Corporate Governance

Delaware's Top Five Worst Shareholder Decisions for 2010 (#3: Yucaipa American Alliance Fund v. Riggio)

By J Robert Brown Jr.

Yucaipa American Alliance Fund v. Riggio, 1 A.3d 310 (Del. Ch. 2010) is the second worst decision for shareholders in Delaware in 2010.  We did a series of posts on the case back in September. 

B&N put in place a poison pill with a 20% trigger.  Given Moran and its progeny, the invalidation of a poison pill that prevents acquisitions above a 20% threshold is all but impossible.  The great debate back in the 1990s about whether the Delaware courts would allow management to "just say no" to a hostile tender offer is over.  The answer is "yes, they can."

This pill, however, was challenged because of its impact on a proxy contest.  Poison pills apply not only to acquisitions but also to agreements among shareholders.  A pill will be triggered by agreements on such matters as a common slate of directors and the sharing of proxy expenses.  No Delaware court has or would strike down a pill simply because it directly interferes with the ability of shareholders to organize an election campaign for the board. 

Yucaipa did not, however, involve conventional circumstances.  First, B&N had a staggered board.  Yucaipa's efforts to elect directors by definition could not result in a change of control.  Yucaipa stood at best to elect only one third of the board. In other words, even had Yucaipa succeeded in the proxy contest, Burkle could have made life unpleasant for the remaining directors but he had no ability to impose his will on the board.

The other inconvenient truth was the controlling block of stock owned by the Riggios and their supporters.  The block, when combined with the shares owned by the brothers, management and employees, consisted of about 40% of the voting shares.  The poison pill prevented Yucaipa, which owned around 20% of the shares, from negotiating with other shareholders and putting together a comparable block. 

Moreover, while the pill also prevented the Riggio brothers from entering into agreements with other shareholders, it did not prevent management from doing the same.  Management could have, for example, agreed to include a shareholder's candidate in management's slate of directors in return for support while Yucaipa could not have done the same thing.  The pill, in other words, decidedly tipped the balance of the proxy contest in favor of incumbent management. What could management do?  Add a dissident to its own slate in return for voting support.  A road map for this approach can be found in Cryo Cell. 

A staggered board and a controlling block of shares seemed to tilt the contest in management's favor, even without a poison pill.  To uphold the pill, the Chancery Court had to "find" a threat and to ignore the decided advantage given to management.  The Vice Chancellor did both.  The threat?  The possibility that the board could not be "intransigent" towards shareholders.  See Id. at 346-47 ("Once an insurgent has won one election, the incumbent board majority's ability to be intransigent in the face of stockholder sentiment is greatly limited.").  Intransigent means "uncompromising" and "inflexible." 

Equating a threat with a reduction in flexibility effectively read the threat requirement out of the Unocal standard.  This is the equivalent of "just say no" in the proxy contest.  Boards can adopt poison pills that sharply curtail the ability of insurgents even absent any real threat to the company. 

As for tilting the field in management's favor, that prospect played no role in the analysis.  Management was allowed to adopt a pill that left the controlling shareholder in an enviable position and left with management the ability to cut deals with other shareholders should the need arise. 

The message is clear.  Proxy contests in Delaware are not favored and to the maximum extent possible poison pills will be allowed to prevent and discourage them.

Full post as published by The Race to the Bottom on January 05, 2011 (boomark / email).