By Liz Hoffman
Banks are being sued for loan provisions that can protect
corporate clients from boardroom attacks by hedge funds and hostile
bidders.
The lawsuits, filed on behalf of shareholders of corporate
borrowers, say the provisions--which require companies to repay
debt ahead of schedule if dissidents seize majority control of
their boards--entrench incumbent directors and discourage
dissidents whose arrival could benefit all investors.
The cases shine a light on corporate defenses of all stripes,
which are under scrutiny as hedge funds ramp up boardroom assaults
and hostile bidders seize on a hot merger market. The lawsuits
against Bank of America Corp., Wells Fargo & Co., Citigroup
Inc. and other banks in recent months also highlight a tug of war
between lenders and corporate borrowers that has intensified as
loan protections have eroded in recent years, market participants
said.
These clauses force companies to repay loans before they are due
if a majority of directors are ousted. They are ostensibly meant to
protect creditors, but their ability to shield embattled boards has
earned them the nickname "proxy puts," after the campaigns, known
as proxy fights, often waged by activists.
Nearly 200 companies have struck new loan agreements since the
beginning of 2014 with the provision, including drug maker Actavis
PLC and software provider Salesforce.com Inc., a review of
securities filings shows. Some advisers said banks push to include
it, wary that an activist coup could usher in debt-fueled buybacks,
dividends or other balance-sheet shake-ups that would erode credit
ratings.
"A few years ago, this wasn't necessarily front of mind for most
boards or lenders, but with the level of activism we're seeing
today, that has changed," said Kai Haakon Liekefett, head of the
shareholder-activism group of law firm Vinson & Elkins LLP.
Plaintiffs' lawyers have brought at least 10 lawsuits in recent
months against companies and their lenders. The suits, filed in
Delaware's special corporate court, said the arrangements
discourage would-be activists by threatening a forced refinancing
of the company's borrowings.
Gambling company MGM Resorts International and retailer HSN Inc.
are among the companies facing such lawsuits, and plaintiffs'
lawyers said they are looking closely at new credit agreements for
any that include a proxy put.
"Corporate boards and their advisers are using the threat of
massive debt default to punish shareholders for seeking to replace
directors," Mark Lebovitch, a lawyer for plaintiffs in several of
the lawsuits, said in an interview.
Delaware courts tend to be skeptical of defensive boardroom
tactics.
Last fall, a judge refused to dismiss claims that Healthways
Inc., a health and wellness company, harmed shareholders by
agreeing, in a loan from SunTrust Banks Inc., to repay its debt
should a majority of its board seats turn over. At the time, the
company was facing shareholder pressure to dismantle some corporate
defenses; shortly after, a hedge fund picked a fight for board
seats.
The judge in that case said the debt provision was "highly
suspect" and amounted to a "Sword of Damocles" hanging over
shareholders' heads. Particularly concerning, he said, was that
Healthways's board couldn't waive the provision for dissident
directors, even if it wanted to.
The specter of tighter judicial scrutiny has led some lenders
and companies to drop these provisions, advisers said. Healthways
and SunTrust agreed in February to take it out as part of a
settlement, up for court approval next month, that includes a fee
of as much as $1.2 million for the shareholders' lawyers. MGM has
agreed to do so, too, and is awaiting bank approval, court filings
show.
Bank of America, which advisers said had held tight to the
provision, in recent weeks began phasing it out of their credit
agreements, according to a person familiar with the matter.
But some banks are pushing back, advisers said. Lenders like the
certainty of knowing they can cash out if a company's leadership is
replaced.
"Certain lenders are pushing hard for the feature in light of
the current shareholder activism wave," Vinson & Elkins and
Goldman Sachs Group Inc. wrote in a February presentation.
Activist investors, whose assets under management have swelled
to more than $127 billion, according to researcher HFR, often urge
companies to sell slower-expanding businesses or borrow money to
pay dividends or buy back shares, all of which can divert cash
flow, ding credit ratings and unnerve debtholders. They have run
127 campaigns so far this year, the most since 2008, according to
FactSet.
"Creditors don't want to wake up one day and find out someone
else is driving the train," said Richard Farley, a finance partner
at law firm Paul Hastings LLP.
Darden Restaurants Inc., eBay Inc. and DuPont Co. are among
companies that have had their credit ratings downgraded or placed
on review in the wake of activist campaigns. "Shareholder activism
is rarely good news for credit investors," Moody's Investors
Service wrote in a report this month.
Mr. Lebovitch, a partner at Bernstein Litowitz Berger &
Grossmann LLP, said lenders can protect themselves in other ways,
like barring companies from taking on excessive debt or selling
assets without approval.
But those restrictions, known as covenants, are less common
these days and offer banks less protection than they once did, said
Alexander Dill of Moody's. In a recent survey, the credit-rating
firm found bonds today are far less likely to include limits on how
companies can borrow, use cash and structure new debt.
Write to Liz Hoffman at liz.hoffman@wsj.com
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