Alea iacta est

Boards often settle actual or threatened proxy fights by trading away board seats to activists. Delaware courts will analyze this trade as a defensive device, much like greenmail, where the board trades away something valuable to avoid a battle for corporate control.  It follows that, like greenmail or a poison pill, this defensive device would be subject to scrutiny under the Unocal standard[1].  Yet boards in general seem to be remarkably lax in analyzing whether they have fulfilled their fiduciary duties in making such a trade. Below are questions boards should be able to answer before awarding partial control of their company to an activist.

Duty of Loyalty

To survive the enhanced scrutiny of Unocal, the board bears the burden of proving that it has identified a threat to corporate policy and effectiveness, that its motivation in implementing the defensive measure is “proper and not selfish or disloyal” and that the defensive measure is reasonable in relation to the threat identified.[2]

I. Has the board identified a cognizable threat?

What the company typically gets in return for trading away board seats is, at best, avoiding any further cost and distraction from a proxy fight, a short standstill commitment, a say in who steps off the board and a say in who gets added to the board.  It follows that the “threat” neutralized by this trade is (i) the short-term threat of continued expense and distraction, and (ii) the longer-term threat that, if elected by stockholders, the activist’s original nominees may disrupt the agenda and priorities of the board to a greater extent than nominees appointed in the settlement.

At the point when settlement is reached, the board should have a very well-developed idea of exactly just how distracting and expensive a proxy fight will be. This defines the short-term threat. Before turning over board seats to avoid this cost and distraction, the board should also determine whether the cost and distraction, by itself, rises to the level of an actual “threat to corporate policy and effectiveness,” or if it is merely an expensive nuisance.[3]

The board can test its determination on this point by asking whether it would be willing to suffer the short-term cost and distraction if it were certain that management would win the proxy contest.  If the answer is yes, this may indicate that the board is motivated not by the short-term threat of distraction, but rather by the longer-term threat of having the board’s agenda and priorities disrupted by activist directors.  It is an important question, as this longer-term threat will be more fundamental to the company’s future, but may be harder to justify as a cognizable threat under Unocal.

Then Vice Chancellor McCormick in Williams Companies Stockholder Litigation observed that “there is room to disagree” as to whether an activist seeking short-term profit or threatening disruption to corporate plans could be deemed a cognizable threat under Delaware law.[4]  She also noted that “directors cannot justify their actions by arguing that ‘without their intervention, the stockholders would vote erroneously out of ignorance or mistaken belief’ in an uncoerced, fully informed election.”[5] Taken together, it is unclear that (now Chancellor) McCormick would agree that  an activist winning a proxy fight and imposing short-term or otherwise wrong-headed priorities is a cognizable threat justifying the transfer of board seats to an activist.

In light of the Williams Companies case, the best the board can do is to agree on exactly what long-term “cognizable threat” they are seeking to neutralize – identifying any activist plans or proposals they view as value destructive, excessively short-term, or otherwise ill-conceived or under-developed, identifying shortfalls in the quality of any nominees floated by the activist and articulating exactly how the activist’s plans present a “specific and on-going threat”[6] to corporate policy and effectiveness.  The Delaware Chancery Court may still take the position that a settlement thwarts the stockholder franchise by taking a decision about the corporation’s direction out of the hands of stockholders, but the board will at least have identified the good faith aims of the settlement in a clear and comprehensive manner, making it less likely that the court will give credence to any allegations that the board acted “solely or primarily out of a desire to perpetuate themselves in office.”[7]

II. Is giving away board seats reasonable in relation to the identified threat?

Giving away board seats in settlement is a partial surrender of control to the activist.  As common as it may seem, this is far from a minor concession.  It gives the activist access to decision-makers and influence over corporate policy far beyond that of any similarly situated stockholders.  It gives the activist at least some ability to drive or destroy value at the corporation, with consequences for all stockholders.  The stockholders have elected the current board, and presumably wanted the current board to manage the corporation.  So when is it reasonable for the board to avoid a proxy fight by appointing activist representatives to the board?

If the identified threat is simply that of cost and distraction, and the corporation is convinced that it will lose the proxy fight, then it would seem reasonable to give away the board seats that would have been lost anyway, especially as the activist will typically concede a short standstill as part of the settlement and may make concessions over other important matters such as the number and/or identity of its appointees and whether any current board members will need to step down.

