Rights Plans (“Poison Pills”) in the COVID-19 Environment—“On the Shelf and Ready to Go”?

David A. Katz and Sabastian V. Niles are partner at Wachtell, Lipton, Rosen & Katz. This post is based on their Wachtell memorandum. Related research from the Program on Corporate Governance includes Toward a Constitutional Review of the Poison Pill by Lucian Bebchuk and Robert J. Jackson, Jr. (discussed on the Forum here); and The Case Against Board Veto in Corporate Takeovers by Lucian Bebchuk.

The human and business challenges confronting America from the COVID-19 pandemic are unprecedented. These global challenges have also emerged during a time when most companies have unfortunately given up nearly all of the traditional and effective “takeover” defenses like classified boards, have structural profiles that do not deter (and may invite) opportunistic attack and whose non-index fund investors continue to confront tremendous pressure to show short-term performance or face redemption requests. As a number of public companies have seen the value of their common stock decline precipitously, some advisors have suggested to public company directors that such companies should rush to adopt and announce shareholder rights plans, known more colloquially as “poison pills,” solely in response to significant stock price declines. A handful of companies, especially those whose market capitalization have dropped below $1 billion, have implemented pills in recent weeks due to the now-present possibility of building a large stake rapidly and under the disclosure radar. In addition, a number of other companies facing specific threats of disruption, takeover threats, activist attacks, unusual trading activity or the need to preserve value and an announced strategic direction have considered implementing (and in some cases implemented) rights plans.

Our Firm developed the shareholder rights plan in 1982 and after almost four decades, this creation has withstood the test of time. We litigated the legality of the poison pill in the Delaware Supreme Court in 1985 in the Moran v. Household Int’l case, where the court found that the plan’s implementation was a legitimate exercise of business judgment by Household’s board. And over the last four decades, we have regularly modified and adapted the rights plan to meet evolving and current business and market conditions.  Since the Moran case, our Firm has regularly defended the use of rights plans in Delaware and other jurisdictions and established its legality, culminating in the Delaware Airgas decision in 2011. Airgas reaffirmed the primacy of the board of directors in matters of corporate control under bedrock Delaware law and upheld the use of a rights plan to defeat a year-long, opportunistic hostile takeover attempt. We have litigated other favorable court rulings upholding rights plans and other defensive measures in a variety of contexts, including aggressive activism.  Our Firm has adapted our form of rights plan for the COVID-19 crisis. We will use our expertise in designing and using the rights plan to sustain its legality and effectiveness in the current crisis environment and continue to provide judgment as to when and whether to adopt a pill.

A rights plan remains the single most effective device available to a board of directors to enable the directors to discharge their fiduciary duties, deter stealth accumulations of controlling blocks of stock and maximize leverage regarding the timing and outcome of an unsolicited takeover bid, although it does not make a company takeover-proof.  The basic objectives of the rights plan are to deter abusive tactics by making them unacceptably expensive to the unsolicited bidder or corporate raider and to encourage prospective acquirors to negotiate with the board rather than to attempt an unsolicited hostile takeover or a creeping accumulation of control (including negative control). Properly implemented rights plans can also address the opportunistic use of derivatives and structured economic exposure to a company, limit problematic “group” activity designed to change or influence control of a corporation, and address aggressive share acquisitions by activists, although they will not prevent an activist from launching a proxy contest.

Boards of directors and senior management teams should work closely together to understand any potential strategic threats that may emerge as a result of the global financial, economic and business turmoil that is pervasive in the context of the COVID-19 pandemic.  Companies that have previously received unsolicited overtures from private equity funds, strategic rivals or industry participants should prepare for such inquiries to return later in the year if not sooner once the markets regain stability and the relative impact on companies and sectors becomes clearer.  Once the company’s operational and financial resilience in the current environment is established, the management team and the board should consider the threat of unsolicited potential takeovers or activist attacks, and management may wish to update the board on takeover tactics and potential responses, including reviewing the potential utility of a shareholder rights plan. While the decision to implement a rights plan will be case-specific, there is a significant benefit to having a poison pill “on the shelf and ready to go” so that it can be timely adopted under appropriate circumstances.

Given the negative view of rights plans by the proxy advisory services and some institutional investors, we do not believe that it makes sense for all companies to rush or race to adopt a rights plan. Company-specific circumstances as well as indicia of emerging or present threats will help provide a nuanced rationale for implementation, and tailored design features that strike the right balance without over-reaching will matter. Similarly, we would generally not recommend adopting a poison pill with a triggering level below 10% other than in very limited circumstances (such as a pill with a 4.99% trigger to preserve and protect valuable tax attributes such as NOLs that may be affected by an ownership change). Timing is also a consideration—companies may face additional criticism and adverse near-term voting outcomes if an adoption comes immediately before the annual meeting if there is no apparent threat. Regardless of the rationale for adopting a rights plan, once adopted, the company should accelerate its engagement with shareholders to address the motivation behind the action and respond to any concerns.

It is important to understand that the form of rights plan that would be acceptable to ISS or Glass Lewis diminishes the effectiveness of a rights plan in a takeover contest, and we believe that a board should adopt a rights plan when there is a strong rationale so that it can be deployed in its most potent form. Companies should also consider any potential signaling effects of implementing a rights plan without a clear and announced rationale and assess whether a premature announcement now may limit the board’s practical (though not legal) flexibility and credibility to act when and if a specific threat does emerge in the future.

Rights plans are as important today as they have ever been and boards should be prepared to adopt rights plans in appropriate circumstances where there is a threat to the corporation. To be best positioned to move quickly, boards should update their takeover preparedness and activism response plans and make sure that they have a poison pill “on the shelf and ready to go” so that it can be quickly utilized in appropriate circumstances.

Both comments and trackbacks are currently closed.