Corporate Governance

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

By J Robert Brown Jr.

Unocal also commanded that the defensive tactic be reasonable in relationship to the threat posed.  Said another way, the defensive tactic must be proportionate to the particular threat. To the Chancery Court, threat and proportionality "bleed together."  Given the finding of a threat, the only question was whether the pill "unreasonably inhibits the ability of Yucaipa to run an effective proxy contest."  In effect, proportionality came down to whether the pill had a preclusive effect on the proxy contest. 

In Yucaipa, the Chancery Court concluded that the pill did not have a preclusive effect.  It was a straightforward analysis.  Even though the Riggio brothers had a block consisting of 40% of the outstanding shares, Yucaipa owned 20% and, when combined with a putative ally (Aletheia), had a block about the same in size.  That left approximately 20% of the shares for both blocks to fight over.  As the court reasoned:

• In particular, if the terms of a rights plan, which already has the powerful effect of barring the direct door to an acquisition, in themselves have the effect of rendering a victory for an insurgent improbable, the proportionality prong of the Unocal test should require the board to make an extremely strong showing why the rights plan should be sustained. In other words, precisely because the Supreme Court's pill jurisprudence channels takeover battles into the electoral forum, it is critical that Unocal review of the effect of a pill on election contests be robust. When a pill both prevents a tender offer and unfairly tilts the electoral playing field against an insurgent, this court, to be true to Moran, should not hesitate to enjoin its operation. Here, though, as explained below, the Barnes & Noble Rights Plan does not unreasonably restrict Yucaipa's ability to run a proxy contest because, with the Rights Plan in place, Yucaipa has a fair chance to prevail and indeed is the likely favorite in a proxy contest.

The analysis was straightforward and consistent with existing analysis save one fact.  The insurgents weren't competing for control of the board.  Because of the staggered board, they were only seeking a minority of the directors.   The proportionality analysis conducted by the Chancery Court entirely ignored the meager nature of the threat. 

As a result, it was willing to allow a poison pill that, while not preclusive, clearly tilted the playing field in management's favor.  With its 40% block, management had a natural advantage.  While Yucaipa could combine with Aletheia, the other large investor (which owned 17.44% of the shares), creating a block roughly equal to management's, it was expressly prohibited from doing so by the terms of the poison pill. 

With Yucaipa unable to reach an agreement with Aletheia on a combined slate of directors prior to the context, Aletheia was fair game for an agreement with management.  In other words, management could try to lure Aletheia away through a promise of guaranteed positions on the board.  That is, for example, exactly what occurred in Portnoy v. Cryo-Cell.  Similarly, the court viewed the decision of RiskMetrics with respect to the remaining 20% of the shares (assuming Aletheia voted in an identical fashion with Yucaipa) as outcome determinative.  Yet, putting aside the validity of the conclusion (the proposition is a debatable one), it ignores the fact that management was in a better position to alter the circumstances to meet any concerns that might be expressed by RiskMetrics.  

The court was willing to uphold a pill that tilted the playing field in management's favor.  This was true even though at most the insurgents could have acquired a minority position on the board.  In other words, as long as the pill did not have a preclusive effect (which merely meant that insurgents had a chance of winning a proxy contest), the proportionality analysis all but ignored the marginal nature of the threat or the advantages inuring to management as a result of the poison pill.  

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

Full post as published by The Race to the Bottom on September 09, 2010 (boomark / email).