Poison pills remain one of the most comprehensively debated anti-takeover defence mechanisms, which are adopted by companies to defend themselves against hostile and unsolicited takeover attempts. Innovated and adopted by Mr. Martin Lipton in 19821, poison pills or shareholder rights plan, as they are formally termed, have become increasingly commonplace, subject to regulatory jurisdictions enabling the adoption of such shareholder rights plan. Part I of this article aims to discuss the concept and purpose of poison pills as anti-takeover defences.
The Concept of Poison Pills
In a merger or acquisition, the proposed acquirer may offer to purchase the shares of a target company at a premium over the market price, in return for enabling the acquirer to acquire majority shareholding and/or control of the target company. However, the board of directors of the target company may reject such an offer due to various reasons such as business synergy, protecting the best interests of the shareholders and the target company, or due to a negative impact on the directors' own positions or those of management, resulting in the hostile acquirer directly approaching the existing shareholders of the target company to make a hostile tender offer. Then, the board may advise and recommend that the shareholders reject such offers. The board may also implement various defensive tactics to prevent such unsolicited offers, one of which is the poison pill.2
A poison pill is a prominent defence adopted by a board of directors to deter a potential acquirer from unsolicited purchasing of the shares of the target company, by making such an acquisition unprofitable. In the words of Martin Lipton, "[The poison pill] is an absolute bar to a raider acquiring control ... without the approval of the company's board of directors."3 It is aimed at either (a) absolutely deterring a hostile takeover, or (b) buying time for the board of directors of the target company to seek alternatives to an inadequate takeover bid and ensuring that the target company's shareholders have complete information regarding the relative merits and risks of the unsolicited bid and the true value of their shares.4
A poison pill can be issued by the board of directors to the shareholders to remain dormant until a triggering event occurs or can be issued by the board of directors prior to an unfavourable merger with another entity, as long as such issuance is permitted by the company's charter documents and the applicable law.5
The Various Forms of Poison Pills
Poison pills, in their generic form, are of two varieties, namely, "flip- in" and "flip-over". Flip-in poison pill consists of rights being issued to shareholders of the target company, which are generally non-exercisable and redeemable but contain a trigger mechanism. Upon happening of a certain event such as the hostile acquirer acquiring certain percentage of stake in the target company, the flip in poison pill gets triggered and provides the shareholders of the target company (other than the hostile acquirer and its affiliates), the right to purchase newly issued shares of the target company, at a discount. By such purchase, the existing shareholders of the target company severely dilute the hostile acquirer's value and percentage of stake in the target company, preventing the hostile acquirer from acquiring the majority stake.6
Flip-over poison pills are similar to flip-in poison pills. By triggering such shareholder plans, shareholders of the target company become entitled to purchase shares in the acquiring company upon the merger of the target company into the acquirer.7
Thus, both poison pills are targeted to provide the board of directors with the ability to substantially dilute the ownership stake of a hostile bidder, and giving the board the de facto veto power over any hostile acquisition.8 As such, acquirers are wary of "swallowing the poison pill", that is, purchasing enough shares in order to trigger such shareholder rights plans.9 Even if the acquirer is willing to swallow such a poison pill, the existing shareholders of the target company will not want to sell their shares to the acquirer, as they would rather hold out and exercise the rights after the pill is triggered. Further, since the terms of the poison pill are determined by the board of directors of the target company and subject to local laws, and may not require shareholder approval, the board of directors of the target company has a high degree of flexibility to incorporate a sufficiently deterring poison pill.10 Another way to incorporate poison pills is to prepare the shareholder rights plan in a manner such that the target company's board of directors have the option to redeem a poison pill at little or no cost, by repurchasing the warrants underlying the pill.11
As such, the flip-in and flip-over poison pills are similar to warrants in a manner, such that they provide an option for shareholders to purchase specified shares of the target price, determined by a conversion ratio, at a designated price such as two shares for the price of one. However, unlike warrants, the conversion ratios under poison pills may depend on the happening of triggering events. Under normal circumstances, such conversion ratio would be nominal. But when the poison pill gets triggered, the conversion ratio increases, enabling the shareholder to purchase shares of the target company at a lesser value.12
Conclusion
Poison pills remain predominant in the American jurisprudence, with extensive analysis and commentary by Delaware courts. For example, Netflix Inc. in its strategy to avoid the corporate raider, Carl Icahn, acquiring significant stake in itself, adopted a poison pill which would kick in if any investor acquires 10% (ten percent) or more stake in Netflix Inc. without the approval of its board of directors. In this case, Netflix Inc. would flood the stock market by issuing new shares and make any potential takeover more expensive.13 Similarly, recently, Hilton Grand Vacations Inc. adopted a 364-day duration shareholder rights effective April 16, 2020, to protect its shareholder's interests and maximize value for its shareholders.14
However, such poison plans remain largely absent in the Indian scenario due to regulatory restrictions in India. Part II of this Article analyses the regulatory restrictions in place in India, which curtail the incorporation of such defensive measures by companies in India.
