Sometime in 2008, billionaire investor Ron Burkle set his sights on Barnes & Noble. He knew the company's founder and chairman, Leonard Riggio, and he shared his plans to invest in B&N with Riggio, who tried to dissuade him. Riggio preferred not to have other large holders in the company he built; furthermore, a previous venture with Burkle hadn't gone well.
But Burkle's hedge funds, Yucaipa American Alliance Fund II and its parallel fund, invested anyway. Burkle was disappointed in how the company was being run and let the board know it. At the same time, Yucaipa began increasing its stake in the company.
Then, over four days in November 2009, Yucaipa doubled its stake in B&N to 18 percent. Spurred by the rapid accumulation, the B&N board enacted a shareholder rights plan, sometimes known as a "poison pill," to be triggered when a shareholder acquires more than 20 percent of B&N's outstanding stock.
When activated, the pill would allow current shareholders to scoop up shares at a discount, which would increase the amount of shares Burkle needed to buy for a controlling stake and thus substantially ratchet up the price of doing so.
Shareholder rights plans are a common defensive mechanism that boards take in response to takeover attempts, but Burkle challenged B&N's poison pill in Delaware court on a few of its novelties. On Aug. 12, the Delaware Chancery Court upheld B&N's shareholder rights plan in an 89-page opinion in Yucaipa Funds v. Riggio that provides important guidance to boards.
"The ruling means the poison pill is alive and well as a defense to unwanted takeovers," says Francis Pileggi, a partner at Fox Rothschild and editor of the Delaware Corporate and Commercial Litigation blog. "The case is required reading for any board that is considering their defensive options in light of an unwanted suitor."
Settling on a Standard
In his challenge of the poison pill, Burkle asked the court to apply two standards to strike it down.
First Burkle pitched the "entire fairness" standard, which looks at the fairness of approval processes in merger decisions.
"The general rule is that the courts will not second-guess the decisions of the board of directors--it's the business judgment rule presumption," Pileggi says. "But you're only entitled to that if you follow certain procedures."
Burkle argued that B&N's board did not follow correct procedures in deciding to implement the pill--he focused on the fact that the Riggio family, which already owned an approximately 30 percent stake in the company, was exempted from the pill. That put the Riggios on both sides of the transaction, he said.
The chancery court disagreed. "[T]he mere decision to grandfather an existing holder does not invoke the entire fairness standard," Vice Chancellor Leo Strine wrote.
Burkle also asked the court to apply the "compelling justification" standard the Delaware Chancery Court set forth in 1988 in Blasius Industries, Inc. v. Atlas Corp. That case held that a board must provide a compelling justification for its actions when it would interfere with a shareholder vote.
The court rejected that standard as well. "[T]he trigger under Blasius is as extreme as the standard it invokes," the court wrote. Burkle failed to show that the directors acted "for the primary purpose of thwarting the exercise of a shareholder vote," which is necessary to trigger the Blasius standard, it said. "[T]he board's motivation was to protect Barnes & Noble from the threat of being subject to inordinate influence or even control by a bloc that emerged without paying a fair price for that control. The effect on electoral rights was an incident to that end."
Instead, the court applied the Unocal standard of review, a two-prong test that looks at whether the board has reasonable grounds for believing the corporate policy is in danger and requires the defensive response to be reasonable in relation to the threat posed. The standard was set forth in the 1985 case Unocal Corp. v. Mesa Petroleum Co. and has since been well received by Delaware courts.
Under Unocal, the court found Burkle to be a clear threat, citing Yucaipa's rapid accumulation of B&N stock, its prior takeover attempts and takeovers at other firms, Burkle's stated right to take the company private and his dealings with other investors, which the court said could be part of his plan to take B&N private.
It also found that B&N's rights plan did not preclude Burkle from "a fair chance at victory" in a proxy contest--under the Unocal standard, rights plans cannot be preclusive. Applying that analysis, the court upheld B&N's shareholder rights plans.
"The court's safety valve here was that it concluded this rights plan wouldn't prevent a successful proxy contest," says Steven Haas, an M&A associate at Hunton & Williams. "This case reinforces the idea that generally takeover battles will be won at the ballot box, where shareholders can remove incumbent directors if they disagree with business strategy."
B&N Best Practices
The court wasn't entirely uncritical of B&N's practices, however, and the flaws it found in its processes provide a nice set of best practices for boards facing unwanted takeover situations.
First it assessed the board members' independence, finding.
The court said a separate meeting of independent directors would have been ideal, noting that the fact that the discussions did include Riggio was "well, weird." It wrote that the board could have formed an independent committee or even excused involved parties like Riggio from the room during part of the discussions when considering whether to adopt the shareholder rights plan.
However, the court stopped short of finding B&N's processes unreasonable. Vice Chancellor Strine wrote for the court, "[O]verall, I am convinced that the board acted loyally, in the sense of trying to advance the best interests of the company and its public stockholders, and not those of Riggio."
More problematic to the court was another board member, the lead director of B&N's board as well as the director of a hedge fund, whom Strine called a "political powerbroker." Citing his business and political ties with Riggio, the court found this board member to be heavily dependent on his relationship with Riggio for his success. (Since then, B&N has ousted that director.)
"Legally, the problem is that having just one conflicted board member is not enough," says Brian Quinn, an assistant professor at Boston College Law School and editor of the M&A Law Prof Blog. "For this argument to work, Burkle would have had to show this fact for more than half the board, and he couldn't do that."
The court also found it problematic that B&N management--namely the company's former GC--had selected the board's legal and financial advisers rather than the board choosing independent advisers. It happened that the advisers chosen by B&N's general counsel had previously done work for Riggio.
"The board probably should have selected its own advisers or at least considered the independence of the advisers," Haas says. "But the court recognized that things were transpiring pretty quickly."
The court said Yucaipa's rapid accumulation of stock and willingness to buy half of B&N's shares created "extreme time pressure" and forced the board to rapidly assemble its advisers.
"Notwithstanding those perceived process flaws, the court didn't find any breach of fiduciary duty," Haas says. The Delaware case In Re: The Walt Disney Company Derivative Litigation, he says, set forth the principle that best practices are "aspirational ideals," and that companies can't be found liable for failing to adhere to them. Still, he says, "The best takeaway [from Yucaipa] are the best practices." n