An important consideration for an activist investor seeking board representation through a proxy contest is whether there exist restrictive provisions in any agreements to which the target company is a party. Prior to proceeding with a proxy contest, the activist investor must ascertain whether such third-party agreements contain “change-of-control” or similar provisions which, if triggered by the activist’s successful election of its slate, could have a negative impact on the company. The context in which this issue most often arises is with regard to so-called “golden parachute” provisions in key-person employment agreements and “change-of-control” events of default in debt instruments, such as a company’s credit facilities or indentures. If a change-of-control default would be triggered under such debt instruments, the result most often is that the debt instruments become immediately due. This issue typically arises only where an activist seeks to elect a majority slate, as a change in the majority of a board’s composition may trip such provisions. The triggering of default provisions in credit facilities and/or indentures can have material adverse effects on a company if refinancing is not readily available. The Delaware Chancery Court was recently faced with this issue in the case of San Antonio Fire & Police Pension Fund v. Amylin Pharmaceuticals, Inc., et al., C.A. No. 4446-VCL (2009).
Background of the Litigation
The Amylin case arose in the context of two different activists nominating two independent short slates for seats on the twelve-person board of directors (the “Board”) of Amylin Pharmaceuticals, Inc. (“Amylin” or the “Company”). Icahn Partners LP and affiliates (“Icahn”), holder of approximately 8.8% of Amylin’s shares nominated a five-person slate, as did Eastbourne Capital Management, L.L.C. (“Eastbourne”), holder of approximately 12.5% of Amylin’s shares. If both slates were to be successful, the practical result would be that the majority of the Board’s composition would change.
Pursuant to the Company’s indenture for its 3.00% convertible senior notes due 2014 (the “2007 Notes”), dated June 8, 2007 (the “Indenture”), the noteholders have the right to demand redemption of any or all of their notes at face value in the event of, among other things, a “Fundamental Change” as defined in the Indenture. A “Fundamental Change” will be deemed to have occurred if, at any time, the “Continuing Directors” do not constitute a majority of the Board. As defined in the Indenture, “Continuing Directors” are:
(i) individuals who on the Issue Date constituted the Board of Directors and (ii) any new directors whose election to the Board of Directors or whose nomination for election by the stockholders of the Company was approved by at least a majority of the directors then still in office (or a duly constituted committee thereof) either who were directors on the Issue Date or whose election or nomination for election was previously so approved.
The issue became whether the activists’ nominees, if elected, could be considered “Continuing Directors” or, alternatively, whether their election would trigger a default under the Indenture, thus making the 2007 Notes immediately due and payable. Litigation was ultimately filed by the San Antonio Fire & Police Pension Fund alleging breaches of the fiduciary duties of care and loyalty by the Board for, among other things, approving the “Fundamental Change” provision of the Indenture; and seeking, among other things, a declaration that the “Continuing Directors” provision was invalid.
The litigation was partially settled on April 13, 2009, with Amylin agreeing that, if the court determined it had the contractual right to do so, it would “approve” (as that term was used under the Indenture) the Icahn and Eastbourne nominees, and San Antonio Fire agreeing to discontinue the bulk of its claims against Amylin and the Board. At this stage in the litigation, Amylin, in an effort to resolve conclusively the issue of whether it had the right to approve such directors with respect to the Indenture, and in an attempt to resolve the impact the election of the activists’ nominees would have under the Company’s credit facility,19 brought in as third-party defendants both the trustee under the Indenture and the administrator under Amylin’s senior secured credit agreement.
Shortly thereafter, in early May 2009, Eastbourne and Icahn each announced that they had reduced their respective slates—to three nominees in the case of Eastbourne and two nominees in the case of Icahn. As the election of all of these nominees would not give rise to a change-of-control as defined in the Indenture, the Indenture trustee argued that the case was no longer ripe. The court, however, proceeded to a determination as to whether the Board had the power and the right under the Indenture to “approve” the stockholder nominees.
