The first of a six-part series examining six specific and evolving rights plan provisions.

An increasing number of companies are choosing to adopt shareholder rights plans (otherwise known as “poison pills”) in response to the steep declines in public company stock prices that have resulted from the COVID-19 pandemic. Indeed, over the past three months, [46] companies have adopted traditional anti-takeover rights plans, compared to just 23 in all of 2019.[1] In light of this, we have prepared a series of articles on some of the interesting features of rights plans and the various considerations that go along with them.

Under a rights plan, a company issues to its stockholders rights to purchase from the company newly issued shares of company stock (usually a new series of preferred stock). If someone acquires ownership above a specified ownership threshold (typically 10% or 15%), the rights plan is triggered, and the stockholders (other than the triggering acquiror) can purchase shares at 50% of the market price. The board can also exchange the rights for shares of stock, rather than allowing stockholders to exercise the rights. Either result significantly dilutes the triggering acquiror, thus discouraging—though not necessarily preventing—a person from exceeding that specified threshold without prior approval by the company’s board.

This article in the series focuses on an exception that is contained in most rights plans for when an acquiror’s ownership percentage goes above the specified threshold “inadvertently.”

The Inadvertent Triggering Exception

Typically, a rights plan is crafted as a trip wire: if an acquiror crosses the specified threshold, the rights plan is triggered and the dilutive effects cannot be stopped or reversed. Not even the company’s board can undo them. Some plans allow the board a “last look” so that the board can redeem or amend a plan after an acquiror crosses the specified threshold, but then only for a limited time (typically 10 business days).

Crafting a rights plan as a trip wire creates a strong deterrent to an acquiror thinking about a hostile takeover or accumulating a control position in a company without obtaining the board’s prior approval—the acquiror will know that it cannot force or persuade the board after the fact into providing an exception, since that is not permitted by the plan. This deterrent effect forces such an acquiror to seek the board’s prior approval, thereby giving the board leverage in negotiations.

But having a rights plan as simply a trip wire can also lead to a bad result for the company if an acquiror that has no intention of buying control or influencing the company crosses the specified threshold inadvertently. This is so because, when a rights plan is triggered, it not only dilutes the acquiring person, but also causes a major change in the capital structure of the company (with the company issuing a number of new shares equal to almost its current capitalization to many multiples of its current capitalization), requires the execution of complex mechanics relating to the exercise or exchange of the rights and significantly distracts the company’s board and its management from the company’s core operations. These consequences can create a major headache for a company and may interrupt trading of the company’s securities[2]—and unnecessarily so where an acquiror crosses the specified threshold due to a legitimate accident.

To avoid the severe consequences of inadvertent triggering, almost every rights plan includes a carveout provision for acquirors who inadvertently trigger the plan.

How can a stockholder accidentally exceed the specified threshold? Companies publicize their rights plans. Buyers of shares of public companies at these levels of ownership should be aware of numerous hurdles, such as U.S. federal securities law beneficial ownership reporting requirements (under Sections 13(d) and 16 of the Securities Exchange Act of 1934, as amended) and antitrust and other regulatory thresholds, as well as rights plans themselves. But, surprisingly, it does happen.[3] A buyer might have established an automated purchase program without appropriate controls. Another scenario would be a fund complex with multiple portfolio managers and inadequate enterprise-level controls, such that multiple portfolio managers purchase shares of the same company, each below the specified threshold but in the aggregate above the threshold. Another scenario would result from a merger or acquisition, where both parties to the transaction own shares of a third company and, following the closing of the transaction, the combined company winds up owning both blocks of shares, together exceeding the specified threshold.

Inadvertent triggering is more likely in the case of rights plans with lower specified thresholds; an investor is significantly more likely to accidentally cross a 5% threshold than a 15% threshold. The carveout provision therefore will be more relevant in rights plans with a lower threshold.

A standard carveout provision for inadvertent triggering looks like the following:

If the Board determines that a person who would otherwise be an Acquiring Person has become such inadvertently (including because such person was unaware that it Beneficially Owned a percentage of the Common Shares that would otherwise cause such Person to be an Acquiring Person or such Person was aware of the extent of the Common Shares that it Beneficially Owned but had no actual knowledge of the consequences of such Beneficial Ownership), and such Person divests as promptly as practicable (as determined by the Board) a sufficient number of Common Shares so that such Person would no longer be an Acquiring Person, then such Person shall not be deemed to be an Acquiring Person.

Companies may include a few bells and whistles on this standard carveout provision, some of the most prevalent being:

• No intention to influence company: Some rights plans provide that the provision only applies if the board also determines that the acquiror went over the specified threshold without intending to obtain, change or influence control of the company.
• Concurrence of board members not affiliated with acquiror: Rights plans sometimes include a provision requiring that the determination of the board include the concurrence of a majority of the members of the board who are not, and are not representatives, nominees, affiliates or associates of, the acquiror that crossed the specified threshold.
• Opportunity to divest shares: Rights plans also can allow an acquiror that crosses the specified threshold inadvertently to enter into an irrevocable commitment, satisfactory to the board, to divest the necessary shares within a certain period of time instead of forcing the acquiror to sell down immediately.

In addition to the standard carveout provision, companies generally include a related provision that a stockholder cannot become a triggering acquiror solely as the result of the company repurchasing its outstanding shares. A share repurchase by the company reduces the number of outstanding shares and thus increases the proportional number of shares beneficially owned by the stockholder. This repurchase could lead to a form of “inadvertent” triggering of a rights plan by the stockholder, as the stockholder could cross a specified threshold, having taken no action to increase its ownership.

Ultimately, a rights plan should be drafted with enough flexibility that the board can address inadvertent triggers, but not so much flexibility that the deterrent effect is reduced or that the board has too much of a burden to determine whether the rights plan has been triggered.

[1] DealPointData.

[2] See Selectica, Inc. v. Versata Enterprises, Inc., C.A. No. 4241-VCN, 2010 WL 703062 (Del. Ch. Feb. 26, 2010).

[3] Instances of acquirors inadvertently triggering rights plans do not always become public. Below are two publicly known examples:

• In 1998, the Crabbe Huson Group, Inc. inadvertently triggered Arcadia Financial Ltd.’s rights plan, acquiring 16.8% of Arcadia’s outstanding shares, which pushed it past the 15% threshold of Arcadia’s rights plan. See Tim Huber, Gulp! Buying spree triggers poison pill, Minneapolis/St. Paul Business Journal (February 8, 1998), available at: https://www.bizjournals.com/twincities/stories/1998/02/09/story2.html.
• In 2003, