United States: Delaware Decision Upholds Board Discretion In Implementing Rights Plan Against Activist Hedge Fund

The Delaware Court of Chancery decision in Third Point highlights once again the breadth of the discretion of boards of directors when implementing defensive tactics subject to the Unocal standard. The decision is an illustration of the potential role of rights plans to fend off shareholder activists. Interestingly, it recognizes that negative control wielded by activists may present an objective threat to corporate policy and effectiveness that could justify the implementation of defensive measures.

From a Canadian perspective, the Third Point decision must be read in light of our particular legal landscape governing defensive tactics. Still, to the extent that National Policy 62‑202 Take-over Bids – Defensive Tactics does not purport to regulate defensive tactics outside the realms of takeover bids, it is worth reflecting on the teachings of Third Point in the context of shareholder activism from the point of view of corporate law and securities regulation. 

Background

In 2013, hedge fund activity increased significantly in Sotheby's stock with three funds accumulating a position of about 15% of the shares at the end of summer. The situation was monitored closely by Sotheby's board of directors. Presentations were made by the company's legal and financial advisors to the board on the stockholder activism market generally and stockholder activism issues specific to Sotheby's. Management also met separately with two of the funds in August to exchange opinions on Sotheby's and its business.

On October 2nd, Third Point filed an amended Schedule 13D disclosing that it had increased its stake in the company to 9.4%. A letter was attached to the filing in which Daniel Loeb of Third Point criticized Sotheby's management and board of directors. The letter recommended that Sotheby's CEO, William Ruprecht, be replaced, and mentioned that Third Point already had identified potential CEO candidates.

The following day, the board held a special meeting with its legal and financial advisors to discuss the filing and letter, and review possible courses of action including the adoption of a shareholder rights plan. On October 4th, at its regularly scheduled meeting, Sotheby's board adopted a rights plan with a one-year term.

The rights plan had an unusual two-tier structure. While the plan generally provided for a 10% threshold trigger, it also allowed an "acquiring person" who reported its ownership pursuant to Schedule 13G (used by passive institutional investors) to acquire up to a 20% interest in the company. The plan also contained a qualifying offer exception pursuant to which it would not apply to an any-and-all shares offer for the company that cashed out all Sotheby's stockholders and gave them at least 100 days to consider the offer.

After failed negotiations with Sotheby's board to avoid a proxy contest, Third Point increased its stake to 9.62% in March 2014. Third Point also requested a waiver from the rights plan's 10% trigger to allow it to purchase up to a 20% stake. After consideration, Sotheby's board denied the request to avoid a change in effective control of the company without any premium being paid to shareholders.

Chancery Court decision

Third Point challenged the board's decision by filing a motion for preliminary injunction with the Delaware Court of Chancery. In a nutshell, Third Point argued that Sotheby's directors violated their fiduciary duties by adopting the rights plan and refusing to provide it with a waiver from the rights plan's terms so as to obtain an impermissible advantage in the ongoing proxy contest. Third Point's request was denied by the Court.

To analyze the board's decision to implement the two-tier rights plan and refuse to grant Third Point's request for waiver of application, the Court applied the Unocal standard of review. The Unocal standard is a two-pronged test whereby the board has the burden of proof. The first prong is a reasonableness test. Specifically, the board must demonstrate that it "had reasonable grounds for believing that a danger to corporate policy and effectiveness existed". The second prong is a proportionality test that requires the board to demonstrate that its defensive response was reasonable in relation to the threat posed. For the defensive response to be proportionate, it must not be draconian by being either preclusive or coercive. Further, the response must fall within a range of reasonable responses to the threat posed.

After examining the adoption of the rights plan in October 2013 in light of the Unocal standard, the Court held that the board conducted a good faith and reasonable investigation into the threat posed by Third Point. The investigation gave the board reasonable grounds to believe that Third Point presented an objectively reasonable and legally cognizable threat to Sotheby's. Specifically, Third Point posed a threat of forming a control block with other hedge funds without paying a control premium.

The board's decision to implement the rights plan also passed muster under the second prong of Unocal. Referring to the Blasius line of cases, the Court found that the primary purpose of the board was not of interfering with the shareholder franchise, i.e. of impeding the voting rights of Sotheby's shareholders. The plan was neither preclusive nor coercive in that it did not "impose any consequences on stockholders for voting their shares as they wish[ed]". Indeed, despite the adoption of the rights plan, the proxy contest remained eminently winnable by either side according to the Court. In addition, the Court held that the rights plan fell within the range of reasonableness. Interestingly, the Court recognized that the two-tier structure of the plan was a proportionate response to the threat posed by Third Point. For the Court, the plan was "a closer fit to addressing the company's needs to prevent an activist or activists from gaining control than a garden variety rights plan".

The Court likewise dismissed Third Point's challenge of the board's decision not to grant a waiver from the rights plan 10% threshold. The Court expressed skepticism toward the board's ability to argue successfully that it still had a reasonable belief that Third Point posed a risk of creeping control in March 2014. However, it accepted that the threat of negative control constituted an objectively reasonable and legally cognizable threat. The Court acknowledged Sotheby's concerns that if it reached the 20% threshold Third Point could exercise disproportionate control and influence over major corporate decisions, even if it did not have an explicit veto power.

Finally, the Court held that the refusal to grant the waiver fell within the range of reasonableness. The Court remarked that there may well be some level of ownership between 10% and 20% where the board could have allowed Third Point to increase its stake. It emphasized, however, that the test is one of reasonableness, not perfection. In this case, the 10% threshold was reasonable.

Third Point LLC v. William F. Ruprecht, et al., and Sotheby's (Del. Ch.), May 2, 2014.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
Similar Articles
Relevancy Powered by MondaqAI
 
In association with
Related Topics
 
Similar Articles
Relevancy Powered by MondaqAI
Related Articles
 
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions