Withholding approval is a threat to the shareholder franchise when the incumbent board retains power to approve a dissident slate but refuses to entrench itself.
SandRidge Energy found itself in a proxy fight launched by hedge fund instigator, TPG-Axon. TPG launched a consent solicitation to de-stagger SandRidge’s board, amend the bylaws, remove all of the current directors and install its own slate. Let’s just say that SandRidge’s performance had been lacking at the time.
The SandRidge board resisted and warned stockholders that the election of TPG’s slate would be a change of control that would trigger a requirement for SandRidge to repurchase its outstanding notes, referred to colorfully as the “Proxy Put.” If a new board majority is not approved by an incumbent board, the Proxy Put was triggered for purposes of the notes.
A stockholder claimed breach of fiduciary duty because the sitting SandRidge board did not have a proper basis for failing to approve the TPG slate for the purposes of the Proxy Put.
The court said that a board deciding whether to approve directors for the purposes of the Proxy Put could not act consistently with its fiduciary duties by simply failing to approve any director candidates opposing the incumbents.
The duty of loyalty demanded that the incumbents may only refuse to grant approve if the dissidents posed such a material threat of harm to the corporation that it would constitute a breach of the duty of loyalty to pass control to them. For example, unless the dissidents lacked ethical integrity, were looters or proposed a program that would demonstrably be materially adverse to the company’s ability to meet its obligations to the creditors, then the incumbents should approve the dissidents and allow the stockholders to vote.
The incumbents noted that the dissidents did not have sufficient energy experience, although several members of their slate had substantial experience, even if not in the upstream oil and gas industry. However, that the incumbents believed that they were better suited to run the company is not a sufficient fiduciary basis to deny approval of the dissidents. The incumbents did not have reason to doubt the integrity of the dissident slate. As the court said:
“In other words, the incumbent board has simply made the same determination that all incumbents who seek to continue in office make: we are better than the new guys and gals, so keep us in office.”
The court went on to disparage a company that would enter into an agreement with a Proxy Put without hard negotiation and clear economic advantage given the obvious entrenching purposes of a Proxy Put as the court believes that the costs of resisting such a term would be insubstantial to non-existent.*
SandRidge and TPG settled, and SandRidge added four TPG nominees to the board.
Kallick v. SandRidge Energy
*Ed. Note: Not really. Many lenders/noteholders/counterparties want to know exactly who they will be dealing with during the term of their agreement. The Proxy Put is probably more widely used and integral to many transactions than the court realizes.