The annual cycle of stockholder challenges to "poison pill" rights plans is underway again. In 2004, the Investor Responsibility Research Center (IRRC) reported that 101 rights plan proposals were submitted to companies, requesting that corporate boards redeem or terminate rights plans or subject the plans to stockholder approval. Approximately 52 of those proposals appear to have gone to a stockholder vote, and 40 were approved by a majority of the shares voting. So far this year, the IRRC reports 46 rights plan proposals, down substantially from 2004, but still a significant number by longer historical standards. How much support these proposals will receive from stockholders, and whether additional rights plan proposals will emerge as the year progresses, remain to be seen.
This article examines the range of responses that corporations may take if a rights plan proposal wins approval or substantial support from stockholders.1 Different responses may be appropriate in different circumstances, and there is no single right answer, either from the takeover defense or corporate governance perspective. The appropriate response will depend on a careful consideration of the benefits and risks of the available alternatives in light of a corporation's circumstances.
Overview And Background Of Rights Plans
Since their development and refinement in the early 1980s, stockholder rights plans have become a common feature in the M&A and corporate governance landscape. By the end of 2004, IRRC counted close to 2,000 U.S. companies with rights plans in place. When triggered by potential acquirers, rights plans dilute the acquirer's equity voting interest in the target company or the post-merger company. Generally, rights plans accomplish these results by issuing rights to stockholders that are essentially worthless unless triggered by the acquisition of a specified percentage of the target's voting stock (generally, 10-20%). Triggering the rights plan would cause substantial dilution of the equity ownership and the voting power of the corporate raider, making it impossible to progress with the takeover attempt.
In simplest terms, the basic arguments for and against rights plans can be summarized as follows. Proponents of rights plans argue that they:
- force would-be acquirers to negotiate with the target company's board, and protect stockholders from coercive takeover tactics that deprive stockholders of a meaningful choice whether to sell their shares; and
- promote higher takeover prices by increasing the target board's negotiating leverage and giving the target board more time to explore alternatives and the ability to "just say no."
Opponents of rights plans argue that they:
- entrench management and the board, making them less accountable to stockholders for underperformance;
- reduce stockholders' ability to accept attractive tender offers and allow boards to block not only the abusive or unfair offers, but all offers not negotiated with the board; and
- give too much authority to the board - authority that properly belongs to stockholders as the owners of the corporation.
Rights plan proposals may vary in their details, but in general, they call for the board to give stockholders a binding vote on the adoption of a new rights plan and the maintenance and extension of an existing rights plan.
Considerations And Choices
A board's response to stockholder approval of a rights plan resolution will of course depend on the specifics of the resolution and the corporation's circumstances. Legal considerations will play a part in the board's response, but the response seldom will be dictated by purely legal considerations. Rather, a board's response will depend as much or more on a practical assessment of takeover risks, the profile of the corporation's stockholder base, impact on investor relations, corporate history, the corporation's stock price and earnings outlook, corporate governance rankings, and other business considerations. In this regard, a corporation's rights plan policies and its response to a rights plan proposal may affect its ranking on the corporate governance "scorecard" maintained by ISS and other stockholder and corporate governance advocacy groups. In general, these scorecards disfavor rights plans and reward policies requiring stockholder approval or ratification of rights plans.
As a legal matter, corporate boards are not required to follow a rights plan proposal. Under Delaware corporate law, stockholders elect directors but stockholders do not manage the corporation or set corporate policy; the board does. A board must consider what it believes is in the best interests of the corporation, and in doing so it is free to consider what it believes to be the long- as well as short-term interests of stockholders. Moreover, rights plan proposals to date have generally been cast in the form of non-binding precatory resolutions.
For these reasons, boards generally have a number of alternatives if stockholders approve a rights plan proposal calling for the termination or redemption of a rights plan or for stockholder approval before any future rights plan is adopted. A board can implement the proposal; it can take no action at all; or it can take a middle course, adopting some but not all elements of the proposal (or taking other action such as adopting a rights plan policy).
