It has something for everyone, mostly for lawyers and corp gov junkies. We find a couple of nuggets for plain old investors, mostly related to how to pursue proxy contests.

Most of all, Delaware will allow BoDs to use a poison pill based on only a relatively slight threat that an investor will seek control without paying a control premium. So, wise investors will remove all sign of those threats - don’t even think about control, and certainly don’t write it down anywhere.

The Delaware court defines control even in a “negative” way. It allows the Sotheby’s BoD to implement a poison pill that prevents Third Point from gaining some sort of veto power over the company, and posits that a 20% shareholding would allow that veto power.

All investors should read the decision, especially the first 30 pages. It narrates a fascinating case study of egotistic investors, stubborn executives, and an obtuse BoD. For some interesting (and slightly technical) detail, read blog posts by John Coffee and Gilson and Gordon

Relevant Background (Which You Can Skip if You Know the Case)

In response to Third Point’s launching a proxy contest, Sotheby’s approved a poison pill with a two key features:

1. ❖two-tier, so activist investors (Form 13(d) filers) trigger the pill at 10% of shares, and passive ones (Form 13(g) filers) trigger it at 20%
   

2. ❖allows a “qualifying offer”, so any investor can buy the entire company, subject to a 100 day period in which the company can seek other bids
   

These features, along with some other technical detail, indicate that the BoD feared “creeping control”. It perceived that Third Point, either alone or with other investors, would gradually accumulate enough shares that they would gain effective control over the company, without paying a control premium.

Third Point sued Sotheby’s over the legitimacy of the poison pill. The decision, issued a couple of weeks ago, takes Sotheby’s side.

What Delaware Decided

All poison pill cases mediate between two opposite reasons for having the pill:

1. 1.Defend investors from “bad” takeover bids - at worst, coercive ones that prey on naive shareholders; at best, subtle ones in which the investor seeks control over the company without paying a control premium
   

2. 2.Entrench the BoD and executives by interfering with corporate elections.
   

Delaware courts generally allow 1. and frown on 2. Many BoDs pursue 2. in the guise of 1. And, it can become difficult to distinguish between the two.

Third Point accused Sotheby’s of pursuing 2., claiming it had no interest any sort of control. It showed how it had not pursued anything like that in its portfolio companies.

Sotheby’s suspected Third Point of 1., and had some evidence that Third Point wanted control. Discovery uncovered internal Third Point documents that referred to taking Sotheby’s private, among other tactics.

The Delaware court concluded that Third Point represented enough of a threat to gain control of Sotheby’s. This threat extended to capturing enough shares, either by itself or with other investors, that it could control the company by vetoing important decisions (the “negative control” idea). This threat, then, could merit the poison pill response.

What the Decision Means for PMs

Delaware doesn’t need very much or very good evidence to support BoDs. The decision concludes that Sotheby’s responded properly to Third Point (1. above):

1. [When the BoD adopted the poison pill] several hedge funds accumulat[ed] its stock simultaneously, and ... the accumulation [occurred rapidly]. ... BoD [advisors] also ... informed [the BoD] that it was not uncommon for activist hedge funds to form a group or ‘wolfpack’ for the purpose of jointly acquiring large blocks of a target company‘s stock. Based on these facts, and the profiles of Third Point and Marcato presented to the Board in materials prepared by its financial and legal advisors, I ... conclude that ... the Board [made a] ... reasonable determination that Third Point posed a threat of forming a control block for Sotheby‘s with other hedge funds without paying a control premium.
   

So, some observations from biased advisors, plus increasing share ownership by hedge funds, represents a control threat. Actual investor behavior has only something to do with it.

Two factors mitigate this situation. First, Third Point sought an injunction of Sotheby’s annual meeting. This required the Chancery Court to assess the likelihood of success of Third Point’s case in a full trial, in a sort of abbreviated hearing. A full trial might lead to a different outcome.

Second, Third Point won, or at least settled for most everything it wanted, including three BoD seats. So, the poison pill didn’t limit its opportunity too greatly.

We’re waiting to see who litigates a poison pill next.