In Kallick v. Sandridge Energy, the Delaware Chancery Court addressed the duties of directors in the context of a proxy put contained in a notes indenture. A group of dissident shareholders of Sandridge had advised the board of directors of their willingness to launch a consent solicitation whereby shareholders would be asked to consent to de-stagger the board, and to support their slate of candidates to the board. The board argued that the proposed candidates were not as qualified as the incumbent directors to manage the company. The board also notified shareholders that following the proxy put, the election of the dissidents’ candidates would be a change of control triggering the obligation for the company to buyback the notes at 101% of par value. According to the board, the notes buyback would put financial stress on the company. The proxy put provided that the buyback obligation was not triggered if the board approved the list of nominees. However, the board refused to take position.
The dissidents petitioned the Chancery Court for an injunction to force the board of directors to approve the list of nominees. They argued that the directors were effectively breaching their fiduciary duties by failing to do so. The directors replied by stating that their decision was protected by the “business judgment rule”.
Chancellor Strine qualified the change-of-control provision as a form of defensive measure. By doing so, the Chancellor remarked that “because of management’s special interest in retaining office, the independent directors of the board should police aspects of agreement like this, to ensure that the company itself is not offering up these terms lightly precisely because of their entrenchment utility”.
Most importantly, qualifying the change-of-control provision as a form of defensive measure meant that the board’s decision was subject to the enhanced scrutiny test formulated in the Unocal decision, and not the “business judgement rule”. With respect to the first prong of the Unocal test, Chancellor Strine remarked that the rival slate did not represent a material threat of harm to the corporation. In fact, the incumbent board had admitted that it had no basis to doubt the integrity or the basic qualifications of the dissident’s slate. With respect to the second prong of the Unocal test, the board’s decision not to approve the slate was not proportionate to the threat posed. Indeed, the board could neutralize the effect of the Proxy Put by approving the dissent’s nominees without endorsing the slate, thereby maintaining its ability to run its own campaign. To summarize, to comply with their duty of loyalty, the directors were required to approve the dissident’s slate.
To conclude, the Chancery Court enjoined the board of directors from: 1) soliciting any further consent revocations; 2) relying upon or otherwise giving effect to any consent revocations they have received to date; 3) impeding the consent solicitation in any way, unless the board approves the slate for purposes of the Proxy Put.
For a pdf version of this post, see Legal Trends Fall 2013.