On June 23, 2009, the Board of the Brazilian Securities and Exchange Commission (Comissão de Valores Mobiliários – CVM) approved Opinion (Parecer de Orientação) No. 36, of the same dated, about statutory provisions imposing encumbrance(s) on shareholders who vote favorably to the elimination of the share dispersion protection clause inserted in the company´s bylaws. These clauses are usually referred to as "poison pills"1 and are also known as "shark repellent", "porcupine provisions" or "shareholder rights plan".
In the last years, the bylaws of several Brazilian companies have been amended to include share dispersion protection clauses which force any investor who is determined to acquire a certain percentage of the outstanding shares of the target company to make a public offering to purchase the remaining shares. Furthermore, some of these bylaws contain an accessory clause, imposing a substantial burden on the shareholders who vote favorably to suppress or amend such provisions, that is, to eliminate the obligation to make a public offering previously contemplated in the bylaws.
These accessory clauses are classified under Brazilian law as "cláusulas pétreas", which means "clauses carved on stone", i.e. provisions that cannot be modified or eliminated at the discretion of the beneficiaries (the shareholders) or at the request of third parties (the potential purchasers).
CVM understands that the mandatory application of these accessory clauses is not compatible with several principles and rules of Law No. 6.404, of December 15, 1976, as amended (the Brazilian Corporate Law – BCL), mainly those contemplated in articles 115, 121, 122, I, and 1292, which are analyzed below.
In this regard, the CVM Board has identified the following legal grounds which justify the understanding expressed in the Opinion:
- By imposing a substantial encumbrance to the shareholders who approve the suppression of a share dispersion protection clause, the accessory clause may limit the sovereignty of the General Shareholders´ Meeting established by article 121 of BCL3.
- If the purpose of the accessory clause is to make the share dispersion protection clause almost unchangeable in practice, this will be contrary to the provisions of article 122, I, of BCL4, which empowers the General Shareholders´ Meeting to amend the bylaws whenever this is required by the social interest.
- The practical effect of the accessory clause is to require the unanimous consent, or the approval of almost all the shareholders, to eliminate the share dispersion protection clause from the bylaws. Indirectly, the accessory clause may increase the quorum set forth in the applicable legislation to take this resolution, which is forbidden in the case of a publicly-held corporation by force of article 129, § 1º, of BCL5.
- The bottom line is that the accessory clause may violate article 115 of BCL6. Consequently, the economic burden established by the accessory clause may prevent the shareholder to exercise his/her/it voting rights in the best interest of the company as determined by law.
Based on the above-mentioned reasons, the Brazilian regulator decided to issue an Opinion to clarify that CVM will not apply any penalties, in administrative proceedings, to the shareholders who, in compliance with the legislation in force, vote for the suppression or amendment of the share dispersion protection clause, regardless of making a public offering as set forth in the accessory clause.
The first benefit to justify the adoption of "poison pills" by a company is to assure equal treatment to all the shareholders and to cause the acquisition of control of a target company to also favor the minority shareholders by means of a public offering addressed to all the shareholders. However, it is important to give the shareholders the option to exclude the "poison pills" from the bylaws should under specific circumstances they deem convenient to do so, i.e. if they conclude that the administrative cost of the public offering is not justified in the concrete case and may be avoided.
Unlike other jurisdictions such as the United States in which the wider share dispersion is quite common and constitutes the general rule, in Brazil many publicly-held corporations have an owner (or a group of owners) holding the share control7 and share dispersion still remains an exception8.
In the case of wider share dispersion companies, the shareholders do not have any specific interest in suppressing the "poison pills" because they would like to maintain the equal treatment among them in the event of takeover of the target company by a potential investor.
If the company is controlled by a person or a group of persons, the importance of the "poison pills" is dramatically reduced since the equal treatment is assured, at least in part, by article 254-A of BCL9. Upon transfer of control of a publicly-held corporation, this provision grants to the minority shareholders the right to receive at least 80% of the amount paid for the voting shares comprising the controlling stock (tag along). Furthermore, from the 63 companies that have "poison pills" in their bylaws, 60 are listed in the New Market (Novo Mercado) segment of BM&FBOVESPA. The New Market regulations contemplate a tag along of 100% for all the shareholders in case of sale of control. Therefore, even if and when the "poison pills" are suppressed, the equal treatment will continue to be assured by the New Market regulations in the majority of the cases.
The second benefit of the "poison pills" is to protect the shareholders against compulsory offers. However, this protection is also questionable, as outlined herein.
