Corporate Governance

Yucaipa American Alliance Fund II, LP v. Riggio: The Growing Use of Poison Pills to Preclude a Proxy Contest (Introduction)

By J Robert Brown Jr.

In the 1980s, hostile takeover attempts were common.  When boards of target companies resisted, bidders commonly made a hostile tender offer, seeking to purchase at least a majority of the outstanding shares.   Boards of target companies would resist acquisitions through a panoply of colorful defensive tactics.  These included lock up options, scorched earth, the pac man defense, and sales of crown jewels.  Most significantly, however, was the use of poison pills.  Poison pills, if triggered, diluted the interest of the bidder and made an acquisition prohibitively expenses. 

Until very recently, no hostile acquisition had over continued in the face of a triggered poison pill.   The law that developed around poison pills largely gave the board unlimited discretion to issue them and keep them in place.  As a result, hostile tender offers have all but disappeared as an acquisition mechanism.

The Delaware courts, however, held that a poison pill or other defensive tactic would be invalid if it had a preclusive effect on a proxy contest.  In other words, while a board had the authority to stop additional purchases, it did not have the authority to preclude a proxy context.  See Unitrin, Inc. v. Am. Gen. Corp ., 651 A.2d 1361, 1387 (Del. 1995)

More recent cases involving poison pills have turned upon whether they have a preclusive effect on proxy contest.  Two recent cases have shown that poison pills can be adopted that discourage proxy contests by making them more expensive and the outcome less certain.  Selectica, a case already extensively discussed on this Blog, took the astounding position that a poision pill with a 5% trigger did not preclude a proxy contest.  While mathmatically true, the likelihood that shareholders with less than 5% would pursue a proxy contest, given the expense and the uncertainty of the outcome, is obvious.  Yet the message was clear.  Delaware courts would affirm the use of low triggers that made proxy contests functionally impossible. 

The more recent salvo in the area is Yucaipa American Alliance Fund v. Riggio.  It effectively upholds the use of poison pills to prevent shareholders from reaching agreement on a common slate of directors and on a division of costs associated with the proxy contest.   In short, the case validates the use of poison pills to substantially restrict the use of proxy contests. 

We will discuss the case in the next several posts. 

Primary materials are posted on the DU Corporate Governance web site.

Full post as published by The Race to the Bottom on September 06, 2010 (boomark / email).