Poison Pills Still Offer Protection

Properly structured agreements can deter hostile takeovers.

Having been under siege in recent years by activists and others, shareholder rights agreements, also known as poison pills, can still be valuable anti-takeover devices, according to a new study by The Conference Board.

In "Poison Pills in 2011," the group recommends that company board members consider drafting shareholder rights plans so they satisfy standards of acceptability set by the most influential proxy voting advisers such as Institutional Shareholder Services (ISS). However, the report said members should also take into account that investors may use certain types of derivative instruments to conceal their relative voting power. Boards should consider whether their rights plans should be drafted to include derivative positions when computing the level of stock ownership a person holds.

In addition, as shown in the Versata case, net operating losses (NOLs) can be a valuable corporate asset when they can be claimed for U.S. tax purposes. The report points out that since tax law establishes that NOL cannot be claimed if the corporation undergoes an "ownership change" (defined by the Internal Revenue Code as when a holder of 5% or more of the company's stock increases its ownership level by more than 50% of the corporation's stock over a rolling three-year period), it may be appropriate to implement the poison pill with a trigger below 5%. ISS recommends that these poison pills should be evaluated on a case-by-case basis, and expire at the earlier of the pill's third year anniversary and the exhaustion of the NOLs.

The report also recommends that management maintain a thoughtful business plan for the corporation. As shown in the Air Products vs Airgas case, it states, keeping a sensible, regularly updated, business plan in place and making certain that the board understands and approves of the plan and its assumptions can be very important factors in defending against potential hostile takeovers.

Also recommended is that board members abstain from certain defensive tactics, such as introducing supermajority voting requirements or disallowing action by written consent or limiting the ability to call special meetings, because they could cause the ire of ISS and attract activist shareholders.

The report says boards should consider adopting advance notice bylaws so that directors can avail themselves of enough time to obtain the information necessary to make a rational business decision about the acquisition or merger offer they have received. Establishing an advance notice requirement may comply with directors' fiduciary obligations as it allows directors to avoid the pressure of a rushed decision that could be detrimental to a long-term shareholder value-creation strategy. As shown in the Nomad case, Delaware judges have deemed even a 60-day advance notice provision as valid.

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