In Third Point LLC v. Ruprecht, et al.,1 the Delaware Court of Chancery denied the motion of Third Point LLC and its co-plaintiffs for a preliminary injunction to enjoin Sotheby’s from holding its annual meeting. Third Point had claimed that Sotheby’s directors had violated their fiduciary duties in order to obtain an impermissible advantage in a proxy contest with Third Point by (i) adopting a stockholders right plan (commonly referred to as a “poison pill”) in anticipation of the proxy contest and (ii) refusing to provide a waiver to Third Point from certain of such poison pill’s terms. The Court held that Third Point was not reasonably likely to succeed on the merits on such claims based on its findings that the Sotheby’s board of directors had identified legitimate and legally cognizable threats to the company’s corporate policy and effectiveness and that the board’s actions were proportionate responses to the threats posed and were not preclusive of a proxy contest.
In the summer of 2013, Sotheby’s became aware that Third Point, led by Daniel Loeb, and other “activist hedge funds” had acquired significant ownership positions in Sotheby’s stock. Sotheby’s subsequently engaged in discussions with two of those funds (including Third Point). However, in response to a perceived threat2 posed by increasing hedge fund activity in Sotheby’s stock, the board adopted a poison pill in October 2013.
The poison pill established a two-tiered structure whereby Sotheby’s stockholders who file a Schedule 13G with the Securities and Exchange Commission (SEC) and who certify in the Schedule 13G as to their passivity could acquire up to a 20% interest in Sotheby’s without triggering the poison pill, while all other Sotheby’s stockholders, including those required to file a Schedule 13D with the SEC, were limited to acquiring no more than a 10% interest before triggering the poison pill.3 Notably, the terms of the poison pill also provided that it would expire after one year and that it would not apply to “qualifying offers”, which were defined as offers for “any-and-all” shares that would give Sotheby’s stockholders at least 100 days to consider such offer and that would cash out all such stockholders.
Despite negotiations in the succeeding months between Sotheby’s and the activist funds, on February 27, 2014, Third Point filed with the SEC an amended Schedule 13D announcing its intention to commence a proxy contest to elect three directors to the Sotheby’s board. Shortly thereafter, Third Point requested that Sotheby’s grant it a waiver from the 10% trigger of the poison pill and allow it to purchase up to a 20% ownership position in Sotheby’s. The board promptly declined to provide such a waiver.
The Court’s Holdings
To assess the board’s actions with respect to both its adoption of the poison pill and its refusal to grant to Third Point a waiver from the 10% trigger, the Court applied the two-prong standard set forth in Unocal Corp. v. Mesa Petroleum Co., which requires (i) that the board articulate a legally cognizable threat to the company’s corporate policy and effectiveness and (ii) a showing that the board’s defensive response was proportional or reasonable in relation to the threat posed.
In applying the first prong of the Unocal standard to Third Point’s first claim, the Court held that the board articulated a legally cognizable threat: “creeping control.” Specifically, the Court noted that the Sotheby’s board was aware that several hedge funds were accumulating shares of Sotheby's stock simultaneously, and at least one, Third Point, was accumulating shares relatively rapidly. The Court also noted that the board had been informed by its advisors that it is not uncommon for activist hedge funds to form a group or “wolfpack” for the purpose of jointly acquiring large blocks of a target company’s stock. Based on these facts, the Court accepted the board’s assertion that its good-faith investigation led it to determine that Third Point posed a legally cognizable threat, i.e., the formation of a controlling block without the payment of a control premium. In applying the second prong of the Unocal standard, the Court held that it was reasonably probable that the board could demonstrate that its adoption of the poison pill was a proportionate response to such control threat. Specifically, the Court found that when the poison pill was adopted, there was the “objectively reasonable possibility” that Third Point was working with one or more other hedge funds in an attempt to create a control block without paying a control premium, as noted. A trigger level for a poison pill much higher than 10% could make it easier for a relatively small group of activist investors to achieve control, a factor which the Court found supportive of its conclusion that the poison pill was a proportionate response to the control threat posed by Third Point.
In applying the first prong of the Unocal standard to Third Point’s second claim, the Court held that the board’s concern that an ownership position in Sotheby’s greater than 10% could effectively provide Third Point with a veto right over Sotheby’s actions, even though Third Point would not have majority control (a concept known as “negative control”), could be at least one objectively reasonable and legally cognizable threat considered by the board.4 With respect to this point, the Court specifically noted, among other things, Mr. Loeb’s aggressive and domineering manner in relation to Sotheby’s as an adequate basis for the board’s legitimate concern that Third Point would be able to exercise negative control. In applying the second prong of the Unocal standard, the Court held that the plaintiffs had not shown a reasonable probability that the board would be unable to demonstrate that its refusal to waive the 10% ownership limit was a reasonable response to such threat of negative control.
