7. Poison Pills: a Case Study of Defensive Tactics and ...
7. POISON PILLS: A CASE STUDY OF DEFENSIVE TACTICS AND JUDICIAL REVIEW Introduction to Poison Pills The poison pill as defensive tactic most effective defensive tactic of the last quarter century aims to make the unwanted bidders offer more expensive so as to discourage the bidder from going forward. The poison pill seems unusual as a defense -- turns on its never being used but then Unocal defensive tactic designed so it would never be used but only deter an unwanted bid.
poison pill is case study of how entrepreneurial lawyers respond in a takeover setting and the ongoing dynamic between courts and lawyers lawyers innovate, opposing lawyers respond, courts decide and then the cycle continues into the next iteration. focus is on the New York law firm of Wachtell, Lipton, Rosen and Katz in the mid1980s, but carries over to any lawyer in any period.1980s, but carries over to any lawyer in any period. A. THE CHALLENGE FACING THE DRAFTERS OF THE POISON PILL What would happen if the board did nothing? A hostile bidder could make an offer at a substantial premium to market price (even if below what the board thought was a fair price)
and the shareholders would tender because of the premium, leaving the board members out of a job and the shareholders with what the board thought was an inferior price for their shares. What did the lawyers need to do? if the board can sufficiently shut down the channels for shareholder action, the board would remain in control. How did the lawyers want to do that? The poison pill works by making a bidders purchase of shares so expensive that it no longer makes economic sense. Poison Pills: the Mechanics
1. Issuance 7. Exchange 2. Term 8. Redemption 3. Exercise Price 9. Voting 4. Rights Detach & Become
Exercisable 10. Terms of Preferred Stock 5. Protection against squeeze out 11. Tax consequences 6. Protection vs. creeping acquisition
12. Accounting consequences Organizing the pill think about the twelve items as part of three headings: (1) the feint ( 2) the poison (3) the law
(i.e. anticipating the judicial response). The feint Items 1, 3 and 10 come under the feint. These terms essentially mis-directional they relate to preferred stock which dont seem to have much to do with the real defense. The feint cont. #1 what is being issued? Right to purchase preferred stock, but not just preferred stock in the abstract but 1/100 of a share of preferred stock which should raise a
quizzical response as to what is really going on. # 3 How much would a shareholder pay for this 1/100 share of preferred stock? The plan provides that the board will set the price and suggests something equivalent to the boards estimate of long1980s, but carries over to any lawyer in any period.term value, but practically the key point is that it is three to five times current market price. Nonredeemable, junior to other preferred, dividend and voting equal to common Placeholder no one would ever exercise right to get this preferred Puts a familiar coating on whats inside, like a virus The feint (cont.)
#10 What do you get for that price? A stock that is nonredeemable and junior to other preferred with dividend, liquidation and voting rights equal to one share of common. Why would anyone do thispaying three to five times current value of common to receive what is the economic equivalent of a share of common? No one would. This doesnt make any economic sense and is not intended to do so. It is there as a placeholder. Could they have done without it? Perhaps, in theory, but it put a familiar corporate law envelope (and one that was clearly within the traditional director power) around this new and questionable defensive tactic.
