Yucaipa American Alliance Fund II, L.P. v. Riggio, C.A. No. 5465-VCS (Del. Ch. Aug. 12, 2010), read post-trial opinion here. This Delaware Court of Chancery opinion rejected breach of fiduciary duty claims and upheld the poision pill defense that Barnes & Noble implemented as part of a plan to spurn the advances of investor Ron Burkle’s Yucaipa entity. The issues in this 87-page opinion of the Court of Chancery have been both anticipated and discussed by commentators and scholars. See, e.g., Professor Davidoff’s preview analysis linked on this blog here. His post-opinion analysis is here.
Copious scholarly commentary on this important opinion is expected and will be linked to this post as it appears periodically. Though one could justify a lengthy exegesis of this tome, even if that type of length is not typical for a blog post, for the time being, I will simply highlight a few of the many gems of Delaware law provided in this decision, in the form of bullet points.
• The Court determined that Unocal provides the appropriate standard of judicial review for the Court to uphold the poison pill at issue in this case.
• The Court explained why the entire fairness standard would not apply. See page 33.
• The Court also explained why the Blasius compelling justification standard did not apply. See pages 34 to 36.
• In explaining one of the reasons why the the Unocal standard applied the Court observed that: “From the inception of pill litigation, a key feature of the Unocal review of the pill the Supreme Court requires is whether the pill unreasonably restricts the ability of stockholders to run a proxy contest. That is the mandated inquiry I must and now do undertake.” See pages 44 to 46. See generally Unocal Corp. v. Mesa Petroleum Co., 493 A.2d 946, 955 (Del. 1985).
• Under the familiar Unocal standard, adoption of defensive measures will be protected by the business judgment rule so long as: (1) The board that adopts the measure in question had “reasonable grounds for believing that a danger to corporate policy and effectiveness existed;” and (2) The “defensive response was reasonable in relation to the threat posed.” See Unitrin, 651 A.2d 1361, 1373 (Del. 1995).
• Though the process used by the board in this case was “not ideal” according to the Court, for example because it did not employ a special committee, the Court concluded that the board made good faith and reasonable determinations that Yucaipa was a threat. See page 62.
• The Court’s explanation about why the board was justified to view Yucaipa cautiously was thoroughly explained from pages 69 to 71. See also footnote 228 (citing to The Federalist Papers, No. 51 (James Madison)).
• The Court explained that the board was not required to assume that Yucaipa was an angelic investor “whose actions, unlike that of other humans, are immune from a temptation to act selfishly, especially when there is a record that Yucaipa has negotiated for itself special protections in connection with others of its investments, and that it has reserved to itself the right to take Barnes & Noble private. See page 69. In addition, the Court reasoned that: “Likewise, the board could reasonably conclude that Yucaipa should deal with the board in the first instance if it wished to obtain such a control bloc, and to pay a price to the company’s investors that reflected the value of obtaining that power.” See footnote 229.
• In addition, the Court reasoned that: “. . . the board was concerned that Yucaipa could, along with Aletheia as an admiring and devoted fellow traveler, essentially form a control bloc without paying a control premium.” See page 71.
• The Court explained on page 74 why the pill was proportionate in reply to the threat faced.
• Finally, the Court noted that shortly before the decision was issued, an announcement was made that the board was now considering the possible sale of the company, but the Court explained why that new development would not change its conclusions.
Kevin F. Brady of Connolly Bove Lodge & Hutz, LLP, provides a more comprehensive summary below:
In Yucaipa American Alliance Fund II, L.P. v. Riggio, C.A. No. 5465-VCS (Del. Ch. Aug. 12, 2010), the Court of Chancery dismissed claims of breach of fiduciary duties and found that Barnes & Noble (“B&N”) had proven at trial that its adoption and use of a rights plan was a good faith, reasonable response to threat to B&N and its shareholders from Ron Burkle.
In 2008 investor Ron Burkle, through his hedge fund, Yucaipa American Alliance Fund II started investing in B&N. When Yucaipa increased its stake to approximately 18 percent, the B&N board enacted a rights plan which would be triggered when a shareholder acquired more than 20 percent of B&N’s outstanding stock. When the rights plan was triggered, each share of B&N common stock would be able to exercise an option to purchase 1/1000th of a share of a new series of preferred stock. B&N explained that the reason for setting the threshold at 20% was that Leonard Riggio, the founder of B&N owned 30% of the common stock (Riggio’s ownership by itself would not trigger the pill unless he acquired more shares) and a lower cap might have raised preclusion issues. Following the board’s adoption of the rights plan, Burkle complained to the board criticizing the decision.
