United States: Doubt Cast on Value of Continuing Director Provisions in Debt Agreements by Delaware Court of Chancery Decision

Originally published June 23, 2009

Keywords: Director Provisions, Debt Agreements, Delaware Court of Chancery Decision, San Antonio Fire & Police Pension Fund v. Amylin Pharmaceuticals Inc., proxy contest,

The Delaware Court of Chancery's decision in San Antonio Fire & Police Pension Fund v. Amylin Pharmaceuticals, Inc. raises serious concerns for lenders regarding the protection afforded by "continuing director" change of control provisions in indentures and credit agreements.¹ The court determined that the "continuing director" provision in Amylin's indenture did not prevent the incumbent directors from "approving" as "Continuing Directors" persons nominated by dissident stockholders even as the incumbent board publicly opposed those nominees in a proxy contest. The court suggested that such provisions could be unenforceable to the extent that they did not permit a board to approve dissident slates and constituted entrenchment mechanisms that coerced stockholders into voting only for incumbent directors.

Under Amylin's indenture, if at any time the "Continuing Directors" did not constitute a majority of the company's board of directors, the holders of Amylin's public notes had the option to put their notes to the company at par. The indenture defined "Continuing Directors" as:

Two of Amylin's shareholders, Icahn Partners LP (Icahn) and Eastbourne Capital Management, LLC (Eastbourne), nominated separate five-person slates for election to the twelve-person board at Amylin's 2009 annual meeting. The Amylin board had recommended its own slate of nominees. If seven of the ten stockholder nominees were elected without the incumbent board's approval, the redemption right would be triggered under the continuing directors provision. Amylin's notes were trading at a substantial discount, so noteholders likely would have opted to put their notes to the company at par if the redemption right were triggered.

An Amylin stockholder filed a lawsuit seeking, among other things, a mandatory injunction requiring the Amylin board to approve the nominees for purposes of the change of control provision. The suit was later amended to seek a declaration that the Amylin board had the right to approve the dissident nominees; Amylin added a cross-claim against the indenture trustee seeking declaratory relief to the same effect. Subsequently, Icahn and Eastbourne reduced their numbers of nominees to two and three, respectively. As a result, even if all dissident nominees had been elected, the change of control provision would not have been triggered immediately (although it still might have been triggered in subsequent board elections).

The company argued that the continuing director provision did not prevent the company's board from "approving," for purposes of the change of control provision, persons nominated by the dissident stockholders in opposition to the slate nominated by the incumbent board. The indenture trustee argued that the incumbent directors did not have the power to so approve any person whose election the incumbent directors publicly opposed. The court held that the incumbent directors were permitted to approve, for purposes of the change of control provision, any person, even if the board did not endorse such person for election and even if the board recommended an opposing slate.

Because of the limited factual record in the case, and given that the dissidents had reduced their slates in a manner that would not have resulted in the triggering of the put right, the court declined to decide whether the Amylin board had in fact properly exercised its right to approve the dissident nominees.

However, the court stated that, were the issue to be considered, the board's action would be evaluated in terms of whether the approval of the dissident slate had comported with the company's duty of good faith and fair dealing inherent in its duties under the indenture. The court further stated that the board could approve stockholder nominees if the board determined in good faith that the election of one or more of the dissident nominees would not be materially adverse to the interests of the corporation or its stockholders. The court noted that "it is important to recognize here that the directors are under absolutely no obligation to consider the interests of the noteholders in making this determination" (emphasis in original).

The Amylin case casts doubt on the value of continuing director provisions in debt agreements. Based on the reasoning in Amylin, a board of directors might approve a dissident slate in a proxy contest for the express purpose of avoiding a change of control put or default in a debt instrument (and notwithstanding that the board is recommending its own slate of candidates). The only limit on a board's ability to take such action would be the board's duty to determine in good faith that the election of the dissident nominees would not be materially adverse to the corporation or its stockholders. A board could claim that, even though it had publicly opposed a dissident nominee and had run its own candidate in opposition, the election of the dissident nominee was not materially adverse to the corporation or its stockholders and then approve the nominee for purposes of the change of control provision.

Further, the Amylin case seems to restrict the ability of lenders to tighten a continuing director change of control provision. For example, continuing director provisions frequently state that a board candidate may not be approved by the existing board of directors for purposes of the change of control provision if such candidate was initially nominated by other parties during a proxy contest.² According to the Amylin court, a change of control provision that did not allow a board to approve dissident nominees (or contained material limitations on the ability of the board to so approve) in order to avoid triggering a change of control provision might be an impermissible infringement upon the shareholder franchise — which might coerce stockholders to vote only for incumbents in order to avoid the company being obligated to prepay a material amount of debt under an indenture or a credit agreement — and thus unenforceable as against public policy.

Whether a continuing director change of control provision would be deemed to force stockholders to vote for incumbents, and the extent to which it would do so, will depend on the facts and circumstances of the particular case. In Amylin, the court found that honoring the potential put would cause a substantial economic problem for the company. Accordingly, companies may be more likely to resist having such provisions — particularly those that contain limits on the board's right to approve dissident nominees — in their debt agreements. In addition, the case may also have the effect of encouraging lenders that have the benefit of a provision which limits the ability of the board to approve dissident nominees to waive it in negotiations with the borrower rather than risk such provision being held to be unenforceable as against public policy.

Footnotes

1. San Antonio Fire & Police Pension Fund v. Amylin Pharmaceuticals, Inc., 2009 WL 1337150 (Del. Ch.)

2. The Amylin credit agreement contained a tighter change of control provision than the Amylin indenture. The credit agreement provision(among other things) disregarded board approval of any dissident nominee whose nomination occurred as a result of a proxy fight. That provision was not at issue in the Amylin case because the lenders under the credit agreement had waived the change of control default. A more restrictive continuing directors provision like the one in the Amylin credit agreement would seem to be at risk of being held to be unenforceable in some circumstances, in particular in an instance where a dissident stockholder sought to replace a majority of the board in a single election and the acceleration of the debt would adversely affect the company. However, the Amylin court noted that a more restrictive provision in a syndicated credit agreement would be "somewhat less concerning" than if contained in a public debt indenture "because of the relative ease with which consents and waivers are obtained in bank lending than in public debt."

Learn more about our Leveraged Finance practice.

Visit us at www.mayerbrown.com.

Mayer Brown is a global legal services organization comprising legal practices that are separate entities ("Mayer Brown Practices"). The Mayer Brown Practices are: Mayer Brown LLP, a limited liability partnership established in the United States; Mayer Brown International LLP, a limited liability partnership incorporated in England and Wales; and JSM, a Hong Kong partnership, and its associated entities in Asia. The Mayer Brown Practices are known as Mayer Brown JSM in Asia.

This Mayer Brown article provides information and comments on legal issues and developments of interest. The foregoing is not a comprehensive treatment of the subject matter covered and is not intended to provide legal advice. Readers should seek specific legal advice before taking any action with respect to the matters discussed herein.

Copyright 2009. Mayer Brown LLP, Mayer Brown International LLP, and/or JSM. All rights reserved.