Siege Mentality: Proxy Puts in S&P 100 Credit Agreements in the Wake of Healthways

April 21, 2015

meeting boardroom professionalsIndentures and loan agreements typically include a section listing events constituting a breach of the agreement, or default. A common event of default is a “change in control,” meaning a material change in the borrower’s shareholders, officers, or directors. A “proxy put,” or continuing director clause, discourages wholesale changes in the borrower’s board by giving the lender the option to employ its default remedies (e.g., exercising rights against collateral and demanding repayment) if a majority of the borrower’s board changes without consent of a majority of the incumbent, or continuing, directors.

The proxy put is under attack in Delaware. In three recent cases, complainants have argued, and courts have agreed, that proxy puts are problematic because of their tendency to entrench management and disenfranchise shareholders. In San Antonio Fire & Police Pension Fund v. Amylin Pharmaceuticals, Inc. (C.A. No. 4446-VCL (Del. Ch. May 12, 2009), aff’med 981 A.2d 1173 (2009)(Amylin)), and four years later in Kallick v. SandRidge Energy, Inc., et al. (68 A.3d 242 (2013)(Kallick)), the Delaware Court of Chancery held that during a proxy contest sitting directors are obligated to “approve” the dissident slate, in order to prevent triggering a proxy put, unless such approval would constitute a breach of duty.

More recently, on October 14, 2014, the Chancery Court allowed two claims to proceed: one of breach of duty against the board of Healthways, Inc., and one of aiding and abetting that breach against SunTrust Bank, N.A., the company’s lender administrative agent. The sole grounds for liability was that Healthways and SunTrust entered into a credit agreement containing a proxy put. By declining to dismiss these claims the Chancery Court further opened the door to the possibility that proxy puts might become a potential source of liability for directors and lenders (Pontiac Gen. Employees Ret. Sys. v. Ballantine, C.A. No. 9789-VCL, 2014 WL 6388645 (Del. Ch. Oct. 14, 2014) (Healthways)).

The Healthways Decision

In 2011, Healthways, Inc. CEO, Ben R. Leedle, Jr., pronounced himself “pleased” with the company’s Q3 financial results, but the markets heard only the bad news: Cigna Corporation, Healthways’ largest customer, had announced plans to “wind down” its contract early (8-K | EX-99.1, Healthways, Inc., Oct. 24, 2011). Cigna’s defection led, eventually, to Healthways taking a $184 million writedown in goodwill (10-K, Healthways, Inc., 2012 WL 11245542, Mar. 14, 2012). Market reaction was swift:  Healthways’ stock price, already lower due to a weak Q2 report, lost 40% of its value in one day (Healthways hits 3-year low on contract woes, reuters.com, Oct. 25, 2011).

Shareholders who chose to retain their shares reacted as well. At the 2012 annual meeting, a shareholder proposal submitted by New York State Comptroller Thomas P. DiNapoli “urged” Healthways to do away with its “classified” board (a classified board comprises directors with different overlapping, multi-year terms, so that not all directors’ terms expire in the same year). DiNapoli’s supporting statement made the threat to Healthways’ board explicit: classified boards “frustrate, to the detriment of long-term shareholder interest, the efforts of a bidder to acquire control or a challenger to engage successfully in a proxy contest” (DEF 14A, Healthways, Inc., 2012 WL 11323841, Apr. 20, 2012). The board opposed the proposal, but 90% of Healthways’ shareholders sided with DiNapoli (8-K, Healthways, Inc., 2012 WL 11463247, Jun. 5, 2012).

Eight days later, Healthways announced it had renegotiated its credit agreement with SunTrust Bank. Along with a reduced credit line and a lower interest rate, the revised agreement added a “dead hand” provision to the existing proxy put. The dead hand clause, so-called because it prospectively forbids specific conduct, further narrowed the class of continuing directors by excluding any director elected as the result of an actual or threatened proxy contest (8-K | EX-10.1, Healthways, Inc., Jun. 11, 2012).

The struggle to unseat Healthways’ board attracted new investment. Between 2011 and 2013, the roster of professional investors holding 5% or more of Healthways equity increased from four controlling 40% of the stock (DEF 14A, Healthways, Inc., 2011 WL 12042239, Apr. 15, 2011), to seven – including new owners Wells Fargo & Company, The Vanguard Group, Inc., and North Tide Capital Master, LP – controlling 54% (DEF 14A, Healthways, Inc., 2013 WL 9254537, Apr.30, 2013). North Tide in particular proved an active investor, as it sought meetings with management, and filed a Schedule 13D proclaiming itself “shocked by the Board’s … unwavering support for CEO Ben Leedle despite the substantial value destruction … suffered during his tenure” (SC 13D/A, Healthways, Inc., 2014 WL 5561602, Jan. 14, 2014).”  On February 28, 2014, North Tide filed a preliminary proxy statement nominating an alternative slate of directors (DFAN14A, Healthways, Inc., 2014 WL 6383321, Feb. 28, 2014). After months of negotiation, Healthways agreed to withdraw three of its proposed slate in favor of directors approved by North Tide, creating a board composed of 25% non-continuing directors (8-K, Healthways, Inc., 2014 WL 6105259, Jun. 03, 2014).

