There are a number of respects in which corporate law is moving, slowly but perceptibly, in the direction of shareholder sovereignty, against the various schemes by which incumbent boards have entrenched themselves. The consequences of this trend for the search for alpha are, as usual, unclear. In general, the trend may well be on the side of market efficiency, and efficiency is by definition bad for alpha. But the road is a bumpy one, and there will be a lot of exploitable inefficiencies along the way.
Consider in this regard the existence of “proxy put provisions” in contemporary credit agreements: clauses that allow a lender to put its outstanding debt in the event of a change in corporate control.
Deterrent Effect
In most such agreements, in the event of a proxy contest, the incumbent board must decide whether to approve prospective candidates on a dissident slate. If it approves them, it is saying: “their presence on their board will not constitute a change in control for the purposes of those clauses, and so will not trigger our lenders’ proxy puts.”
Clearly, from the point of view of the incumbents, there is both a “pro” and a “con” to extending such control. The pro is that extending approval to the other side in a proxy battle defangs the very real financial risk the proxy puts otherwise generate. But since the shareholders may themselves be worried about that very threat, and may be induced to vote for the incumbents over the challengers precisely to avoid that threat, an extension of approval abandons this feat as a weapon of persuasion within that contest.
As William Savitt, of Wachtell Lipton, wrote recently in the Harvard Law School Forum on Corporate Governance, this practice “can give rise to complex fiduciary duty litigation” but it doesn’t seem to be “vulnerable to facial attack under prevailing law.”
What if the incumbent management, in negotiating a proxy put, does not reserve to itself the option of approving the dissidents? What if any victory by a dissident slate would constitute a change in control, triggering the obligations of the clause? That is known as the “dead hand” proxy put, and that is more vulnerable than the discretionary sort of proxy put. At least such is the natural inference from recent decisions.
Amylin and Healthways
In 2009, in San Antonio Fire & Police Pension Fund v. Amylin Pharmaceuticals, the Chancery Court recognized that proxy puts “can operate as improper entrenchment devices that coerce shareholders into voting only for persons approved by the incumbent board.” The entrenchment feature is considerably mitigated when management retains the right of approval. After all, at some point before the votes are actually counted the incumbents will generally learn which way the wind is blowing, and they can then extend approval as necessary to avoid the consequences of the put.
More recently, indeed just last year, the same court, in Pontiac General v. Ballantine, addressed a complaint alleging that the directors of Healthways (a company that offers a range of “specialized products and services designed to help people maintain and improve their health,”)had “breached their fiduciary duties by approving and maintaining the Dead Hand Proxy Put, which serves no purpose other than to entrench the incumbent Board.”
The creation of this Dead Hand Proxy Put in the Healthways matter was especially egregious because it took place immediately after the board had agreed, under considerable shareholder pressure, that it would de-stagger its elections. Staggering is of course itself a venerable tool of entrenchment so it appears that, after giving up one defensive moat, the incumbents with the help of lenders immediately created for themselves another.
In October, last year, Vice Chancellor J. Travis Laster heard arguments on a motion to dismiss Pontiac’s lawsuit, then issued a decision from the bench. V.C. Laster denied the motion to dismiss. He denied the motion, specifically finding that the plaintiffs don’t have to wait until such a clause is actually triggered and liabilities thereunder are due in order for the controversy to be ripe. It is ripe already, he said, because the existence of the proxy put “necessarily has an effect on people’s decision-making about whether to run a proxy contest and how to negotiate with respect to potential board representation.”
The litigation should go forward, Laster said, in large part because there existed already “decisions of this Court that should have put people on notice that there was a potential problem here such that the inclusion of the provision was, for pleading-stage purposes, knowing.”
Further litigation on the subject is a certainty.