However, if the identified threat includes the longer-term threat that the activist’s agenda will destroy long-term value at the corporation, query whether appointing the activist’s directors to the board (without a stockholder vote) is a reasonable defense to that longer-term threat.  If the activist is pushing for an immediate sale, will appointing the activist’s nominees to the board (and, as has been the case in a number of settlements, establishing a “strategic alternatives committee” staffed in part by the activist’s nominees) advance the goal of defending against what the board views as an untimely sale?[8]  Is it sufficient for the board to say that appointing the activist’s nominees in settlement permits the board to fight another day?[9] Or should the decision to add activist directors, putting at risk the board’s strategic agenda, more properly be made by stockholders?[10]

These questions become particularly acute where the activist’s nominees are “dual fiduciaries”—owing duties both directly to the activist (who may “espouse short-term investment strategies and structure their affairs to benefit economically from those strategies”) as well as to the entire shareholding base of the corporation (which presumably will include long-term indexed institutional investors).[11]  In such a case, will appointing a dual fiduciary, potentially embedding a conflict at the board without stockholder consent and tilting the playing field in favor of the subset of stockholders aligned with the activist, itself be deemed a breach of the duty of loyalty? Will subsequently acquiescing to the objectives of the activist be deemed to be a case where the board breached its duty of loyalty by allowing “a conflicted fiduciary . . . [to] tilt the . . . process toward his own personal interests in ways inconsistent with maximizing stockholder value?”[12]  These are questions best asked before the settlement is entered into.

Duty of Care

Directors have a duty to inform themselves, prior to making a business decision, of all material information reasonably available to them.[13]  In the context of appointing an activist’s candidate to the board, this information will include detailed information about the conflicts and allegiances of the candidate and the plans, proposals and agenda of both the nominee and the activist.  Questions asked should include those below.

I. Is the nominee truly independent of the activist?

Financial, Professional and Personal Independence. In appointing activist nominees to the board, a critical inquiry will be whether the nominees are fully independent of the activist, or whether the nominees will view themselves as working for, owing duties to or otherwise being aligned with the activist.  Often, activist nominees are described as “independent” in press releases after their appointment, but these press releases typically fail to define what is meant by “independent” beyond perhaps noting the lack of a current employment relationship between the activist and nominee.

But an employment relationship is far from the only type of relationship evaluated by Delaware courts in determining the independence of directors.  Accordingly, beyond asking whether any particular nominee is an employee, officer, partner, director or co-investor of the activist, the board should inquire as to whether any nominee has a “golden handcuffs” type of arrangement, whereby the nominee will rely on the activist for compensation or receive bonus payments based on specified results.  The board should understand whether the activist has paid for the professional services of the nominee, has appointed the nominee to other board seats or has other financial, familial or close social ties to the nominee.[14]  Failure to understand whether the nominee is in fact independent of the activist would be a fairly significant omission for a board deciding to reshape itself precisely in order to fend off a perceived threat from the activist.

Substantive Alignment. Understanding the degree of substantive alignment between the activist and the nominee will allow the board to better judge whether the nominee has been selected to advocate at the board for a pre-determined agenda, or whether the nominee will come to the board with an open mind.  The board should ask whether the activist and nominee have had substantive conversations regarding the operation, strategy or management of the target company, or have reached an understanding between themselves regarding, e.g., the quality of management, or operational, investment or strategic initiatives.  The content of such conversations will be at least as important to the board as to the activist.  If the nominee has been vetted by the activist for shared views, the board should have some idea of those views before bringing the nominee on to the board.

To take an easy case, if the activist and its nominees are unified in seeking to press for, e.g., a sale of the company in which the activist will be a bidder, or for a PIPE investment by the activist, the board may well decide that appointing board nominees determined to impose a conflict transaction on the company will not improve the functioning of the board.  It certainly would be something the board should take into consideration.

A more nuanced case is presented when, for example, the activist and its nominees have aligned on an agenda that includes cutting R&D expenses in favor of an immediate large dividend—a course which the board strongly believes would be detrimental to the long-term value of the company.  Here, there may be a “horizontal conflict” between what is best for short-term stockholders and what is best for long-term holders.  The board will want to consider whether short-term holders deserve a dedicated representative, especially given that “Delaware law has consistently rejected the concept of so called ‘constituency directors[.]’”[15]  If the board believes that creating a board consisting of captured representatives from different stockholder constituencies is too difficult to balance or otherwise problematic, the board may want to insist on appointing only nominees who are unaligned with any particular group of stockholders on agenda.[16]

Ongoing Communications. Delaware common law provides an exception to a director’s duty of confidentiality “when it is understood that the director acts as the stockholder’s representative.”[17] This exception, if available to the activist, would allow unfettered communications between the activist and the appointed directors, giving the activist access to confidential board deliberations and the opportunity to press its nominees to adopt the activist’s preferred position on topics of importance to all stockholders.  The activist’s nominees may even be expected to present to the board analyses prepared by the activist.  Beyond considering the effect that this exception will have on candid board deliberations, the board may wish to consider exactly what it means for a director to “act as the stockholder’s representative” on the board.  The board should also consider whether the “understanding” that a public company director will act as the activist’s representative is properly based on an “understanding” between the activist and the board in a settlement agreement, or whether stockholders need to acquiesce to this understanding by voting for the nominees with the express understanding that this representative relationship will exist.[18]

