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Allergan Stockholders' Board-Removal Contest Was Not Ripe

December 3, 2014
Albert H. Manwaring, IV
Delaware Business Court Insider

Delaware courts have consistently recognized that disputes challenging corporate defensive measures are ripe for review when the defensive measures have a substantial deterrent effect on the ability of stockholders to exercise their rights. For example, in Moran v. Household International, 490 A.2d 1059, 1072 (Del. Ch. 1985), a corporation's implementation of a shareholder rights plan, which deterred the ability of stockholders to receive takeover proposals and engage in a proxy fight for control of the corporation, was ripe for review. Similarly, in KLM Royal Dutch Airlines v. Checchi, 698 A.2d 380, 384 (Del. Ch. 1997), a corporation's implementation of a shareholder rights plan or poison pill, which interfered with a stockholder's contractual right to exercise a stock option, was ripe for review. More recently, in Pontiac General Employees Retirement System v. Ballantine, C.A. No. 9789-VCL, at *72-77 (Del. Ch. October 14, 2014) (Transcript Op.) (Laster, V.C.), the board's implementation of a proxy put, which gave noteholders a right to accelerate payment of their debt if stockholders removed and replaced the majority of the corporation's board, had a deterrent effect on the stockholders' ability to conduct a proxy contest, and was thus ripe for review. In each of these cases, the key factor that the challenge was ripe for review was the "deterrent effect" of the defensive measure on the ability of stockholders to exercise their rights.

But, a hypothetical proxy contest strategy that was proposed by stockholders to gain control of an entire board, but which was not pursued, and which did not deter other stockholders from exercising their stockholder rights to seek control of the board through alternative means, was not ripe for review. In its recent decision, In re Allergan Stockholder Litigation, C.A. No. 9609-CB (Del. Ch. November 7, 2014) (Bouchard, C.), the Court of Chancery denied the plaintiff stockholders' motion for summary judgment, which sought a declaration that a "Similar Item" limitation in a special stockholder meeting bylaw did not prohibit a stockholder request for a special meeting to remove and elect the entire board (as long as the proposed board members were not nominees up for election in the preceding year). In Allergan, the court held the plaintiffs' challenge to the bylaw was not ripe because the plaintiffs were seeking an advisory opinion regarding the interpretation of the "Similar Item" limitation to support a hypothetical proxy contest strategy to remove and replace the entire Allergan board that was not pursued by any stockholder, and did not deter other stockholders from exercising their right to seek control of the board, albeit through an alternate proxy contest strategy.

Background

Valeant Pharmaceuticals International Inc. and Pershing Square Capital Management L.P. were working together to support Valeant's acquisition of Allergan Inc. In settlement of two lawsuits filed in the Court of Chancery by a joint entity (PS Fund 1) created by Valeant and Pershing Square to consummate the acquisition of Allergan, the parties stipulated that PS Fund 1 may pursue a proxy contest to remove six of the nine directors of the Allergan board and replace them with six PS Fund 1 nominees at a special meeting of Allergan's stockholders scheduled for Dec. 18.

In this action, other plaintiff stockholders of Allergan chose a different proxy strategy than PS Fund 1 to support Valeant's takeover of Allergan. Here, the plaintiff stockholders sought to remove and replace the entire Allergan board, rather than just a majority or six of the nine directors, at a special meeting of Allergan's stockholders. The plaintiff stockholders reasoned that removing the entire board was more advantageous when compared to just removing part of the board because a partial board strategy would not negate Article 8 of Allergan's certificate of incorporation, which provides that board vacancies resulting from removal of any directors "shall be filled solely by the affirmative vote of a majority of the remaining directors then in office, even though less than a quorum, or by a sole remaining director."

Before the court was the plaintiff stockholders' motion for summary judgment, seeking a declaration that a "Similar Item" limitation in Allergan's certificate and bylaws did not prohibit 25 percent of the stockholders from requesting a special meeting to remove and elect an entire new board, as long as the proposed nominees had not been up for election to the board within the preceding year. In a proxy statement, Allergan had asserted that while the "Similar Item" limitation would not prevent 25 percent of the stockholders to request a special meeting to remove directors, the limitation would bar stockholders from electing their successors at the special meeting because a similar item—the election of directors—had occurred at the annual stockholder meeting within the preceding year.

Challenge Was Not Ripe

The Court of Chancery itself raised the issue of ripeness, and found that the plaintiff stockholders' challenge, asserting that the "Similar Item" limitation in Allergan's certificate of incorporation and bylaws did not prohibit 25 percent of the stockholders from requesting a special meeting to remove and elect an entire new board, was not ripe for review. The court reasoned that the plaintiffs were not asserting that the "Similar Item" limitation in Allergan's organizational documents was facially invalid, but rather were advancing a claim of contractual construction of the limitation as it might apply to a hypothetical situation. Indeed, the court pointed out that no stockholder had actually pursued a proxy contest strategy to request a special meeting of the stockholders to remove and replace the entire Allergan board. Instead, Allergan had agreed to permit other stockholders, Valeant and Pershing Square, to request a special meeting of the Allergan stockholders to remove six of the nine directors of the Allergan board and replace them with six of their own nominees at a special meeting scheduled for Dec. 18. The court explained that if Valeant and Pershing Square were successful in their proxy contest strategy to take control of the Allergan board, the hypothetical proxy contest strategy to remove and replace the entire board being challenged by the plaintiffs might never arise.

In sum, the court concluded that the "Similar Item" limitation was not a "significant deterrent" to the ability of Allergan's stockholders to exercise their stockholder franchise rights. The court emphasized that Valeant and Pershing Square were currently engaged in a proxy fight for control of the Allergan board, which will be resolved at the special stockholder meeting Dec. 18. Hence, while Valeant and Pershing Square were not pursuing the plaintiff stockholders' proposed proxy strategy to remove and replace the entire board, they were pursuing an alternate proxy strategy to take control of the Allergan board, and therefore had not been deterred from exercising their stockholder franchise rights to seek control of the board. Accordingly, based on the strong policy considerations of the Delaware courts against issuing advisory opinions to address hypothetical issues or hypothetical harm, and the lack of any deterrent effect on the ability of Allergan stockholders to exercise their franchise rights to take control of the board, the court ruled that the plaintiffs' challenge to the "Similar Item" limitation in Allergan's organizational documents was not ripe for review.

Lessons Learned

The key factor to demonstrate that a stockholder's challenge to a corporation's defensive measure is ripe for review is the deterrent effect that the defensive measure has on the ability of stockholders to exercise their stockholder franchise rights.

Delaware Business Court Insider  |  December 3, 2014