Meanwhile, other investors were questioning the convenient timing of credit agreement amendments further entrenching Healthways’ board. On March 20, Healthways shareholder Pontiac General Employees Retirement System served Healthways with a request for production of books and records under section 220 of the Delaware General Corporation Law (Del. Code Ann. tit. 8, § 220). Eleven days later, Pontiac General filed a class action complaint alleging a breach of fiduciary duty by Healthways’ board, aided and abetted by SunTrust as administrative agent for the credit agreement lenders, for entering into a credit agreement with a proxy put. Healthways and SunTrust moved to dismiss. On October 14, in a ruling from the bench, Vice Chancellor Laster rejected the motion. Though emphasizing that his decision was “factually specific,” Laster highlighted the problem of negotiating “in the shadow” of the proxy put. “If somebody’s got a piece of artillery sitting on a hill overlooking my town,” he said, “I change my behavior driven by the fact that somebody has a piece of artillery on a hill over my town.” (Pontiac Gen. Employees Ret. Sys. v. Ballantine, C.A. No. 9789-VCL, 2014 WL 6388645 (Del. Ch. Oct. 14, 2014).)

Following the Healthways ruling, commentators advised forswearing the proxy put. A Practical Law Legal Update, for example, counseled that lenders and borrowers were “best advised to avoid” proxy puts (Legal Update, Pontiac GERS v. Ballantine: Chancery Court Declines to Dismiss Claims Against Board and Lenders Based on Loan Agreement Proxy Put. See, e.g., Pontiac General Employees Retirement System v. Healthways,Inc.: Delaware Chancery Court Declines to Dismiss Fiduciary Duty Claims Against Directors and Aiding and Abetting Claims Against Lender, S&C Memos, Oct. 27, 2014; Is the “Proxy Put” Dead? Pontiac General Employees Retirement Fund v. Healthways, Debevoise & Plimpton Client Update, Dec. 2, 2014).

Analysis of Credit Agreements at S&P 100 Companies

To gauge whether these decisions have started to have an effect on market practice regarding continuing director provisions, we surveyed the 57 in-force credit agreements filed with the SEC by companies in the S&P 100. All the agreements antedate the 2009 Amylin decision, and 35, or 61%, were entered into after the 2013 Kallick decision. Only five are dated after Healthways (Oct. 14, 2014).

Our survey found evidence of a decline in the use of proxy puts, but ongoing fluctuation muddied the picture. While it is possible that the decline in the use of continuing director clauses occurring between 2013 and 2014 was the result of an intentional flight from the proxy put, it may prove to have been an aberration. It appears to be too soon to declare the proxy put kaput.

The credit agreements surveyed use a variety of methods to establish which directors are continuing. The most common mechanisms are:

  1. Manner of election: Defines continuing directors as individuals nominated or appointed by a majority of the sitting board. Every agreement surveyed employed this method of establishing incumbency. Most also used one, though not both, of the following:
  2. Agreement date: Defines continuing directors as those in office on the date of the agreement.
  3. Timed look-back: Defines continuing directors as those sitting at the beginning of a designated time window. The length of the look-back typically ranges from 12 to 24 months.
  4. Dead hand: Carves out from the definitions above any director elected as the result of an actual or threatened proxy contest.

Our survey found:

  • Continuing director clauses are common, appearing in 60% of the agreements surveyed.
  • During the period reviewed, our sample indicates that 2013 may have been the high-water mark for the use of proxy puts. In 2011, 36% of new agreements in our sample contained continuing director clauses. In 2012, this figure increased to 45%, and in 2013, continuing director clauses appeared in 82% of new agreements. After this groundswell, however, the percentage of new credit agreements with such clauses decreased to 58% in 2014.
  • Our sample also provides evidence of ongoing fluctuation in the use of proxy puts. For instance, four of the five agreements signed since Healthways contain a continuing director clause.
  • A significant majority (81%) of loans over $4 billion have a continuing director clause, suggesting a potential correlation between the size of the loan and the presence of a proxy put.
  • Among the three most active administrative agents, agreements with JPMorgan Chase Bank, N.A. as administrative agent are most likely to contain a continuing director clause (64%), contrasted with 54% for Bank of America, N.A., and 55% for Citibank, N.A.
  • Dead hand proxy puts are rare, appearing in 9% of all S&P 100 credit agreements, and 8% of S&P 100 agreements over $4 billion. In our sample, use of dead hand clauses remained steady between 2012 and 2014. We found no evidence that Amylin, Kallick or Healthways had an impact on their use.

A further review, of a larger body of credit agreements with dead hand proxy puts signed in the months of November and December 2012, 2013, and 2014, reinforced the findings that most administrative agents use dead hand clauses sparingly and their use of such clauses is not declining. Most administrative agents employed dead hand clauses at the same rate during that period. We observed a decline among administrative agents for whom the use of dead hand clauses was more routine. Bank of America, N.A., for example, entered into 15 dead hand agreements in November and December of 2012, 16 in 2013, but only five in 2014.

Further Resources

Legal Update, Pontiac GERS v. Ballantine: Chancery Court Declines to Dismiss Claims Against Board and Lenders Based on Loan Agreement Proxy Put

Legal Update, Kallick v. SandRidge Energy: Delaware Court of Chancery Finds Board Likely Breached Fiduciary Duty by Failing to Approve Dissident Nominees 

Legal Update, DE Supreme Court Affirms Chancery Court’s Decision in Amylin “Proxy Put” Dispute

Legal Update, DE Chancery Court Interprets Poison Put Provisions in an Indenture

Standard Clause, Loan Agreement: Change of Control Event of Default

Practice Note, Loan Agreement: Events of Default

Business Law Center Trending Topic Search, Dead Hand Proxy Puts in Credit Agreements

Article, Lenders Beware: After Kallick, are Proxy Puts Worth the Paper They’re Written On?

Shark Repellants in Debt Instruments, (Fleischer, Takeover Defense: Mergers and Acquisitions (Wolters Kluwer/Aspen, 7th Ed., 2015))

Poison pills and poison proxy puts, (Rachelson, Corporate Acquisitions, Mergers and Divestitures (Thomson Reuters, 2015))