I appreciate the engagement by long-term pill observer Eric Robinson with my Corporate Vote Suppression piece. I am also glad that he agrees that the pill in The Williams Companies Shareholder Litigation ought to be struck down, though he narrowly confines his ground for supporting the Delaware Chancery Court’s decision to do so.  His invitation to re-examine Moran v. Household International shows how far the anti-activist pill has strayed from its initial justification (and limitation).  Moran sustained a “flip-over pill” against the threat of a front-loaded two-tier hostile bid and countenanced a 20 percent pill trigger because it represented the lowest edge of a control threshold.

The fundamental point is this: Activists, whether “performance activists,” or “ESG activists,” have no intention of engaging in a hostile takeover of the target company.  Rather, they seek a change in the strategy or operations of the company, counting on the proxy contest, the core element of shareholder governance, as their vehicle.  Their influence, often expressed through settlements that result in the consensual nomination of new directors, stems from their capacity and credibility in a director election contest. The Delaware Supreme Court has not previously considered a pill whose very purpose is to disrupt the organization of a successful proxy contest by a party without a takeover motive.  This novelty seems to invite consideration of an anti-activist pill like the one in The Williams Companies Shareholder Litigation through a Blasius lens rather than Unocal.  There are no precedents to overturn.

Here’s an analogy: Cases like Unocal, Revlon, and the Paramount twins teach that, when faced with a hostile takeover bid, the board can defend its pre-existing business plan with defensive measures that are quite inhibitory.  In the case of a sale or a control shift, however, the board loses that prerogative; the doctrinal analysis shifts.   So when the antagonist is pursuing a takeover that would by-pass the board’s structural vetting authority, Unocal sets the right framework.  But when the antagonist pursues a challenge solely through the election machinery, not a hostile takeover, the doctrinal framework must shift as well.  Unless we are prepared to give up on shareholder democracy, the board simply cannot use inhibitory defensive measures to thwart a proxy contest in the name of protecting its pre-existing business plan.  And it will be hard to distinguish performance activist villains from ESG activist champions in the resulting doctrinal framework.  After all, the very point of Engine No. 1 and the other ESG activists that played a role in the ExxonMobil contest was radical change in the company’s business plan.  Similar contests are foreseeably in the future of shareholder engagement.

Let’s turn now to the pill’s “origins” and “discrimination.”  Robinson asserts that the pill considered in Moran v. Household Int’l, the flip-over pill, was not “discriminatory” because all shareholders who held stock at the time of the backend merger with the acquirer were entitled to the benefit of the flip-over right.  He freely admits that the flip-in pill was indeed discriminatory, but that was a subsequent development.  In evaluating the flip-over provision, however, the Moran court describes its intended effect as producing “dilution of the acquiror’s capital [that] is immediate and devastating.”  The goal of the flip-over pill was the same as the discriminatory self-tender in Unocal: to create a backend more lucrative than the bidder’s front-end, and thereby reverse the incentives to tender. Sounds like discrimination against the acquirer was part of the structure.

But assume the discrimination in the pill comes later, after the flip-over pill validated in Moran.  Then Robinson loses the claim that Providence & Worcester Co. v. Baker, cited in Moran, amounts to the Moran court’s sanctioning of the kind of discrimination that makes the (flip-in) pill effective.  Moran cited the case simply for the proposition that a particular Delaware statute ought not be read as a straitjacket that bars a company from including a “capped” voting provision in its charter.[1]  In its charter  means present in the IPO charter or added through a charter provision approved by shareholders, which is quite unlike how a pill is adopted.  Capped voting limits the shareholder’s vote only; it does not dilute the shareholder’s economic claim in respect of shares owned above the “cap” (i.e., pro rate participation in dividends and other distributions); it does not impair the voting rights of a subsequent purchaser of those shares.  Differential rights as set forth in a capped-voting charter provision (or in dual-class common stock issuances) are not akin to the discrimination against an unwanted acquirer that animates the pill.

I agree that a further cleverness of the flip-over pill was its framing in terms of the “anti-destruction” clauses that protect holders of convertible senior securities (preferred stock or debt) in the event of a merger or recapitalization that might entail a dilutive exchange.  That’s the way I teach it, adding that Del. G. Corp. L Section 259 does the wondrous work of obliging the acquirer to fulfill the flip-over provision.

