In Carmody v. Toll Brothers, the Delaware chancery court (per Vice Chancellor Jack Jacobs) cast considerable doubt on the validity of so-called dead hand poison pills. Carmody v. Toll Bros., Inc., 723 A.2d 1180 (Del.Ch.1998). In addition to fairly standard flip-in and flip-over features, the Toll Brothers pill provided that it could be redeemed only by those directors who had been in office when the shareholder rights constituting the pill had become exercisable (or their approved successors). This provision was intended to foreclose a loophole in standard poison pills. Most pills are subject to redemption at nominal cost by the target’s board of directors. Such redemption provisions purportedly allow the target’s board to use the pill as a negotiating device: The poison pill makes an acquisition of the target prohibitively expensive. If the prospective acquirer makes a sufficiently attractive offer, however, the board may redeem the pill and allow the offer to go forward unimpaired by the pill’s dilutive effects. Although such redemption provisions gave the target’s board considerable negotiating leverage, and were one of the justifications used to defend the whole idea of the poison pill, they also made the target vulnerable to a combined tender offer and proxy contest. The prospective acquirer could trigger the pill, conduct a proxy contest to elect a new board, which, if elected, would then redeem the pill to permit the tender offer to go forward. The dead hand pill was intended to close this loophole by depriving any such newly elected directors from redeeming the pill. A shareholder sued, alleging both lack of authority and breach of fiduciary duty claims.
In denying Toll Brothers’ motion to dismiss, Vice Chancellor Jacobs indicated that dead hand pills likely ran afoul of several aspects of Delaware law. First, such pills implicated the Delaware statutes governing the powers of directors: “Absent express language in the charter, nothing in Delaware law suggests that some directors of a public corporation may be created less equal than other directors, and certainly not by unilateral board action.” Second, by deterring proxy contests by prospective acquirers, the dead hand pill effectively disenfranchised shareholders who wished to elect a board committed to redeeming the pill. Accordingly, the shareholder stated a claim under Stroud v. Grace, 606 A.2d 75, 92 n. 3 (Del.1992), in which the Delaware supreme court held that defensive measures that disenfranchise shareholders are strongly suspect and cannot be sustained absent a compelling justification. Finally, Vice Chancellor Jacobs concluded that the plaintiff-shareholder had stated a “far from conclusory” breach of fiduciary duty claim. Although standard pills had been upheld against such claims, the dead hand pill was both preclusive and coercive. It was coercive because the pill effectively forced shareholders to re-elect the incumbent directors if they wished to be represented by a board entitled to exercise its full statutory powers. The pill was preclusive because the added deterrent effect of the dead hand provision made a takeover prohibitively expensive and effectively impossible.
In Mentor Graphics v. Quickturn Design Systems, 728 A.2d 25 (Del. Ch. 1998), Vice Chancellor Jacobs likewise invalidated a so-called no hand pill. Unlike Toll Brother’s pill, Quickturn’s pill contained no provision for redemption by continuing directors. Instead, it made the pill nonredeemable for six months after a change in control of the board. Vice Chancellor Jacobs concluded that the no hand pill violated the target board’s fiduciary duties and, accordingly, declined to address plaintiff’s authority-based claims.
The Delaware supreme court affirmed, but on different grounds. 721 A.2d 1281 (Del. 1998). The supreme court’s opinion focused on the board’s authority. According to the court’s opinion, Delaware law “requires that any limitation on the board’s authority be set out in the” articles of incorporation. The no hand pill limited a newly elected board’s authority by precluding redemption of the pill—and thereby precluding an acquisition of the corporation—for six months. Consequently, the no hand pill tended “to limit in a substantial way the freedom of [newly elected] directors’ decisions on matters of management policy.” Accordingly, it violated “the duty of each [newly elected] director to exercise his own best judgment on matters coming before the board.” Absent express authorization of such a limitation in the articles, the no hand pill was invalid as beyond the board’s authority.
In striking down the no hand pill as lacking statutory authority, the Delaware supreme court relied solely on section 141(a) of the Delaware General Corporation law. Section 141(a) states:
The business and affairs of every corporation organized under this chapter shall be managed by or under the direction of a board of directors, except as may be otherwise provided in this chapter or in its certificate of incorporation. If any such provision is made in the certificate of incorporation, the powers and duties conferred or imposed upon the board of directors by this chapter shall be exercised or performed to such extent and by such person or persons as shall be provided in the certificate of incorporation.
On its face, section 141(a) is directed to an entirely different problem than the one raised by the no hand pill. In particular, note the reference in the second sentence of section 141(a) to the “powers and duties” of the board being “exercised or performed” by such other persons as provided in the certificate of incorporation. This language clearly reflects a concern with the special problems of close corporations, whose shareholders often seek to modify the default rules of corporate governance so as to run the firm as though it were a partnership. Hence, section 141 is concerned with attempts to transfer the board’s authority to some other body (such as the shareholders) rather than self-imposed limitations on the board’s authority. On its face, the statute therefore provides no support for the court’s holding. As we will see in the next post, moreover, the court’s policy rationale holds even less water.
References:
Corporation Law and Economics at 685-90.
Dead Hand and No Hand Pills: Precommitment Strategies in Corporate Law
