For almost 30 years, companies have used the pill as the critical legal tool to ward off hostile takeovers.
But in the Air Products/Airgas battle, the pill itself has come under attack and. In the next few weeks, a Delaware judge is expected to rule on its use.
According to the story, corporate attorneys are calling it one of the most significant legal decisions in a generation, one that could affect the balance of power between boards and shareholders.
The “poison pill,” invented in the early 1980s by Marty Lipton, of Wachtell Lipton, effectively derails a takeover by making it prohibitively expensive to acquire a certain percentage of company shares, typically more than 20%.
Air Products has already placed three directors on the company’s 10-member board. And many shareholders seem keen on Airgas being sold. That goes against the wishes of Airgas founder Peter McCausland and other board members, who say it undervalues the company. Airgas is employing a pill to fend off Air Products’s bid.
Now Chancery Court Judge William Chandler must rule whether to end the pill, a decision that sets off a crucial question for all corporations: At what point should power and responsibility shift from the board to shareholders in a takeover offer? ...
Proponents of pulling the Airgas pill argue that it has done its job, giving Airgas’s board enough time to find alternatives to Air Products’ hostile bid.
For those of you who are wondering What's a Poison Pill?, follow the link.
The first problem I have with Jones' story is that the Delaware Supreme Court upheld the validity of the pill in Moran v. Household Int'l, Inc., 500 A.2d 1346 (Del.1985). The Delaware supreme court subsequently invoked the principle of stare decisis to reject a post Moran challenge to poison pills: "It is indisputable that Moran established a board's authority to adopt a rights plan." Account v. Hilton Hotels Corp., 780 A.2d 245 (Del.2001). "To recognize viability of the [plaintiff's] claim would emasculate the basic holding of Moran, both as to this case and in futuro, that directors of a Delaware corporation may adopt a rights plan unilaterally. The Chancellor determined that the doctrine of stare decisis precluded that result and we agree." Id.
Second, according to conventional wisdom, the principle that, once it becomes clear the best possible alternatives were on the table, the board is required to redeem the pill and permit the shareholders to choose between the available alternatives was advanced by Chancellor Allen in City Capital Assoc. Ltd. Partnership v. Interco, Inc., 551 A.2d 787 (Del.Ch.1988). But it's not at all clear that Interco should be so interpreted. Granted, Chancellor Allen enjoined the board's obstructive tactics, using dicta that broadly endorsed the shareholder choice position. Tellingly, however, he concluded "that reasonable minds not affected by an inherent, entrenched interest in the matter, could not reasonably differ with respect to the conclusion that the [bidder's] $74 cash offer did not represent a threat to shareholder interests sufficient in the circumstances to justify, in effect, foreclosing shareholders from electing to accept that offer." If the right to decide belongs to the shareholders, however, what relevance does the board's motives have? A motive analysis is only necessary--or appropriate, for that matter--if the board not the shareholders has decisive authority in takeover battles. This reading of Allen's Interco opinion is supported by his subsequent TW Services decision, in which he distinguished Interco and the other poison pill cases from the case at bar on the ground that the former did not "involve circumstances in which a board had in good faith (which appears to exist here) elected to continue managing the enterprise in a long term mode and not to actively consider an extraordinary transaction of any type." TW Servs. v. SWT Acquisition Corp., 1989 WL 20290 (1989). Plus, of course, there's the not unimportant fact that Interco was decisively rejected by the Delaware Supreme Court in Paramount Communications, Inc. v. Time Inc., 571 A.2d 1140, 1153 (Del.1989).
Third, the Delaware Supreme Court recently upheld a so-called NOL pill in which the acquisition of a mere 5% of the company's stock triggered the pill's poisonous effects. It did so matter of factly, as though there were no question but that pills are invalid.
Some of the Chancellors have been sniffing around the edges of the pill, not unlike hungry wolves sniffing around the edges of a herd of sheep (and, yes, I mean Strine), but given the precedents I've just described it's hard to see how a trial court judge could plausibly write an opinion that broadly limits the pill. Even if Chandler were so inclined, stare decisis would seem to limit him to nibbling around the edges.
And, anyway, the idea that "responsibility [should at some point] shift from the board to shareholders in a takeover offer" is just bad public policy. The following is taken from my book on Mergers and Acquisitions.
Corporate law generally provides for free alienability of shares on the secondary trading markets. Mergers and related transfers of control, however, are treated quite differently. As we saw above, corporate law gives considerable responsibility and latitude to target directors in negotiating a merger agreement. The question then is whether unsolicited tender offers are more like secondary market trading or mergers.
