What SandRidge May Herald for Challenge Slates

oil, Energy 27 Mar 2013

The oil-and-gas company SandRidge Energy has resolved a proxy fight with hedge fund TPG-Axon, adding to its board of directors four nominees backed by TPG.

TPG-Axon, a hedge fund, holds 7 percent of the equity of SandRidge. It had been waging a proxy fight (to be more specific, a consent solicitation campaign) to amend the by-laws, de-stagger the company’s board, and change its composition. Among TPG’s contentions: that the board has wildly overpaid the chief executive, Tom Ward.

Ward has received more than $150 million in compensation over the last five years, and those have not been good years for the shareholders.  In July 2008, SandRidge’s stock was selling for about $68. That is now down to less than $6.

Kallick v. SandRidge

A recent decision by the Chancery Court in Delaware seems to have forced the board into a settlement. The decision may also have consequences that go far beyond this one dispute. It looks like a more-than-marginal victory for shareholder activists.

The litigation, Kallick v. SandRidge, led to an opinion that addresses when a board of directors must approve a particular dissident slate for the purpose of avoiding a so-called “poison put.”

The poison put, also known as the “proxy put,” is an indenture provision that gives a lender the right to demand bond redemptions before maturity when or if certain events take place. Often it is demanded by the lenders as a hedge. There are times, though, when it is welcomed by the management of a borrowing company, on the same logic as that which inspires the “poison pills.” A poison put threatens so much damage to a company that a would-be acquirer or dissident slate would not want to do anything to trigger the put, unless of course its members wanted to inherit that damaged company.

In the case at hand, the company, SandRidge Energy, had agreed to give its creditors a proxy put to become effective should an “unapproved” slate of directors take over. The creditors don’t seem to have had to overcome any board-level reluctance in getting approval of this provision. The Delaware decision cites evidence that the independent board members weren’t “engaged in any memorable way in reviewing any of the indentures, at least insofar as considering the implications of the put provisions.”

Approved and Unapproved

But: what does “unapproved” mean? Surely the incumbent directors, seeking re-election, seldom feel warm and fuzzy feelings towards their challengers. And “approval” in the specific context of a proxy put doesn’t require warmth or fuzziness.  An incumbent board has the power and may even have the duty to declare certain challengers “approved” for purposes of removing the danger of the exercise of the poison put, even while it is waging a vigorous campaign for their defeat.

As of December 2012, SandRidge’s board was declining to approve the challengers in this sense, and was taking the position that if shareholders elected a new board majority, the lenders would have the right to put $4.3 billion worth of notes back to the company. Shareholders such as the plaintiff, Gerald Kallick, can be excused for thinking that a rather objectionable exercise in twisting their arms.

On February 8, 2013, SandRidge reversed course, announcing that the proxy put posed no danger after all, because the debt at issue was trading at prices above the repo set in the indentures. Debtholders would be unlikely to tender at a below-market price, no matter what incendiary challengers got themselves onto the board.

But as Chancellor Leo Strine observed in his opinion issued March 8, SandRidge’s February 8th announcement was not brought about by any change in the market price of those notes. SandRidge’s debt had already been trading well above par when the incumbent board was warning about how “extreme” the consequences of triggering the proxy put would be.

A Duty to Approve

More important (in terms of the broader significance of the decision), the incumbent board left the TPG slate unapproved, and Strine took the opportunity provided by this litigation to discuss how a board’s fiduciary obligations apply to that decision.

A director’s duty of loyalty is to the corporation and its shareholders, and for this reason he should approve opposed boards, rendering the poison puts harmless to the corporation, unless the rival candidates lack ethical integrity, fall “within the category of known looters,” or propose a program that “would have demonstrably material adverse effects for the corporation’s ability to meet its legal obligations to its creditors.”

Strine issued an injunction barring the board from soliciting consent revocations, giving effect to any revocations they had received to date, or impeding TPG’s consent solicitation in any way, unless the board first approved the TPG slate for the purposes of the proxy put.

His reasoning does seem likely to make it difficult for incumbents hereafter not to approve most of their challengers in this sense, effectively taking the “poison put” out of the armory of pro-incumbent weapons.

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