Carmody v. Toll Brothers, Inc.
The controversial "deadhand" version of the poison pill takeover defense may be dead after the first Delaware judge to rule on the issue allowed shareholders of Toll Brothers, Inc. to proceed with their claim that this tactic takes away their right to vote directors out of power. Carmody v. Toll Brothers, Inc. et al, No. 15983 (DE Ch. Ct., July 24, 1998).
Although it was only a decision denying the company's move to dismiss the suit from Delaware Chancery Court, Vice Chancellor Jack Jacobs' July 24 ruling expressed grave doubts about whether deposed directors should control the powerful shareholder rights plan defenses.
Delaware courts have generally upheld poison pills -- which make unfriendly acquisitions nearly impossible by granting new shares of the target company to all shareholders except the hostile suitor -- because shareholders had the power to remove directors who used the pills in ways that did not benefit the company. But the "deadhand" provision appears to tip that balance of power by allowing only the incumbent board members to vote on when the pill should be deactivated.
Plaintiff attorney Jay Eisenhofer, with Grant & Eisenhofer in Wilmington, compared the deadhand pill to a statute that would allow a defeated incumbent president to make appointments in the cabinet of the new president. Since the majority of the nation's Fortune 500 companies are chartered in Delaware or in states that follow Delaware caselaw, the ruling is extremely significant to merger and acquisition attorneys.
Joseph Grundfest, a professor of law at Stanford University, said the ruling focuses on "the coercive nature of the deadhand provision and on its threat to the fundamental mechanism of corporate democracy."
James Carmody filed the suit in October of last year on behalf of shareholders of the Pennsylvania-based home construction business. The suit charges that the Toll directors breached their duty when they added the deadhand pill to their arsenal of defenses. Even though there is no known offer for Toll Brothers, the company is seen as attractive, and Carmody said the deadhand provision would unfairly allow the current board to control the rights plan -- and the company -- until the pill expires in 2007. Ruling on the company's motion to dismiss the suit, the vice chancellor said that in the seminal ruling on poison pills, the Delaware Supreme Court affirmed a Chancery Court decision which found that even the more potent version of the shareholder rights plan was legal Moran v. Household International, Inc., DE Ch., 490A.2d 1059, 1072, aff'd DE Sup., 500 A.2d 1346 ). The linchpin of those decisions was that the poison pill did not completely preclude an offer that the board did not like because the shareholders could remove the directors through a proxy vote or sue them for breach of duty.
Editor's Note: If the Delaware Chancery Court threw out a suit challenging a deadhand provision, it would undercut both of those pillars on which the poison pill stands.
Vice Chancellor Jacobs said in addition to the problem of shareholder disenfranchisement, the deadhand created the potential problem of setting up two classes of directors; i.e. incumbent board members who were voted out would have a vote on redeeming the poison pill but their replacements would not. "Vesting the pill redemption power exclusively in the continuing directors transgresses the statutorily protected shareholder right to elect the directors who would be so empowered," he wrote.
The vice chancellor's ruling sided with the reasoning in Bank of New York v. Irving Bank Corp., NY Sup. Ct., 139 Mis. 2d 665, 528, N.Y.S. 2d 482 (1988); see Corporate Officers & Directors LR, Oct. 12, 1988, P. 4,809. That was one of the only two decisions on the deadhand provision to date.
He said the only other ruling on the issue -- a decision by a federal judge in Georgia which upheld a deadhand provision by the directors of Healthdyne Technologies Inc. -- is too different to support the board here. He said that case was based on Georgia corporate law, which provides significantly greater latitude to directors of companies chartered in that state Invacare Corp. v. Healthdyne Technologies, Inc., No. 97-0205 [ND GA, July 3, 1997]; see Corporate Officers & Directors LR, July 9, 1998, P. 21,481.
Vice Chancellor Jacobs also found that plaintiffs need not wait until a hostile offer situation arises because the deadhand pill could have a current adverse impact on the company's viability as an acquisition prospect.
The court also rejected the company's argument that the deadhand provision is the same as delegating a function to a special committee.
He noted that the Delaware courts have sometimes declined to endorse poison pills where the directors have manipulated the corporate machinery to deprive shareholders of an opportunity to vote -- such as where the board postpones a shareholder meeting for such a long period of time that the challenged deal would be history by then.
While the ruling is not final, it is seen as a warning shot to boards of Delaware-chartered companies, some of which have adopted similar measures.
Plaintiff is represented by Jay Eisenhofer, Cynthia Calder and Stuart Grant of Grant & Eisenhofer in Wilmington.
Defendants are represented by David Margules and Barry Klayman of Wolf, Block, Schorr & Solis-Cohen in Wilmington.
(Call 800-345-1101 for a copy of the 38-page opinion. Copies of the briefs may also be obtained.)