The poison The three middle provisos, (#41980s, but carries over to any lawyer in any period.6) are where the poison is found. #4 Rights Detach. The trigger for the poison is that upon the hostile bid or acquisition above a triggering amount (here 20% but today 15% or smaller) the right to buy preferred stock becomes something else, described in the next two paragraphs. #6 Flip1980s, but carries over to any lawyer in any period.In. The core point is that each holder obtains the right to buy the number of shares equal to two times the exercise price (from paragraph #3) by paying the exercise price, a 2 for 1 purchase priced that any bargain1980s, but carries over to any lawyer in any period.seeker should be able to follow
For example if stock were trading for $75 and the exercise price was specified as $150, once you paid your $150 you would get four shares not just two. Bidder is excluded from this two-for-one deal Moran v. Household International, Inc. Moran is the Delaware Supreme Courts first treatment of this new innovation. two core legal issues: (1) Is it within the boards power to do this? (2) Review under Unocal. The challengers seek to distinguish this use of rights and preferred shares as not designed to raise money for the corporation
-- but the court is unwilling to so restrict the board power. the flip1980s, but carries over to any lawyer in any period.over option how can action by target board of directors create rights of its own shareholders in another separate corporation? court points to anti1980s, but carries over to any lawyer in any period.dilution features that long have been part of debt and stock provision that provide holders of one company with rights in another Example of Pill Dilution Effect ---Flip-in pill gives one pfd share to each common share--Flip-in trigger: Hostile bidder % ownership level 15% Shrs Target shares outstanding 1 MM Pre-bid market price per share $10 Bid price per common share (50% premium) $15 Bidders cost for .15MM toehold @ $15 $2.25 MM
Exercise price of a pfd stocks right in SHP $40 Flip-in discount on shares purchased (dilution rate) 50% Each pfd share can buy common shares worth $80 At share bid price of $15, each pfd share can buy 5.33 common shares ($80/$15) = at an exercise price of $40 Bidders Cost of Acquisition Flip-in rights of 5.33 new shares go to old shares .850 MM Shrs New shares (5.33 x .85MM old non-bidder Shrs) 4.533 MM Adjusted shares outstanding (incl. bidder Shrs) 5.533 MM
Bidder % shares post-pill (.15 / 5.533 MM) 2.7% Target equity pre-pill @ $15 Bid x1MM $15. MM Proceeds of rights exercise ($40 x .85MM) $34. MM Target equity - post-pill (with proceeds) $49. MM Diluted market value per common share $8.856 Bidder capital loss ($15 8.856 MM) $6.144 Diluted value of Bidders .15 MM shares $1.328 MM
Moran Decided at same time as Unocal Unocal: Our corporate law is not static. It must grow and develop in response to, indeed in anticipation of, evolving concepts and needs. Merely because the General Corporation Law is silent as to a specific matter does not mean that it is prohibited. Moran Unocal analysis in Moran : court applies the threat and proportionality test and finds this
director action easily passes Key legal move last paragraph of opinion court separates out redemption (remember Item #8 from the Wachtell Lipton list) specifies that directors response at the time of the takeover1980s, but carries over to any lawyer in any period. i.e., whether their action in refusing to redeem the poison pill, must pass Unocal test. Brilliant, lucky, or both? Do you think the planners put the redemption item in for this purpose? More likely redemption (see
page 207; specified at very low cost of $.01 per right), was designed to let directors remove the pill so they dont interfere with a friendly merger But clause ends up being the hook on which subsequent analysis of poison pills turns Marty Lipton City Capital Associates Ltd. Partnership v. Interco, Inc.
The company is a conglomerate, a holding company with four parts that dont overlap with one another. successor to International Shoe Company encountered in civil procedure course. St. Louis based company with a board that included many established business leaders in the city. City Capital Associates Ltd. Partnership v. Interco, Inc.: The Deal proposed transaction came when financial restructuring
near cyclical peak. bidders are the Rales brothers, Mitchell and Stephen, backed by legendary financier Michael Milken and Drexel Burnham financial, not a strategic buyer likely they would break up this conglomerate, using its cash, selling some of its assets, and replacing management. cash offer at a substantial premium over existing trading price. Milken & Wasserstein Interco: The Deal (cont.)
Company retained Bruce Wasserstein, himself an outsized reputation in the takeovers market. WP conducts a valuation study (more on valuation in Ch. 9) There is a Discounted Cash Flow (DCF) analysis, comparable companies and comparable deals analysis, and a divestiture analysis. The result, not surprisingly given his client, is that the value of the company is not only above current market value by a significant amount, but also above the City Capital offer. Complication -- when Rales brothers raise their offer so it is within the investment bankers range of fairness, bankers revise it, so just two weeks after the first study, range of fairness is again higher than the offer. ?!
