An Antidote for Poison Puts: a Eulogy for a Management Entrenchment Device

David Hudson, Emory University

Abstract

Poison puts are a type of event risk covenant commonly found in financing agreements. Lenders, both as bondholders and banks, utilize this provision as one layer of protection. However, poison puts can also be utilized to entrench a corporation’s management. The provision grew in popularity with the growth of the leveraged buyout boom of the 1980’s, but was frequently ignored during the subsequent economic growth period and merger activity that accompanied it. With the recent collapse in credit markets, companies and shareholders have challenged the provision’s interpretation and enforceability. These challenges have come in tandem with lenders taking more aggressive positions alleging the triggering of the provision. As both lenders and shareholders vie for more influence over management in formulating corporate policy, scholars have focused attention on the dynamics between these groups. Poison puts provisions are one front in this war over control.

This Comment examines recent litigation regarding poison puts. It distinguishes poison puts that are triggered through proxy contests from standard poison puts. This Comment argues that standard poison puts, drafted in their current form, do not provide either substantive protection to lenders or entrenchment benefits to management. Re-drafting standard poison puts to preserve entrenchment benefits will not correct current deficiencies without raising the same problem as proxy poison puts–thwarting the shareholder franchise. This Comment proposes a framework within Delaware corporate law, for evaluating whether proxy poison puts are enforceable so lenders can achieve similar levels of protection without constraining shareholder democracy. If the market values bonds with poison puts, then removing the ‘continuing director’ clause also achieves this goal.