Poison Pill

poison pill by Harry Campbell

A shareholder rights plan, colloquially known as a ‘poison pill,’ is a type of defensive tactic used by a corporation’s board of directors against a takeover. There are a number of such tactics, referred to as ‘shark repellents’ generally. In the field of mergers and acquisitions, shareholder rights plans were devised in the early 1980s as a way for directors to prevent takeover bidders from negotiating a price for sale of shares directly with shareholders, and instead forcing the bidder to negotiate with the board.

Shareholder rights plans are unlawful without shareholder approval in many jurisdictions such as the United Kingdom, frowned upon in others such as throughout the European Union, and lawful if used ‘proportionately’ in others, including Delaware in the United States. They are controversial because they hinder an active market for corporate control. Further, giving directors the power to deter takeovers puts directors in a position to enrich themselves, as they may effectively ask to be compensated for the price of consenting to a takeover.

The typical shareholder rights plan involves a scheme whereby shareholders will have the right to buy more shares at a discount if one shareholder buys a certain percentage of the company’s shares. The plan could be triggered, for instance, when any one shareholder buys 20% of the company’s shares, at which point every shareholder (except the one who possesses 20%) will have the right to buy a new issue of shares at a discount. The plan can be issued by the board as an ‘option’ or a ‘warrant’ attached to existing shares, and only be revoked at the discretion of the board of directors. A shareholder who can reach a 20% threshold will potentially be a takeover bidder. If every other shareholder will be able to buy more shares at a discount, such purchases will dilute the bidder’s interest, and the cost of the bid will rise substantially. Knowing that such plan could be called on, the bidder could be disinclined to the takeover of the corporation without the board’s approval, and will first negotiate with the board so that the plan is revoked.

The poison pill was invented by mergers and acquisitions lawyer Martin Lipton of Wachtell, Lipton, Rosen & Katz in 1982, as a response to tender-based hostile takeovers. Poison pills became popular during the early 1980s in response to the wave of takeovers by corporate raiders such as Carl Icahn. The term ‘poison pill’ derives its original meaning from a poison pill physically carried by various spies throughout history, a pill which was taken by the spies when they were discovered to eliminate the possibility of being interrogated by an enemy. It was reported in 2001 that since 1997, for every company with a poison pill which successfully resisted a hostile takeover, there were 20 companies with poison pills that accepted takeover offers. The trend since the early 2000s has been for shareholders to vote against poison pill authorization, since poison pills are designed to resist takeovers, whereas from the point of a shareholder, takeovers can be financially rewarding.

Some have argued that poison pills are detrimental to shareholder interests because they perpetuate existing management. For instance, Microsoft originally made an unsolicited bid for Yahoo!, but subsequently dropped the bid after Yahoo! CEO Jerry Yang threatened to make the takeover as difficult as possible unless Microsoft raised the price to US$37 per share. One Microsoft executive commented, ‘They are going to burn the furniture if we go hostile. They are going to destroy the place.’ Yahoo had had a shareholders rights plan in place since 2001. Analysts suggested that Microsoft’s raised offer of $33 per share was already too expensive, and that Yang was not bargaining in good faith, which later led to several shareholder lawsuits and an aborted proxy fight from Carl Icahn. Yahoo’s stock price plunged after Microsoft withdrew the bid, and Jerry Yang faced a backlash from stockholders that eventually led to his resignation.

Because the board of directors of the company can redeem or otherwise eliminate a standard poison pill, it does not typically preclude a proxy fight or other takeover attempts not accompanied by an acquisition of a significant block of the company’s stock. It can, however, prevent shareholders from entering into certain agreements that can assist in a proxy fight, such as an agreement to pay another shareholder’s expenses. In combination with a staggered board of directors, however, a shareholder rights plan can be a defense.

The effects are twofold: It gives management time to find competing offers that maximizes selling price; and several studies indicate that companies with poison pills (shareholder rights plans) have received higher takeover premiums than companies without poison pills. This results in increased shareholder value. The theory is that an increase in the negotiating power of the target is reflected in higher acquisition premiums. A ‘dead-hand’ provision allows only the directors who introduce the poison pill to remove it (for a set period after they have been replaced), so potentially delaying a new board’s decision to sell a company.

The legality of poison pills had been unclear when they were first put to use in the early 1980s. However, the Delaware Supreme Court upheld poison pills as a valid instrument of takeover defense in its 1985 decision in the ‘Moran v. Household International, Inc.’ case. However, many jurisdictions other than the U.S. have held the poison pill strategy as illegal, or place restraints on their use. In Canada, almost all shareholders rights plans are ‘chewable,’ meaning they contain a permitted bid concept such that a bidder who is willing to conform to the requirements of a permitted bid can acquire the company by take-over bid without triggering a flip-in event. Shareholder rights plans in Canada are also weakened by the ability of a hostile acquirer to petition the provincial securities regulators to have the company’s pill overturned.

In the United Kingdom, poison pills are not allowed under the Takeover Panel rules. The rights of public shareholders are protected by the Panel on a case-by-case, principles-based regulatory regime. One disadvantage of the Panel’s prohibition of poison pills is that it allows bidding wars to be won by hostile bidders who buy shares of their target in the marketplace during ‘raids.’ The London Stock Exchange itself is another example of a company that has seen significant stakebuilding by a hostile suitor, in this case the NASDAQ. The LSE’s ultimate fate is currently up in the air, but NASDAQ’s stake is sufficiently large that it is essentially impossible for a third party bidder to make a successful offer to acquire the LSE.

In professional sports, a poison pill is a component of a contract, which one team offers a player, that makes it difficult or impossible for another team (which has the right of first refusal) to match. While it can often refer to a salary structure or clause that would affect all teams equally, it has taken on a new specific meaning of a clause that has unbalanced impact. The NFL’s collective bargaining agreement has many poison pills, should either the players or owners, or both, allow it to reach its final year, including an increase in the requirement for unrestricted free agency from four seasons to six, the lack of a salary cap, and restrictions on the ability of top teams to sign free agents. Because these terms would theoretically be disagreeable to both sides, it effectively aims to make sure that should the agreement be broken it would be in the best interests of both sides to agree to new terms. Nevertheless, the NFLPA and NFL owners did not reach a new agreement before the end of the 2009–2010 season, and those poison pills went into effect.

A poison pill may also be used in politics, such as attaching an amendment so distasteful to a bill that even the bill’s supporters are forced to vote against it. This manipulative tactic may be intended to simply kill the bill, or to create a no-win situation for the bill’s supporters, so that the bill’s opponents can accuse them of voting for something bad no matter what. This is known as a ‘wrecking amendment.’

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