March 27, 2020

Proxy Contests: Will Covid-19 Put Them on Ice?

This Sidley memo says that one of the consequences of the coronavirus outbreak may be a decline in proxy contests during the current season. As this excerpt points out, the reason is that given current market volatility, activists may be unwilling to commit to the kind of long-term hold that a successful proxy fight would necessitate:

It is important to understand that if an activist launches a proxy contest to replace directors, an activist must be prepared to remain in the stock for the foreseeable future – at least until the annual shareholder meeting and, if successful in obtaining board seats, at least 6-12 months beyond that. While there are no legal restrictions to the contrary, as a practical matter, an activist cannot initiate a proxy contest and sell or reduce its position shortly afterward.

An activist who does this stands to lose credibility with long-term institutional investors and becomes more susceptible to being portrayed as a “short term” investor in future activism campaigns. It is even more difficult for an activist to exit a stock if an employee of the activist fund, rather than candidates that are at least nominally independent, takes a board seat. Material nonpublic information received by the activist employee in the board room is imputed to the activist fund, thereby restricting the fund’s ability to trade in the stock.

The memo cautions that once the crisis passes, companies should expect activists to return to proxy contests with a vengeance. It notes that 130 proxy contests were launched in 2009, after the financial crisis, and many companies that can hide during a bull market have their vulnerabilities laid bare during a downturn.

Speaking of vulnerabilities, Sidley recently published a follow-up memo discussing the advisability of implementing a poison pill. This excerpt provides a reminder about how Delaware courts will evaluate such a decision:

In the current environment, boards of public companies should, at a minimum, make sure they have an up-to-date poison pill on the shelf and consider whether to adopt one. At least in Delaware, the standard of review of the board’s decision to adopt depends on the company’s particular circumstances at the time of adoption. In Delaware, if a poison pill is adopted on a “clear day” (i.e., where the company is not facing a hostile takeover bid or other specific threat), the business judgment rule applies (Moran), whereas adoption of a poison pill as a defensive measure in response to a specific threat is subject to enhanced scrutiny (Unocal).

Notably, even if a poison pill is adopted on a clear day, the decision whether to redeem the poison pill in the face of a hostile bid remains subject to enhanced scrutiny. In these extraordinary times, a board may, in the exercise of its reasonable business judgment, conclude that it is in the best interests of the company and its shareholders to adopt a poison pill even in the absence of a specific threat.

John Jenkins