DealLawyers.com Blog

Many companies resolve potential activist proxy contests by entering into cooperation agreements under which the company agrees to add one or more activist nominees to its board of directors. A recent post on the CLS Blue Sky Blog says that following the Delaware Supreme Court’s decision in Coster v. UIP, (Del.; 6/23), boards should proceed with caution when considering entering into these agreements.

In essence, the blog argues that Coster made it clear that a decision to enter into these agreements should be evaluated under the Unocal standard, which requires the board to establish that it has identified a cognizable threat to the corporation and that its response to that threat is reasonable and proportionate and neither preclusive nor coercive.  This excerpt from the blog says that satisfying both prongs of Unocal may prove to be tough sledding for the board:

Post-Coster, the approval of cooperation agreements raises several significant problems for boards.  First, Coster imposed a more rigorous definition of a reasonable threat. Many of the concerns that have been historically identified as reasonable threats justifying a defensive response to an activist shareholder may not constitute cognizable threats under Coster, or are, at most, mild threats to the corporation.  For example, boards often attempt to justify their opposition to an activist’s proxy fight by arguing that the activist’s focus on short-termism will harm the company.  However, that seems to be just another example of a “board knows best” argument, which Coster rejected.

In addition, boards often point to disruptions to the company’s business operations as a threat justifying a cooperation agreement.  However, cooperation agreements also cause disruptions.  This is especially true when the company has agreed to form a special board committee charged with exploring the activist’s strategic vision, which is often the case. Therefore, any reduction in disruption due to the cessation of the proxy fight must be offset with the disruption due to the cooperation agreement.

In addition, a board will be unlikely to pass the more stringent proportionality prong.  Cooperation agreements are “preclusive.”  Their sole purpose is to make proxy fights unattainable.  The agreements accomplish this goal in two ways. First, the secrecy and speed with which an activist investor’s designated directors assume board seats prior to an annual meeting deprive all other stockholders of a contested vote.

A board might argue that a cooperation agreement is not preclusive because the activist’s designated directors will be subject to a vote at the next annual meeting.  However, herein lies the second part of the preclusive effect of cooperation agreements. They ensure that newly appointed board members effectively run as incumbents in uncontested elections at annual meetings. Directors who are nominated in an uncontested election are almost always elected, meaning that the activist’s designated directors are almost certain to get elected.

With some exceptions, Unocal has not been a particularly daunting standard to satisfy in cases involving deal protections and defensive measures such as poison pills. However, boards & their lawyers would be well advised to take this argument about the challenges facing cooperation agreements seriously, particularly since Vice Chancellor Laster flagged this blog on LinkedIn and characterized it as a “good take.”

– John Jenkins