In Pontiac Gen. Employees Retirement Syst. v. Ballantine (Healthways) [1], the plaintiffs  alleged that Healthways’ directors had breached their fiduciary duties by entering into a credit agreement with a “dead-hand proxy put” – that is, a provision that provides for an event of default under the credit agreement if the majority of directors on the board are replaced without the consent of the directors in office on the date of the credit agreement (or the consent of successors approved by such directors), without any room for existing directors to approve new directors if they were nominated in connection with a proxy contest. The complaint also alleged that, as lender, SunTrust should be liable for aiding and abetting such a breach of fiduciary duty.  It is worth noting that the provision at issue in Healthways was put in place less than two weeks after Healthways’ shareholders voted to de-stagger its board at a time when there was increasing shareholder activism at the company.

In a bench ruling issued on October 14, 2014 [2], Vice Chancellor Laster denied the defendants’ motion to dismiss, finding that the mere existence of the dead hand provision had an effect on shareholder decision-making as to whether to run a proxy context.  In refusing to dismiss the aiding and abetting claim against SunTrust, the court pointed to the fact that there was “ample precedent…putting lenders on notice that these provisions were highly suspect and could potentially lead to a breach of duty on the part of the fiduciaries who were the counter-parties to a negotiation over the credit agreement.”  The ruling triggered significant concern among companies, boards and lenders alike about dead hand proxy put provisions, a sentiment that was further fueled by the spate of litigation brought against companies and their lenders with respect to dead hand proxy put provisions, even those that were not adopted in the face of shareholder activism.

On May 8, 2015, in approving a settlement in the matter, Vice Chancellor Laster stated that his prior ruling “was probably one of the more frequently misrepresented or misunderstood rulings of mine” and highlighted that it was not a finding of liability but rather a ruling on a motion to dismiss.  Vice Chancellor Laster also acknowledged that some had interpreted the ruling to apply to “any change-in-control provision in any loan agreement” rather than “a dead hand proxy put, adopted in the shadow of a proxy contest,” an interpretation that he described as “specious.”

Following the Delaware Court of Chancery’s prior decisions in Amylin [3] and SandRidge [4], it is clear that, without a dead hand feature, proxy put provisions provide limited protection for lenders in the event of  a change of control at the board level.  This is because, in the absence of the dead hand provision, the outgoing directors, even after their defeat in the proxy contest is apparent, may still “approve” the new directors (and thereby assure that these new directors, despite their “insurgent” origins, do not count toward a change in control).  Indeed, according to the SandRidge decision, the outgoing directors in most cases must approve these new directors if doing so would prevent an acceleration of the debt and therefore be in the best interests of the corporation.  Thus, the lenders would not be able to exit the loan by virtue of a significant governance change, even if the change significantly affected the creditworthiness or profile of the company (unless the adverse impact trips a different covenant, such as a financial covenant).  Nonetheless, after Healthways, and even after Vice Chancellor Laster’s clarifying statement in approving the settlement, it is clear that the dead hand feature included in proxy put provisions is inherently suspect.  The circumstances in which any such provision is adopted should be carefully considered, both by boards and by their lenders.  Both boards and lenders should also carefully document their consideration of these provisions.  Boards should in general resist dead hand proxy puts or have a clear view that failing to agree to a dead hand proxy put would impair the borrower’s ability to access credit on favorable economic terms.  Lenders should document their belief that adoption of such a provision serves as a means of assuring the continued credit profile of the borrower and could not be construed as a device to entrench board members.

[1]  Pontiac Gen. Employees Retirement Syst. v. Ballantine, C.A. No. 9789-VCL transcript (Del. Ch. May 8, 2015).

[2] Pontiac Gen. Employees Retirement Syst. v. Ballantine, C.A. No. 9789-VCL, transcript (Del. Ch. Oct 14, 2014).

[3] San Antonio Fire & Police Pension Fund v. Amylin Pharmaceuticals, Inc., C.A. No. 4446-VCL (Del. Ch. May 12, 2009).

[4] Gerald Kallick v. SandRidge Energy, Inc., C.A. No. 8182-CS (Del. Ch. March 8, 2013).