Investment Banker Joke How many investment bankers does it take to screw in a light bulb? What sort of number did you have in mind? Interco: defenses Target Interco has a poison pill also launches affirmative restructuring 2 cash dividends to shareholders
four tranches of debentures and preferred stock to be issued to shareholders And then the shareholders would still be left with their common stock termed a stub since so much of its value has been separated from it in the form of the dividends and new securities. Interco Restructuring Cash dividend I (11/7) 14.00
Cash dividend II (11/29) 24.15 Sr. Sub. Debentures 11.00 Sub. Discount Debentures 6.80 Jr. Subordinated Deben. 5.44 Conv. Preferred Stock Stub 10.00 Total $76.15 4.76 Restructuring analysis The result is a package that on its face trumps the Rales brothers offer.
But how would shareholders view the two offers? The Rales brothers are offering all cash. The company is offering a handful of paper which may not turn out to be worth the face value if the company cannot pay its debts. the common stock, as the residual holders and last in line to be paid, would be the first to suffer so that $10 value is the element most likely to be unreal. Interco litigation What is plaintiff (here the bidder) seeking? A judicial finding that the director action is a breach of their fiduciary duty as measured by
Unocal. Interco: Unocal Analysis What is the threat? how is the threat is different than what we saw in Unocal? There is no longer the possible coercion from a two 1980s, but carries over to any lawyer in any period.tier, front1980s, but carries over to any lawyer in any period.end loaded offer that will create a prisoners dilemma. But look how threat is now being defined: That shareholders will not understand how a cash price for all shares is inadequate a harder argument to make as a threat, but the court finds this, too, meets the threat standard.
This is an easier burden for the company to meet than might have been thought after Unocal. Interco: Unocal analysis Is the response proportional? proportionality leg of the Unocal test seems more difficult to satisfy here. Chancellor Allen notes that there may come a time when directors have to let shareholders decide, language that was not part of the earlier analysis. to let the pill be used to deprive shareholders of their ability to choose a noncoercive offer after directors have had an coercive offer after directors have had an opportunity to pursue alternatives would be so inconsistent
with widely shared notions of appropriate corporate governance as to threaten to diminish the legitimacy and authority of our corporate law. (at page 233). Interco: Unocal analysis But . . . Chancellor Allen doesnt have the last word. The Delaware Supreme Court the following year in Paramount, Inc. v. Time, Inc, the Supreme Court reaches out to slap down the Interco analysis as the court substituting its judgment for the boards and not in keeping with a Unocal analysis. (see page 146 and 147.)
Judicial review of the restructuring defense in Interco The sale of Ethan Allen, the furniture division with a valuable brand name, and the dividends both pass muster the Ethan Allen sale explicitly the dividends question technically reserved by the court but with language that leaves little room to challenge such action: difficultto imagine how a pro rata distribution of cash to shareholders could itself ever constitute an unreasonable response to a bid believed to be inadequate. (page 234)
Why do the Rales brothers withdraw their bid? The Chancellors ruling came down on November 1. By November 14, 93% of Interco shareholders had tendered into the Rales brothers offer. Yet two days later, the Rales brothers withdraw their tender offer. Why? Rales bros. had won on the poison pill but lost on the restructuring. Why do the Rales brothers withdraw their bid? cont. By deciding to implement the restructuring, the
managers were implementing much of what the Rales brothers would have done after acquiring control. the acquisitions attractiveness had declined. a scorched earth defense. If you are willing to do enough things to your company, you can block the bidder. Also, Drexel under investigation by Feds See this book: http://www.amazon.com/Payback-Conspiracy-Destroy-Financial-Revolution/dp/088730804X Could the director action be challenged on Revlon grounds? This could have been a much more difficult question.
The Rales brothers were offering $74 in cash. The restructuring was supposedly valued at $76 but had greater uncertainty. The results that followed for the company were dismal. Time line Nov 22 1980s, but carries over to any lawyer in any period. Interco board approves restructuring plan Nov 30 1980s, but carries over to any lawyer in any period. Interco pays cash dividend of $38.60 ($1.42 billion) financed with $1 billion of debt & planned divestitures. Ex1980s, but carries over to any lawyer in any period.dividend stock price falls to $29.63
Dec 23 1980s, but carries over to any lawyer in any period. Interco distributes senior securities to shareholders ($1 billion of debentures and $342 million of preferred). Ex1980s, but carries over to any lawyer in any period.dividend (stub) stock price falls to $3.25 time line 1989: Divestiture proceeds falls $260 1980s, but carries over to any lawyer in any period. $410 million short of forecast. Earnings from remaining operations are below forecast. Financial pressure mounting, WP is dropped as financial advisor, Saligman is fired as CEO. Spring 1990 1980s, but carries over to any lawyer in any period. Interco settles a shareholder lawsuit charging Interco directors breached their fiduciary duty. Company agrees to pay $18.5 million.
