San Antonio Fire & Police Pension Fund v. Amylin; Is There a Future For Continuing Director Poison Puts?

In one of his final decisions before his retirement this July, Vice Chancellor Lamb has handed down an important ruling on continuing director poison puts, San Antonio Fire & Police Pension Fund v. Amylin Pharmaceuticals, Inc. (Nasdaq: AMLN), 2009 WL 1337150 (May 12, 2009). A poison put is a contractual provision, typically found in loan agreements or indentures, that triggers adverse consequences to the debtor upon a change-in-control of the debtor. In this case the question was whether the holders of the $625 million 3% convertible notes, due 2014 (the “Convertible Notes”), acting through The Bank of New York Mellon Trust Company, the indenture trustee, would have the right to redeem the Convertible Notes (which were trading at a discount) at face value upon the occurrence of a “fundamental change” in Amylin, defined to include, among other things, a change in the makeup of the board of directors of Amylin such that the “continuing directors” would not constitute a majority of the board. “Continuing directors” included those on the board on the date of issuance of the Convertible Notes — June 2007 — and any successors who are approved by the directors then in office (or their approved successors).

The plaintiff’s allegations and the Court’s treatment of the poison put in the Convertible Notes Indenture and in Amylin’s Credit Agreement with Bank of America raise troubling questions concerning the viability of continuing director poison puts.

A. The Context

This lawsuit was triggered by a proxy contest over the directors to be elected at Amylin’s 2009 annual meeting of shareholders, to be held May 27, 2009. Twelve directors are to be elected. In January 2009 two dissident shareholders — Icahn Partners LP, an 8.8% Amylin stockholder, and Eastbourne Capital Management, L.L.C., a 12.5% stockholder — each nominated a five-person short slate for election to the board. Eastbourne, having done its homework, asked the Amylin board to take action to prevent the adverse consequences that would befall Amylin if the continuing directors’ provision of the Convertible Notes’ Indenture were triggered. Eastbourne’s proposed solution was to ask Amylin to include a “significant” number of nominees from its and Icahn’s slates in management’s slate of directors to be recommended to the stockholders.

Amylin filed its 2008 10-K with the SEC on February 27, 2009. In the 10-K, Amylin highlighted the potential adverse consequences of the continuing directors’ provisions of the Convertible Notes’ Indenture and the BofA Credit Agreement if they were triggered by election of the Icahn and Eastbourne slates. (The BofA Credit Agreement is even more restrictive than the Convertible Notes’ Indenture, in that candidates elected or appointed to the board as a result of an “actual or threatened solicitation of proxies or consents for the election or removal of Amylin directors” would not qualify as continuing directors.)

Promptly after the filing of the 10-K, Eastbourne sent a letter to the Amylin board questioning the “legitimacy” of the continuing directors’ provisions of the Convertible Notes’ Indenture and the BofA Credit Agreement, “calling upon the board to use its power to remove any obstacle to the operation of the stockholder franchise,” and calling upon Amylin to “approve” the dissident slates under the Convertible Notes’ Indenture.

On March 17, 2009, Amylin announced publicly the tentative date for its 2009 annual meeting – May 27, 2009.

B. The Litigation

Plaintiff launched a frontal assault on the continuing director provisions of the Convertible Notes’ Indenture and BofA Credit Agreement. It alleged —

• breaches of the fiduciary duties of care and loyalty by the Amylin board in its 2007 adoption of the Indenture and Credit Agreement, insofar as they both contained continuing directors covenants;

• breaches of the fiduciary duties of care and loyalty by the board in failing to approve the dissident nominees in order to “sanitize” them under the continuing directors provision of the Indenture; and

• breaches of the fiduciary duties of care and loyalty in the allegedly misleading and coercive manner in which the board disclosed the risks presented by the continuing directors provisions in the Indenture and Credit Agreement in the context of the proxy contest in Amylin’s 2008 10-K.

Besides seeking declaratory relief, plaintiff sought a mandatory injunction requiring the directors to approve the Icahn and Eastbourne nominees for director.

The plaintiff filed its class action complaint on March 24, 2009. In April the plot thickened. Clearly made a bit anxious by plaintiff’s allegations, and seeing a relatively harmless settlement strategy, Amylin and its board first filed an answer on April 7, 2009, which included a cross-claim against the Indenture trustee, seeking declaratory relief that the board has the power to approve any or all stockholder nominees at any time up to their election. And, on April 13, 2009, plaintiff and Amylin announced a partial settlement. Under the terms of the settlement, plaintiff withdrew its allegations of breach of the duty of loyalty and lack of good faith by the Amylin board. That withdrawal is important for indemnity and insurance purposes, as under Delaware GCL §102(b)(7), and Amylin’s charter, the personal liability of directors cannot be eliminated for breaches of the duty of loyalty or acts or omissions not taken in good faith. Plaintiff also agreed not to seek damages against Amylin or the board, to dismiss its claim of coercive disclosure in the 2008 10-K, and to dismiss its claim against the board for breach of fiduciary duty in failing to approve the Icahn and Eastbourne nominees. In return, the board, subject to court affirmation of its power to do so, agreed to “approve” the Icahn and Eastbourne nominees solely for the purpose of the continuing directors provision of the Indenture. This is called a clever work-around.

