The Dead Hand
In the context of credit agreements, a “proxy put” is a provision that can trigger a default which then allows the lender to accelerate debt as a result of changes in control of the borrower. A proxy put containing a “dead hand” feature allows the lender to call the entire debt due to a change in control resulting from the appointment of a director elected as a result of an actual or threatened proxy contest. For purposes of the proxy put, such a director is treated as a non-continuing director, thus triggering a default under the loan.
Although proxy puts are common, dead hand proxy puts have come under scrutiny in recent years. Such provision eliminates the discretion of the board to approve a slate of dissident directors in a proxy contest. Additionally, a dead hand provision raises questions of a board’s fiduciary duty to its shareholders to appoint a dissident slate when such appointment triggers the put.
Most recently, in a ruling from the bench, the Delaware Chancery Court refused to dismiss a claim of breach of fiduciary duty against a board for agreeing to a proxy put in the face of a proxy contest, and, significantly, a claim against a lender for aiding and abetting the breach for including the dead hand proxy put in its credit agreement (Pontiac General Employees Retirement System v. Ballantine, C.A. No. 9789-VCL (Del. Ch. Oct. 14, 2014) (transcript ruling). The case stems from Healthways, Inc.’s execution of a fifth amended and restated credit agreement with a dead hand provision just days after its shareholders voted to de-stagger the board, a move that the board opposed. Notably, until the threatened proxy contest, Healthway’s credit agreement historically provided for a proxy put without a dead hand prong.
Although the lender argued that the proxy put arose out of an arms-length negotiation, was market practice and that there were legitimate business purposes served by the put, the court ultimately found issue with the dead hand proxy put adopted in the shadow of a proxy contest and the entrenching effect of such provision. The court found that although a claim of aiding and abetting may be negated by evidence of an arms-length transaction, an arms-length negotiation does not allow lenders “to propose terms, insist on terms, demand terms, contemplate terms, incorporate terms that take advantage of a conflict of interest that the fiduciary counterparts on the other side of the negotiating table face.” The court further noted that that lenders had notice that such proxy puts are “highly suspect” and could result in a breach of duty. See generally, San Antonio Fire & Police Pension Fund v. Amlin Pharms., Inc., 983 A.2d 304 (De. Ch. 2009); Kallik v. SandRidge Energy, 68 A.3d 242 (Del. Ch. 2013).
Although the court never ruled that the board breached its fiduciary duty, the lender aided and abetted the board’s breach, or that dead hand proxy puts were per se illegal, since the court’s initial ruling, in May 2015, the parties reached a settlement agreement which required the parties to eliminate the dead hand proxy put from the credit agreement (Pontiac General Employees Retirement System v. Ballentine, C.A. No. 978-VCL (Del. Ch. May 8, 2015) (Transcript).
Proceed with Caution
In light of the Healthway’s case, lenders should proceed with caution when negotiating proxy put provisions in credit agreements, particularly in the context of a pending or actual proxy contest. Lenders would be wise to consider viable alternatives without an entrenching effect that allow them to gauge their borrower and its business, including financial covenants with coverage and leverage ratios.