Yucaipa American Alliance Fund II, L.P. v. Riggio, C.A. No. 5465-VCS (Del. Ch Aug. 11, 2010) (Vice Chancellor Strine) (Barnes & Noble decision)

In this post-trial opinion, the Court of Chancery held that the decision of the board of directors of Barnes & Noble, Inc. (“Barnes & Noble” or the “Company”) to adopt a rights plan (the “Rights Plan”) with a 20% threshold and a provision that  grandfathered the Company’s founder but limited his stake to its existing level was a reasonable response to a threat to Barnes & Noble and its stockholders.

Unhappy with the direction of Barnes & Noble, Ronald Burkle, through certain of his investment funds (“Yucaipa”), doubled his ownership interest in Barnes & Noble to nearly 18% over a 4-day period. In response, the Barnes & Noble board adopted the Rights Plan, which prevented a single stockholder or group of stockholders from accumulating more than 20% of the outstanding shares of the Company.  The Rights Plan exempted the Riggio family’s existing holdings (which totaled nearly 30%), but provided that any increase in the Riggio family’s ownership (with limited exceptions) would trigger the issuance of the rights. Yucaipa filed suit and claimed that the board breached its fiduciary duties by adopting the Rights Plan and by failing to amend it in accordance with Burkle’s request.

The Court first determined that five of the board’s nine directors were independent; the remaining four consisted of Barnes & Noble’s founder and chairman, Leonard Riggio, his brother Stephen Riggio, and two other directors alleged to have close ties to Leonard Riggio. Although the Court noted the board’s process when considering the Rights Plan was imperfect, the Court concluded that the independent directors who comprised the majority of the board had acted reasonably and in good faith to protect the Company and its stockholders and not to perpetuate Riggio as the largest stockholder or otherwise further his interests.

Yucaipa argued that the standard of review for evaluating whether the board’s adoption and amendment of the Rights Plan complied with its fiduciary duties should be either the entire fairness standard or the Blasius compelling justification standard. Yucaipa claimed that the entire fairness standard applied because Leonard Riggio, the Company’s largest stockholder, stood on both sides of the transaction. The Court rejected this argument because the Rights Plan prevented Riggio from increasing his stake and did not grant him any special benefit. The Court stated that the decision to grandfather an existing stockholder but limit him to his current ownership level would not invoke the entire fairness standard of review. The Court also noted that the business judgment standard would apply because an independent majority of directors had approved the Rights Plan. The Court held that the Blasius standard did not apply because it could not conclude that the board’s primary purpose was the disenfranchisement of the Company’s stockholders. The Court found that the board adopted the Rights Plan to protect the Company and its stockholders from the threat posed by Yucaipa’s rapid stock purchases and its stated intent in public disclosures to purchase up to 50% of the shares.

Describing the argument for a higher standard of review as “[s]eeking to reverse decades of settled law,” the Court held that the Unocal standard of review applied. Yucaipa attempted to distinguish the precedents holding that Unocal was the appropriate standard by arguing that the Rights Plan unfairly and unreasonably prevented it from forming a coalition to jointly run a proxy contest to elect new directors. The Court noted that it was not unprecedented for a rights plan to restrict the ability of stockholders owning more than 20% of the outstanding shares from forming a group to promote a joint slate of directors and held that such rights plans do not disenfranchise any stockholder in the sense of preventing them from freely voting or soliciting revocable proxies. The Court held that the Rights Plan did not prohibit Yucaipa from soliciting and receiving proxies during a proxy contest. 

The Court rejected Yucaipa’s argument that the Rights Plan’s definition of “beneficial ownership” was ambiguous and, therefore, unreasonable. The Court determined that the Rights Plan’s trigger was based on a well-recognized standard, which sophisticated investors such as Yucaipa must address regularly and which has been the subject of many judicial proceedings.

The Court emphasized that, even though the Blasius standard was not appropriate, the Unocal analysis required the Court to consider whether the Rights Plan unreasonably restricted the ability of stockholders to run a proxy contest. Vice Chancellor Strine noted that he did not espouse the view that rights plans are not preclusive if they merely provide “a mathematical or theoretical possibility of winning a proxy contest.” A rights plan could be deemed preclusive if it did not grant a proxy insurgent a “fair chance for victory.” The Court stated that, when a rights plan “both prevents a tender offer and unfairly tilts the electoral playing field against an insurgent, this court … should not hesitate to enjoin its operation.” The Court held that the Rights Plan did not unreasonably restrict Yucaipa’s ability to run a proxy contest.

Noting that Yucaipa abandoned its argument that the board did not reasonably believe Yucaipa’s actions posed a threat to the Company, the Court considered whether the adoption of the Rights Plan was reasonable in relation to the threat. Under Unocal, when a majority of independent directors adopt defensive measures, the proof of a board’s good faith generally is “materially enhanced.” The Court noted that it did not rely on this “material enhancement” feature in this case because Leonard Riggio and the directors allegedly affiliated with him participated in all board deliberations with respect to the Rights Plan and because there was a bare majority of independent directors. However, the Court was convinced that the independent directors acted loyally and in good faith.

The Court held that the Rights Plan was a proportional response to a legitimate threat to corporate policy by Yucaipa. The Court rejected Yucaipa’s contention that the Riggio family’s 30% stake made the Rights Plan’s 20% threshold unreasonable because it inhibited Yucaipa from running an effective proxy contest. The Court noted that Yucaipa likely could obtain half the necessary votes from one other stockholder, Aletheia Research and Management, Inc. (“Aletheia”), which had a history of shadowing Burkle’s investments and which had followed Yucaipa by increasing its ownership stake in Barnes & Noble from 6.37% to 17.44%.

Yucaipa also claimed the board’s failure to amend the Rights Plan to increase Yucaipa’s threshold to 37%, which would have permitted Yucaipa and Aletheia to jointly run a proxy contest, was not within the range of reasonable responses. The Court found that the board’s decision not to amend the Rights Plan was reasonable because the board had good cause for concern that Yucaipa and Aletheia would join to take effective control of Barnes & Noble.

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