Wednesday, February 16, 2011

Delaware Chancery Court Upholds Poison Pill under Enhanced Unocal Test

A target company’s board of directors that has a good faith, reasonable basis to believe a takeover bid is inadequate may block a non-coercive bid using a poison pill irrespective of stockholders’ desire to accept it, ruled the Delaware Chancery Court in an eagerly awaited opinion. This was an independent board that relied on the advice of three different outside independent financial advisors in concluding that the tender offer was inadequate, said Chancellor Chandler, and thus the directors complied with their fiduciary duties. Air Products and Chemicals, Inc v. Airgas, Inc., Del Chan Ct, Civ. Action 5256-CC, Feb. 15, 2011.

The Chancellor clarified that poison pills act as potent anti-takeover drugs with the potential to be abused and that he was not endorsing a “just say never” concept. Rather, he was endorsing Delaware’s long understood respect for reasonably exercised managerial discretion, so long as boards are found to be acting in good faith and in accordance with their fiduciary duties after rigorous judicial fact-finding and enhanced scrutiny of their defensive actions.

Directors of a company do owe fiduciary duties to all of the shareholders, short-term as well as long-term, the court emphasized, but at the same time a board cannot be forced into Revlon mode any time a hostile bidder makes a tender offer that is at a premium to market value. The mechanisms in place to get around the poison pill, even a pill in combination with a staggered board, which makes the process prohibitively more difficult, have been in place since 1985 when the Delaware Supreme Court first decided to uphold the pill as a legal defense to an unwanted bid.

Because of the omnipresent specter of entrenchment in takeover situations, noted the court, when a poison pill is being maintained as a defensive measure and a board is faced with a request to redeem the rights the Unocal standard of enhanced judicial scrutiny applies. Under that standard, the target board must show that it had reasonable grounds for believing a danger to corporate policy and effectiveness existed and that any board action taken in response to that threat is reasonable in relation to the threat posed.

The first hurdle under Unocal is a process-based review under which directors must demonstrate good faith and reasonable investigation, which was enhanced by the approval of a board comprised of a majority of outside independent directors. But process alone is not sufficient to satisfy the first prong of Unocal. The directors must also articulate a legitimate threat to corporate policy and effectiveness. Once the board has reasonably perceived a legitimate threat, the second prong of Unocal engages the court in determining if the board’s action taken in response to that threat is proportional to the threat posed.

The board met the threshold of showing good faith and reasonable investigation, said the Chancellor, and acted in good faith and relied on the advice of its financial and legal advisors in coming to the conclusion that the offer was inadequate. A board that in good faith believes that a hostile offer is inadequate may properly employ a poison pill as a proportionate defensive response to protect its stockholders.

The board’s defensive measures were a proportionate response. Under Delaware precedent, defensive measures are not preclusive if they delay a bidder from obtaining control of a target board even if that delay is significant so long as obtaining control at some point in the future is realistically attainable.

The bidder here had two options if it wanted to continue to pursue the company at this time. It could call a special meeting and remove the entire board with a supermajority vote of the outstanding shares or it could wait until the 2011 annual meeting to nominate a slate of directors.

The fact that something might be a theoretical possibility does not make it realistically attainable, noted the Chancellor. Realistically attainable must be something more than a mere mathematical possibility or hypothetically conceivable chance of circumventing a poison pill.

While achieving a supermajority vote necessary to remove the entire board at a special meeting may not be realistically attainable, said the court, getting a simple majority of the voting stockholders to obtain control of the board at next year’s annual meeting was. If the bidder was unwilling to wait another eight months to run another slate of nominees, reasoned the court, that was a business decision. But, since waiting until the next annual meeting only delays the bidder from obtaining control of the board, the target’s defensive measures were not preclusive.

Since the pill was neither coercive nor preclusive, the Unocal proportionality test shifted to the reasonableness of the board’s response to the specific threat identified. Here, a board composed of a majority of independent directors, acting in good faith and with numerous outside advisors, concluded that the takeover bid clearly undervalued the company in a sale transaction.

The board believed in good faith that the offer price was inadequate by no small margin. Thus, the court found that the board was responding to a legitimately articulated threat, a conclusion bolstered by the fact that the three of the bidder’s nominees on the target company board wholeheartedly joined in the board’s determination to keep the pill in place.

The maintenance of the board’s defensive measures fell within a range of reasonableness. Chancellor Chandler noted that the board is not cramming down a management-sponsored alternative. Rather, the board is maintaining the status quo, running the company for the long-term, and consistently showing improved financial results each passing quarter. The board’s actions do not forever preclude this bidder or any bidder from acquiring the company or getting around the defensive measures if the price is right. In the meantime, the board is preventing a change of control from occurring at an inadequate price, concluded the court, a course of action clearly recognized under Delaware law.