Corporate Governance

Poison Puts, Shareholder Voting Rights and the Need for an Even Stronger Shareholder Bill of Rights: San Antonio Fire & Policy v. Amylin Pharmaceuticals (Upholding The Puts)

By J. Robert Brown

We are discussing San Antonio Fire & Policy v. Amylin Pharmaceuticals, a Delaware court that upheld the use of coercive contractual terms that effectively denied shareholders their voting rights.

Management of the company negotiated an indenture in 2007.  The indenture essentially provided that the loan would be accelerated in the event that shareholders nominated and elected a majority of the board.  Only if the board "approved" the shareholder candidates would the debt not be accelerated. 

The plaintiffs rightfully challenged the provision, asking the court to declare the poison put a violation of the duty of care. The analysis demonstrates the emasculated nature of the duty of care.  One can imagine a situation where the board needs to borrow funds for the survival of the company but can only do so where the lender insists on terms that are detrimental to shareholders.  Alternatively, one can imagine a situation where management encourages the inclusion of terms that are detrimental to shareholders because it benefits management.

The court undertook none of this type of analysis.  Instead, the court concluded that since the provisions were common, they were valid, notwithstanding the impact on shareholders.

• The board retained highly-qualified counsel. It sought advice from Amylin's management and investment bankers as to the terms of the agreement. It asked its counsel if there was anything 'unusual or not customary' in the terms of the Notes, and it was told there was not. Only then did the board approve the issuance of the Notes under the Indenture. This is not the sort of conduct generally imagined when considering the concept of gross negligence, typically defined as a substantial deviation from the standard of care.

That the provisions could deny shareholders their voting rights had no impact on the analysis.  Moreover, even if the provision was demanded by the creditors (there was nothing in the opinion that suggested this had been the case), they could have been paid in the form of slightly more favorable terms to give up on the requirement.  The court effectively took the position that the board need not have any role or responsibility for terms in a contract that severely constrained shareholder voting rights. 

The court acknowledged the harmful nature of the poison puts, but rather than put any responsibility on the board, admonished outside counsel to be more forthcoming.

• Outside counsel advising a board in such circumstances should be especially mindful of the board's continuing duties to the stockholders to protect their interests. Specifically, terms 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.

In other words, the board had no responsibility.  It was up to outside counsel to be "especially mindful" of the matter.  But unfortunately for shareholders, outside counsel doesn't have fiduciary obligations to shareholders.  It is the board that does and this case eliminates any responsibility by the board for the resulting diminution of the shareholder franchise.

The plaintiff was not seeking monetary damages against the board.  Plaintiff only wanted to enjoin application of the provision in order to allow the election to go forward without the specter of economic coercion.  In those circumstances, the court had an opportunity to impose on the board an obligation to inquire about, and consider, contractual provisions that affected voting rights.  This would not mean that all such provisions were invalid but would require the board to weigh the benefits (in the form of any lower interest rates) against the consequences to shareholders.  Instead, the court eliminated any responsibility of the board even to consider the interests of shareholders.

The opinion and assorted documents have been posted on the DU Corporate Governance web site.

Full post as published by The Race to the Bottom on June 02, 2009 (boomark / email).