II. What is the activist’s agenda?

Plans, Proposals and Analyses.  Most critical to fulfilling the board’s duty of care is understanding the plans and proposals the activist is advocating before appointing nominees who may have a vested interest in executing on those plans and proposals.  Has the activist actually disclosed its plans, or is it simply running on a campaign to remove management, with no explicit plan as to what happens after management is ousted?  Are threats to management designed simply to cause management to acquiesce to a particular course of action (like a sale or buyback)?  In other words, does the board genuinely understand the ultimate goals of the activist?[19]

Understanding the activist’s ultimate goals requires taking into account the activist’s overall investment commitments and strategy.  Does the activist have a short-term investment horizon, making it less supportive of (or even hostile to) longer-term initiatives?  Has the activist hedged its downside exposure, making it more open to pursuing riskier strategies than may be welcomed by stockholders holding unhedged shares and with a longer investment timeline?  Does the activist hold any short positions in the company’s stock?  What is the activist’s cost basis?  Answering these straightforward factual questions can give the board insight into the consistency of the activist’s stated goals and its investment incentives.

Having understood the activist’s plans and proposals, the board can judge whether those plans and proposals present a threat to long-term corporate interests.  Have similar plans and proposals been considered by the board but dismissed as unworkable or unlikely to produce long-term benefits? Has the activist shared well-thought through analyses of its plans, or do its plans seem underdeveloped or ill-conceived?  If the latter, will appointing a representative of the proponent of an ill-conceived business plan be deemed a reasonable response to the threat to corporate efficacy posed by the proxy fight?  Does appointing the activist’s nominees amount to an admission that the activist’s plans are well-thought through and at least potentially accretive?

Duty of Disclosure

Disclosure of activist settlements often disappoints, in that little, if anything, is said of what the settlement means for the company.  Most typically, stockholders are treated to nothing more than (i) a perfunctory description of the terms of the settlement agreement (how many board seats have been given away and for how long, whether a committee has been formed to examine strategic alternatives, the terms of the activist’s standstill, etc.) and (ii) a brief description of the nominees’ professional qualifications.  Very little is said of the nominees’ independence, beyond perhaps a statement of whether the nominees are employed by the activist.  Occasionally, the nominees are “players to be named later”, which only deepens the mystery of what the settlement indicates for the future direction of the company.

In order for stockholders to understand what the settlement means for the company going forward, much more robust disclosure is called for—starting with clear disclosure of the judgments made by the board in discharging its fiduciary duties.  Especially pertinent—just what is gained by the company from the settlement, what threat is being neutralized and why is giving board seats to the activist’s nominees is a superior course to allowing stockholders to decide the composition of the board?

An Inflection Point

Not every activist appointee is a dual fiduciary or has a fixed substantive agenda. But adding conflicted board members who will promote a fixed strategic agenda fundamentally alters the corporate governance dynamics of a company. Moreover, such additions are often (explicitly or not) designed to, and do, set the company on a new and different course in terms of its management, investment or operational strategy, or even in terms of its existence as an independent operating company. Given the importance of a decision to collaborate with an activist, board conduct at this particular inflection point requires careful attention to the fundamental duties of loyalty and care. Focusing on these duties only when the merits of, e.g., a particular sale transaction are being evaluated may miss a prior, potentially more important decision implicit in appointing activist directors to the board – the decision to pursue a sale transaction (or, more colloquially, the decision to “explore strategic alternatives”). Once activist directors have been appointed to the board, query whether the die is cast.

[1] Settlement of a proxy fight would seem to necessarily to involve the stockholder franchise, and, accordingly, be subject to review under Blasius.  However, Blasius review has recently been “folded into Unocal review to achieve the same ends.” Coster v. UIP Companies, Inc., No. 163, 2022, 2023 WL 4239581, at *11 (Del. June 28, 2023).

[2] Id. at *12.

[3] Unocal Corp. v. Mesa Petroleum Co., 493 A.2d 946, 955 (Del. 1985) (quoting Bennett v. Propp, Del. Sup. Ct., 187 A.2d 405, 409 (1962)).

