The “proxy put,” a common provision in debt agreements with publicly traded companies, has become a matter of increasing concern following recent opinions of the Delaware Chancery Court. The proxy put permits a lender to accelerate the debt of a borrower if a majority of the borrower’s board of directors is no longer comprised of continuing directors (i.e., directors who are either (i) the original board members from when the debt agreement was executed or (ii) directors who were approved by those original directors or their approved replacements). The “dead hand proxy put,” is a variation of the proxy put that provides for acceleration of the debt if a majority of the borrower’s board was elected pursuant to an actual or threatened proxy contest, regardless of whether such directors were approved by continuing directors. These provisions protect the lender’s interest in maintaining familiarity with a borrower and its business approach throughout the life of a debt instrument. Delaware courts have exercised increased scrutiny with respect to proxy puts due to the potential entrenchment effect that they offer boards. As a result, directors of Delaware corporations may face claims that they are in breach of their fiduciary duties to their stockholders in failing to approve a dissident slate of directors when the corporation is party to a debt agreement that includes a proxy put (Kallick v. SandRidge Energy, Inc., C.A. No. 8182-CS (Del. Ch. Mar. 8, 2013) or in even entering into a debt agreement containing a dead hand proxy put (General Employees Retirement Fund v. Healthways, Inc., C.A. No. 9789-VC transcript (Del. Ch. Oct. 14, 2014)). Additionally, the lender to a corporation may face potential liability for aiding and abetting the board’s breach of its fiduciary duties in negotiating an agreement that includes these provisions (Healthways).

Although no similar cases have been decided in Maryland, the Maryland courts may reach a different result from SandRidge and Healthways due to the difference in the standard of review utilized by Maryland courts for board conduct. In SandRidge, the board refused to approve a dissident slate of nominees, creating the concern that their election as non-continuing directors would trigger acceleration of the corporation’s debt under the proxy put in the debt agreement. The court utilized the Unocal intermediate standard of review to evaluate the board’s decision. Under this review, the board had the burden of proving that it was responding to a threat to the corporation and that its response was reasonable in relation to the threat posed (Unocal v. Mesa Petroleum Co., 493 A.2d 946 (Del.1985)). The SandRidge court rejected the board’s assertion that the dissident slate was less qualified due to a lack of experience in the corporation’s industry and with the corporation’s principal asset, ultimately ruling that such justification was insufficient to support the board’s decision to deny the approval of the dissident slate.

Maryland has explicitly rejected an intermediate standard of review. Section 2-405.1(f) of the Maryland General Corporation Law provides that in a change of control context, no greater scrutiny shall be applied to the action of directors. The Court of Appeals in Shenker v. Laureate Educ. Inc., 411 Md. 317, 427 n. 15 (2009) recognized this as a rejection of the Delaware heightened standard of review. Thus, under Maryland law, the actions of a board with respect to a proxy put would be subject to review under the statutory business judgment presumption. Under this review, a board’s decision not to approve what it believed to be a less qualified dissident slate, for example, would be presumed to be in the best interest of the corporation. In regards to the inclusion of a dead hand proxy put provision in a debt agreement, such board action would be presumed to be in the best interest of the corporation without requiring a showing that the corporation received an extraordinary financial benefit in return (as was required in Healthways). The stockholders would face a high bar to rebut the business judgment presumption by a showing of the lack of good faith or the absence of an informed basis for the decision.

Lastly, the increased scrutiny on proxy puts (and more specifically, the aiding and abetting claim against the lender that survived a motion to dismiss in Healthways) has created major concerns for lenders in negotiating debt agreements. Lenders to a Maryland corporation seemingly should be less concerned about aiding and abetting claims related to proxy puts. The application of the Maryland business judgment presumption imposes a greater burden upon a party claiming that directors breached their fiduciary duties in agreeing to debt instruments containing proxy puts or dead hand proxy puts than in Delaware. Without a finding of an underlying breach by the directors, a claimant likely would not be able to sustain an aiding and abetting claim against the corporation’s lender.

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