The so-called structural argument—also known as the shareholder choice argument—asserts that the tender offer is much more closely analogous to the former. According to its proponents, an individual shareholder’s decision to tender his shares to the bidder no more concerns the institutional responsibilities or prerogatives of the board than does the shareholder’s decision to sell his shares on the open market or, for that matter, to sell his house.[1] Both stock and a home are treated as species of private property that are freely alienable by their owners.
The trouble is that none of the normative bases for the structural argument prove persuasive. That shareholders have the right to make the final decision about an unsolicited tender offer does not necessarily follow, for example, from the mere fact that shareholder have voting rights. While notions of shareholder democracy permit powerful rhetoric, corporations are not New England town meetings. Put another way, we need not value corporate democracy simply because we value political democracy.[2]
Indeed, we need not value shareholder democracy very much at all. In its purest form, our authority-based model of corporate decisionmaking calls for all decisions to be made by a single, central decisionmaking body—i.e., the board of directors. If authority were corporate law’s sole value, shareholders thus would have no voice in corporate decisionmaking. Shareholder voting rights thus are properly seen not as part of the firm’s decisionmaking system, but as simply one of many accountability tools—and not a very important one at that.
Nor is shareholder choice a necessary corollary of the shareholders’ ownership of the corporation. The most widely accepted theory of the corporation, the nexus of contracts model, visualizes the firm not as an entity but as a legal fiction representing a complex set of contractual relationships. Because shareholders are simply one of the inputs bound together by this web of voluntary agreements, ownership is not a meaningful concept under this model. Each input is owned by someone, but no one input owns the totality. A shareholder’s ability to dispose of his stock thus is not defined by notions of private property, but rather by the terms of the corporate contract, which in turn are provided by the firm’s organic documents and the state of incorporation’s corporate statute and common law. The notion of shareholder ownership is thus irrelevant to the scope of the board’s authority. As Vice Chancellor Walsh observed, “shareholders do not possess a contractual right to receive takeover bids. The shareholders’ ability to gain premiums through takeover activity is subject to the good faith business judgment of the board of directors in structuring defensive tactics.”[3]
Finally, and most importantly, the structural argument also ignores the risk that restricting the board’s authority in the tender offer context will undermine the board’s authority in other contexts. Even the most casual examination of corporate legal rules will find plenty of evidence that courts value preservation of the board’s decisionmaking authority. The structural argument, however, ignores the authority values reflected in these rules. To the contrary, if accepted, the structural argument would necessarily undermine the board’s unquestioned authority in a variety of areas. Consider, for example, the board’s authority to negotiate mergers. If the bidder can easily by-pass the board by making a tender offer, hard bargaining by the target board becomes counter-productive. It will simply lead to the bidder making a low-ball tender offer to the shareholders, which will probably be accepted due to the collective action problems that preclude meaningful shareholder resistance. Restricting the board’s authority to resist tender offers thus indirectly restricts its authority with respect to negotiated acquisitions.[4]
Indeed, taken to its logical extreme, the structural argument requires direct restrictions on management’s authority in the negotiated acquisition context. Suppose management believes that its company is a logical target for a hostile takeover bid. One way to make itself less attractive is by expending resources in acquiring other companies. Alternatively, the board could effect a preemptive strike by agreeing to be acquired by a friendly bidder. In order to assure that such acquisitions will not deter unsolicited tender offers, the structural argument would require searching judicial review of the board’s motives in any negotiated acquisition.
To take but one more example, it is quite clear that managers can make themselves less vulnerable to takeover by eliminating marginal operations or increasing the dividend paid to shareholders and thus enhancing the value of the outstanding shares. A corporate restructuring thus can be seen as a preemptive response to the threat of takeovers. It is hard to imagine valid objections to incumbents securing their position through transactions that benefit shareholders.[5] Why then should it matter if the restructuring occurs after a specific takeover proposal materializes? The structural argument not only says that it does matter, but taken to its logical extreme would require close judicial scrutiny of all corporate restructurings. ...