[4] Williams Companies S’holder Litig., No. CV 2020-0707-KSJM, 2021 WL 754593, at *33 (Del. Ch. Feb. 26, 2021). Chancellor McCormick quoted arguments to the effect that concerns regarding short-termism boiled to down to the illegitimate concern that stockholders will “cast votes in a mistaken assessment of their own best interests.” Id. (quoting Marcel Kahan & Edward Rock, Anti-Activist Poison Pills, 99 B.U. L. Rev. 915, 931 (201)), But it is an interesting question as to whether the board can take actions that will prevent short-term investors with a temporary majority from disrupting plans to protect the viability of the company as a long-term investment – at least until the board is voted out of office. Airgas  would seem to answer that question in the affirmative. Air Products v. Airgas, 16 A.3d 48 (Del. Ch. 2011)

[5] Id. at *30 (quoting Pell v. Kill, 135 A.3d 764, 788 (Del. Ch. 2016)).

[6] Id. at *31 (noting that the hypothetical threat of activism is not sufficient to pass muster as a “threat” recognized by Unocal).

[7] Unocal Corp. at 955.

[8] The board should also ask itself what happens if it loses the fight after appointing activist directors. In In re PLX Tech. Inc. S’holders Litig., an activist succeeded in electing three directors (of a board of eight) through a proxy fight. See generally In re PLX Tech. Inc. S’holders Litig., 2018 WL 5018535, (Del. Ch. Oct. 16, 2018)).  The activist had been advocating in favor of a sale proposal, which the legacy board strongly opposed.  See id.  Once seated, however, the board reversed course, forming a special committee and appointing a representative of the activist to head the committee. See id.  Subsequently, in a lawsuit over the sale of the company, the court found that these facts supported a reasonable inference that “activist pressure” caused the directors to breach their duty of loyalty. Id. at *45.

[9] There is also a question under Unocal as to whether the defensive device is “coercive or preclusive.”  Coster at *8 (citing Unitrin, Inc. v. Am. Gen. Corp., 651 A.2d 1361, 1367 (Del. 1995)).  If the settlement is reached in order to avoid the consequences of losing a proxy fight, it seems self-evident that the primary purpose of the settlement is to preclude the vote.  The twist of course is that the settlement is reached with the stockholder that is  challenging  the board.  While stockholders in general are precluded from voting, the activist is not precluded from carrying out its plans—those plans are in fact facilitated.

[10] It would be logical to assume that all of the many advocates of shareholder primacy, who have waged a long and continuing campaign to strip corporate structural defenses, would prefer to exercise their vote than to have the board settle.  However, one might be forgiven for occasionally getting the sense that at least some long-term shareholders would prefer for the board to “work it out” on its own with the activist. It points to the burden on shareholders that is created when required to make individual decisions on the strategic direction of one of their many portfolio companies, and the burden on boards that is created when left without active and vocal support from long-term stockholders in facing down an activist. Making clear early in an activist campaign their support for management requires a dedication of resources and responsiveness by long-term holders that is not always available. Yet ISS’s positions, followed by many long-term holders, on reimbursement of dissident proxy fight expenses, actions by written consent, and the ability of stockholders to call special meetings, will only increase these burdens.

[11] In re PLX Tech. Inc. S’holders Litig. at *41 (citing Glob. GT LP v. Golden Telecom, Inc., 993 A.2d 497, 508–09 (Del. Ch. 2010)).

[12] In re Mindbody, Inc. S’holders Litig., C.A. No. 2019-0442-KSJM (Del. Ch. Mar. 15, revised Mar. 21, 2023).

[13] Aaronson v. Lewis, 473 A.2d 805, 812 (Del 1984).

[14] See Goldstein at 108 (the practice by activists of making repeat appointments to boards of target companies need to be considered in judging the independence of a director from the activist that appointed the director).

[15] J. Travis Laster & John Mark Zeberkiewicz, The Rights and Duties of Blockholder Directors, 70 Bus. Law 33, 48 (2015).

[16] On a more practical level, the board may wish to consider whether electing a one-note johnny promises anything other than constant disruption.

[17]  Kalisman v. Friedman, 2013 WL 1668205, at *6 (Del. Ch. Apr. 17, 2013).

[18] Neil Whoriskey, Milbank Discusses Universal Proxy and “Horizontal” Conflicts, The CLS Blue Sky Blog at *6 (May 10, 2023),

[19] If the plans and proposals of the activist are unclear or obscured, it seems unlikely that the stockholders will be headed to an “uncoerced and fully informed election”—which perversely may be a sufficient threat to justify a settlement.  In re Merge Healthcare Inc. Stockholders Litigation, No. 11388-VCG (Del. Ch. Ct. January 30, 2017).  It would be galling to give away board seats to an activist precisely because the activist has not made its agenda sufficiently clear.