Corporate Governance

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

By J Robert Brown Jr.

We are discussing the significance of Yucaipa American, a case that declined to invalidate a poision pill that prevented an insurgent shareholder from negotiating a common slate and expense sharing arrangement with other shareholders. 

The legal analysis focused upon whether there was a threat to management and whether the response by management was proportionate.  The case did not focus on whether the poison pill tilted the playing field in management's favor.  In this case, it did. 

For one thing, it left management with a 40% block (the Riggios, directors and employees) while prohibiting Yucaipa from forming a block larger than 20%. The Chancery Court avoided the issue mostly by assuming away the limitation.  See Id. ("Second, if, as is clearly possible and even likely, Aletheia supports a Yucaipa slate that advocates a plausible value-maximizing platform and is comprised of distinguished business persons, Yucaipa almost immediately levels, if not exceeds, the Riggio advantage.").

More importantly, management could cut deals with other shareholders while Yucaipa could not.  The court noted but disregarded the possibility. 

• In one of its ever-growing and ever-changing list of arguments, Yucaipa argues that the Rights Plan is unreasonable because it restricts Yucaipa from forming a group of holders of more than 20% of the company's stock but also leaves the Barnes & Noble board free, in its official capacity, to enter into understandings with holders of more than 20% of the shares. It is not at all clear what Yucaipa believes the Barnes & Noble board could do in this regard. By its plain terms, the Rights Plan restricts the Riggios, in their capacity as stockholders, from forming such a group, and thus they could not be party to any such arrangements in the sense of committing their voting power. It is, I suppose, possible to think that the Barnes & Noble board might engage in back and forth with holders during the proxy solicitation process that would raise the potential for improper quid pro quos. See Portnoy v. Cryo-Cell Int'l, Inc., 940 A.2d 43, 71-73 (Del. Ch. 2008).

The court viewed fiduciary duties as sufficient to ensure that the board did not favor the Riggios over the insurgents.  See Id.  ("But, critically, any understandings the board would reach would be subject to the requirement that those understandings be in the best interests of the company and its stockholders, and not for the personal benefit of the board.").   To the extent that the board favored the Riggios, it would violate the duty of loyalty.  See Id.  ("To the extent the board, for example, sought to act as an instrument to protect the Riggios rather than for a proper purpose, they would be acting disloyally.").   

The irony in all of this is that fiduciary duties were sufficiently robust to prevent the board from entering into transactions that favored the Riggios.  Yet when the court considered the "threat" posed by Yucaipa's attempt to elect a minority of the board, fiduciary duties weren't enough.  See Id. ("No doubt our law provides substantial protections for other investors in the event that a large stockholder with board representation proposes a going private transaction or engages in other forms of unfair value extraction, but that does not mean that the Barnes & Noble board was not entitled to take reasonable, non-preclusive action to ensure that an activist investor like Yucaipa did not amass, either singularly or in concert with another large stockholder, an effective control bloc that would allow it to make proposals under conditions in which it wielded great leverage to seek advantage for itself at the expense of other investors."). 

In other words, fiduciary duties were sufficiently robust to prevent any potential abuse by management but not sufficiently robust to prevent any abuse by insurgents elected to the board.

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

Full post as published by The Race to the Bottom on September 13, 2010 (boomark / email).