Delaware Court of Chancery Upholds 20% Rights Plan
By: Byron F. Egan and Charlene Wandrisco
On August 11, 2010, the Delaware Court of Chancery upheld a rights plan, or “poison pill,” adopted by the board of directors (the “Board”) of Barnes & Noble (“B&N”) in Yucaipa American Alliance Fund II, L.P. v. Riggio et al., C.A. No. 5465-VCS. In the 87-page opinion, Vice Chancellor Leo Strine ruled that the Board’s adoption of the rights plan was a good faith, reasonable response to a threat to B&N and its stockholders and consistent with the directors’ fiduciary duties.
Facts
In late 2009, billionaire activist investor Ronald Burke’s Yucaipa American Alliance (Parallel) Fund II, L.P. (“Yucaipa”) rapidly bought an 18 percent stake in B&N, and met with B&N’s chairman and largest shareholder to propose changes in its strategic direction. Yucaipa communicated in public filings that it might seek to implement changes in the company’s governance, buy additional shares in the company and propose M&A transactions. Additionally, another investment advisory firm, which had followed Yucaipa’s lead in prior investments, quickly bought another 17 percent of B&N. In response to the threat that B&N’s shareholders “would relinquish control through a creeping acquisition without the benefit of receiving a control premium,” the Board adopted a rights plan (the “Plan”) that would be triggered if a stockholder became the beneficial owner of more than 20 percent of B&N stock. The Plan’s typical definition of “beneficial owner” effectively restricted two or more stockholders from joining together to control the company, but did not preclude a proxy contest. The Plan “grandfathered in” the founder of B&N with his current 30 percent B&N stake, but would trigger and apply to the founder if he acquired additional shares.
Standard of Review
The Court rejected Yucaipa’s attempt to reverse “decades of settled law” in arguing the entire fairness standard review should apply rather than the Unocal1 standard of review to the Board’s adoption of the Plan. Under the Unocal standard, the adoption of a poison pill is protected by the business judgment rule if (i) the Board had “reasonable grounds for believing that the danger to corporate policy and effectiveness existed,” and (ii) the “defensive response was reasonable in relation to the threat posed.”
In applying the Unocal standard, the Court recognized that directors must demonstrate that their actions were reasonable in relation to their legitimate objective, and “whether the pill unreasonably restricts the ability of stockholders to run an effective proxy contest.” In this case, the Court found that “the board had a reasonable basis that Burke was potentially planning to acquire a controlling stake in B&N, or form a governing bloc with another large stakeholder.” The Court also found that the Plan did not prevent an effective proxy contest by finding that the Plan did not “disenfranchise any stockholder in the sense of preventing them from freely voting [nor did it] prevent a stockholder from soliciting revocable proxies.” The Court further rejected the entire fairness standard as the Board did not adopt the Plan in an effort to provide a special advantage in favor of the founder of B&N, but merely grandfathered in an existing stockholder.2
Fiduciary Duties
The Court further rejected Yucaipa’s claim that the Board breached its fiduciary duties by adopting the Plan. The Court noted that the Board’s process in regard to the Plan was not “ideal” because the Board did not hold an executive session with only the independent directors or utilize a special committee. However, the Court held that the Board acted loyally to advance the best interests of B&N and its public stockholders. Additionally, the Board was properly informed and appropriately advised by outside counsel regarding their duty to avoid restricting the stockholders’ ability to hold an effective proxy contest.
The Future for Rights Plans
The Court of Chancery’s decision in Yucaipa is further evidence of the Delaware courts’ willingness to respect rights plans. Rights plans with relatively high thresholds, such as the 20 percent threshold in Yucaipa, are typically developed to give boards tools to deal with third party threats to corporate policies However, companies have recently adopted rights plans with a lower threshold of 4.99 percent (typically called an “NOL Poison Pill”) in an effort to prevent the loss of net operating loss (“NOL”) carry forwards which could result from changes in stock ownership. The Delaware Court of Chancery also upheld the use of an NOL Poison Pill in Selectica Inc. v. Versata Enters., Inc., C.A. no. 4241-VCN (Del. Ch. Feb. 26, 2010). The Supreme Court of Delaware is expected to rule on an appeal of the Selectica decision in the near future. Jackson Walker will continue to monitor this case for further developments.
Jackson Walker attorneys have been instrumental in the adoption of numerous NOL Poison Pill plans. If you have any questions or would like more information on how a rights plan or a poison pill could assist your business, please contact any of the following attorneys:
Austin
Elise F. Green – 512.236.2228 – egreen@jw.com
Michael F. Meskill – 512.236.2253 – mmeskill@jw.com
Dallas
Richard F. Dahlson – 214.953.5896 – rdahlson@jw.com
Byron F. Egan – 214.953.5727 - began@jw.com
Alex Frutos – 214.953.6012 – afrutos@jw.com
Jeffrey M. Sone – 214.953.6107 – jsone@jw.com
Houston
Mark L. Jones – 713.752.4224 – mljones@jw.com
Richard S. Roth – 713.752.4209 – rroth@jw.com
San Antonio
Stephanie L. Chandler – 210.978.7704 – schandler@jw.com
Steven R. Jacobs – 210.978.7727 – sjacobs@jw.com
1 In Unocal Corp. v. Mesa Petroleum Co., 493A.2d 946 (Del. 1985), the Delaware Supreme Court held that the enhanced judicial scrutiny is required when directors authorize takeover defensive measures. The entire fairness standard of review requires a company to prove the entire fairness of its board’s decision in relation to the company’s shareholders, which includes fair dealing and fair price. See Byron F. Egan, Recent Fiduciary Duty Cases Affecting Advice to Directors and Officers of Delaware and Texas Corporations, University of Texas School of Law 32nd Annual Conference on Securities Regulation and Business Law (February 12, 2010) 136-139, http://www.jw.com/site/jsp/publicationinfo.jsp?id=1344.
2 The Court noted that if the Board had attempted to entrench the founder of B&N, then it would be a breach of fiduciary duty. However, the application of the entire fairness standard is not invoked simply with the Board’s decision to grandfather in a existing shareholder.
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