In re Third Point LLC v. Ruprecht, et al.
(Del. Ch. May 2, 2014) (denying preliminary injunction of Sotheby's annual meeting, applying Unocal standard of review and allowing Sotheby's "poison pill" to protect against activist campaign)
In the much anticipated review of Sotheby's two-tiered stockholder rights plan adopted in response to Third Point's activist campaign and proxy contest, the Delaware Court of Chancery held that the Sotheby's board did not breach its fiduciary duties by adopting and refusing to waive the application of a two-tiered "poison pill." While the ruling is a preliminary one, it reaffirms the long standing Delaware position that directors, acting in good faith and on in an informed basis with the advice of outside counsel, may take appropriate action to defend against any reasonably perceived threat to corporate effectiveness, including threats posed by stockholder activists.
In connection with Third Point's lengthy and highly public activist campaign against Sotheby's board and management team, the fund accumulated a 9.4% stake in the company and publicly filed a "poison pen" letter from its CEO, Daniel Loeb, to Sotheby's CEO raising concerns about leadership, strategic direction and governance. Loeb indicated both a willingness to sit on the company's board himself and recruit additional outside directors (including one from another fund, presumably one that had also filed a Schedule 13D outlining similar concerns regarding the company). Loeb advocated for CEO replacement and separation of the CEO and chairman roles, and further noted that he had already identified potential CEO replacement candidates. In response to this activity, the Sotheby's board adopted a two-tiered stockholder rights plan, or "poison pill." The plan included (i) a two-tiered trigger, capping stockholders who file Schedule 13Ds at 10% of the outstanding company stock, but permitting passive investors who file Schedule 13Gs to acquire up to 20% of the outstanding company stock and (ii) a "qualifying offer" exception, which made the plan inapplicable to an offer for all of the company's shares. The plan also expired in one year unless approved by a shareholder vote. In February of 2014, Third Point commenced a proxy contest and nominated three director nominees, while concurrently requesting that the Sotheby's board waive the 20% rights plan restriction. Sotheby's denied the request and Third Point sued to enjoin the Sotheby's annual meeting, alleging that the directors violated their fiduciary duties by adopting the pill and refusing to grant the waiver.
The Delaware Court of Chancery denied the motion to enjoin and applied the Unocal, rather than the Blasius, standard of review to the board's actions. With respect to the adoption of the pill, the court held on a preliminary basis that the majority of independent directors had shown that (i) the board acted reasonably in identifying a legally cognizable threat of activists obtaining a controlling stake in the company without paying other company stockholders a premium and (ii) the board's response was proportionate to the threat. Although the plan treated holders disparately, the court determined that it was appropriately tailored as a response to the threat of "creeping control" by funds acting in concert. The court noted that the board's denial of the waiver was "a much closer question" but determined that the board had proportionately responded to the threat of the exercise of "negative control" over major company decisions by a group of activist investors.
For boards reviewing strategic alternatives, including the use of rights plans and activist defense measures, this recent decision also highlights the importance of strong governance practices. A detailed and timely record of board review and action is imperative in the review of any company defensive measure. The record must be clear regarding the specific determination of potential threats when making a determination to adopt a rights plan, and boards are wise to employ tactics that demonstrate non-entrenchment (such as the waiver and "qualifying offer" mechanics used by Sotheby's). Review and implementation of a rights plan should always be led by independent directors, aided with the use of outside legal, financial and other advisors. It is also important to review the company's general governance history in connection with adoption of any rights plan or other measure. While Delaware has made a preliminary assessment of the new "two-tier" pill mechanic, every board defensive measure will be measured independently under its own facts, circumstances and historical activity.