The Indenture trustee argued that a board cannot “approve” stockholders’ nominees which the company publicly opposes and against whom it recommends its own competing slate. However the court found that a board could “approve” stockholders’ nominees without endorsing them, reasoning in part that to find otherwise would sanction a provision with “an eviscerating effect on the stockholder franchise,” forcing stockholders to vote for management’s board nominees and thereby entrenching incumbent management. The court then turned to the question of whether the Amylin Board had in fact approved the stockholder nominees in accordance with its contractual duty of good faith and fair dealing, and held that it could do so if it “determines in good faith that the election of one or more of the dissident nominees would not be materially adverse to either the interests of the corporation or its stockholders.” The court then stated that the record of the Board’s deliberations was inadequate, and declared the issue “unripe” pending the outcome of the election and its aftermath.
One of the most encouraging aspects of the opinion was its criticism of the “poison put” provisions so commonly found in indentures and debt documents. The inclusion of such provisions has long been the subject of “a wink and a nod” between the lenders and underwriters who include them as boilerplate and the issuers who are happy to have an entrenchment defense handed to them. The provision has become so routine that in Amylin’s case, its existence was, unsurprisingly, neither brought to the attention of the Board nor discussed by it before it approved the Indenture and debt documents. Amylin’s CEO and CFO both admitted that they had no idea of the existence of these provisions in Amylin’s material contracts until they were raised in the proxy contest.
Yet the court indicated that its contractual interpretation was influenced by the fact that such provisions “can operate as improper entrenchment devices that coerce stockholders into voting only for persons approved by the incumbent board”; that they raise concerns relating to the board’s fiduciary duties in agreeing to them (suggesting that the board should get “extraordinarily valuable economic benefits” not otherwise available to it in exchange for agreeing to their inclusion); and that they “might be unenforceable as against public policy”. The court warned outside counsel to boards to “be especially mindful of the board’s continuing duties to stockholders to protect their interests” and to highlight these provisions to their board clients to enable them to exercise their fully informed business judgment.
It will be interesting to see whether lending practices, and board deliberations and decisions, change as a result of this opinion. Boards may be hard-pressed to show that they obtained “extraordinarily valuable economic benefits” in trade for including the poison put. Lenders and underwriters may insist on the more restrictive, and entrenching, poison put provision found in Amylin’s credit agreement rather than the “weaker” form in the Indenture. And board minutes will no doubt be dressed with the due consideration given by the board to its agreement to the poison put terms.
The Standard for Denial of Approval
Another interesting aspect of the decision is the standard adopted by the court for a board’s decision on whether to “approve” stockholder nominees: it must determine in good faith that the election of “one or more” of the stockholder nominees would not be “materially adverse to the interest of the corporation or its stockholders.” Could a board determine that the election of one or two would be okay but all five would be materially adverse, and then proceed to “approve” the nominees it least disfavored? It is curious that a board would determine whether the stockholder nominees’ election would be adverse to the interest of stockholders when the stockholders would be voting on that very question in the proxy contest. And is a difference in view as to how to operate, or sell, a company enough to be “materially adverse”? The court gives no guidance as to the standards to be applied in making such a determination, and future courts will no doubt give substantial deference to the directors’ judgment on the matter, even though they’re making a self-interested, even “entrenching,” decision.
The Amylin court, having determined that the controversy was not ripe for adjudication, indicated that the plaintiff or Amylin would be free after the annual meeting to replead its case that the stockholder nominees, if in fact elected, are Continuing Directors by virtue of Amylin’s “approval.” At Amylin’s annual meeting, the stockholders elected ten directors proposed by management and one each proposed by Eastbourne and Icahn. The status of the stockholder-nominated directors as Continuing Directors therefore will only become relevant if there is an election contest again at Amylin next year as a result of which management-proposed directors cease to constitute a majority of the board. Meanwhile, Vice Chancellor Lamb, who decided the Amylin case, has stepped down from the Chancery Court bench. So we are left with the court’s criticism, in dicta, of “poison put” practice in a case unlikely to be revived.