This “approval” did not mean that Amylin would endorse Icahn’s or Eastbourne’s nominees for election: the “approval” was solely to finesse the trigger under the Indenture permitting the Convertible Noteholders to redeem their Notes at face value. Amylin continued to oppose Icahn’s and Eastbourne’s nominees, with vigor.

Plaintiff, Amylin, and BofA also agreed to remove the BofA Credit Agreement continuing director provision from the case. Under this settlement, BofA and its group of lenders agreed to waive any event of default that might be triggered by the election of Icahn’s and/or Eastbourne’s nominees to the Amylin board, in return for — what else — money: a $625,000 fee (payable in the event that the continuing directors provision of the BofA Credit Agreement would otherwise be triggered by the election of the Icahn and/or Eastbourne nominees).

The parties then tinkered with the record before Vice Chancellor Lamb even further. On May 6, 2009, two days after close of the record date for determining the stockholders entitled to vote at the meeting, Amylin notified the Court that Eastbourne had reduced the number of candidates it was nominating to the board from five to three, and Icahn from five to two. Accordingly, even if the dissidents’ nominees are elected to the board, the board will still consist of a majority of continuing directors.

The sole remaining creditor defendant, the Indenture trustee, in response to these developments, at this point pleaded with the Court to dismiss or stay the claims against it, as the issues of the validity of the continuing director provision in the Indenture were now not ripe for determination. Plaintiff and Amylin, on the other hand, asked the Court to proceed because “whether or not the stockholder-nominated directors constitute Continuing Directors may have a significant effect on next year’s annual stockholder meeting.” 2009 WL 1337150 at *6.

C. Vice Chancellor Lamb’s Ruling

The trustee’s argument for application of the continuing directors provision of the Indenture to the Amylin proxy contest was straightforward:

“[t]he Board’s determination not to recommend the election of any of the Dissident Nominees, to recommend its own competing slate, and that the election of the Dissident Nominees would not be in the best interests of the Company—determinations that have not changed as a result of the Partial Settlement—simply cannot be reconciled with the plain meaning of the term ‘approval.’ To the contrary, such determinations by the Board clearly indicate disapproval.”

2009 WL 1337150 at *7 (footnote omitted) (emphasis in original).


Amylin, on the other hand, argued that “approval” does not mean “endorsement” or “recommendation.” “By Amylin’s reading, therefore, the board may approve a slate of nominees for the purpose of the Indenture (thus sanctioning their nomination for election) without endorsing them, and may simultaneously recommend and endorse its own slate instead.” Id.

The Vice Chancellor concluded that Amylin’s reading of the Indenture was the correct one. Clearly he was motivated by the effect of the continuing director provision upon the stockholder franchise, and he uses terms that should cause all boards considering continuing director poison puts concern:

“A provision in an indenture with such an eviscerating effect on the stockholder franchise would raise grave concerns. In the first instance, those concerns would relate to the exercise of the board’s fiduciary duties in agreeing to such a provision. The court would want, at a minimum, to see evidence that the board believed in good faith that, in accepting such a provision, it was obtaining in return extraordinarily valuable economic benefits for the corporation that would not otherwise be available to it. Additionally, the court would have to closely consider the degree to which such a provision might be unenforceable as against public policy.”

2009 WL 1337150 at *8 (footnotes omitted).

Having concluded that the Amylin board had the power under the Indenture to “approve” a dissident’s slate under the continuing director provision of the Indenture, while at the same time opposing the election of that slate, Vice Chancellor Lamb next turned to the question of whether the Amylin board had properly approved the dissidents’ slates under the Indenture. Relying upon Hills Stores Company v. Bozic, 769 A.2d 88 (Del. Ch. 2000), the Vice Chancellor applied this test:

“… the board may approve the stockholder nominees if the board determines 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.”

Id. at *8 (footnote omitted).

Here, the Vice Chancellor ran into a problem. There was no evidence before him as to how the Amylin board came to its decision to “approve” Icahn’s and Eastbourne’s nominees or, to be more precise, the evidence before the Vice Chancellor cut the other way. First, and most obviously, the public record was replete with negative comments made by Amylin about the Icahn and Eastbourne nominees, some of which are quoted by the Vice Chancellor in note 39 to his decision. But these negative comments are not dispositive, so concluded the Vice Chancellor, because he recognized that such comments could be election “puffery” in the context of a proxy contest. In other words, the other guys’ nominees could be worse, much worse than management’s nominees, but not bad. That is a fine line to walk. The second unhelpful fact before the Vice Chancellor was the circumstance of the Amylin settlement with the plaintiff, clearly giving rise to the inference that Amylin agreed to “approve” Icahn’s and Eastbourne’s nominees to settle breach of duty and loyalty claims against its board of directors.

