How to Answer When an Activist Calls
The increasing activist stockholder demands upon boards of directors call for careful responses. The recent Delaware Court of Chancery decision In re Ebix Stockholder Litigation, C.A. No. 8526-VCN (Del. Ch. Jan. 15, 2016), provides guidance on how to respond when the activist calls. Moreover, Ebix is being overlooked by many because most of the opinion focuses on the scope of releases contained in settlements of stockholder litigation. That itself is a hot topic that is part of the increased scrutiny the Court of Chancery is now giving to disclosure-only settlements. But while Ebix's discussion of the scope of releases is important, Ebix is worth a closer review for its guidance on activism.
Ebix involved various bylaw amendments and an agreement with an activist stockholder that placed two of the activist's nominees on Ebix Inc.'s eight-person board of directors (the director nomination agreement). The plaintiffs contended that both the bylaw amendments and the director nomination agreement were defensive measures designed to maintain the board's control over Ebix in violation of the Unocal v. Mesa Petroleum, 493 A.2d 946, principles. The court first upheld the director nomination agreement and then denied a motion to dismiss the claims that the bylaw amendments violated Unocal. This different treatment of those claims is illuminating.
The court recognized that it is a common response to a stockholder activist's demands to cede a limited number of board seats to settle an activist's claims. Such a concession does, to some extent, entrench the board because it removes the activist as a threat to the board's control. But other board actions also tend to preserve board control without triggering scrutiny under Unocal, such as rejecting an acquisition offer or issuing preferred stock with put rights upon a change of control. Where to draw the line is the issue. The director nomination agreement did not cross the line to invoke Unocal because it directly lessened the control of the existing board and that decrease in control outweighed any indirect or collateral effect that preserved the board's ultimate control.
The bylaw amendments, however, did warrant Unocal scrutiny, according to Ebix. Those amendments restricted the stockholders' power to call for a special meeting and to elect directors. That result has two components, each of which merit separate discussion. First, the court dealt with the defendants' argument that Unocal did not apply to the bylaw amendments because the director nomination agreement had removed any immediate threat to board control and that such an immediate threat must be present to trigger Unocal. The court rejected that argument because the activist that had targeted Ebix might again do so when the director nomination agreement expired in two years.
This reasoning has potential application whenever an activist stockholder has appeared. Does this mean that a board is in Unocal land thereafter, even if the activist has gone away, and if so, for how long afterward must a board be able to justify defensive measures? While there is no sure answer to that question, it is probably important that the activist in Ebix continued to be involved with Ebix through its holding of two board of director positions. Thus, the court may have accepted the defendants' argument that Unocal did not apply if the activist has really gone away. The Ebix opinion's citations to other decisions deciding not to apply Unocal absent a "known threat" seems to support that interpretation.
Ebix's second component of its reasons to apply Unocal to the bylaw amendments is also important. The timing and content of the amendments was critical. The bylaw amendments were adopted after the activist stockholder had contacted Ebix. That "factual chronology" was "viewed in a light most favorable to" the Ebix plaintiffs and led the court to conclude the amendments were the type of defensive action Unocal was intended to address.
The scope of the amendments was also important. Ebix deals with not just a single bylaw that had some small impact on stockholder voting rights. After all, the Delaware courts have upheld many bylaws that impact voting rights and Ebix acknowledged that precedent. Instead, Ebix involved "a salvo of new provisions," particularly including limiting "the use of special meetings to hold [board of directors] elections." The cumulative impact of the bylaw amendments "requires an explanation," according to Ebix.
What, then, does Ebix mean for the future of defensive measures taken in response to the call of an activist stockholder? At the very least, Ebix informs that the board that takes steps to counter an activist needs to be able to satisfy the "reasonableness" test of Unocal. That involves both a valid process and a minimal impact on voting rights. Each set of circumstances is different; each requires its own unique approach. But, defensive measures are still themselves defensible after Ebix.