In the wake of COVID-19, global stock prices have plummeted. Yet, the current depressed state of the markets may distort the long-term outlook of many businesses. Hostile bidders and unwelcome activists may capitalize on this situation by attempting to gain control of companies without paying an appropriate premium to all stockholders. Given this economic environment, companies should review their current defenses and consider whether it is appropriate to prepare (or update an existing) “on-the-shelf” rights plan, or “poison pill,” that boards can adopt quickly in response to coercive tactics. Correctly implemented, a poison pill can prevent opportunists from exploiting stockholders and ensure that all stockholders realize the long-term value of their investment.
Purpose of the Poison Pill
Once activated, a typical poison pill would substantially dilute a hostile bidder’s stake in a target company. As a result, poison pills deter would-be acquirers from bypassing the company’s board of directors when attempting to gain control of the company. The dilution occurs because a poison pill gives all stockholders, other than the hostile bidder, the right to buy additional stock (either in the company or the acquirer) at a steep discount once the right is triggered. In general, when a hostile bidder acquires, or announces an intention to acquire, beneficial ownership of a company’s stock over a specified threshold, the purchase right is triggered.
Basic Features of a Poison Pill
While a company can tailor its poison pill to include customized provisions, below is a description of the most basic features of a poison pill as well as a discussion of how proxy advisory firms (such as Institutional Shareholder Services, Inc. (ISS)) view such features. In general, ISS and other proxy advisory firms oppose poison pills because they view pills merely as tools to achieve board entrenchment. ISS, for example, will recommend voting against each director of a company that adopts a poison pill that fails to include certain basic features described below. In designing a poison pill, a company should consult with its proxy solicitor to help the board understand how proxy advisory firms and a company’s stockholders are likely to react to specific terms.
Trigger Threshold. This is the percentage of shares that, if acquired, would trigger the poison pill. The appropriate trigger threshold varies based upon a particular company’s facts and circumstances. Trigger thresholds typically range from 10 percent to 20 percent. Depending on the stake of current stockholders, a company could structure its poison pill to include a “grandfather” clause. This allows a stockholder who already owns a stake equal to or greater than the trigger threshold to maintain its stake without triggering the poison pill unless the stockholder’s ownership increases after adoption of the poison pill. A company may also want to consider a two-tier pill, which contains a bifurcated structure that sets the trigger threshold at a lower percentage for Schedule 13D filers (which would include hostile bidders or unwelcome activists) but permits Schedule 13G filers, who are passive investors, to accumulate stakes in the company up to a greater percentage before triggering the pill. For example, Sotheby’s implemented a two-tier pill, which was upheld by the Delaware Court of Chancery, that imposed a 10 percent trigger threshold on Schedule 13D filers and a 20 percent trigger threshold on Schedule 13G filers.
Proxy Advisor Position: ISS recommends a trigger threshold of 20 percent or higher.
Flip-In. The “flip-in” feature of a poison pill is what gives stockholders, other than the acquirer, the right to purchase additional shares of the company at a discount to the market price once the hostile bidder acquires, or announces an intention to acquire, beneficial ownership of the company’s stock over the trigger threshold.
Flip-Over. A poison pill’s “flip-over” feature is implicated in connection with a merger, consolidation or sale of a certain percentage (typically 50 percent) of the company’s assets or earning power. Upon triggering of the flip-over feature, the company’s stockholders, other than the acquirer, have the right to acquire shares of the acquirer at a discount to market price.
Term. Poison pills generally expire after a certain time period without any action by the board. While 10-year terms were common in the past, shorter terms, such as one to three years, are now the norm. The move towards a shorter term is, in part, a response to the pressure from the proxy advisory firms. For example, many poison pills automatically expire after one year, at which time stockholders can vote to extend the term to three years.
Proxy Advisor Position: ISS and Glass, Lewis & Co. generally will recommend voting against each director on the board of a company that adopts a poison pill with a term longer than one year without obtaining stockholder approval. Additionally, if a poison pill is put to a stockholder vote, ISS recommends that the poison pill have a duration of no more than three years.
Redemption. Poison pills are typically redeemable at a nominal price at the option of the company prior to the would-be acquirer gaining control or the expiration of a period of time (typically 10 days) following the public announcement that a person has crossed the trigger threshold.
- While some poison pills include “dead hand” provisions that bar anyone but the directors who adopted the poison pill from redeeming it, such provisions are controversial and have been invalidated in some jurisdictions, such as Delaware.
- Poison pills may include a provision stating that if the board does not redeem the pill to accommodate a “qualifying offer” that meets certain pre-defined characteristics, then stockholders may call a special stockholder meeting to vote on redeeming the pill. The pre-defined characteristics for qualifying offer may be an all-cash offer that represents a premium over the highest reported market price during the last 12 months and includes a grace period for the board to solicit advice regarding the adequacy of the offer. In effect, the qualifying offer provision allows the stockholders to override the board’s decision not to redeem the pill in the event the company receives a qualifying offer.
Proxy Advisor Position: ISS recommends that a poison pill have no limitations on a future board’s ability to redeem the pill. ISS also recommends that poison pills include provisions that allow stockholders to redeem the poison pill after the announcement of certain qualifying offers. According to ISS, such provisions should permit stockholders holding at least 10 percent of the outstanding shares to call a special meeting or seek a written consent to vote on rescinding the poison pill if the board refuses to redeem the poison pill 90 days after the announcement of a qualifying offer.
In considering the adoption of a poison pill, a board should analyze not only the legal implications, but also the perception of its investors. During circumstances like those that we are experiencing today, the adoption of a poison pill can send a positive signal to the market by letting it know that the board believes its stock is undervalued and is acting to protect the best interests of the company’s stockholders. Of course, poison pills can easily be viewed as entrenchment devices; so boards need to be mindful of how a poison pill impacts the shareholder franchise, especially in light of other defensive provisions a company may have, such as a classified board or the protections from Section 203 of the Delaware General Corporation Law. As a result, without the proper communication plan in place, key investors may be wary of a company adopting a poison pill. Therefore, if a board decides to adopt a poison pill, it should make a proactive effort to provide full disclosure to its stockholders about the reasons for and the terms of the poison pill and emphasize the use of the poison pill to protect stockholder value.
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