Exercising judicial discretion, the Vice Chancellor elected to punt on the question of whether the Amylin board properly “approved” the Icahn and Eastbourne nominees under the terms of the continuing director provision of the Indenture to a later date. It helped the Vice Chancellor in making this decision that the dissidents had reduced their slate of nominees to a number less than a majority of the Amylin board. If the dissidents are elected, and Amylin chooses to do so, then it could return to the Court for sanction of the board’s due care in “approving” the dissident nominees.

D. Did the Amylin Board Breach its Duty of Due Care in Approving the Poison Put?

The one due care issue remaining in the case that the Vice Chancellor did address is one that will give boards and their advisors pause.

The standard applied by the Vice Chancellor is one of gross negligence, that is, was the Amylin board grossly negligent in approving the Indenture with its continuing director provision? Here, the record was somewhat embarrassing, in that, in its consideration of the Indenture, the committee of the board that approved the Indenture was unaware of the poison put! So too were Amylin’s CEO and CFO! Indeed, the poison put proceeded through drafts of the Indenture without comment by Amylin or its counsel. (Indeed, there is more: when counsel was asked by the board committee whether the Convertible Notes were subject to any terms which counsel saw as “unusual or not customary,” Amylin’s counsel responded that they were not.)

Nevertheless, the Vice Chancellor concluded that the Amylin board was not grossly negligent “in failing to learn of the existence of the Continuing Directors provisions…” 2009 WL 1337150 at *10. Focusing on the board, and the advice it had received from “highly-qualified counsel,” the Vice Chancellor observed that “no one suggests that the directors’ duty of care required them to review, discuss and comprehend every word of the 98-page Indenture.” Directors can breathe a sigh of relief at that observation.

But then the Vice Chancellor concludes with words of caution to boards and their advisors:

“This case does highlight the troubling reality that corporations and their counsel routinely negotiate contract terms that may, in some circumstances, impinge on the free exercise of the stockholder franchise. In the context of the negotiations of a debt instrument, this is particularly troubling, for two reasons. First, as a matter of course, there are few events which have the potential to be more catastrophic for a corporation than the triggering of an event of default under one of its debt agreements. Second, the board, when negotiating with rights that belong first and foremost to stockholders (i.e., the stockholder franchise), must be especially solicitous to its duties both to the corporation and to its stockholders. This is never more true than when negotiating with debtholders, whose interests at times may be directly adverse to those of the stockholders. Outside counsel advising a board in such circumstances should be especially mindful of the board’s continuing duties to the stockholders to protect their interests. Specifically, terms which may affect the stockholders’ range of discretion in exercising the franchise should, even if considered customary, be highlighted to the board. In this way, the board will be able to exercise its fully informed business judgment.”

Id. at *10.

E. Plaintiff Appeals

Not satisfied with the Vice Chancellor’s blessing of its strategy for finessing the continuing director provision of the Indenture, plaintiff has appealed the Vice Chancellor’s ruling deferring a decision on whether the Amylin board exercised due care in “approving” the dissidents’ shortened slate of director nominees. Plaintiff essentially doesn’t like the uncertainty created by the Vice Chancellor’s ruling. In its application for an expedited hearing before the Delaware Supreme Court, it argues that, in the absence of an expedited final resolution prior to the date of the stockholder meeting, “stockholders will be coerced from voting for the five stockholder nominees because of the cloud cast by the lower Court’s ruling.” Plaintiff’s Motion for Expedited Scheduling Regarding Dismissal of Count III, dated May 13, 2009, at 2. Justice Jacobs of the Delaware Supreme Court denied the motion for an expedited hearing on May 15.

F. Whither the Continuing Director Poison Put?

If Vice Chancellor Lamb’s decision stands, it is hard to see how continuing director poison puts will survive. If drafted more restrictively, to protect lenders, it could subject a board to claims of entrenchment and thereby implicate the duty of loyalty, stripping from the directors the “due care” waivers permitted in charter provisions such as those permitted by Delaware GCL §102(b)(7). As to existing poison puts, plaintiff’s strategy in this lawsuit provides a roadmap on how to neuter them, although the path that a board must follow is akin to Ulysses’ travels between Scylla and Charybdis: how to “approve” a dissident slate while at the same time slamming them in the heat of battle.

Breaches of continuing director provisions are not, of course, monetary defaults. They provide a signal to lenders of potential trouble. A more classic way of signaling such trouble is through the use of financial covenants, e.g., debt to equity ratios, debt service coverage, or through events of default that foreshadow trouble, such as a rating decline, or through negative covenants such as a requirement to secure the lenders’ consent for any merger, consolidation, etc. Debtors and their counsel will in all likelihood point lenders to reliance upon these types of provisions in lieu of reliance upon continuing director poison puts (assuming, of course, it is the lenders who are the parties requesting continuing director poison puts).