When it comes to prior instances of judicially-sanctioned purportedly “anti-activist” measures, Chancellor McCormick shows how these addressed the threat of potential take-over bids, particularly through significant market purchase accumulations aimed at accomplishing an acquisition of control without payment of a control premium.[2]  Potential control acquisition cases like Polk v. Good[3]and Cheff v. Mathes[4] dealt with share repurchases and seem to me relatively easy,  because no parties are discriminated against.  The purported “greenmailers” consent to repurchase of their stock, and the target shareholders are presumably better off because, in the board’s judgment, long term share values are higher than the repurchase price.

Yucaipa American Alliance Fund II  v. Riggio[5]  is a pill case in which the protagonist had acquired a 17.8 percent block and indicated in its 13D filing a willingness to acquire as much as 50 percent.  The Delaware Chancery Court found that a pill with a 20 percent threshold was a reasonable response to a well-founded threat of a “creeping tender offer.”

The closest case to an anti-activist pill is Third Point LLC v. Ruprecht,[6] in which the Sotheby’s board created a two-tier pill: a pill with 10 a percent threshold  against activist Dan Loeb/Third Point and a 20 percent pill against “passive” acquirers.  Chancellor McCormick regarded this as yet another case that fell within the hostile takeover framework, since the pill was initially adopted when it appeared that Third Point was assembling a group that would obtain “creeping control:” “a specific takeover attempt that started as an effort to obtain creeping control.”[7]   Yes, the case can be brought into the hostile takeover framework in this way, but in candor I think this case was wrongly decided.  A 20 percent pill threshold is adequate to protect against the creeping tender offer; the 10 percent pill aimed specifically against Third Point – which by then had limited itself to a proxy battle – is hard to defend.

The core of possible disagreement between Robinson and me may be less in the standard of review than in a critical part of Chancellor McCormick’s opinion that Robinson does not address: the scope of “beneficial owner” in the Williams Companies pill and other anti-activist pills. That is, if in applying a Unocal-Unitrin framework the court will presumptively find that a pill aimed at disrupting a potential proxy battle (vs. a tender offer or creeping tender offer for control) is necessarily disproportionate, then that would probably produce the same result as a Blasius-framed analysis.

Yes, a 5 percent pill threshold is impossible to justify in The Williams Company Shareholder Litigation, or more generally, except in the sui generis case of an NOL pill.  But it’s the sweeping beneficial ownership definition that has the potential to do the greatest damage to future proxy contests and where the Delaware Supreme Court should be forthright.  As I argued in my initial piece, a proxy contest, unlike a cash tender offer, requires persuasion as to the superiority of the proponent’s business plan.  That necessarily involves communication with other shareholders and, frequently, among shareholders.  Sweeping definitions of “acting in concert” that extend well beyond the 13D regulations target that communication and thus aim to disrupt the proxy contest as a mode of shareholder governance.

Engine No.1, the instigating ESG activist in the ExxonMobil proxy contest, owned 0.02 percent of the company’s stock yet ran a proxy contest that won three board seats.  Obviously the election outcome depended on the support of the largest institutional owners, including BlackRock, State Street, Vanguard, and the California State Teachers Retirement System, and many others.  Many such owners are participants in Climate Action 100+, which is focused on the need for companies to act in the face of the emergent climate-change risk.  Although the Climate Action 100+ strategy statements are careful to avoid the kind of agreements that would trigger Regulation 13D exposure, the pill is different. Sweeping acting-in-concert provisions in pills that include “parallel” conduct or “common goals” or “influencing control” (what else is a proxy contest about if not “influencing control”?)  would create the risk, and are intended to create the risk, of a punitive economic response that would weigh on a financial fiduciary and thereby suppress shareholder governance action.[8]

The Williams Companies defendants having appealed, the Delaware Supreme Court should now draw some sharp lines.

ENDNOTES

[1] For a discussion of the role of “capped voting” in the development of corporate governance in the public corporation, see Henry Hansmann & Marianna Pargendler, The Evolution of Shareholder Voting Rights: Separation of Ownership and Consumption, 123 Yale L. J. 948 (2014).

[2] The Williams Companies Shareholder Litigation, 2021 WL 754593, at *30-*33.

[3] 507 A.2d 531 (Del. 1986).

[4] 199 A.2d 548 (Del. 1964).

[5] 1 A.3d 310 (2010).

[6] 2014 WL 1922029 (Del. Ch 2014).

[7] 2020 WL 754593 at *32.

[8] Much of the necessary spade-work will invariably occur before formal launch of a proxy contest, so pill carve-outs for proxy solicitations are inadequate.

This post comes to us from Jeffrey N. Gordon, the Richard Paul Richman Professor at Columbia Law School.