A number of public companies have become the target of shareholder books and records inspection demands and litigation related to certain “change of control” provisions in their loan agreements. The type of provisions at issue, known as “proxy put” provisions, allow lenders to demand immediate payment of all outstanding debt if, within a specified period, a majority of the borrower’s board of directors becomes composed of “non-continuing directors” who have not been approved by the incumbent members of the board. If new directors are approved by the incumbent members of the board, then those new directors would be deemed “continuing directors,” thereby avoiding a change of control that would allow the company’s lenders to declare an event of default under its credit facility and accelerate outstanding amounts under that credit facility.
Some loan agreements contain a variant of the proxy put provision known as a “dead hand proxy put” (the Dead Hand Provision). The effect of the Dead Hand Provision is to change the typical proxy put provision by disallowing directors nominated or seated by an actual or threatened proxy contest to be considered continuing directors regardless of whether those directors are approved by the incumbent members of the board. As a result, the board would not have the ability to defuse a potential change of control trigger since a dissident slate of directors could not qualify as “continuing directors” under any circumstances, even if the dissident directors were appointed to the board as part of the settlement of a proxy contest.
Lenders have often required proxy put language in loan agreements to provide them with the ability to cut off any obligation to lend money to a borrower that is taken over by corporate raiders. However, stockholder plaintiffs have brought claims alleging that Dead Hand Provisions are presumptively illegal because they deter stockholders from bringing proxy challenges (i.e., the replacement of a majority of the board would enable lenders to call a default and demand immediate payment of outstanding debt). Plaintiffs’ lawyers have alleged that this has the effect of entrenching the current members of the board, and raises questions as to whether the board members have breached their fiduciary duty of loyalty to the company by agreeing to the Dead Hand Provision, as well as whether the lenders involved have aided and abetted such a breach of fiduciary duty.
Although recent Delaware court decisions (e.g., Pontiac General Employees Retirement System v. Ballantine, et al. and Healthways, Inc., C.A. No. 9789-VCL, transcript (Del. Ch. Oct.14, 2014)) indicate that Dead Hand Provisions are not invalid per se, these provisions are nonetheless likely to give rise to books and records demands and stockholder challenges, which can be costly and time-consuming to defend.
In order to avoid these challenges, public companies with a Dead Hand Provision in their loan agreements should consider seeking the consent of their lenders to amend their existing loan agreements to remove the Dead Hand Provision, and, if such an amendment is entered into, filing a Current Report on Form 8-K with the Securities and Exchange Commission to provide public notice that such Dead Hand Provision has been deleted. In our experience, we have found that sophisticated lenders recognize the legitimacy of the borrower’s concerns with the litigation risk of continuing to include these provisions, and, perhaps most importantly, are concerned about the potential aider and abettor liability to which the lenders may be subject from these provisions. As a result, lenders often accommodate borrower requests for the deletion of these provisions as long as the basic proxy put language remains intact.
The original memorandum was published by McDermott Will & Emery on August 13, 2015, available here.