COVID-19 and Poison Pills: The Right Prescription?
The coronavirus pandemic continues to have profound effects on the U.S. and global economies. Investor concerns about the impact of COVID-19 and government-imposed restrictions on individuals and businesses have led to unprecedented market volatility. Further material volatility is anticipated. The resultant precipitous decline in stock prices has made many companies vulnerable to opportunistic takeover bids, creeping accumulations or activist strategies of parties seeking either to take control of a company without paying an appropriate control premium to all stockholders or to influence companies to take actions in the particular interests of such parties and not the companies’ stockholders’ best interest. In this environment, publicly traded companies may want to evaluate the adequacy of their corporate defenses to protect their stockholders from such predatory activities. Specifically, the board of directors (“Board”) of a publicly traded company may want to consider whether it would be appropriate (1) to adopt preemptively a Shareholder Rights Plan, also known as a Rights Plan or “poison pill,” or (2) to go through the readiness exercise of putting a Rights Plan “on the shelf,” but not yet adopting and publicly announcing it unless and until circumstances warrant it.
In March 2020, there was a surge of companies adopting and publicly announcing Rights Plans, often specifically citing in their press releases the market dislocation caused by the pandemic. The pace of adoption of new Rights Plans has continued at an elevated level in April 2020. Further, while there is no way to estimate how many companies instead put “pills on the shelf” during this period, there is strong anecdotal evidence that many more companies took that action, so overall defensive activity in the last two months has been high and may continue to be for some time.
Rights Plans — Overview
Rights Plans are generally adopted by companies to address the principal concerns that (1) a person or group could acquire control of the company in the open market or otherwise without paying an appropriate premium for control and without offering a fair and adequate price to all stockholders; or (2) a person or group could accumulate shares of a company with a view to making a profit by putting the company “in play” at a time when that could be seriously disruptive and detrimental to the company and its business and, thus, not in the best interest of stockholders.
In essence, a Rights Plan “buys time” for a company by preserving and maximizing the Board’s flexibility to seek alternatives to an inadequate takeover bid and making sure that the company’s stockholders have full information regarding (1) the relative merits and risks of the unsolicited transaction compared to remaining an independent entity and (2) the true value of the company. By encouraging a bidder to negotiate directly with the Board in good faith, the Rights Plan enables the Board to function more effectively as a vigilant “bargaining agent” for the company’s public stockholders. The Board can more readily seek to maximize the value of such stockholders’ investments (if a sale of control of the company is determined to be in the best interests of the stockholders) and set an appropriate course of action. Alternatively, if the Board believes that remaining an independent entity and pursuing the company’s business strategy is in the best interests of stockholders, the Rights Plan affords the Board the opportunity to make this case to stockholders and to deal at arm’s length with the insurgent party.
A Rights Plan involves a distribution to stockholders of rights (“Rights”) that, in the event of an acquisition without Board approval of a triggering amount of shares (usually 10–20%), become rights to purchase a large amount of the company’s common stock at a 50% discount. The potential acquiror does not have these purchase Rights and, therefore, would suffer catastrophic dilution if triggered. Due to the substantial dilution of value that would be suffered by an acquiring person crossing the threshold, no rational acquiror would intentionally cross the threshold. Indeed, there are only two known instances of an acquiror deliberately triggering a Rights Plan, and both involved very unusual circumstances.
Some general points about Rights Plans:
- Rights Plans work very well. They deter predatory acquirors from attempting to accumulate a control position without paying fair value and without negotiating with the company’s Board. While academic and industry-sponsored studies are inconsistent, they have generally shown that Rights Plans have had a beneficial effect on the takeover premiums ultimately paid for the companies adopting them.
- Delaware courts have consistently upheld Rights Plans in the face of specific takeover threats where the Board has proven the Rights Plan was a reasonable and proportionate response to a legitimate corporate threat.
- A Rights Plan does not make a company “bulletproof.” Certain vulnerabilities will persist including (1) a raider can possibly commence a proxy contest to replace the Board with directors who will redeem the Rights Plan; (2) while a “just say no” defense remains viable in certain circumstances, at some point a Board may not be permitted to keep a Rights Plan in place in the face of a takeover proposal with a significant premium, especially in the case of an all-cash deal; and (3) ownership triggers in Rights Plans may be evaded by the use of synthetic equity (e.g., total return equity swaps) and coordinated attacks by “wolf packs,” though special provisions can be included in the Rights Plan to address these risks.