If the target company has no controller, in the vast majority of the cases, the shareholders will have no great interest in suppressing the "poison pills" because they will be the main adversely affected parties by a coercive offer. Thus, one can trust and rely on the decision to be taken at the General Shareholders´ Meeting in this regard.
It is true that the situation might be different if the potential purchaser makes an offer to acquire the control conditioned to the revocation of the "poison pills". If such situation happens, the shareholders may be interested in revoking the "poison pills". Again when this situation occurs, the General Shareholders´ Meeting will be able to take the right decision, and the shareholders may exercise their free will and accept the offer without agreeing to suppress the "poison pills" from the bylaws, if they believe that the offered price is too low or unfair. Consequently, the chances of coercion are practically none.
On the other hand, whenever the target company has a controller, the protection against coercive offers is unnecessary, because the current legislation and the applicable regulations on closing the capital stock and increasing the equity participation are deemed to be sufficient to resolve any problems of coercion.
The third benefit attributed to the "poison pills" is to increase the management´s bargaining power on behalf of the shareholders. However, the ancillary clauses do not bring any protection in this scenario and in fact they may produce the opposite result. In the absence of a mandatory ancillary clause, the administrators will be able to freely negotiate the price and other business conditions with the potential purchaser and, subsequently, call a General Shareholders´ Meeting to revoke the "poison pills". If the ancillary clause precludes the suppression of the "poison pills", the alternatives at the disposal of the management will be substantially diminished and limited to the exceptions expressly permitted under the bylaws.
In summary, the lack of ancillary clauses does not affect in any way the first two benefits of the "poison pills", namely the equal treatment to the shareholders and the protection against coercive offers. In addition, the ancillary clauses restrain the third benefit – the possibility of negotiation – since they reduce the bargaining power of the management in detriment of the shareholders.
Last but not least, the "poison pills" do not bring solely benefits but may also represent additional costs which need to be carefully evaluated, some of which are quite obvious and relevant: (i) they can preclude the closing of an effective deal from an economic standpoint; and (ii) they will certainly increase the so-called "agency costs" to the extent that hostile takeover acquisitions become more difficult. For the purposes of our analysis, the most important agency costs are the losses suffered by virtue of the inefficiency or opportunism of the management. In the companies with no controller, these losses can represent a major problem, since the share dispersion will reduce each individual shareholder´s incentive for monitoring the administration of the target company. One of the mechanisms to avoid such losses is the hostile takeover acquisition because it eliminates the ex post losses, through the replacement of the administrators who are inefficient or opportunist and also reduces the ex ante losses, with the simple threat of change of control by fostering the administrators to be more diligent (efficient) and loyal to the shareholders10, considering that the company´s value will be reduced when the market´s perception is that the company is inefficiently managed.
To conclude the "poison pills" should be a prerogative to be used if favor of the shareholders and not a curse to make their lives miserable and each shareholder individually must be entitle to decide whether or not to accept a hostile takeover offer!
Footnotes
1. It was a legal mechanism to hinder or prevent hostile takeover attempts created in the 1980´s by Martin Litpon, a founding partner of the US law firm Wachtell, Lipton, Rosen & Katz. He developed the idea for the poison pill defense during two 1982 hostile takeover battles in Texas. In the first case, General American Oil was defending itself against a bid by corporate raider T. Boone Pickens. Lipton urged the Board to dilute Pickens´ stock purchase by flooding the market with new shares. His recommendation, however, was not followed and the company was sold to a last-minute bidder. In the second case, he employed another version in the defense of El Paso Company. Using the threat of the "poison pill" (a term not coined until the next year), El Paso negotiated its sale to the hostile suitor from a position of strength. While still controversial, the tactic was ruled legal in 1985.
2. All the provisions of the BCL transcribed in the subsequent footnotes reproduce the English free translation prepared by CVM, which is available at http://www.cvm.gov.br/ingl/indexing.asp.
3. "Article 121. A general meeting called and opened in accordance with the law and the bylaws is empowered to decide all matters relating to the corporate purposes of the corporation and to pass such resolutions as it deems necessary for the protection and progress of the corporation."
4."Article 122. The general meeting has exclusive authority: (Text as determined by Law No. 10.303, of October 31, 2001)
I – to amend the bylaws; (Text as determined by Law n. 10.303, of October 31, 2001)"
5. "Article 129. Except as otherwise provided for by law, the resolutions of a general meeting shall be passed by a simple majority of votes, abstentions not being taken into account.
Paragraph 1. The bylaws of a closed corporation may increase the quorum required for certain resolutions, provided they specify the matters."
