NACD Insight & Analysis: Delaware Courts Reconfirm Poison Pills
The poison pill is back in the news.
Formally known as a shareholder-rights plan, business news has been flush with reports of companies adopting the provision. Well-known companies—such as Barnes & Noble, Airgas and most recently Family Dollar Stores, Inc.—have recently implemented shareholder-rights plans in the face of takeover bids. While poison pills are often controversial and their use is strictly limited in Canada, Australia and the U.K., the Delaware Chancery Court recently upheld their use in the U.S., a decision reinforced by the Delaware Supreme Court. In the new environment of increased investor participation, directors may choose to revisit the implications of the poison pill.
The poison pill was created by Martin Lipton, a noted mergers and acquisitions lawyer with the business law firm of Wachtell, Lipton, Rosen, and Katz in the early 1980s. A response to activist investors gaining control of companies through either the proxy statement or share purchases, the poison pill earned its name from its impact—impairing both the company and the bidder. Following specific trigger events, such as a large equity acquisition by an entity, the shareholder-rights plan gives shareholders the right to buy additional stock at a discounted price. In the commonly used “flip-in” style, all shareholders, except the acquirer, can purchase additional discounted stock. The flood of equity purchases thus dilutes the purchasing power of the acquirer, but also devalues the current value of company stock.
Popular through the 1990s, many shareholder-rights plans were dismantled in the 2000s, likely the result of decreased M&A activity and shareholder pressure. When used in combination with a staggered board, these provisions can form an effective method of board entrenchment, a point of contention with shareholders. NACD’s Key Agreed Principle VIII: Protection Against Board Entrenchment, recommends that “governance structures and practices should encourage the board to refresh itself.” Many also view the decline of poison pills as the result of proxy advisory services’ recommendations. For instance, Institutional Shareholder Services recommended a “no” vote for companies that renewed an expiring pill that was not put to a shareholder vote within one year.
Why, then, the resurgence in use of poison pills? Many companies saw their market value decline as a result of the recent economic crisis, creating more opportunities for hostile takeovers. Now in the midst of a recovery, M&A activity has picked up as well. Directors have a fiduciary duty to provide the greatest possible shareholder value in a transaction. In the case that directors feel they are receiving an inadequate bid, a poison pill can provide the board with time to deliberate and negotiate a better offer for shareholders. In the case of Airgas, the Delaware Supreme Court upheld the use of a shareholder-rights plan as “a reasonable response to a threat posed by an inadequate offer.”