June 1990 1980s, but carries over to any lawyer in any period. Interco defaults on bond payments. Jan. 1991 1980s, but carries over to any lawyer in any period. Interco files for bankruptcy; Stub trades at $0.50 per share. Aug 1992 1980s, but carries over to any lawyer in any period. Emerges from bankruptcy after 19 mos. Stub & preferred equity are worthless; Subordinate debt paid to shareholders has little value. Divestiture Proceeds Shortfall - 1990 Proceeds from sales were disappointing: Projected Actual
Ethan Allen $550-625 $338 Central Hardware $300-325 $245
Apparel Group $425-475 $278 ------------- $61 ------------ $1,275-1,425
$911 Other Units TOTAL: Epic Interco Fail stockholders received $38.60 cash dividend and some very risky senior securities 1980s, but carries over to any lawyer in any period. worth very little! Stockholders also lost by being taxed at ordinary rates on $38.60 cash dividend, whereas Rales brothers $74 tender offer likely would be treated as capital gain. With the benefit of hindsight, it would not satisfy Revlon even in real time, the court termed the Wasserstein Perella valuation a
highly debatable proposition (page 232) later observed that the shareholders could prefer a $74 cash payment now to the complex future consideration offered through the restructuring. [This is in the poison pill part of the opinion before the court weighs in on depriving the shareholders of their ability to effectively choose. ] Why should not the same reasoning apply to the restructuring under a Revlon analysis? Air Products and Chemical, Inc. v. Airgas, Inc. Air Products recalibrates judicial approach to poison pills. The deal pill will impose a financial penalty large enough that a bidder has
turned to voting in order to replace board then use the director power to terminate pill But the target has a staggered board (this defense was declining rapidly among larger companies at the time of this case for reasons related to institutional shareholders approach to corporate governance). Air Products and Chemical, Inc. v. Airgas, Inc. Air Products successfully captured the seats that were up for election in 2010 but was left short of a majority because of the staggered board. also successful in getting shareholder approval to
change the date of the annual meeting of shareholders so that it would be able to come back to the Air Products shareholders just four months later in January Air Products and Chemical, Inc. v. Airgas, Inc. if successful, Air Products would get a second set of directors that would give it more than a majority. This route was foreclosed by a Delaware Supreme Court decision that interpreted Delaware law to preclude shortening of director terms. But Air Products went forward with its three directors and a higher offer sought a judicial declaration that the boards failure to redeem the pill in these circumstances failed Unocal and was a breach of duty.
Air Products and Chemical, Inc. v. Airgas, Inc. Just say no. common label in takeovers, drawn from First Lady Nancy Reagans well-known clich used in the anti-drug campaign of the 1980s Can directors continue to say no, or, as Chancellor Allen suggested in Interco, there may well come a time when they have to let shareholders decide for themselves.
Air Products and Chemical, Inc. v. Airgas, Inc. Chancellor Chandler, time has come for judicial invalidation The chancellor says he has a hard time believing a non-discriminatory all-cash, all shares fully financed offer poses any threat as Unocal would require. Airgass poison pill has served its legitimate purpose Airgas has received more time than any litigated poison pill in Delaware history. Air Products and Chemical, Inc. v. Airgas, Inc. Chandler points to the trial record - Airgass stockholder base is sophisticated and wellinformed. Why then does the poison pill survive?
