Shareholder rights plans, commonly known as poison pills, are used by companies to defend against hostile takeovers. A poison pill creates an incentive for a hostile bidder to negotiate with the target company and, in certain cases, deter an unwanted offer completely. Poison pills first became popular in the 1980s and, by 2002, 60 percent of the S&P 500 companies had a poison pill in place. Fast-forward to 2008 and only 28 percent of the S&P 500 companies had poison pills in place. This decline was due in part to the booming economy and in part to a shareholder activism movement.
Recently, however, with the resurgence of takeovers, poison pills are back in the news. For example, in Air Products and Chemicals, Inc., v. Airgas, Inc., the Delaware Supreme Court held that a board of directors was not obligated to "pull" a pill even after two years of takeover offers and requests from shareholders to negotiate with the bidder. Also, in Versata Enterprises, Inc. and Trilogy, Inc. v. Selectica, Inc., the same court upheld the board of directors' decision to trigger a pill and issue additional shares, thereby diluting the hostile bidder's interest and preventing a takeover. In light of the renewed interest in poison pills, this article provides a quick refresher.
Poison pills provide a mechanism by which an unwanted bidder suffers an extreme dilution of its equity position if it crosses a specified ownership threshold (usually 15 percent) by having additional equity issued in exchange for "rights" granted to the company's shareholders other than the unwanted bidder. There are two principal types of poison pills — flip-in and flip-over plans. The flip-in plan, the most frequently used type, gives the target company's shareholders (other than the shareholder that has triggered the pill) the right to purchase additional shares of the company at a discounted price. The flip-over plan gives the target company's shareholders the right to purchase the shares purchased by the hostile bidder at a discounted price. A poison pill is implemented through the adoption of a shareholder rights plan by a company's board of directors. As long as there are sufficient authorized shares to cover the shares issuable upon the exercise of the poison pill rights, no shareholder action will be required. Recently, however, more companies are giving shareholders a say on poison pills.
Poison pills can also be adopted to protect the net operating losses of a company (NOL pill). An NOL pill, or a 382 poison pill, is a variation on the general poison pill and is used to protect a company's net operating losses that can be used to shelter future income (or, generally speaking, income over the prior two years) from taxation. Under section 382 of the Internal Revenue Code, a company which experiences an ownership change (as described in the next sentence) in a three-year period is prevented from using any net operating losses occurring before that ownership change. Generally, an ownership change occurs for this purpose when more than 50 percent of a company's share ownership changes; however, only those shareholders holding a 5 percent or greater block of the company's outstanding shares are considered in calculating this change.
Several studies have analyzed the effect of poison pills on shareholder value. Some studies indicate that companies with poison pills in place receive higher takeover premiums. However, other studies have concluded that poison pills decrease shareholder value.
Poison pills are among the most important anti-takeover defenses that public companies should consider. The following are factors to be considered in determining whether a public company should implement a poison pill:
- The other anti-takeover devices that a company has in place should be considered. For example, if a company has a staggered board or supermajority voting requirements for certain actions, certain combinations of anti-takeover devices may create a preclusive effect.
- When implementing a poison pill, companies should undertake a thorough investigation process and engage outside experts as appropriate.
- Poison pills often include automatic "sunset" provisions after a specified period (typically 10 years). Moreover, some poison pills include a requirement that an independent director review the poison pill every three years and decide whether it is in the best interests of the shareholders. While the independent director's finding is not binding on the board, it would be difficult for a board to ignore it completely.
- Implementation of an NOL pill should be considered by any company with substantial operating losses.
- Institutional investors generally remain hostile to poison pills and, with respect to NOL pills, the Institutional Shareholder Services, a leading provider of corporate governance services, recommends NOL pills have a term that is the shorter of three years or the remaining life of the company's net operating losses.
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