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Shareholder Rights Plans: Self-Limiting Features and Redemptions; What’S up with Stapled Financing? by Joris M

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Shareholder Rights Plans: Self-Limiting Features and Redemptions; What’S up with Stapled Financing? by Joris M SRLJ34#3pb.fh10 8/25/06 8:48 AM Page 1 SRLJ34#3pb.fh10 8.23.06 hg ROCHESTER SPECIALTY COMPOSITION Saint Paul, MN55164-0779 Saint Paul, DISTRIBUTION CENTER DISTRIBUTION 610 OppermanDrive Securities Regulation LawJournal P.O. Box64526 P.O. Securities Regulation Law Journal Volume 34 Number 3 Fall 2006 Is Evidence of Contacts Followed by Trading Sufficient to Infer and Prove Tipping in an Insider Trading Case? The “Plus Factor” Rule By Thomas O. Gorman Merrill Lynch v. Dabit: Federal Preemption of Holders’ Class Actions By Mark J. Loewenstein Volume 34 Number 3Volume F Shareholder Rights Plans: Self-Limiting Features and Redemptions; What’s up with Stapled Financing? By Joris M. Hogan A Comment on Restricted Stock Sold by a Non-Affiliate By Robert A. Barron **Special Update—Is it Necessary to File a Copy of Form 144 with NASDAQ? By Robert A. Barron all 2006 Quarterly Survey of SEC Rulemaking and Major Appellate Decisions By Victor M. Rosenzweig 40372241 *40372241* PERIODICALS Composite Shareholder Rights Plans: Self-Limiting Features And Redemptions; What’s Up With Stapled Financing? By Joris M. Hogan* After briefly summarizing the history and operation of shareholder rights plans, this article will discuss the vigorous attack by institutional shareholders against these plans in recent years as well as the resulting effects which include the adoption of various self-limiting features and , in some cases, outright redemption. The recent Unisuper decision by the Delaware Chancery Court may add impetus to this growing trend. Part two briefly describes stapled financing and its benefits to sellers and buy- ers in transactions where financeability may be an issue. Following a dis- cussion of certain precautions that sellers and their financial advisors of- ten take to mitigate conflict of interest concerns, the article concludes that Vice Chancellor Strine’s expressed discomfort with stapled financing in the recent Toys “R” Us decision is unlikely to turn the tide against the use of this financing technique. Shareholder Rights Plans: History And Basic Operation As takeovers increased in the 1970s, the topic of responses to hostile bids became more of a concern for corporate boards and the lawyers who advised them.1 In the face of such bids, companies had a small arsenal of defenses, including the anti-takeover statutes that had been adopted in thirty-seven states. Then, in 1982, the Supreme Court held that the Will- iams Act,2 one of the few federal statutes that address corporate decision- making, preempted any state statute that upset the balance struck by the Act.3 That decision left only the minimal protections of the Williams Act such as the requirement that unsolicited tender offers remain open for at least twenty business days.4 * Joris M. Hogan is a partner in the Corporate Group of the international law firm, Torys LLP, specializing in mergers and acquisitions, securities law and corporate governance matters. The author gratefully acknowledges the contributions of Timothy B. Martin and Carmen Korehbandi in the preparation of this article. 221 222 SECURITIES REGULATION LAW JOURNAL In the fall of 1982, Martin Lipton published his memorandum entitled, “Warrant Dividend Plan,” earning credit as the inventor of the device that restored directors’ ability to determine their company’s destiny when confronted with an unsolicited takeover bid. The warrant he proposed came to be used in many forms, but each was designed to allow the board additional time to respond to an unsolicited bid. The labels given the war- rant were just as various as its forms. While it is referred to technically as a “shareholder rights plan” or “preferred share purchase rights plan,” the colloquial name stuck after it appeared in The Wall Street Journal in the summer of 1983: the “poison pill”.5 As the use of poison pills increased, the stage was set for a confronta- tion between the corporate raiders and the proponents of these new devic- es. With state legislatures effectively sidelined by the Supreme Court’s Edgar v. MITE decision and federal judges similarly hamstrung,6 state courts were left to create a framework for takeover fights. The Delaware Supreme Court led this effort with four cases it decided in 1985: Smith v. Van Gorkom,7 Revlon, Inc. v. MacAndrews & Forbes Holdings,8 Unocal Corp. v Mesa Petroleum,9 and Moran v. Household International, Inc.10 Each case added to the framework, though Moran is regarded as a water- shed moment for the poison pill defense.11 The Delaware Supreme Court upheld the right of a board to adopt a poison pill without first getting shareholder approval and also upheld the board’s right to reject a take- over bid, subject to a new intermediate level of judicial scrutiny.12 Prior to the decision in Moran, there were thirty-five poison pills in effect; in the year after the decision, approximately 300 companies adopted a pill.13 Shareholder rights plans, though not structurally