Chancery Court Analysis of Rights Plan with a 20% Trigger: Yucaipa American Alliance Fund II, L.P. v. Riggio et al.
August 12, 2010
In Yucaipa American Alliance Fund II, L.P. v. Riggio et al., C.A. No. 5465-VCS (Del. Ch. Aug. 11, 2010), the Delaware Court of Chancery confirmed in a post-trial decision that a board’s decision to adopt and maintain a stockholder rights plan triggered upon the acquisition of beneficial ownership of more than 20% of the company’s shares is subject to Unocal review, even where the board “grandfathers” an existing significant stockholder from the operation of the plan. The Court ultimately concluded in the instant case that the board’s adoption and use of the rights plan was a good faith, reasonable response to a threat to the company and its stockholders and, therefore, dismissed the plaintiffs’ claims for breach of fiduciary duty.
In November 2009, funds associated with Ronald Burkle (“Yucaipa”) doubled their stake in Barnes & Noble, Inc. (“B&N”) to nearly 18% through open-market purchases. Yucaipa disclosed these acquisitions on Schedules 13D in which it criticized B&N’s management and indicated that it might pursue various M&A transactions. In response, B&N’s board adopted a rights plan with a 20% triggering threshold. The rights plan included a “grandfather” clause for Leonard Riggio, B&N’s founder and the holder of approximately 30% of B&N’s stock, but limited further acquisitions by Riggio. Yucaipa brought suit, claiming that the adoption of the rights plan, and the board’s refusal to amend the plan according to Yucaipa’s requests, constituted a breach of fiduciary duties.
Yucaipa argued in the first instance that the board’s decision to adopt the rights plan was subject to entire fairness review, claiming that Riggio, as the largest stockholder, stood on both sides of that matter. The Court rejected this argument, noting that the rights plan did not confer any special benefit upon Riggio. While the rights plan “grandfathered” his existing stake, it also prevented him from acquiring a majority stake in B&N. In any case, the approval of the rights plan by an independent board majority invoked the business judgment rule standard. Alternatively, Yucaipa argued that the board was required to demonstrate a “compelling justification” under Blasius for adopting the rights plan, arguing that the plan was adopted for the purpose of disenfranchising stockholders. Noting that the Blasius standard of review applies where the board acts for the primary purpose of impeding a stockholder vote, the Court rejected Yucaipa’s argument. The Court found that the evidence reflected that the Board’s motivation was to protect B&N from the threat of a group of stockholders potentially acquiring control without paying a control premium.
Yucaipa also challenged the rights plan on the basis that it prevented groups of stockholders holding over 20% in the aggregate from forming coalitions to mount a proxy contest. To this argument, the Court confirmed the following: (1) it is not unprecedented for rights plans to restrict stockholders collectively owning shares in excess of the triggering threshold from banding together to promote a joint slate in a proxy context, and (2) the test articulated in Unocal (generally, the board must reasonably perceive a threat to corporate policy and effectiveness, and the response must be proportionate to the threat posed) is the appropriate standard of review in determining whether a rights plan is being exercised in a manner consistent with the board’s fiduciary duties.
In its Unocal analysis, the Court noted that the concepts of preclusion and coercion are useful in determining whether the defensive measure is reasonable. In a footnote, the Court expressed skepticism about the view that a rights plan is “not preclusive if it merely leaves open a mathematical or theoretical possibility of winning a proxy contest,” suggesting instead that the rights plan must not prevent the insurgent from having a “fair chance for victory.” The Court further stated that where a plan “unfairly tilts the electoral playing field” against the insurgent, its operation may be enjoined. In the present case, however, B&N’s rights plan did not unreasonably restrict Yucaipa’s ability to mount a proxy contest because, according to the Court, even with the rights plan in place, Yucaipa had a fair chance to prevail in the proxy contest.
The Court next addressed Yucaipa’s argument that the rights plan was not a reasonable response to the threat posed. Specifically, Yucaipa argued that Riggio’s significant equity stake made the use of a 20% triggering threshold unreasonable. Yucaipa argued that the board’s refusal to amend the rights plan to increase the triggering threshold to 37% at Yucaipa’s request was unreasonable. (A 37% threshold would have enabled Yucaipa and fellow investor Aletheia, which had amassed a 17% stake in B&N and which had a history of following Yucaipa’s investment decisions, to select and promote a joint slate.) The Court indicated that Riggio likely had reasons to view other significant stockholders as a threat and that those concerns were distinct from the threats posed to B&N. The Court also expressed some concern with the process through which the rights plan was adopted. Nonetheless, the Court was convinced that the board acted loyally—that is, in the best interests of B&N and its stockholders generally—and also was convinced that the rights plan is not an unreasonable device that “fundamentally restricts” Yucaipa from winning a proxy contest.