One possibility is My bosses made me do it. There has been a difference through the years of the approach of the Chancery Court and the Supreme Court (think of the response to Interco for example) and the Supreme Court gets the last word. Air Products and Chemical, Inc. v. Airgas, Inc. But there is also a more nuanced alternative explanation. Recall that Air Products had successfully elected three of its nominees to the Airgas board in September. The trial showed, as described in the last paragraph of the excerpt from the courts opinion, that these three had joined wholeheartedly in the boards determination to protect the pill. This by itself likely doomed the poison pill in a state whose
litigation puts so much faith in the board of directors. Air Products and Chemical, Inc. v. Airgas, Inc. In deciding the proportionality of the defenses to the tender offer, Chandler quotes the Supreme Courts then-recent Selectica decision - a defensive tactic (a classified board in that setting) that delays but does not prevent a hostile acquirer from obtaining control of the board over a two-year period satisfies the Delaware review so long as obtaining control at some point in the future is realistically obtainable. Air Products and Chemical, Inc. v. Airgas, Inc. Is control of the board realistically obtainable via the
shareholders calling a special meeting? under the Airgas charter this would require a 67% vote-- which would have been 85-86% of the unaffiliated voters Chandler concludes that the poison pill is assuredly preclusive in the everyday common sense meaning of the word but concludes it does not end the proportionality analysis Air Products and Chemical, Inc. v. Airgas, Inc. Air Products has the alternative of gaining control if it were to wait around another 8 months until the next Airgas annual meeting and duplicate its success at the prior annual meeting by electing another one third of the board the two meetings together would give it two-thirds control
Chandler concludes the poison pill was not preclusive. Air Products and Chemical, Inc. v. Airgas, Inc. What are we to make of this? Chancellor Chandler, like Chancellor Allen before him, two of the most experienced participants in Delaware corporate governance, seem to have felt constrained by the Supreme Court precedent. Clear holding of Delaware law was narrower than the Chancellors might prefer. Also, for Chandler, as Note 3 suggests, after all the discussion of threat and proportionality, he acknowledges that the three directors Air Products successfully added to the board had voted to keep the Airgas defense in place. In a system that lets directors make most corporate decisions, that by itself may have been enough to turn the tide.
Carmody & Quickturn Dead hand and slow hand pills Even more poisonous pills . . . What does the poison pill do? Makes a tender offer so expensive that no bidder will want to give the shareholders the opportunity to tender. Is the poison pill absolute? What antidote is there? As Moran and Interco illustrate, directors are given redemption power. Their non1980s, but carries over to any lawyer in any period.redemption can be challenged via a fiduciary duty suit, but even more importantly, a hostile bidder can replace the board and get
the new board to redeem the poison pill. What modification in the poison pill would shut off the channel of shareholder selling even after a change of control? A dead hand pill or a slow hand pill. Carmody & Quickturn How is the Carmody pill different? The redemption paragraph has been tweaked so that now the pill can only be redeemed by the directors who put it in or their designated successors, effectively seeking to close the avenue for redemption left by the earlier cases. Vice Chancellor Jacobs (prior to his appointment to the
Supreme Court) finds the dead hand comes up short on two separate threads of analysis. First it would interfere with the boards statutory power to manage the business (see Part IIB). Additionally it fails Unocal (see Part IIIB3). If you were a lawyer for targets after Carmody, do you see any room for further adjustment that would still satisfy the Delaware courts? With the dead hand pill blocked, lawyers turned to a less intrusive way to further narrow the channel for shareholders to sell.
In Quickturn we see a slow hand pill that effectively builds a six month delay process into the redemption of the pill. The Chancery Court struck down this new pill version under Unocal The Supreme Court refers both to Unocal and the alternative ground from
Carmody that the slow had pill deprives any newly elected board of its statutory authority to manage the corporation. the board has to be free to discharge its fiduciary duty and this plan interferes with that Difference between Unocal and Carmody/Quickturn? The Supreme Courts approach focuses on directors and what the law requires for them to run the corporation. The dead hand poison pills and the slow hand pill interfere with
directors ability to fully exercise their rights. In contrast, the Unocal claim and other fiduciary duties claim look at the shareholder side of the governance equation as well. Recall that Chancellor Allen in Interco spoke of the shareholders ability to choose. The focus on directors gives that less importance, a difference that seems to show up in the cases in the next chapter.
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