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Insights 1210.Indd MERGERS AND ACQUISITIONS The Return of the Poison Pill— hostile bidders. Public companies with valuable tax loss carry forwards or which fi nd themselves Lessons Learned in 2010 from attractive targets for hostile bidders, may either the Selectica and Barnes & adopt poison pills or draft poison pills to be kept Noble Cases “on-the-shelf” for implementation if and when needed. Boards considering poison pills today will have new technologies at their disposal, and With recent validation from Delaware courts the 2010 Delaware court decisions allow them that directors will receive the protection of the busi- renewed confi dence that the poison pill will be ness judgment rule if it can be demonstrated that a upheld when needed. poison pill was reasonable in relation to the threat posed, and with stock prices stagnant below highs Background reached in the prior decade, this previously defanged shark repellent may be growing new teeth. In 2011, Stockholder rights plans were born in the 1980s poison pills are poised to regain their position as in response to the proliferation of corporate raid- a key defensive measure to protect tax assets and ers making hostile bids for public companies, and against corporate raiders. were designed to provide public company boards of directors with a “poison pill” with which to By Louis Lehot, Kevin Rooney, defend themselves against hostile takeover bids. John Tishler, and Camille Formosa Stockholder rights plans allow the target board of directors time and leverage to negotiate for a In 2010, Delaware courts upheld the use of control premium or other alternatives to hostile stockholder rights plans, or poison pills, includ- bids. Typically, a stockholder rights plan provides ing with features that had not previously been rights to all holders of common stock that, if fully expressly sanctioned. In these cases, the Dela- activated, will give all stockholders, other than the ware courts reiterated that the Unocal/Unitrim hostile bidder, the right to buy additional stock at standard applies to poison pills and held that the a substantial discount. The rights initially trade boards that adopted and applied the subject plans together with the common stock, do not have satisfi ed their burdens of demonstrating that their separate certifi cates and are not exercisable. actions were reasonable in relation to the threats posed. While activist institutional investors and A poison pill typically has two triggers that proxy advisory fi rms continue to disfavor poison will cause the rights to be distributed separately pills, particularly those adopted without stock- from the common stock and to become exercis- holder approval, poison pills are a key defense able. The date this occurs is usually called the mechanism to protect tax assets and against “distribution date.” Louis Lehot and Kevin Rooney are partners, and Camille One trigger occurs when a potential acquirer Formosa is an associate at Sheppard, Mullin, Richter & launches a tender offer for the purchase of at Hampton LLP in Palo Alto, CA. John Tishler is a partner least a specifi ed percentage of the stock of the practicing at the firm in Del Mar Heights (San Diego), CA. target company. Upon this trigger, the rights are 23 INSIGHTS, Volume 24, Number 12, December 2010 distributed and become exercisable. Upon a dis- so, triggering a poison pill results, in theory, in tribution for this trigger, one right is usually exer- unpalatable dilution to the potential acquirer’s cisable to purchase the equivalent of one share ownership interest and increased acquisition cost, of common stock 1 a t a fi xed price (the “exer- thereby forcing a potential acquirer to negotiate cise price”), which is customarily set at a price with the target board of directors prior to com- representing the hypothetical appreciation of pleting any acquisition. the stock over the duration of the plan. Often, a board seeks the advice of an investment bank on By the mid-1990s, poison pills had been widely setting the exercise price. 2 adopted by public companies in the United States, and were a key structural defense, or “shark repel- The second trigger occurs when someone lent” to hostile corporate raiders. By the end of actually acquires benefi cial ownership of stock 1993, approximately 1,375 companies had poi- over a specifi ed percentage. When this occurs, the son pills in place. 3 Adoptions and extensions of holder is usually given some time to divest itself poison pills continued and by the end of 2001, of excess holdings, and if it does not, the rights approximately 2,200 companies had poison pills undergo what is called a “fl ip-in.” On a fl ip-in, in force. 