Footnotes
[1] A Tough and Inventive Corporate Lawyer, Wharton Sch. U. Pa., available at https://magazine.wharton.upenn.edu/issues/anniversary-issue/a-tough-and-inventive-corporate-lawyer-martin-lipton-w52/
2. A. Christine Hurt, The Hostile Poison Pill, 50 U.C. Davis L. Rev. 137 (2016)
3. Martin Lipton, Wachtell, Lipton, Rosen & Katz, Memorandum to Clients (Jan. 15, 1993)
4. Matthew J. Gardella, Scott M. Stanton, Joshua B. Bergmann, David G. Conway, COVID-19 and Poison Pills: The Right Prescription?, Volume X, Number 121, National Law Review (2020)
5. John C. Coates, Takeover Defenses in the Shadow of the Pill: A Critique of the Scientific Evidence, 79 Tex. L. Rev. 271 (2000)
6. Finkelstein, Antitakeover Protection Against Two-Tier and Partial Tender Offers: The Validity of Fair Price, Mandatory Bid, and Flip Over Provisions Under Delaware Law, I 1 Sac. REG. L.J. pp. 291, 303 (1984); Robert A. Ragazzo, Protecting Shareholders against Partial and Two-Tiered Takeovers: The "Poison Pill" Preferred, Vol. 97, Harvard Law Review, pp. 1964-1983, Issue 8 (1984).
7. MacMinn, Richard D and Douglas O. Cook, An Anatomy of the Poison Pill, Managerial and Decision Economics, Volume 12, Issue 6, pp. 481-87 (1991). Accessed September 2, 2020.
8.K. J. Martijn Cremers, Scott B. Guernsey, Lubomir P. Litov, Simone M. Sepe, Shadow Pills and Long-Term Firm Value, March 2018, available at https://www.law.nyu.edu/sites/default/files/upload_documents/Simone%20Sepe%20Shadow%20Pills%20and%20Long-Term%20Firm%20Value.pdf,
9.Jordan M. Barry and John William Hatfield, Pills and Partisans: Understanding Takeover Defenses, Vol. 160, No. 3, University of Pennsylvania Law Review, pp. 633-713 (2012);
10. Emiliano M. Catan and Marcel Kahan, The Law and Finance of Anti-Takeover Statutes, Vol. 68, Issue 3, Stanford Law Review (2016)
11. David R. Ellin, The Poison Pill Warrant - Apothecary and Antidote: Moran v. Household International, Inc., 36 DePaul L. Rev. 413 (1987)
12. Ibid; Supra Note 6
[13] David Goldman, Netflix Adopts Poison Pill to Fend off Icahn, CNN Business, November 5, 2012, available at: https://money.cnn.com/2012/11/05/technology/netflix-poison-pill/
[14] Hilton Grand Vacations Adopts One-Year Shareholder Rights Plan, BusinessWire, April 16, 2020, available at: https://www.businesswire.com/news/home/20200416005165/en/Hilton-Grand-Vacations-Adopts-One-Year-Shareholder-Rights-Plan
Originally published Jun 11, 2021
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