Yucaipa continued to purchase common stock and Aletheia Research and Management, Inc. increased its stake in B&N from 6.37% to 17.44%. The B&N board suspected that Yucaipa and Aletheia were capable of and interested in cooperating in a joint effort to take effective voting control of B&N. Burkle then demanded an exception to the rights plan to allow Yucaipa to buy up to 37% and after the board denied the request Burkle filed suit challenging the implementation of the pill and the board’s refusal to amend as a breach of fiduciary duty
Unocal standard of review
Yucaipa argued that the standard of review to evaluate whether a board’s adoption of a poison pill was not Unocal but was either “entire fairness” (because the Riggios the largest shareholders stood on both sides of the transaction) or the “compelling justification” standard of Blasius (because the poison pill was adopted for the improper purpose of disenfranchising the shareholders by preventing shareholders such as Yucaipa from forming a coalition to jointly propose a slate and run a proxy contest to elect new directors.) The Court rejected the “entire fairness” test because the rights plan did not confer any special benefit on the Riggios and the rights plan was approved by an independent board majority. The Court also rejected the “compelling justification” standard because the Court found that the rights plan did not act “for the primary purpose of interfering with the effectiveness of a stockholder vote.”
Under Unocal and Unitrin the adoption of a poison pill will be protected by the business judgment rule as long as: (1) the board that adopts the measure at issue had “reasonable grounds for believing that a danger to corporate policy and effectiveness existed;” and (2) the “defensive response was reasonable in relation to the threat posed.” Yucaipa argued that the rights plan was impermissibly vague (especially with respect to the definition of “beneficial ownership”) such that it not only prevented Yucaipa from understanding what activities could trigger the issuance of the rights plan but that the rights plan prevented Yucaipa from holding discussions about a proxy contest with other stockholders. Yucaipa also argued that the rights plan was beyond the range of reasonable responses to any threat posed by Yucaipa. The Court rejected the argument that the language of the pill made it ambiguous. Indeed, the Court pointed out that to the extent there was any ambiguity as to the definition of “beneficial ownership,” the Board amended the plan to permit and not foreclose such things as “agreeing to talk or meet about a proxy contest, participating in forums or group call discussing the candidates or grievances of the dissident, [and] having a regional or group meeting with other investors.”
Court Finds No Breach of Fiduciary Duty in Adopting the Rights Plan
Yucaipa asserted that the board failed both prongs of Unocal in that (i) the board did not have reasonable grounds for believing there was a threat to the company; and (ii) the rights plan was not a proportional response to that perceived threat because it precluded shareholders from voting. By trial, however, Yucaipa had abandoned its argument that the board did not have a reasonable basis for believing that there was a threat to B&N. It also acknowledged that the rapidity of Yucaipa’s purchase of B&N stock and its expressed intention to acquire up to 50% of B&N shares gave the board a reasonable basis to adopt the rights plan. At trial, Yucaipa also argued that “once the situation was stabilized, it was unreasonable not to amend the Rights Plan, per Burkle’s request, to allow Yucaipa to buy up to 37% of the company’s stock.” Yucaipa conceded that it was realistically possible for it to prevail in a proxy contest despite the rights plan and the shares held by the Riggios, the rest of the board, and B&N employees.
Yucaipa argued that the rights plan was disproportionate because it did not fall within the Unitrin “range of reasonableness” The Court characterized the Yucaipa’s “creative” argument as follows:
first, although there was an initial threat to the company, that threat somehow receded or became clearer over time; and second, even though the Rights Plan is not preclusive, keeping it in place without amending it in the ways requested by Burkle is unreasonable in light of the more confined threat that Yucaipa poses. That is, Yucaipa argues that once the immediate danger of further purchases by Yucaipa was addressed, there was no threat to Barnes & Noble that justified leaving the trigger for the Rights Plan at 20%, rather than raising it, as Burkle proposed, to 37%, the total voting power of the Riggios, the rest of the board, and Barnes & Noble’s stockholding employees. In addition, Yucaipa says that no threat justified applying the Rights Plan to cover discussions and agreements between Yucaipa and Aletheia regarding the selection and financing of a proxy slate.
In the end, the Court concluded that the board acted in good faith and for reasons unrelated to keeping Riggio as the largest stockholder of B&N. The Court also noted that while the board could have done a better job at isolating the board process from Riggio at certain times, the board ultimately acted with loyalty and in the best interests of B&N and its shareholders.
A Legitimate Threat and a Proportional Response
Yucaipa argued that it did not pose a threat to B&N because all it was seeking to do was to elect three directors, not a controlling slate and that it had not announced a tender offer to acquire all of the company’s shares. The Court, however, disagreed finding that Yucaipa did pose a threat looking not only at Yucaipa’s past behavior as an activist shareholder which indicated that it was not a friendly investor but noting that three directors in a staggered board is not insignificant especially when the three directors up for election included Riggio, the lead independent director on the board and Riggio’s personal financial advisor.
While Yucaipa originally argued that the rights plan was preclusive, at trial Yucaipa conceded that there was evidence that Yucaipa could succeed in a proxy contest if it put together a platform and a slate of candidates that were attractive to Aletheia and the leading institutional proxy advisors. Moreover, if Aletheia were to team up with Yucaipa (which the Court noted seemed like a real possibility) Yucaipa would then be at a level of ownership which exceeded the level of ownership of Riggio. Finally, given the role of institutional proxy advisors, the Court noted that there was nothing in the pill that would inhibit Yucaipa from having discussions with other stockholders about the company, the qualities they would be looking for in directors and any other considerations.
Supplement: Melissa Maleske of the publication Inside Counsel wrote a helpful review and commentary of the case here.