In its takeover jurisprudence, Delaware has balanced the competing claims of authority and accountability by varying the standard of review according to the likelihood that the actions of the board or managers will be tainted by conflicted interests in a particular transactional setting and the likelihood that nonlegal forces can effectively constrain those conflicted interests in that setting. In other words, the Delaware cases suggest that motive is the key issue. As former Delaware Chancellor Allen explained in the closely related context of management buyout transactions: “The court’s own implicit evaluation of the integrity of the . . . process marks that process as deserving respect or condemns it to be ignored.” Assuming that a special committee of independent directors would be appointed to consider the proposed transaction, Allen went on to explain: “When a special committee’s process is perceived as reflecting a good faith, informed attempt to approximate aggressive, arms-length bargaining, it will be accorded substantial importance by the court. When, on the other hand, it appears as artifice, ruse or charade, or when the board unduly limits the committee or when the committee fails to correctly perceive its mission—then one can expect that its decision will be accorded no respect.”[1] Our claim is the same is true with respect to board resistance to unsolicited tender offers. If the conflict of interest inherent in such resistance has matured into actual self-dealing, the court will invalidate the defensive tactics. If the board acted from proper motives, even if mistakenly, however, the court will leave the defenses in place.
[1] E.g., CTS Corp. v. Dynamics Corp. of Am., 794 F.2d 250, 254 (7th Cir. 1986), rev’d on other grounds, 481 U.S. 69 (1987); Hanson Trust PLC v. ML SCM Acquisition Inc., 781 F.2d 264, 282 (2d Cir. 1986); Norlin Corp. v. Rooney, Pace Inc., 744 F.2d 255, 258 (2d Cir. 1984). In addition to the normative arguments we discuss in the text, Professor Bebchuk advances two other justifications for shareholder choice: moving corporate assets to their highest valued user and encouraging optimal levels of investment in target companies. See Lucian A. Bebchuk, Toward Undistorted Choice and Equal Treatment in Corporate Takeovers, 98 Harv. L. Rev. 1693, 1765-66 (1985). Neither of these legitimate goals, however, requires shareholder choice. Rather, they require only a competitive process that produces the highest-valued bid; in other words, they require only fair competition for control.
[2] The analogy between political and corporate voting rights is especially inapt in light of the significant differences between the two arenas. First, voting rights are much less significant in the corporate than in the political context. Second, unlike citizens, shareholders can readily exit the firm when dissatisfied. Third, the purposes of representative governments and corporations are so radically different that there is no reason to think the same rules should apply to both. For example, if the analogy to political voting rights was apt, it would seem that the many corporate constituents affected by board decisions would be allowed to vote. Yet only shareholders may vote. Bondholders, employees and the like normally have no electoral voice.
[3] Moran v. Household Int’l, Inc., 490 A.2d 1059, 1070 (Del. Ch.), aff’d, 500 A.2d 1346 (Del. 1985) (affirmed post-Unocal). Accord Shamrock Holdings, Inc. v. Polaroid Corp., 559 A.2d 257, 272 (Del. Ch. 1989).
[4] Many acquisitions are initiated by target managers seeking out potential acquirers. A no resistance rule would discourage these takeovers, thus harming shareholders. No sensible seller would seek out potential buyers unless it is able to resist low-ball offers. Note that there is a subtle difference between our position and what might be called the “management as negotiator” model of takeover jurisprudence. Under this model, management can resist a tender offer in order to extract a better offer from the bidder. While this model can be found in some of the Delaware cases, it poses some difficulties. Just how target directors are supposed to use takeover defenses as a negotiating tool, for example, never has been made entirely clear. Unless the directors can plausibly threaten to preclude the bid from going forward, their defensive tactics have no teeth and thus provide no leverage. Yet, in light of management’s conflict of interest, a board refusal to drop its defenses is necessarily suspect. Judicial review of such a refusal, moreover, would require courts to pursue some very thorny lines of inquiry: Is target management correct in believing that they are better managers than the bidder. Or would the company, in fact, be better off with the bidder at the helm? Neither is the sort of question courts are comfortable asking about business decisions, even decisions involving self-dealing. As described below, our approach therefore centers not on how the board used takeover defenses, but rather on whether the board’s decisions were tainted by conflicted interests.
[5] Cf. Shamrock Holdings, Inc. v. Polaroid Corp., 559 A.2d 257, 276 (Del. Ch. 1989) (upholding an employee stock ownership plan despite its anti-takeover effects, because the plan was “likely to add value to the company and all its stockholders”).
[1] William T. Allen, Independent Directors in MBO Transactions: Are They Fact or Fantasy?, 45 Bus. Law. 2055, 2060 (1990); see generally Michael P. Dooley, Two Models of Corporate Governance, 47 Bus. Law. 461, 517-24 (1992) (discussing the significance of board motives in Delaware’s takeover jurisprudence).
