On March 8, 2013, the Delaware Court of Chancery held that a board may not impermissibly infringe on stockholders’ ability to elect a replacement board of directors.1 In this decision, Chancellor Strine reminds directors in no uncertain terms never to undermine the integrity of the electoral process.
SandRidge Energy, Inc. (“SandRidge” or the “Company”), an oil and gas company focused on domestic exploration and production, went public in 2007 at $26 a share. The stock rose to $68 in July 2008, but thereafter fell precipitously. It currently trades at around $6 per share.
In November 2012, hedge fund TPG-Axon (“TPG”), frustrated with SandRidge’s performance, made public a letter criticizing the incumbent board (the “Board”) for a series of alleged missteps, including focusing on natural gas at the expense of oil, lax spending and financial discipline, and “appalling” corporate governance. TPG demanded that the Board (i) amend SandRidge’s bylaws to declassify its Board, (ii) reconfigure the Board’s composition to include TPG’s representatives, and (iii) consider strategic alternatives to maximize the Company’s value, including an asset sale.
The Board responded by adopting a poison pill, making it more difficult for stockholders to take action by written consent and increasing the requisite affirmative vote of stockholders to amend any part of the bylaws concerning the election of directors. In turn, TPG took steps to initiate a consent solicitation under 8 Del. C. § 228 to destagger the Board and remove and replace the incumbent directors. TPG filed a preliminary consent solicitation statement on December 26, 2012.
The Board responded with a preliminary consent revocation statement. Among other things, the Board warned that under the terms of an indenture governing SandRidge’s senior notes, replacing the Board would be deemed a change of control, and the Company would be obligated to offer to repurchase $4.3 billion of debt at 101% of par (the “Proxy Put”).
On January 7, 2013, Kallick - another SandRidge stockholder - filed suit, accusing the Board of breaching its fiduciary duties by failing to approve the TPG slate so as to avoid the Proxy Put. In essence, the Board had the ability, but failed, to eliminate the mandatory refinance requirement by simply approving the TPG slate.
In determining the appropriate standard of review applicable to the defensive conduct of the Board, the Court summarized the evolution of the Blasius standard. In defending the applicability of the Unocal standard, the Court commented that a reasonable review offers the Court an opportunity to employ equity in a way that preserves the stockholders’ franchise rights while “smoking out” the true reasons behind the Board’s defensive measures. The Court went a step further finding that Unocal would apply to the Board’s decision to enter into any debt instrument that in any way limits or curtails the stockholders’ ability to unseat the Board such as the Proxy Put or other change of control limitations hinging on the Company’s governance.
Applying the intermediate standard of review to the facts before it, the Court concluded that SandRidges’s Board likely violated its fiduciary duty of loyalty by withholding approval of the TPG slate. The Court found the Board acted without a reasonable basis, and thereby caused confusion to the voting stockholders on whether approving the dissident slate would expose the Company to any material harm from the Proxy Put. The Court found that, on the limited record before it, the Board had offered no evidence of reasonable suspicion, let alone an affirmative determination, that the TPG slate was somehow ill-fitted to serve as the Company’s Board. The Court chastised the Board for questioning the “cognitive abilities” of the Company’s stockholders to make an informed decision as to whom would be better qualified to serve on the Board.
Among other troubling facts that led Chancellor Strine to question the incumbents’ integrity was the fact that the senior debt has been trading well above 101% of par - making it economically unfeasible for the noteholders to redeem their debt for less money through the Proxy Put than in the open market. The Court noted that the Board’s stated concern regarding the Proxy Put had no substantive support since the Board had the contractual discretion to approve the TPG slate and thereby eliminate that risk without breaching the terms of the indenture.
The Court enjoined the Board from (i) impeding TPG’s consent solicitation in any way, (ii) relying upon or giving effect to any consent revocations they may have already received, and (iii) further soliciting any other revocations.