Poison puts, part 2

Vice Chancellor Stephen Lamb may have mooted the effect of poison puts on proxy contests with his May 12 decision in San Antonio Fire & Police Pension Fund v. Amylin Pharmaceuticals Inc. Since debt markets started to tighten last fall, one impediment to changes in corporate control -- proxy fights for a majority of the board among them -- has been the right that many creditors have to put debt instruments back to a company that undergoes such a change. That became a possibility at Amylin Pharmaceuticals Inc. when both Icahn Partners LP and Eastbourne Capital Management LLC nominated five-member slates to the company's 12-member board in late January.

Developments in the case allowed Lamb at the Delaware Court of Chancery to duck the issue, but he declined to do so. "A provision in an indenture with such an eviscerating effect on the stockholder franchise would raise grave concerns," the judge wrote in his 28-page opinion. Lamb suggested that such provisions should be eviscerated instead.

Ethan Klingsberg, a partner at Cleary Gottllieb Steen & Hamilton LLP, says the case raises a conflict between the Delaware court's suspicion of takeover defenses and lenders' desire to protect their investment: "It's an example of an M&A mentality on things like dead hand pills being applied to a world that's just not used to seeing things that way."

Had Amylin shareholders elected both dissident slates, they might have triggered a clause in the trust indenture governing that company's notes that allows noteholders to put the debt back to Amylin if shareholders elect a majority of directors whom current members do not "approve" as well as a similar clause in its credit agreement.

But Bank of America Corp., the administrative agent for the credit facility, agreed to suspend the clause in exchange for a 50-basis-point fee paid by Amylin if the provision were triggered and a 25-basis-point fee for persuading the other lenders on the credit agreement to waive the clause, which is standard. Eastbourne and Icahn both reduced their slates in early May to three and two, respectively, meaning that the proxy contest no longer threatened a change in control.

Lamb forged ahead nonetheless. The key question in the case was whether a company's "board may approve a slate of nominees without endorsing them" and thus avoid triggering the change-in-control provisions in its debt while opposing a dissident slate. Lamb held that it may. In this context, he wrote, using the definitions in "Black's Law Dictionary," "to approve" means "to give formal sanction to; to confirm authoritatively" rather than "to endorse" or "to recommend."

Even if a target board tried to use a poison put as a defense in a proxy contest, Lamb suggested a Delaware court might void such a put were it triggered. Not only would a judge "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 otherwise not be available to it," Lamb wrote. He would also "have to closely consider the degree to which such a provision might be unenforceable as against public policy." That's an extraordinary sentence for Lamb who, like his fellow Delaware judges, almost always defers to corporate contracts absent a showing of conflict on the part of those who enter into them.

In the last substantive paragraph of his opinion, Lamb noted "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." When a board does so, he continued, it "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 interests at times may be directly adverse to those of the stockholders."

The judge ended by telling boards to create a good record on the issue: "[T]erms 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."

Kris Heinzelman, a partner at Cravath, Swaine & Moore LLP, says the ruling may have little effect on how the relevant provisions in debt instruments are written. "There was a similar decision 10 or 12 years ago. When this happened a dozen years ago, the high-yield market absorbed it. Whether bank lenders react the same way, time will tell."

David Marcus is a senior writer at Corporate Control Alert.