1. Non-implementation
A board can decide to make no change in the rights plan and take no implementing action in response to the passage of a rights plan proposal. Before deciding on a non-implementation response, a board would be well advised to give careful consideration to the proposal and the various possible responses, including the risk and consequences of an unsolicited takeover bid, the strength and dependability of the corporation's other takeover defenses, the composition of the corporation's stockholders base, and other factors relevant to the decision. Boards also have taken into account the absolute level of support for the proposal - whether the proposal was supported by a majority of all outstanding shares or only a lesser majority of the shares voted at the meeting.
Non-implementation also may increase the number of "withhold" votes in subsequent elections of directors, increasing the practical pressure on boards to take action. ISS recommends a withhold vote with respect to directors who ignore a stockholder proposal that is approved by a majority of the outstanding shares or by a majority of the votes cast for two consecutive years. (ISS also recommends a withhold vote relating to directors who adopt a rights plan without stockholder approval with no requirement to put the plan to a vote within twelve months of adoption.) Non-implementation and increased "withhold" votes may also have possible future legal implications under proposed changes in the rules governing the election of directors, including the "direct access" rules proposed in October 2003 by the SEC to facilitate stockholder nomination of directors and proposals by others that would require directors to be elected by an absolute majority rather than by a plurality of the votes cast. At the same time, a growing body of opinion seems to believe that the SEC's "direct access" proposal is unlikely to be adopted, at least not in its current form. As a result, the shadow of "direct access" may diminish, at least in immediacy, as a factor in boards' responses to the passage of rights plan proposals.
If a board opts not to implement a rights plan proposal and to make no change in its rights plan, the board may consider other ways to demonstrate responsiveness to stockholder concerns and to address underlying points of discontent that stockholder proposals often reflect. In the short-run, this may involve little more than a proactive communications strategy to explain the board's reasoning, and in the longer-term it may involve changes in corporate management or strategy and improvements in corporate performance.
2. Implementation
Depending on the company's circumstances and the details of the proposal, a board may choose to implement a rights plan proposal in its entirety or substantially in its entirety. Although comprehensive statistics are not available, 38 out of approximately 1,000 "core" companies tracked by IRRC terminated, redeemed, or allowed or accelerated the expiration of rights plans in 2004.
Mechanically, implementation may involve termination of an existing rights plan, redemption of outstanding rights, or merely allowing the plan to expire at its stated expiration date. Implementation also may involve the adoption of a policy stating that no rights plan will be adopted in the future without stockholder approval. Generally, the policy would be adopted by simple board resolution, but in theory it also could be effected by means of a change in the bylaws or even by means of an amendment to the corporation's charter. This last alternative would require additional stockholder approval.
On the surface, implementation would seem to be straightforward and the most responsive board action to stockholders' expressed desires. Closer examination, however, indicates a number of unresolved legal questions must be considered and a number of choices must be made.
(a) Legal Questions: Implementation of a rights plan proposal makes it likely that the corporation will not have the benefit of a rights plan as a defense to a future unsolicited takeover bid, and will have only defenses that may be significantly less effective. Before taking such a risk, a well advised board will carefully consider the corporation's other defenses and their effectiveness relative to a rights plan.
In addition, questions have been raised as to whether a board can properly foreswear the adoption of a rights plan without advance stockholder approval. Under Delaware law, the board has the sole authority and responsibility to manage and direct the business and affairs of the corporation. Delaware cases indicate that a board cannot delegate this responsibility - not even to the stockholders. The non-delegation principle applies with particular force to functions specifically assigned by statute to the board. In addition, the Delaware Supreme Court had held that directors' fiduciary duties are "unremitting"; that directors have "a continuing obligation to discharge their fiduciary responsibilities, as future circumstances develop"; and that a board cannot tie the hands of a future board so as to prevent the future board from exercising "full power to manage and direct the [corporation's] business and affairs."
