A recent decision of the Delaware Court of Chancery highlights the need for boards of directors of Delaware publicly traded companies to develop heightened awareness and vigilance in responding to shareholder activists, particularly those following a short-term agenda of putting the company up for sale. The failure of boards to do so may put all directors at risk of being found in breach of their fiduciary duties.
The factual background of the court’s decision in In re PLX Technology Inc. Stockholders Litigation may sound familiar to many public company directors. Following the December 2012 termination of a pending sale to Integrated Device Technology (IDT) due to an FTC antitrust challenge, PLX’s stock plummeted and activist shareholder Potomac Capital Partners accumulated a stake in the company. The court found that Potomac’s investment thesis was simple: Achieve short-term profits if PLX was able to sell itself to Avago Technologies, another bidder that had expressed interest in buying PLX during the IDT go-shop period.
After quickly accumulating a 5.1 percent stake in PLX in January 2013, later increased to 9.4 percent, Potomac commenced an aggressive campaign to pressure PLX into a sale. Eric Singer, Potomac’s co-managing member, led the activist campaign, which included a series of highly critical public letters, as well as private threats of litigation and personal liability against PLX executives and board members.
Potomac’s campaign escalated later in 2013 to a proxy contest that resulted in the election of three Potomac representatives, including Singer, to the PLX board. Of interest, the court found that Potomac’s internal communications leading up to the shareholder vote “show that Singer had no meaningful ideas other than selling the Company.” Singer could not personally come up with anything, so his proxy adviser offered some generic ideas that “[h]istorically … have worked” at other companies. As its “plan,” Potomac incorporated nearly verbatim its proxy adviser’s generic list of ideas.
Following Singer’s election to the PLX board, Avago reached out to PLX’s financial adviser in December 2013 to indicate that in light of a pending acquisition Avago was in the process of completing, Avago would be in the “penalty box” until that deal closed. However, the Avago representative indicated that once that transaction closed, Avago would be “open for business on all topics,” including an acquisition of PLX, which he described as a “$300M deal.” This information was shared with Singer, but Singer failed to share it with the other members of the PLX board.
Over the next four months, Singer bided his time. But promptly following Avago’s completion of its pending transaction, the company submitted a bid for PLX. Singer immediately took control of the matter and “managed” the process, discussing various issues directly with Avago’s management. Nine days later PLX and Avago had agreed to a purchase at virtually the same price that had been communicated to Singer four months earlier. The recommendation statement sent to PLX shareholders did not disclose Avago’s earlier contact with PLX’s financial advisor. The transaction closed in August 2014.
The Court of Chancery concluded that the stockholder plaintiffs proved that the PLX directors breached their fiduciary duties by engaging in a sale process without knowing critical information about Avago’s communication with PLX’s financial advisor in December 2013. The court admitted that Singer was the only director that withheld information from the rest of the board, and the other directors “should not be blamed for this oversight in any morally culpable sense.” However, the court ultimately concluded that in terms of fulfilling their fiduciary duties, “the directors fell short.”
The 137-page PLX decision provides a fascinating and unique look into an activist campaign from both an activist and board perspective. Taken at face value, the unfolding of events can be used as confirmation of a broader narrative of activist hedge funds as promoters of short termism, ready to use aggressive tactics to get their way – tactics that may include intimidation via public and private letters that use the threat of litigation and personal liability as a vehicle to impose the activist’s agenda on the target’s board. Of note is the court’s statement, quoting an academic article, that “[a]ctivist hedge funds … are impatient shareholders, who look for value and want it realized in the near or intermediate term. They tell managers how to realize the value and challenge publicly those who resist the advice, using the proxy contest as a threat.”
But more importantly, the narrative and legal findings of the court in PLX should assist in raising awareness among public company directors regarding the potential perils that need to be navigated by corporate boards in the context of an activist campaign, particularly in instances where activist designees get elected to a corporate board in furtherance of a narrow agenda.
Year-over-year, 2018 has witnessed an increase in the number of activist campaigns seeking an immediate sale of the target company. It is clear that boards need to assess any such demand as fiduciaries of all shareholders and determine whether, absent the activist threats, a sale is a better option at the time as compared with a stand-alone strategy or other options.
If an activist designee gets elected to the board – whether through a settlement or shareholder election – it remains vital that the board and its advisers retain a process to make sure that all information is shared with all board members. And in situations in which the Balkanization of a board becomes obvious, or even probable, all directors need to work constructively to make sure all information is promptly shared internally, and that no single member, or group of members, hijacks a sale process. As PLX shows, regardless of who may be “morally culpable” for the board’s shortfalls, all directors—both activist designees and incumbents—will share in the legal and reputational repercussions of failing to fulfill their fiduciary duties.
 The PLX opinion includes other important observations and lessons that go beyond the scope of this piece regarding late changes to projections to arguably accommodate financial advisers’ fairness conclusions; “lawyers drafting minutes after the fact in an effort to paper a good process, but not getting the details right;” the calculation of post-closing damages and the impact that recent appraisal cases may play in the future in this context; and the dangers of “partial disclosure” of financial adviser analyses in disclosure documents. The appendix to the opinion also includes a handy chart collecting data from Delaware decisions approving a passive market check.
This post comes to us from Eduardo Gallardo, a partner in the New York office of Gibson Dunn & Crutcher, who specializes in mergers & acquisitions and corporate governance. The opinions in this piece are solely his and do not necessarily represent the views or opinions of Gibson Dunn or any other partner of the firm.