- Adoption of a Rights Plan generally has no balance sheet, income statement or cash flow effects. The initial distribution of Rights is generally not taxable to stockholders or the company.
- Proxy advisory firms, like ISS and Glass Lewis, and institutional investors generally disfavor Rights Plans and urge withholding votes for the election of directors who approve them, unless certain conditions are met (including stockholder approval or ratification for long-term Rights Plans).
How to Implement a Rights Plan
Subject to the directors’ fiduciary duties, a Rights Plan can be implemented by the Board unilaterally and does not require stockholder approval, unless the Board desires to obtain proxy advisory firms’ and institutional stockholders’ support for a Rights Plan that has a duration of more than one year (see ISS discussion below). In connection with its adoption, the Board must review and approve a Rights Agreement and appoint a Rights Agent, usually the company’s transfer agent, to administer the Rights Plan. After approval of the Rights Agreement, the Board sets the record date and declares a dividend distributable to all stockholders consisting of one Right for each share of common stock that they own. The adoption of the Rights Agreement and declaration of the dividend requires public disclosure via press release, the filing of a Form 8-K and a mailing to all stockholders describing the Rights. Only upon a triggering event does a Right separate from the common stock and become exercisable.
The key terms of a Rights Plan for a Board to determine are:
- the duration of the Rights Plan;
- whether to seek stockholder approval of the Rights Plan and whether to include terms that ISS has deemed “investor friendly” and necessary for its recommendation for any long-term Rights Plan;
- the exercise price of the Rights, which often entails obtaining the advice of an investment banking firm;
- the ownership trigger(s), including “grandfathering” provisions and the treatment of synthetic equity positions;
- redemption and amendment provisions; and
- whether to include a “wolf-pack” or acting in concert provision.
Institutional Investors and Rights Plans; ISS and Glass Lewis on COVID-19 and Pills
Many institutional investors and the influential proxy advisory firm, ISS, have stated policies about companies adopting Rights Plans. The thrust of these policies is that Rights Plans should generally not be adopted without obtaining stockholder approval and that such approval should not be given unless the Rights Plan contains certain investor-friendly provisions, which may limit the effectiveness of the Rights Plan from a company’s perspective.
If a company adopts a Rights Plan without obtaining or committing to obtain stockholder approval within 12 months, it should expect ISS to recommend a withhold vote for the election of all directors for as long as the company maintains a non-stockholder approved Rights Plan. When a Rights Plan is submitted for stockholder approval, ISS will recommend a vote in favor only if the Rights Plan contains certain features, including:
- an acquisition trigger no lower than 20% of the outstanding shares;
- a term of no more than three years;
- no limitation on a future board’s ability to redeem the Rights Plan; and
- a “qualifying offer” provision, which gives holders of 10% or more of a company’s common stock the ability to call a special meeting or seek written consent to vote on rescinding the Rights if the Board refuses to redeem the Rights within 90 days after a “qualifying offer” is announced, as defined in the Rights Plan (for example, an all-cash deal exceeding a specified premium).
Because of the foregoing, most companies take the approach of adopting a Rights Plan only when needed (i.e., “in the heat of battle”) and do so only on a short-term basis (i.e., one day shy of a one-year duration). Under the right circumstances, adopting a Rights Plan with a duration of less than one year generally avoids any ISS withhold recommendation against directors, even if such Rights Plan does not comply with the investor-friendly provisions described above. Historically, if a Board adopts a Rights Plan with a term of less than one year without shareholder approval, ISS has recommended voting on directors on a case-by-case basis, taking into account:
- The time period between the Rights Plan’s adoption and the next stockholders’ meeting;
- The company’s justification for the Rights Plan;
- The company’s corporate governance track record; and
- The company’s past record of stockholder accountability.
ISS has periodically supplemented this case-by-case guidance in its annual Proxy Voting Guidelines and has done so in its statement on April 8, 2020 as described below.
Glass Lewis will consider recommending against the members of the governance committee, depending on a company’s justification for adopting a Rights Plan with a term of less than one year.
