Settlement Agreements with Activist Investors - the Latest Entrenchment Device?
|June 2nd, 2016||
|Contributed by: Derek D. Bork, Thompson Hine LLP|
|An increase in settlements between public companies and activist investors that have targeted a campaign against a company has been widely reported. An increase in the speed with which these settlements occur—meaning the number of days a settlement is reached after an activist initiates a campaign—has also been widely reported. Some commentators attribute increased settlements to boards being motivated to avoid the costs, distractions and negative publicity that usually come with an extended proxy contest. Other commentators suggest that increased settlements are an indication that boards have begun to recognize the value that activists and other shareholder representatives can bring to a board. The driving force behind increased settlements, however, may be altogether different. Companies may be more frequently seeking settlements with activists, not in the name of good corporate governance, but for a less noble reason—as a defensive measure.|
As shareholder activism has grown, boards have increased their efforts to be prepared for and more effectively respond to activist campaigns. Some of these actions are arguably positive—boards are implementing more effective shareholder outreach programs, reexamining their governance structures and strategic plans, and sometimes even preemptively adopting the proposals made by activists. In many cases, however, boards are deciding to challenge activists and are fighting back more aggressively. In each of these cases, the board’s ultimate goal is not to constructively engage with activists, but to keep them out of the boardroom and minimize their influence.
Boards are pursuing settlements with increased frequency not only because this path is now more commonly presented to boards as an option, but often because they view a settlement as a means to restrict the activist, or a group of activists, and avoid more drastic changes at the board level. Although a settlement agreement usually provides an activist with one or more board seats, the restrictions that companies attach to the board seats often reveal an entrenchment motive. In more extreme cases, the settlement approach may be motivated by an even more questionable objective—to hand-cuff the activist while the board seeks to effect a sale of the company or other extraordinary corporate transaction.
A typical “standstill” provision is aimed at preventing the activist from continuing a public campaign against the company; the activist may not, for example, run a proxy contest, call a special meeting of shareholders, raise proposals directly for a vote of shareholders, or engage in a public “fight” campaign against the company or its board. These provisions make sense—the parties are seeking to resolve the proxy contest and avoid a continuing public battle. Other provisions that are designed to cause the activist to work through the board arguably make sense and also reflect good corporate governance—if an activist has board representation, then the activist should generally seek to effect change and advance proposals through the board.
Yet, companies often push for a long litany of additional restrictions to be placed on the activist while it has a representative on the board, including preventing the activist from having any contact with other shareholders, merely suggesting changes in the composition of the board or to the company’s anti-takeover provisions, making any public statements regarding the company, or even expressing its views on extraordinary corporate events, such as a proposed sale of the company. Companies often seek to bind the activist to vote its shares in favor of every board proposal made while it has a representative on the board, regardless of whether the activist agrees with the proposal as a shareholder. Companies often seek provisions that would prevent an activist from taking any steps that might be aimed at preparing for a future proxy contest or other campaign in support of change at the company. Companies often seek to prevent the activist from making an offer to acquire the company, privately or publicly, which certainly does not seem motivated to advance shareholder interests.
Companies also often seek to place limits on the amount of shares that an activist can acquire, or the amount of shares that the activist can transfer to another shareholder. If a company has not elected to adopt a share limit applicable to all of the company’s shareholders, such as through a poison pill, why should such a limit be imposed on the activist? Boards often decide not to adopt anti-takeover measures such a poison pill to avoid adverse voting recommendations from proxy advisory firms like ISS, which has a policy that disfavors the adoption of a poison pill without shareholder approval. If a company cannot have a poison pill due to the impact of ISS or the views of its shareholders, then why should a company be able to implement the equivalent of a poison pill in a settlement agreement with an activist? It is inconsistent with the corporate governance structure that the board has elected or been forced to implement for all of its other shareholders.
Worse yet, some companies have required board representatives of activists to sign and pre-deliver director resignations that are automatically triggered when the board decides that the representative has breached the settlement agreement, which often includes a long litany of provisions and board policies with which the representative must comply. Board policies are important, and all directors should be required to comply with them, but having a director subject to the threat of being automatically removed from the board for what might be an immaterial breach of an insignificant board policy is an appalling affront to good corporate governance. It creates the appearance that the company is attempting to keep the new director on a short leash—making sure the director is fearful of being too vocal and independent in the boardroom. This problem is even more egregious when the company seeks to require the new director to promote collegiality or some other standard of board decorum to avoid the threat of removal. Pre-delivered resignations also create a potential risk of uncertainty as to who is actually on the board at a given time, in the event that there is a dispute as to whether a resignation has been triggered, which could cause tremendous disruption to the effective functioning of the board.
Boards may be more willing than ever to consider a settlement to avoid a proxy contest, and they may be considering settlements earlier in the process. Nevertheless, this may not actually signify the positive development of boards being more receptive to outside influence; it may be a sign of boards using a settlement as an opportunity to implement defensive measures. When boards propose and push for settlement agreements that go beyond well-known and customary terms, and when they seek restrictions that do not apply to other significant shareholders or their own hand-picked directors, they more likely are advancing entrenchment motives.
Overreaching by boards in this area could lead to courts striking down some of these provisions as unlawful anti-takeover measures or infringements on the ability of directors to carry out their fundamental duties as fiduciaries. It could also lead to proxy advisory firms like ISS implementing formal voting policies, or taking action in specific cases, that result in adverse voting recommendations against directors who implement egregious settlement agreements. In the meantime, activists should be careful to avoid the traps often set by boards in settlement agreements, and they should take their case directly to shareholders when boards go too far.
* Derek D. Bork is a partner with Thompson Hine LLP and the Chair of its Takeovers and Shareholder Activism Group. Mr. Bork and Thompson Hine LLP have represented hedge funds, activist shareholders and public companies in activist campaigns and control contests, and the views expressed in this article do not necessarily represent the views of their clients. Mr. Bork can be contacted at firstname.lastname@example.org or 216.566.5527.