identical, generally operate in a similar fashion. After adoption of the poison pill by the board of directors, the rights are distributed to shareholders and “attach” to the company’s shares of stock. The rights are triggered automatically upon a specified event, which is typically the purchase of 10-20% of the compa- ny’s common stock without the approval of the board. After the rights are triggered, each shareholder, except for the purchaser who triggered the pill, has the right to purchase additional shares or receive other assets at a steep discount, which thereby dilutes the unwanted suitor’s shareholding to an unacceptable degree. This discriminatory discount can take the form of allowing the other shareholders to purchase more shares of the target (a “flip-in” provision) or, in the case of a merger or purchase by an- other acquiror, allowing the other shareholders to purchase a dispropor- tionate interest in the acquiror (a “flip-over” provision). In either case, the [VOL. 34:3 2006] SHAREHOLDER RIGHTS PLANS 223 massive dilution of the acquiror’s position makes it prohibitively expen- sive to complete a hostile bid for control of the target. Efforts to circumvent a poison pill by replacing the board and redeem- ing the pill can be stifled by additional provisions that prevent or delay a board from redeeming the plan. These can take the form of a provision within the plan itself, such as a dead-hand,14 no-hand15 or slow hand16 provision, or by staggering the board so that more than one annual elec- tion cycle must be completed before an acquiror-friendly board can be constituted to redeem the pill. The pill therefore affords a board of direc- tors some control over the takeover process through its ability to redeem the rights for a period before or within a specified period after they are triggered, and through the board’s power to grant an exemption from the pill to friendly buyers. This additional control usually gives the board of directors of the target company sufficient time to examine alternatives to an unsolicited bid. Institutional Shareholders’ Frontal Attack On Poison Pills Nearly twenty-five years after its invention, the poison pill continues to evolve. Because of the power it gives to the board and the perceived danger of entrenchment when shareholder interests might be best served by ac- cepting an unsolicited bid, companies have begun to insert self-limiting features into their shareholder rights plans. This movement to limit a board’s ability to “just say no” has been led by the large institutional share- holders and the corporate governance services they constitute.17 Service providers such as Institutional Shareholder Services (ISS), the Council of Institutional Investors, and the Investor Responsibility Research Center (IRRC)18 have each implemented policies to direct members on how to re- spond to boards that propose new or amended poison pills.19 ISS’ policy on shareholder rights plans is to evaluate management pro- posals on a case-by-case basis. However, ISS does have general guidelines regarding poison pills and recommends that such plans should have a “trig- ger” that is not lower than 20%, have a term not to exceed three years, con- tain no provisions that limit a future board’s ability to redeem the pill (such as a dead-hand provision), and have a “qualifying offer” exception (i.e., be a “chewable pill” that will fall away under certain circumstances). In recent years, institutional investors have been winning the battle against poison pills and their unilateral adoption by boards of directors.20 At the end of 2005, for example, 46% of the S&P 500 companies had a poison pill, a nearly eight-point drop from the number of companies that 224 SECURITIES REGULATION LAW JOURNAL had one at the end of 2004.21 The number of companies with poison pills has been on the decline since 2002, when 60% of the S&P 500 had poi- son pill defenses. Trends In Self-Limiting Features After a shareholder proposal regarding a poison pill is approved by a majority of the shareholders, a board of directors typically will choose to take no action, modify or redeem its poison pill, or, in some cases, make commitments regarding the future adoption of a poison pill. For those that choose to modify their poison pills, there are many options available. The board may, for example, attempt to accommodate the shareholders by: • putting the shareholder rights plan or future plans up for a binding shareholder vote; • adopting “chewable pill” provisions that carve out certain types of qualifying acquisition proposals or acquisition proposals that are approved by shareholders; • including a “permitted offer” exception; • including a three-year independent director evaluation (TIDE) provision; • shortening the term of the shareholder rights plan (a “sunset provi- sion”); or • increasing the shareholder rights plan’s trigger threshold (usually to 15 or 20%); or • provide for more than one trigger level before the rights flip-in or flip-out.22 Frequently, however, institutional investors, who are the main propo- nents of shareholder proposals that oppose or seek to limit poison pills, are not satisfied with these “shareholder-friendly” self-limiting features.
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