While the issue has yet to be adjudicated in Delaware, these cases raise questions as to the enforceability of a rights plan "policy" purporting to make an absolute commitment to repeal a rights plan unless approved by stockholders, or to refrain from adopting a rights plan unless approved by stockholders, with no "fiduciary out" allowing the board to act without stockholder approval. These questions exist whether the policy is adopted as a simple resolution, as part of the corporation's corporate governance policies, as a stand-alone policy, or even as part of the bylaws.
The legal issues, moreover, implicate more than just the validity and enforceability of the commitment. If found to be an impermissible delegation of board authority and an abdication of the board's managerial duties, it may constitute a breach of directors' fiduciary duty of care. Implementing a rights plan policy may be responsive to the desires of some stockholders or even a majority of the stockholders, but the board owes fiduciary duties to all stockholders, and the pro-rights plan minority may argue that the board has abdicated its fiduciary duties to the minority and left the corporation vulnerable to takeover at a reduced price, thereby depriving the minority of the full control premium that stockholders may be entitled to receive in a takeover.
(b) Choices for the Board: In view of this legal uncertainty, a board considering the implementation of a rights plan proposal or the adoption of a rights plan "policy" should consider the possibility of adopting a "fiduciary out" or savings clause to retain flexibility to adopt a new rights plan without a stockholder vote.
If a board opts for a rights plan policy with an explicit "fiduciary out," it can take a number of forms. Points of permutation include (i) which directors make the decision (full board or independent directors); (ii) the standard for invoking the "fiduciary out"; and (iii) whether the exercise of the fiduciary out will later be submitted to a stockholder vote (and, if so, on what terms).
3. Middle Ground - Adoption of Other Changes
Between these extremes of implementation and non-implementation, a board may also fashion other responses to the adoption of a rights plan proposal, to make the rights plan more palatable or to address concerns that may lie behind the adoption of the rights plan proposal.
In the area of rights plan modifications, a number of provisions have appeared:
- "TIDE" Provision - A number of corporations have adopted provisions for regular periodic evaluation of their rights plan by the corporation's independent directors - e.g., every three years (hence "TIDE" - Three-year Independent Director Evaluation). Since the first appearance of TIDE provisions in the 1990s, new board composition requirements (requiring that a majority of the board be independent) and the emergence of corporate governance committees may have eroded some of the benefits of TIDE provisions, but they continue to offer the benefit of regular mandatory review at relatively short intervals by an all-independent committee.
- Qualified Offer ("Chewable Pill") Provisions - Some corporations have made their rights plan inapplicable (or inapplicable without stockholder approval) to certain kinds of offers, such as fully financed all-cash tender offers for all shares (with equal treatment for untendered shares in any back-end second-step merger) with a price in excess of a specified level (e.g., specified premium to market and/or other price point).
- Shorter Terms: Rights plans typically have a term of 10 years, but they can be structured to expire after a shorter period.
- Price-Based Expiration: At least one company adopted a stock-price trigger for expiration, providing for the automatic expiration of the rights plan upon attainment and maintenance of a prescribed stock-price level for a prescribed period of time.
Governance Considerations And Conclusion
As a matter of good corporate governance, a range of alternatives should normally be considered by a board before responding to the adoption of a rights plan proposal. The board should carefully consider the circumstances, the benefits and risks of the various possible courses of action, and the advice of expert M&A advisers.
Our experience is that rights plans are the most effective tool available to a board of directors in protecting against coercive takeover activities that are not in the best interests of all stockholders. For this reason, although it is difficult for directors not to take action in response to a rights plan proposal that has garnered substantial stockholder support, we would caution against any rush to redeem the plan without a thoughtful, thorough and careful analysis. As always, the board must act in good faith, in what it believes to be the best interests of the corporation and all of its stockholders.
1 This article does not address the grounds for excluding a rights plan proposal, but only addresses corporate responses to proposals that have been submitted to, and approved by, stockholders.
Published June 1, 2005.