4 each right other than rights held by the holder that triggered the fl ip-in becomes exercisable for The last decade saw major corporate scandals the number of shares equal to the exercise price from Enron to WorldCom to Tyco, the adop- divided by one-half the then-current trading tion of the Sarbanes-Oxley Act of 2002 and the price of the stock. For example, if a company’s rise of organized institutional investor voting stock is trading at $15 per share at a time when and corporate governance metrics. Stockholder someone triggers a fl ip-in by acquiring 25 percent activists and proxy advisory fi rms rallied against of the outstanding shares, and the rights have a poison pills, arguing that they often resulted in $30 per share exercise price, each right, other than the entrenchment of management and the loss those held by the triggering holder, will enable of stockholder value. With these changes came the purchase of 4 common stock equivalents for declines in the annual number of pill adoptions $30, which is an effective price per share of $7.50. and extensions, with annual decreased activity Assuming all the rights are exercised, the hold- each year. By the end 2007, the number of com- ings of the holder that triggered the rights will panies with poison pills in place had declined to decrease from 25 percent to 6.25 percent. Typi- the levels seen in 1994. 5 By the third quarter of cally, upon a fl ip-in event, the board can elect to 2009, boards of directors of established public exchange each right for one (or more) common companies had largely allowed their stockholder stock equivalents in lieu of permitting the rights rights plans to expire, companies in registra- to be exercised for cash. tion ceased adopting stockholder rights plans in the course of going public and less than a third Later, poison pills were adopted outside the of S&P 1,500 companies had a poison pill in hostile takeover context to protect a corporate place. 6 asset, such as a company’s ability to offset future taxable income with net operating losses (NOLs). The severe market correction of late 2008 and NOL plans typically trigger a fl ip-in at 4.99 per- early 2009, the drop in M&A activity, combined cent of outstanding shares compared to more with several high profi le unsolicited takeover typical trigger percentages of 15 percent or more. bids for large public company targets, including by other public company bidders, and the prolif- While a poison pill is not designed to thwart eration of synthetic derivatives, may hearken the entirely any change of control, and it cannot do potential rebirth of the modern poison pill. INSIGHTS, Volume 24, Number 12, December 2010 24 US-Incorporated Poison Pills in Force at Year End 2500 2,218 2,200 2,114 1,980 2000 1,852 1,617 1500 1,394 1,206 1,037 1000 999 #Companies 500 0 2001 2002 2003 2004 2005 2006 2007 2008 2009 3/31/2010 Source: FactSet Shark Repellent What Are the Fiduciary Duties The principal potential benefi t of a poison Associated with Poison Pills? pill is the preservation of the board of directors’ ability to evaluate unsolicited bids and to solicit The “business judgment rule” is a presump- alternative bids in order to maximize stockholder tion that directors acted consistently with their value. A poison pill will also deter an unsolicited fi duciary duties, were disinterested, and carried accumulation of a control position without the out their functions in good faith, after suffi cient payment of a control premium to all stockholders. investigation, and for acceptable reasons. A more In sum, it encourages negotiation with the board rigorous level of judicial scrutiny is given to deci- of directors so that the board is in a position to sions of board of directors with respect to defen- command of a higher control premium payable sive measures taken in an attempt to block hostile to all stockholders. takeover attempts. In determining whether to enforce a stockholder rights plan or poison pill, What Does ISS Say About Poison Pills? Delaware courts apply the enhanced Unocal/ Unitrin 7 standard and accord directors the benefi t Institutional Stockholder Services (ISS), a of the business judgment rule only if (1) the plan nationally recognized proxy advisor, will recom- was not preclusive or coercive and (2) it was a rea- mend “withhold” or “against” votes for the entire sonable response to a specifi c articulated threat. board of directors (except new directors) 8 if: The decision of whether or not to adopt a poi- son pill involves the consideration of the neces- • The company adopts a stockholder rights sity of the poison pill and the impact its adoption plan with a term longer than 12 months, or will have on the company and its shareholders. renews any stockholder rights plan, includ- Consideration will also be given to the effect of a ing any “short-term” pill (12 months or less), poison pill’s adoption on the relationship between without prior stockholder approval.
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