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Steven M. Davidoff, The Deal Professor, has an analysis of the proxy fight between William. A. Ackman’s Pershing Square Capital and Target Corporation (NYSE:TGT) in his NYTimes.com DealBook column, Target’s Challenge.  Pershing Square has fund dedicated to its investment in TGT, which Davidoff says controls 7.9% of the company through stock and call options. TGT has a staggered board with twelve directors, four of whom are up for reelection for this year’s meeting, which is scheduled for May 28. Pershing Square, claiming that TGT’s board really comprises thirteen members, has submitted a slate comprising five nominees.

Davidoff writes that Pershing Square’s claim of an extra member relates to Robert J. Ulrich’s resignation from the board in January this year:

Pershing contends that, under Target’s articles of incorporation, the board does not automatically shrink as a result of a resignation; rather, a vacancy is created – in this case, a vacancy for a 13th director to be elected this year.

Pershing bases its claim on Article VI of Target’s articles of incorporation. The article states that:

The business and affairs of the corporation shall be managed by or under the direction of a Board of Directors consisting of not less than five nor more than twenty-one persons, who need not be shareholders. The number of directors may be increased by the shareholders or Board of Directors or decreased by the shareholders from the number of directors on the Board of Directors immediately prior to the effective date of this Article VI; provided, however, that any change in the number of directors on the Board of Directors (including, without limitation, changes at annual meetings of shareholders) shall be approved by the affirmative vote of not less than seventy-five percent (75%) of the votes entitled to be cast by the holders of all then outstanding shares of Voting Stock (as defined in Article IV), voting together as a single class, unless such change shall have been approved by a majority of the entire Board of Directors.”

(emphasis added)

Pershing bases its argument on the italicized language, which states that only a 75 percent vote of the shareholders can reduce the size of the board. Target has disputed this claim, presumably relying instead upon the clause after the italicized language, which provides the power to the board to approve the change.

Target is claiming that the clause modifies the entire requirement for shareholder approval. In contrast, I presume that Pershing is claiming that this language modifies only the part about a 75 percent vote requirement, and otherwise a shareholder vote is mandatory. The ambiguity is certainly there, and given the penchant of courts to interpret articles and bylaws against the drafting companies and in favor of the shareholder franchise, Pershing has a viable claim. It would be more certain if Target were incorporated in Delaware, but it is actually incorporated in Minnesota.

Last week, Pershing offered to arbitrate the issue. Instead, Target has simply and rather cleverly put the matter to its shareholders in its proxy filed Monday. Target has ceded the issue to its shareholders, and asserted that because the change has been approved by a majority of the board of directors, it now only needs the affirmative vote of the majority of the outstanding shares of Target common stock voting at a meeting where the quorum requirement is met. Thus, Target has avoided an initial litigation skirmish that it had a real chance of losing, while appearing shareholder-friendly at the same time. A nice trick.

A nice trick indeed. It seems to us that the net effect of TGT’s fancy footwork is to reduce the threshold for the resolution to shrink the board from 75% of the votes entitled to be cast to a simple majority, which could have been their intention all along. As we’ve discussed recently in the context of the Biotechnology Value Fund (BVF) proxy fight for the board of Avigen Inc (NASDAQ:AVGN) (see our post archive here), achieving a supermajority is nigh on impossible. In BVF’s case it was two-thirds, rather than three-quarters, of the votes entitled to be cast. BVF was unable to get over the line, even at that slightly lower threshold, though they held around 30% of AVGN’s stock and therefore only needed the support of a little over half of the other stockholders. We believe that BVF was ultimately unsuccessful because 30% of AVGN’s stockholders neglected to vote at all, and those votes not cast counted for the incumbents. TGT is clearly concerned it might find itself in a similar position. Even though TGT has the distinct advantage of being the incumbent, they clearly recognize that the 75% threshold is improbably high. At such a high threshold, votes not cast can be fatal to the resolution, so they’ve taken measures to reduce the threshold to a simple majority. We think this will still prove too high for the incumbents, but it’s a nice card to play if you have it in your hand to do so. Davidoff notes that only Pershing Square has nominated a fifth director to take office. This means that if the resolution does not pass and TGT’s board remains at thirteen members, one of Pershing Square’s nominees is automatically elected. We’ll watch the outcome with interest.

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