Corporate Governance

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

By J Robert Brown Jr.

This case involves the adoption of a poison pill with a 20% trigger.  As the Chancery Court rightfully concludes, there is no serious argument that a pill triggered by acquisitions above 20% violates Delaware law.  Right or wrong, this is the teaching of Moran and Unocal.   Unocal in particular requires that the pill be adopted in response to a perceived threat and that the pill be reasonable in relation to the threat posed.  Whatever content these elements seem to have, in the context of pills designed to prevent additional acquisitions, any threat identified by management will be upheld and the pill will always be reasonable in relationship to that threat.

But Yucaipa looks at these tests in a different context.  There is really no serious challenge in the case to the provision that sets the trigger at 20% for acquisitions.  Instead, the real challenge is to whether the pill improperly interferes with a proxy contest.  Unitrin made it clear that a poison pill could not have a preclusive effect on a proxy contest.  651 A.2d 1361, 1387 (Del. 1995).  To the extent not preclusive, the pill still must be within the "range of reasonableness." 

The preclusiveness issue is also a non-starter these days.  While courts in Delaware recognize that preclusion does not require evidence that a successful proxy contest is impossible in a mathematically certain way, the courts have come very close.  They allow poison pills to impose enormous burdens on insurgents, no doubt in many cases causing the challenger to foregoe a proxy contest. 

Selectica is a good example.  The Chancery Court upheld a poison pill with a 5% trigger.  Thus, an insurgent could neither buy more than 5% or form a group that owned more than that amount.  As a result, the insurgent would have to go into the contest with no real certainty about its level of support. Given the costs involved and the fact that the insurgent has to pay its own expenses (management, of course, does not, it can rely on the corporate treasury), this level of uncertainty will discourage all but the most hardy (and rich) shareholder.  In other words, once the court in Selectica concluded that the pill wasn't preclusive, its profound impact on the possibility of a proxy contest was more or less ignored.  

Second, once a court concludes that a pill is not preclusive, the reasonableness analysis is preordained.  In other words, there is really no second step to the analysis.  The only issue is preclusion.

In Yucaipa, the Chancery Court confronted a pill that all parties agreed was not preclusive.  Indeed, the dynamics make it appear that the outcome is highly competitive.  Ordianrily this would be the end of the analysis.  The pill stands. 

There were, however, several complicating factor.  First, plaintiffs were focusing less on the ownership limits and more on the portion of the pill that triggered the instrument anytime shareholders with more than the 20% threshold came to agreement on a common slate and division of expenses.  Because Yucaipa had almost 20%, the impact of the provision was to prevent it from reaching this kind of agreement with any investor, large or small.

Second, Barnes and Noble had a staggered board.  In other words, the most that Yucaipa could accomplish would be the election of a minority of directors (three to be exact).  With only a minority, Yucaipa could not implement any of its goals.  

Third, a large existing shareholders (the founder of Barnes & Noble, Leonard Riggio) had a block of shares, that when combined with management and employees, added up to around 37%.  In those words, the pill, by stopping Yucaipa from organizing with other shareholders, left it with a far smaller block than athe management supported group.

Finally, as long as the board did not actually join with the large shareholder, it was free to negotiate agreements with shareholders about common slates as long as the board group did not exceed 20%.  In other words, while Riggio could not negotiate an agreement, the board could.

Despite these factors, the Chancery Court had no real problem concluding that the pill was valid, despite the practical impact on the proxy contest.  We will examine how the court arrived at this conclusion. 

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

Full post as published by The Race to the Bottom on September 07, 2010 (boomark / email).