Because the plaintiffs did not establish a likelihood of success on the merits of either of their claims, the Court did not grant injunctive relief.
While expressly refraining from endorsing the poison pill’s two-tiered structure, the Court rejected (at least for purposes of the motion for a preliminary injunction) the plaintiffs’ argument that the poison pill’s disparate treatment of Schedule 13G and Schedule 13D filers was inherently unreasonable or disproportionate. It noted that the poison pill was arguably a “closer fit” for the threat the board perceived from Third Point than a more ordinary poison pill (that would have restricted the ownership level of all stockholders, regardless of intent) would have been. However, it also cautioned against overstating the ways in which filers of Schedule 13D differ from filers of Schedule 13G, who are able to vote for directors other than those endorsed by the board without triggering the poison pill.
Subsequent to the Court’s decision, on May 5, 2014, Sotheby’s announced the execution of a settlement agreement with Third Point, pursuant to which Mr. Loeb and two of his nominees were appointed to the board. Under the terms of the agreement, Third Point has certain standstill obligations, including (among other things) the obligation, subject to certain exceptions, not to solicit proxies or consents and not to acquire more than a 15% ownership position in Sotheby’s, for a fixed period that may be extended so long as the board includes Third Point designees in its slate of nominees at each annual meeting of stockholders and such directors continue to serve on the board.
The Third Point decision is informed by facts specific to this case and is further limited by the scope of the inquiry undertaken with respect to a motion for preliminary judgment. Nevertheless, it highlights certain important considerations for directors of Delaware corporations in the context of adopting (and waiving certain of the provisions of) poison pills, including, among others, the following:
- Two-tiered poison pills. While a full trial was not conducted on the merits of the case, the Court’s reasoning in Third Point suggests that the disparate treatment of activist and passive stockholders is not necessarily unreasonable or disproportionate under the Unocal framework. Moreover, such a formulation may even provide a “closer fit” for protecting against the threat a corporation faces from an activist stockholder seeking to acquire control of such corporation (without the payment to stockholders of a control premium) by way of negative control. The Court noted that a poison pill having a limitation much higher than 10% could have made it easier for “a relatively small group of activist investors to achieve control, without paying a premium, through conscious parallelism”, especially in light of the objectively reasonable possibility that Third Point was working in connection with one or more other hedge funds.
- Negative control. A board of directors that refuses to provide a waiver of the applicability of an existing poison pill to a stockholder engaged in a proxy contest with the corporation may be able to justify such refusal based on its reasonable fear of such stockholder being able to exercise “negative control” over such corporation even if the stock ownership and board representation of such stockholder does not amount to majority control. In Third Point, the Court found Sotheby’s refusal to provide a waiver potentially problematic under the first prong of the Unocal test. However, the Court was ultimately persuaded that, given Third Point and Mr. Loeb’s open aggression towards Sotheby’s management (which included assertions by Mr. Loeb to third parties that he was “in charge” of Sotheby’s and would be making company decisions in the future), had Third Point prevailed in plaintiffs’ motion for a preliminary injunction, it could have exercised disproportionate control and influence over major corporate decisions of Sotheby’s.
- Creating the record. In adopting a poison pill or denying a waiver of any provision of a poison pill, a board of directors should take care to develop appropriately the contemporaneous record of its reasoning and the procedures undertaken to arrive at its decision. Such steps will assist the board of directors in demonstrating that it behaved reasonably in perceiving and articulating a cognizable threat posed to the corporation and the proportionality of the board’s response. In Third Point, the Court cited extensively to the Sotheby's board’s meeting minutes with respect to the board’s discussion of the acquisition of shares of Sotheby’s stock by various activist funds, the need to respond to the threat of creeping control and the advice of the board’s advisors as to the appropriate response. The Court’s analysis of the board’s reasonableness and proportionality was informed by, among other things, the extensive record.
- Internal communications. The ruling in Third Point again underscores the importance of implementing strict corporate policies regarding internal communications, whether by email or other means. The Court in Third Point cited frequently to internal communications of both Third Point officers and Sotheby’s directors and officers. In addition to publishing strongly worded and potentially embarrassing communications, the Court’s ruling appears to have been informed, at least in part, by these communications. 5