6. "Article 115. The shareholder shall exercise the right to vote in the corporation's interest; the right to vote shall be deemed abusive if it is exercised with the intent to cause damage to the corporation or to other shareholders, or of obtaining an advantage for the shareholder or for a third party to which neither is entitled, and which results or may result in damage to the corporation or to other shareholders. (Text added by Law n. 10.303, of October 31, 2001)
Paragraph 1. A shareholder may not vote in a general meeting on a resolution which relates to the evaluation report on the property which he contributed to form the corporation's capital, to the approval of his accounts as a corporation officer, nor on any other resolution which may benefit him personally or in which he and the corporation may have conflicting interests."
7. The BCL defines "controlling shareholder" as follows:
"Article 116. A controlling shareholder is defined as an individual or a legal entity, or a group of individuals or legal entities by a voting agreement or under common control, which:
(a) possesses rights which permanently assure it a majority of votes in resolutions of general meetings and the power to elect a majority of the corporation officers; and
(b) in practice uses its power to direct the corporate activities and to guide the operations of the departments of the corporation.
Sole Paragraph. A controlling shareholder shall use its controlling power in order to make the corporation accomplish its purpose and perform its social role, and shall have duties and responsibilities towards the other shareholders of the corporation, those who work for the corporation and the community in which it operates, the rights and interests of which the controlling shareholder must loyally respect and heed."
8. Although the majority of the publicly-held corporations in Brazil has been characterized by a highly-defined and often family-held control group, wider share dispersion is becoming increasingly more common among those companies listed in the New Market (Novo Mercado) segment of BM&FBOVESPA as a result of the enormous growth and consequent sophistication of the Brazilian capital market.
9. "Article 254-A. The direct or indirect transfer of control of a publicly-held corporation can only be effected under the condition that the purchaser agrees to conduct a public offer to acquire the voting shares owned by the remaining shareholders. The offer price for such shares shall be at least eighty per cent (80%) of the amount paid for the voting shares comprising the controlling block. (Text added by Law n. 10.303, of October 31, 2001)
Paragraph 1. Transfer of control shall be understood as the transfer, whether direct or indirect, of shares comprising the controlling block, of shares bound by shareholders' agreements and of securities convertible into voting shares, assignment of share subscription rights and other rights related to securities convertible into shares which may result in the transfer of corporate control. (Text added by Law n. 10.303, of October 31, 2001)
Paragraph 2. The transfer of control provided for in this Section 254-A (first part) shall be approved by the Brazilian Securities Commission as long as the conditions of the public offer comply with the applicable legal requirements. (Text added by Law n. 10.303, of October 31, 2001)
Paragraph 3. The Brazilian Securities Commission shall be responsible for establishing the rules to be observed in the public offer indicated in this Section 254-A (first part).
Paragraph 4. The purchaser of control of a publicly-held corporation may offer the minority shareholders the option to keep their holdings in the company in exchange for payment of a premium equivalent to the difference between the market value of the shares and the amount paid for shares comprising the controlling block."
10. Among the duties of the administrators, the BCL expressly establishes the duties of diligence (article 153) and loyalty (article 154) as follows:
"Article 153. In the exercise of his duties, a corporation officer shall employ the care and diligence which an industrious and honest man customarily employs in the administration of his own affairs."
"Article 155. An officer shall serve the corporation with loyalty, shall treat its affairs with confidence and shall not:
I - use any commercial opportunity which may come to his knowledge, by virtue of his position, for his own benefit or that of a third party, whether or not harmful to the corporation;
II - fail to exercise or protect corporation rights or, in seeking to obtain advantages for himself or for a third party, fail to make use of a commercial opportunity which he knows to be of interest to the corporation;
III - acquire for resale at a profit property or rights which he knows the corporation needs or which the corporation intends to acquire.
Paragraph 1. An officer of a publicly held corporation shall also treat in confidence any information not yet revealed to the public, which he obtained by virtue of his position and which may significantly affect the quotation of securities, and shall not make use of such information to obtain any advantages for himself or for third parties by purchasing or selling securities.
Paragraph 2. An officer shall ensure that the provisions of paragraph 1, above, are not infringed by a subordinate or third party enjoying his confidence.
Paragraph 3. Any person detrimentally affected in a purchase or sale of securities contracted contrary to the provisions of paragraphs I and 2, above, may demand indemnity from the person responsible for the infringement for losses and damages, unless the person was aware of the information at the time the contract was made.
Paragraph 4 Any officer who may receive any confidential information not yet revealed to the public shall not make use of such information to obtain any advantages for himself or for third parties by purchasing or selling securities."
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
