Corporate Governance

Selectica, the Delaware Supreme Court, and the Effort to Limit Access (The Impact of the Staggered Board)

By J Robert Brown Jr.

We are examining the Delaware Supreme Court's recent decision in Selectica.  The opinion affirmed the validity of a poison pill with a 5% trigger.  ?

The low trigger for the poison pill in this case had to be considered in light of the company's staggered board.  The pill made any proxy contest difficult.  But with only one-third of the directors up for election, the company made a proxy contest even more unappealing.  

Insurgents would have to engage in a proxy context with no more than 5% of the shares, pay all of the expenses, and have the possibility of only electing a minority of the board.  Because they cannot come to agreement on a common slate of directors with any other sharehodlers (at least any shareholders that would result in the crossing of the 5% threshold), they come into the contest with markedly less support than otherwise woudl be the case.  As a result, the low threshold likely increases the costs of a contest.

It also makes certain that insurgents will never be reimbursed.  To the extent an insurgent succeeds in obtaining a majority of the board, the new board will likely agree to reimburse the costs expended by the insurgent.  By limiting insurgents to a minority of the board, the company is in effect ensuring that shareholders will not be compensated for the expenses even if they win. 

None of this was acknowledged by the Supreme Court.  The Court simply opined that staggered board were legal. 

• Classified boards are authorized by statute and are adopted for a variety of business purposes. Any classified board also operates as an antitakeover defense by preventing an insurgent from obtaining control of the board in one election.  More than a decade ago, in Carmody, the Court of Chancery noted 'because only one third of a classified board would stand for election each year, a classified board would delay-but not prevent-a hostile acquiror from obtaining control of the board, since a determined acquiror could wage a proxy contest and obtain control of two thirds of the target board over a two year period, as opposed to seizing control in a single election.' The fact that a combination of defensive measures makes it more difficult for an acquirer to obtain control of a board does not make such measures realistically unattainable, i.e., preclusive. ?

The statement is merely a repeat of the justification of a staggered board.  The problem with the analysis is that it does not take into account the staggered board and a poison pill with a 5% threshold.  The two combined do more than limit an insurgent from acquiring control in two years.  They collectively discourage anyone from engaging in a proxy contest. 

None of this was acknowledged in any meaningful way.  In considering both tactics together, the Court simply said that they weren't preclusive.  "In this case, we hold that the combination of a classified board and a Rights Plan do not constitute a preclusive defense."

For materials from the lower court proceeding, access the DU Corporate Governance web site.

Full post as published by The Race to the Bottom on October 26, 2010 (boomark / email).