On April 8, 2020, both ISS and Glass Lewis made important announcements regarding their case-by-case analysis of short-term Rights Plans, each expressing some sympathy for Boards who may determine that adopting a short-term Rights Plan is appropriate given the impact of the pandemic. In particular, ISS stated:
“For poison pills/rights plans with a duration of less than a year, our policy is to consider the situation on a case-by-case basis considering the disclosed rationale for adopting the plan and other relevant factors (such as a commitment to put any future renewal of the pill to a shareholder vote).…Under such reviews, we will generally consider both the board’s explanation for its adoption of a poison pill, including any imminent threats, and the specific provisions (triggers, terms, “qualified offer” provisions and waivers for “passive” investors) of the pill.…”
“A severe stock price decline as a result of the COVID-19 pandemic is likely to be considered valid justification in most cases for adopting a pill of less than one year in duration; however, boards should provide detailed disclosure regarding their choice of duration, or on any decisions to delay or avoid putting plans to a shareholder vote beyond that period. The triggers for such plans will continue to be closely assessed within the context of the rationale provided and the length of the plan adopted, among other factors.”
Rights Plans and Board Fiduciary Duties
Both the adoption of a Rights Plan and the decisions of a Board involved in maintaining it as a defense in any particular situation are subject to the directors’ fiduciary duties. The fiduciary standards applied by Delaware courts to assess the directors’ action in adopting a Rights Plan vary depending on whether the Rights Plan is adopted “on a clear day” or in response to a specific threat:
- When no specific threat exists, courts apply the deferential review standard of the business judgment rule. In general, this protects a board decision from being judicially overturned if the decision is made on an informed basis, in good faith, with a reasonable belief that it is in the best interest of the company’s stockholders and without fraud or self‑dealing.
- When a Rights Plan is adopted in response to a specific threat, courts apply a heightened judicial standard of review called “enhanced scrutiny.” This standard requires the directors to show (if challenged) that (1) they had reasonable grounds for believing that a threat to corporate policy or to stockholders existed and (2) the defensive measure adopted was reasonable in relation to that perceived threat, before they are entitled to the presumption of correctness afforded by the business judgment rule.
Companies incorporated in states other than Delaware would need to consider the applicable fiduciary standards, though many jurisdictions tend to follow similar approaches to the Delaware judiciary.
Putting a Rights Plan “On the Shelf” Versus Preemptively Adopting a Rights Plan
A target company can adopt and announce a Rights Plan as rapidly as within 24 hours of receiving a takeover approach. However, operating at that kind of speed on an informed basis is possible only with appropriate advance preparation before the threat materializes. The cornerstone of the Board’s duty of care is making decisions on an informed basis. Takeover approaches usually come without warning and require a fast response. Yet even the most experienced Board members only see the world of takeover approaches, defenses and responses infrequently, if at all. Accordingly, in the heat of a takeover attempt, the possibility for confusion and perhaps less than fully informed Board decision-making is always real, unless there are advance preparations.
Putting a Rights Plan “on the shelf” involves addressing all of the preparatory steps to launch a Rights Plan, other than the subsequent Board action to formally adopt and implement the Rights Plan with final terms. That would happen only if a threat actually emerges meriting such a response. No public disclosure of the existence of a “shelf pill” is required unless and until it is officially adopted. Having a shelf pill provides a speed advantage (or, said differently, avoids a speed disadvantage) if a takeover threat, harmful ownership accumulation or activist stockholder agitation were to emerge. Also, by putting a Rights Plan on the shelf rather than outright adopting and publicly disclosing it, a company avoids the potential ire of proxy advisory firms and institutional investors. Importantly, it also avoids the distraction and confusion that a public announcement of the actual adoption of a Rights Plan could cause employees, suppliers and consumers. Further, such an announcement could result in unwanted attention and inadvertently put a company “in play.”
However, a company may determine, based on its circumstances and subject to the Board’s fiduciary duties described above, that it needs the deterrent effect of actually adopting a Rights Plan outright and publicly announcing it. For example, many companies with small to mid-sized market capitalizations are legitimately concerned that they will not be able to detect a predatory approach in time to take appropriate defensive action given current weaknesses in the beneficial ownership reporting system under the federal securities laws and the threshold for advance notice under applicable antitrust premerger filings.
In ordinary times, a prudent Board would regularly review the available toolkit of corporate defenses, including implementing or placing a Rights Plan “on the shelf.” In times of market dislocation such as that caused by COVID-19, and in particular, for companies impacted by significant stock price declines or where there is current activist presence in a company’s stockholder base, such a review takes on heightened importance to protect stockholder value.
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This guide is not intended to be exhaustive, nor does it constitute legal advice and no legal or business decision should be based on its contents. Companies should work closely with their legal and financial advisors when adopting a Rights Plan and determining whether it is appropriate to put a Rights Plan in place given its specific circumstances.