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E-MailLucian Bebchuk is Professor of Law, Economics, and Finance at Harvard Law School. Robert J. Jackson, Jr. is Associate Professor of Law, Milton Handler Fellow, and Co-Director of the Millstein Center at Columbia Law School. This post is based on their recent working paper, Toward a Constitutional Review of the Poison Pill, available here.
In a new paper, Toward a Constitutional Review of the Poison Pill, we argue that the state-law rules governing poison pills are vulnerable to challenges based on preemption by the Williams Act. Such challenges, we show, could well have a major impact on the corporate-law landscape.
The Williams Act established a federal regime regulating unsolicited tender offers, but states subsequently developed a body of state antitakeover laws that impose additional impediments to such offers. In a series of well-known cases during the 1970s and 1980s, the federal courts, including the Supreme Court, held some of these state antitakeover laws preempted by the Williams Act. To date, however, federal courts and commentators have paid little attention to the possibility that the state-law rules authorizing the use of poison pills—the most powerful impediment to outside buyers of shares—are also preempted.
Our study examines this subject and concludes that there is a substantial basis for questioning the continued validity of current state-law rules authorizing the use of poison pills. We show that these rules impose tighter restrictions on unsolicited offers than state antitakeover regulations that federal courts invalidated on the grounds of preemption. Preemption challenges to these poison-pill rules could well result in their invalidation by the federal courts.
Finally, we discuss how state lawmakers could revise poison-pill rules to make them more likely to survive a federal preemption challenge. This could be done, we show, by imposing substantial limits on the length of time during which a poison pill can be used to block tender offers. Whether preemption challenges lead to invalidation of existing state-law poison-pill rules or to their substantial modification, such challenges could well reshape the market for corporate control.
Here is a more detailed overview of our analysis:
Nearly all standard corporate-law casebooks include an account of the significant line of cases in which the federal courts reviewed the constitutionality of state antitakeover statutes. These textbooks, however, go on to express the accepted view among researchers and practitioners that these cases are no longer relevant to contemporary corporate law, because a private-law innovation—the poison pill—now dominates the antitakeover influence of state statutes. In our paper, we argue that this widely shared view is mistaken.
The literature on the constitutionality of state antitakeover laws is quite substantial. Indeed, more than one hundred law review articles have considered whether and how the Williams Act might preempt various state statutes that govern corporate takeovers. Just three years ago, the Business Lawyer dedicated a symposium issue to analysis of whether the Williams Act preempts Delaware’s business combination statute. Yet this large literature has paid little attention to the question of whether the state-law rules with the most powerful antitakeover effect—the rules authorizing use of the poison pill—are preempted.
Our paper systematically analyzes this subject. We begin by discussing the legal landscape that the drafters of the Williams Act faced when they passed the Act in 1968. We show that this landscape was fundamentally altered by the emergence of state-law poison-pill rules that empower incumbents to delay tender offers for lengthy periods of time. Indeed, we explain, those rules provide incumbents with an even more powerful antitakeover defense—and impose an even lengthier delay—than the state statute that the Supreme Court invalidated as preempted by the Williams Act. Thus, we argue, the constitutional validity of current state-law rules governing poison pills should not be taken for granted.
Some prior work on the validity of state antitakeover laws has noted that poison pills are private contractual arrangements, suggesting that pills are thereby distinguishable from the state antitakeover laws that have been held preempted by the Williams Act. However, we explain why the claim that these differences preclude preemption challenges to state-law poison-pill rules is mistaken. This view, we argue, overlooks the critical role that state-law rules play in permitting poison pills to delay tender offers for lengthy periods of time—a result in considerable tension with the Williams Act. Furthermore, we show, some of the state antitakeover laws that were invalidated by the federal courts blocked only unsolicited offers that incumbent directors chose to oppose—just as state-law poison-pill rules do today. The courts considering preemption challenges to those laws never suggested that the presence of a private choice by directors precludes a preemption challenge to the state laws making that private choice possible. To the contrary, we explain, these courts proceeded to consider whether the challenged state law was consistent with the Williams Act.
We next provide a comprehensive analysis of how courts can be expected to approach preemption challenges to state-law poison-pill rules. We identify the three approaches that federal courts have followed in the past in evaluating claims that the Williams Act preempts state antitakeover laws, and we analyze the expected consequences that would follow if each approach were applied to current state law governing the poison pill. The first judicial approach we consider focuses on whether tender offerors are given a meaningful opportunity to successfully acquire the target and whether shareholders are given an opportunity to evaluate the merits of tender offers. We show that, if this analysis is applied to current state-law poison-pill rules, the courts would likely conclude that such rules are per se preempted.
We proceed to consider judicial approaches from prior cases on Williams Act preemption that have focused on whether, in fact, the state law at issue enhances investor protection. We show that, if this approach is followed in an examination of the validity of current state-law poison-pill rules, courts will be required to hold evidentiary hearings to determine whether state-law rules that allow incumbents to use the poison pill to delay tender offers in fact enhance shareholder value. We explain that, given existing evidence that agency problems produced by managerial entrenchment might impose significant costs on investors, this approach might well also result in the invalidation of state-law poison-pill rules.
Third, we consider an approach drawn from prior cases in which the courts have indicated that the Williams Act preempts only those state laws that conflict directly with the procedures mandated by the Act. If a court facing a preemption challenge to the validity of state-law poison-pill rules were to follow this approach, it would likely hold that these rules are per se valid. While we discuss this possibility, we identify reasons to believe that this approach is unlikely to carry the day among courts considering preemption challenges to state-law poison-pill rules.
Once state lawmakers recognize that current state-law poison-pill rules may be preempted, they may wish to take steps to avoid that result. We therefore conclude by providing a framework for lawmakers considering changes to state law designed to avoid preemption. Because the federal courts have emphasized the length of the delay that state-law rules impose on unsolicited tender offers, we explain, the risk of preemption may be considerably reduced by substantially limiting the period of time during which incumbents may use a poison pill to block tender offers they disfavor. While such revisions might ensure the survival of some state-law poison-pill rules, they would bring about a considerable change in the current law and practice of mergers and acquisitions.
We recognize that some might be skeptical of our claim that state-law poison-pill rules may be preempted because litigation based on such a claim has not yet been pursued. But it is not uncommon for claims that were ultimately successful to be brought to the attention of the courts after a long period of time during which they were not raised—even when the stakes have been significant, and the potential litigants have had substantial resources. For example, for decades well-advised corporations defended claims under the Alien Tort Statute based on events occurring outside the United States without arguing that the statute did not confer jurisdiction over such claims. Yet the Supreme Court recently declared that the ATS does not provide jurisdiction over such claims—an argument that was not raised by either the corporations or the courts involved in these prior cases. Thus, the fact that a preemption challenge to state-law poison-pill rules has not yet been pursued should not lead one to presume that such a challenge would be unlikely to succeed. Indeed, as we show in our paper, the argument that state-law poison-pill rules are preempted has a substantial likelihood of being accepted by the courts.
While the literature on the constitutionality of state antitakeover law is rather extensive, this work, like previous caselaw, has paid little attention to whether the Williams Act also preempts state-law poison-pill rules. Our paper fills this void by providing a framework for future consideration of the validity of state-law rules governing poison pills. In our view, constitutional litigation over the subject may well have a transformative effect on the modern law of mergers and acquisitions and the corporate-law landscape throughout the United States.
Our paper is available here.
