term loan agreement, with a $200 million revolving credit facility and a $200 million term loan (the “2012 Loan Agreement”). This 2012 Loan Agreement bound Healthways to a Dead Hand Proxy Put.
How did the provision work? As the Complaint alleged:
- Pursuant to the Loan Agreement, if more than half of the incumbent Board is replaced through a contested election or threatened contested election, the lenders under the Loan Agreement may, through the administrative agent, declare a default and cause the principal and any accrued interest on any outstanding loans made pursuant to the Loan Agreement immediately due and payable.
The complaint alleged that the board had "disabled itself from avoiding this Event of Default." As a result, it would be entirely the decision of creditors to decide whether to waive the event of default and forego repayment of the loans. As the Complaint asserted:
- Thus, at a minimum, the price to the Company of stockholders launching a proxy fight would be a payment to the lenders for waiving such an Event of Default. It is both wasteful and bad faith for the Board to impose this cost on the Company. . . Moreover, there can be no assurance that lenders will agree to a waiver of their default rights for any fee. Indeed, a proxy contest is most likely when a company’s financial performance is at its nadir. So, too, lenders’ desire to enforce default provisions or extract significant concessions in exchange for a waiver is at its greatest when a company’s financial performance is at its nadir. Thus, the Board has approved a Dead Hand Proxy Put that will predictably have the greatest deterrent effect when the likelihood of stockholder efforts to exercise their franchise rights is at its peak.
In other words, three years after the decision in Amylin criticizing the use of poison puts, the company chose to amend an existing loan agreement (at least according to the allegations in the opinion) and add one in a dead hand provision.
The provision was, however, challenged. We'll discuss the outcome of that challenge in the next posts.
The primary materials in Pontiac General Employees Retirement v. Healthways can be found at the DU Corporate Governance web site.