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Yahoo’s Tin Parachute

Gordon Smith on the latest developments in the Yahoo takeover fight:

Even as Yahoo and Microsoft try to hammer out a deal over a round of golf and Carl Icahn clears the way to acquire more shares, the Yahoo shareholders litigation plows forward in Delaware. Chancellor Chandler unsealed the plaintiffs’ amended complaint this morning, giving us a lot more detail about the severance plan that we have had to date. (You can find all of the litigation documents on the website of BLB&G.) This is suddenly a lot more interesting case than it was two weeks ago.

At that time, I ventured the following opinion about the plaintiffs’ case: "The claims raised in the shareholder litigation are not viable." In response to Steve Bainbridge’s comment and post on the possibility of Unocal review based on Yahoo’s "threatened" deal with Google, I noted: "The short response to your comment is that there is no Google maneuver, yet. The two sides have been talking, but that seems pretty far from a ‘defensive action’ for purposes of Unocal." I continued, "Other than the severance agreements with Yahoo officers (perhaps), I don’t see anything that Yahoo has done that looks like a defensive action."

Well, the plaintiffs are still arguing about the threatened Google transaction, and I still think that argument is a loser, but the real traction comes from the claims about Yahoo’s severance plan. This is something I have never seen before, and I don’t think we have a clear answer from the courts on this issue. The new complaint makes the plan look like a defensive measure, and this will trigger Unocal review. But the plan does not seem to be either preclusive or coercive, as defined in Unitrin, which leaves the court to decide whether it falls within the "range of reasonableness." Plaintiffs do not have a great batting average against the "range of reasonableness," but this plan is pushing the envelope.

The first thing you should know about the plan is that it covers 100% of Yahoo’s employees. When this proposal was initially disclosed to Tim Sparks, president of Compensia, an outside compensation firm hired by Yahoo, he responded via email, "That’s nuts." Uh, yeah.

The second thing to notice is the potential costs of the plan. Of course, the fact that it covers all of Yahoo’s employees is still a key fact, but also note two things: (1) the size of the benefits, and (2) the breadth of the trigger. The benefits include immediate 100% acceleration of all outstanding equity rights as well as a cash payment, and those benefits are triggered not only by involuntary termination of employment, but also by voluntary termination "for good reason." According to the plan, Yahoo employees have good reason to terminate their employment whenever they are subject to a "substantial adverse alteration" in their duties or responsibilities. The plaintiffs argue that the court should consider the costs of the plan at 100% reduction in force, which seems a bit much, but that would place the costs north of $2 billion. Even at lower amounts, the plan would cost hundreds of millions.

In Minstar Acquiring Corp. v. AMF Inc., 621 F.Supp. 1252 (SDNY 1985), AMF established a “Severance Allowance Plan” providing for an increase in the severance allowance for certain salaried employees on the corporate staff. The Plan doubled AMF’s prior formula of 1 1/2 weeks base pay for each year of completed service. The Plan would become effective only in the event of any involuntary termination during the two year period following a “change in control.” Interpreting New Jersey law, but also citing a lot of Delaware cases, the court held that:

… we find the case of Norlin Corp. v. Rooney Pace Inc., 744 F.2d 255 (2d Cir.1984) to be very instructive. In Norlin the Second Circuit raised a “strong inference that the purpose of [the challenged acts] was not to benefit the employees but rather to solidify management’s control ...” 744 F.2d at 265, thus the burden was shifted to the directors to show that the transaction was fair and reasonable. Id., citing Johnson v. Trueblood (Rosenn J. concurring and dissenting).

Under the facts of this case we believe that at least as strong an inference is raised. This inference is based upon the fact that the severance benefits, like the other defensive tactics, are triggered only by the change in control. Minstar points out that AMF has already announced a long term plan which calls for substantial staff reductions in some areas. Thus, an employee who is to be terminated pursuant to the Plan, will receive twice as many severance benefits, if Minstar takes over, even though the decision to terminate him was already made by the present AMF board. AMF claims the changes are “prudent steps designed for the most part to safeguard rights and benefits already earned by and owed to AMF employees” (defendants’ memorandum at 42). It goes on to argue that the increases were made to bring AMF in line with “severance plans in effect at other companies.” Id. at 44. If this was in fact the true justification then conditioning the program on a change in control would be unnecessary.

In Tate & Lyle PLC v. Staley Continental, Inc., 1988 WL 46064 (Del.Ch. 1988), the court noted that Staley had, among other defenses, adopted a tin parachute providing “that upon an employee’s termination, even for good cause, the employee shall receive the greater of: (1) one month’s pay for each year of employment; or (2) one month’s pay for each $10,000 of annual pay. In total, the tin parachutes could cost Staley at least $3,490,000.” (Emphasis supplied.) The fact that the severance would be paid even if the employee was terminated for cause seems even more questionable that the walk away provision in the Yahoo tin parachute. The court held that:

The compensation packages, consisting of the golden and tin parachutes and the tax gross-ups, however, were each proposed and unanimously approved by an outside directors Committee. Compensation decisions are generally the sole prerogative of the directors. Beard v. Elster, Del.Supr., 160 A.2d 731 (1960). Even when a compensation decision directly benefits directors, if the **432 decision is approved by a committee of disinterested directors, it is afforded the protection of the business judgment rule. Puma v. Marriott, supra.

The Compensation Committee, made up of all the outside directors, unanimously approved the compensation plans. Although the tax gross up provisions are particularly troublesome, as is the totality of the parachute benefits, the defendants seem to have shown that the plans were adopted in a good faith response to possible future hostile tender offer advances and that the directors were not misinformed or uninformed and were not grossly negligent in adopting the plan. Therefore, under the rule in Moran v. Household International, Inc., Del.Supr., 500 A.2d 1346 (1985), the defendants have shown the reasonable probability that the directors’ action in adopting the plans is immune from further judicial scrutiny pursuant to the business judgment rule.

As for that problematic trigger, HR.com tells us that:

Generally, certain events must occur prior to the payment of change-in-control benefits, says Howard Golden, a senior executive compensation consultant in Mercer´s New York office. Benefits may be “triggered” by the change in control itself or by certain actions on the part of either the company or the executive. These triggers typically fall into one of three categories:

Single trigger. Benefit becomes payable automatically upon a change in control or upon a voluntary termination by the executive for any reason within a specified time period following the change in control. Only 3.8% of parachute plans today have such a trigger, compared to 15.8% in 1997, Mercer´s study shows.

Double trigger. Benefits become payable after both a change in control and the subsequent termination of the executive´s employment, either by the company without “cause” or by the executive for “good reason” (i.e., a “constructive termination"). More than two-thirds of the companies (68.4%) had this type of trigger in 2000 - a number that´s remained relatively stable in recent years.

Modified single trigger. Benefits become payable subject to a double trigger. In addition, the executive may voluntarily terminate employment for any reason during a specified “window period” (typically the 30-day period following the one-year anniversary of the change in control). More than a quarter of the companies (27.8%) had this trigger method in 2000, up from 16.3% in 1997.

Apparently, these sort of walk away provisions are fairly common, at least in golden and silver parachutes.

All told, my guess is that unless the size of the benefits is so huge as to be deemed preclusive under Unitrin, that these arrangements will survive Unocal review.

In analyzing the question of whether the tin parachute would be preclusive, we might analogize that question to judicial review of a termination fee. A termination fee of 3% of enterprise value would seem quite reasonable. A termination fee of, say, 100% of enterprise value likely would be deemed be preclusive. (See this review.)