In Kallick v. SandRidge Energy, Inc.,1 the Delaware Court of Chancery enjoined the incumbent board of directors of SandRidge Energy, Inc. (“SandRidge”) from impeding a consent solicitation by a SandRidge stockholder to replace the incumbent board until the incumbent board voted to approve the insurgent board slate for the limited purposes of a “proxy put” provision in SandRidge’s note indentures. Chancellor Strine found an “absence of good faith and reasonableness” on the part of the incumbent board in refusing to approve the insurgent board slate that was inconsistent with the incumbent board’s fiduciary duties to the corporation and its stockholders.
TPG-Axon (“TPG-Axon”), a significant SandRidge stockholder, launched a consent solicitation to (i) amend SandRidge’s bylaws to de-stagger the board, (ii) remove the incumbent board and (iii) install a new slate of directors committed to changing SandRidge’s management and exploring strategic alternatives for the company. The incumbent board resisted the consent solicitation both by campaigning to convince SandRidge stockholders not to deliver consents to TPG-Axon and by seeking to obtain revocations from stockholders who had already delivered consents.
The incumbent board claimed that the insurgent board slate was less qualified than it to run SandRidge because, among other things, the insurgent board slate lacked industry- and asset-specific experience. It also warned stockholders that the election of the insurgent board slate without the incumbent board’s prior approval of such slate would constitute a “change of control” under SandRidge’s credit agreements and trigger a put right on the part of SandRidge’s lenders under related indentures (the “proxy put”). According to the incumbent board, triggering the proxy put, which would require SandRidge to offer to repurchase up to US$4.3 billion of its existing debt, would be an “extreme” action that risked imposing material economic harm on the company.2
The plaintiff, a SandRidge stockholder supportive of the consent solicitation, filed suit against SandRidge and the incumbent board, claiming that the incumbent board breached its fiduciary duties by failing to approve the incumbent board slate for the limited purposes of the proxy put.
The incumbent board’s obligations
Citing its decision in San Antonio Fire & Police Pension Fund v. Amylin Pharmaceuticals,3 the Court held that an incumbent board may not refuse to approve director nominees for purposes of a proxy put unless the board determines that the director nominees pose “such a material threat of harm” to the corporation that passing control to them would constitute a breach of such board’s fiduciary duty of loyalty, in particular because the proposed slate poses a danger that the company would not honor its legal duty to repay its creditors.4 Citing Unocal,5 the Court stated that directors in this situation must identify “a circumstantially proper and non-pretextual basis for their actions, particularly when their actions have the effect of tilting the electoral playing field against an opposition slate.”6
Specifically, unless the incumbent board determined that, for example, the insurgent board slate lacked ethical integrity, consisted of known looters, or had a strategic plan for the corporation that was likely to have “demonstrably material adverse effects” on the corporation’s ability to meet its legal obligations to its creditors, it should approve the insurgent slate for the limited purposes of the proxy put.
Although the record in Kallick did not reflect any such determination by the incumbent board, it nevertheless withheld approval of the insurgent board slate for purposes of the proxy put. Reviewing the incumbent board’s failure to identify a specific and substantial risk to the Company or its creditors posed by the insurgent board slate, the Court found its decision not to approve the insurgent board slate for purposes of the proxy put to be based solely on its belief that it was a better choice to manage the company. The Court held that such a belief is not a sufficient fiduciary basis to deny approval of the insurgent board slate for purposes of the proxy put and that the incumbent directors “likely acted with an absence of good faith and reasonableness inconsistent with their fiduciary duties.”7
As a result, the Court enjoined SandRidge from (i) soliciting any further consent revocations, (ii) relying upon or otherwise giving effect to any consent revocations it had received to that date and (iii) impeding TPG-Axon’s consent solicitation process in any way, unless and until it approved the insurgent board slate for the limited purposes of the proxy put.
Subsequent to the Court’s decision, on March 13, 2013, SandRidge announced the execution of a settlement agreement with TPG-Axon. Under the terms of the agreement, among other things, four of TPG-Axon’s nominees were added to the board, and the board agreed that if it does not terminate the employment of Tom L. Ward as Chairman and CEO by June 30, 2013, three of the remaining seven incumbent directors will resign and an additional TPG-Axon nominee will be elected to the board (which would result in a majority of the board being comprised of TPG-Axon nominees).
The Kallick decision is informed by facts specific to this case; nevertheless, it highlights certain important considerations for directors of Delaware corporations in the context of proxy puts and proxy fights, including, among others, the following:
- Proxy puts in most circumstances are not, and generally should not be treated as, effective defensive measures for incumbent boards. As Kallick underscores, an incumbent board is obliged to approve insurgent director nominees for purposes of a proxy put unless it can make a reasonable, good faith determination that such insurgent director nominees pose “such a material threat of harm” to the corporation that passing control to them would pose a specific and substantial risk to the corporation and its creditors.
- A corporation that implements a staggered board as a defensive measure should do so by amending its certificate of incorporation and not its bylaws alone. In Kallick, the staggered board was implemented by SandRidge’s bylaws and so was subject to direct stockholder reversal. Chancellor Strine referred to this as a “defensive planning flaw,” noting that it is “rare, but not unprecedented.”8 Had the staggered board been implemented by SandRidge’s certificate of incorporation, any amendment or elimination of it would have required approval by the incumbent board in addition to the stockholders.
- The negotiation of, and agreement to, a proxy put may be scrutinized by courts in any subsequent action. Although the original agreement by SandRidge to the proxy put was not at issue in Kallick, the Court observed in dicta that boards “have a duty to their stockholders to pay very close attention to provisions that affect the stockholder franchise,” such as proxy puts. Given the extent to which a proxy put may infringe on the stockholder franchise, the Court also expressed the hope that “any public company would bargain hard to exclude that toll” and only accede to the proxy put “after hard negotiation and only for clear economic advantage.”9