Delaware Court of Chancery Rules on “Poison Puts”

June 8, 2009

Current market conditions have produced an uptick in unsolicited merger and acquisition activity, as well as shareholder activist campaigns.  However, many unsolicited bidders and activists have been forced to rethink their strategies by the presence of change-in-control put provisions in the documents governing their targets’ publicly traded debt.  These provisions–commonly referred to as "poison puts"–are not an uncommon feature of publicly traded debt and other finance instruments and give bondholders and other creditors the right to call the issuer’s debt upon the occurrence of certain fundamental change-in-control events.  Such events often include a forced change in the composition of a majority of the issuer’s board (a so-called "continuing director" provision).  Where debt is trading at a deep discount and additional financing is scarce, the exercise of such a put right by a lender, particularly a disperse group of bondholders, could be devastating to the finances of a corporation and its stockholders.

In May 2009, the Court of Chancery of the State of Delaware issued an opinion in San Antonio Fire & Police Pension Fund v. Amylin Pharmaceuticals, Inc.[1] interpreting under New York law a "Continuing Director" change-in-control provision in the indenture governing certain publicly traded convertible senior notes of Amylin Pharmaceuticals.  The court also analyzed whether the Amylin directors complied with their fiduciary duties under Delaware law when they approved the governing Indenture with such a provision.[2]

Language in the Indenture gave the noteholders the right to demand redemption of the convertible notes at face value upon the occurrence of certain events, including a "Fundamental Change," defined in part to have occurred if "at any time the Continuing Directors do not constitute a majority of the Company’s Board of Directors…."  The Indenture defines "Continuing Directors" as:

(i) individuals who on the Issue Date constituted the Board of Directors and (ii) any new directors whose election to the Board of Directors or whose nomination for election by the stockholders of the Company was approved by at least a majority of the directors then still in office (or a duly constituted committee thereof) either who were directors on the Issue Date or whose election or nomination for election was previously so approved.

Litigation ensued after two Amylin stockholders, Eastbourne Capital Management, L.L.C. ("Eastbourne") and Icahn Partners LP and affiliates ("Icahn"), separately announced their respective intentions to nominate a slate of five directors to Amylin’s 12-person board, potentially implicating the "Continuing Director" provisions.[3]

The court first addressed whether the "Continuing Director" provisions prevent Amylin’s board from "approving", as "Continuing Directors" under the Indenture, persons nominated by stockholders in opposition to the slate nominated by the incumbent directors.  Facing shareholder pressure, Amylin argued that the board has the power to give its approval to any nominee, whether or not nominated by the incumbent directors.  Not surprisingly, the Indenture Trustee argued that the incumbent directors cannot "approve" as a "Continuing Director" any person whose election the incumbent directors publicly oppose.

The court held that Amylin’s reading of the indenture was correct and that the board may approve a slate of nominees for the purposes of the indenture without endorsing them and may simultaneously recommend and endorse its own slate instead.  The court noted that the Trustee’s reading of the indenture "would prohibit any change in the majority of the board as a result of any number of contested elections, for the entire life of the notes."  The court went on to state:

A provision in an indenture with such an eviscerating effect on the stockholder franchise would raise grave concerns.  In the first instance, those concerns would relate to the exercise of the board’s fiduciary duties in agreeing to such a provision.  The court would want, at a minimum, to see evidence that the board believed in good faith that, in accepting such a provision, it was obtaining in return extraordinarily valuable economic benefits for the corporation that would not otherwise be available to it.  Additionally, the court would have to closely consider the degree to which such a provision might be unenforceable as against public policy.

Although determining that the Amylin board had the power to approve a stockholder-nominated slate and still engage in a proxy contest against that slate, the court abstained from deciding whether, in this case, Amylin’s board’s decision to "approve" the insurgent nominees comported with the company’s implied duty of good faith and fair dealing which inheres in all contracts, including the Indenture.[4]

In addition, the court addressed whether the directors, in approving the adoption of the Indenture containing the "Continuing Director" change-in-control provisions, were grossly negligent and thus violated the duty of care.  The plaintiff based its claim largely on the fact that neither the board (nor its delegate, the "Pricing Committee") discovered during its approval process that the proposed Indenture contained a "Continuing Director" provision.  In determining that the board was not grossly negligent here, the court cited that the board retained highly qualified counsel and sought advice from Amylin’s management and investment bankers as to the terms of the agreement.  The board asked its counsel if there was anything "unusual or not customary" in the terms of the convertible notes, and it was told there was not.  The court noted, "this is not the sort of conduct generally imagined when considering the concept of gross negligence, typically defined as a substantial deviation from the standard of care." 

Notwithstanding the foregoing, the court stated the following:

This case does highlight the troubling reality that corporations and their counsel routinely negotiate contract terms that may, in some circumstances, impinge on the free exercise of the stockholder franchise.  In the context of the negotiation of a debt instrument, this is particularly troubling, for two reasons.  First, as a matter of course, there are few events which have the potential to be more catastrophic for a corporation than the triggering of an event of default under one of its debt agreements.  Second, the board, when negotiating with rights that belong first and foremost to the stockholders (i.e., the stockholder franchise), must be especially solicitous to its duties both to the corporation and to its stockholders.  This is never more true than when negotiating with debtholders, whose interest at times may be directly adverse to those of the stockholders.  Outside counsel advising a board in such circumstances should be especially mindful of the board’s continuing duties to the stockholders to protect their interests.  Specifically, terms which may affect the stockholders’ range of discretion in exercising the franchise should, even if considered customary, be highlighted to the board.  In this way, the board will be able to exercise its fully informed business judgment.

We expect that practitioners will pay close attention to the foregoing paragraph in the future when presenting for board consideration the terms of new debt instruments and other contracts containing "continuing directors" change-in-control triggers that could be deemed to limit the ability of shareholders to change the composition of the issuer’s board.  In light of the decision, lenders and their counsel will also have to reconsider the value and permissible parameters in drafting "continuing director" provisions.

[1]   No. 4446-VCL (Del. Ch., May 12, 2009).

[2]   The case is now on appeal with the Delaware Supreme Court.

[3]   On May 4, 2009, Eastbourne reduced the number of candidates it was nominating to the Amylin board from five to three.  Two days later Icahn reduced the number of candidates it was nominating from five to two.  On June 2, 2009, Amylin announced that Icahn and Eastbourne each had one candidate elected to the Amylin board.

[4]   The court did note that “the directors are under absolutely no obligation to consider the interests of the noteholders in making this determination.”

Gibson, Dunn & Crutcher LLP

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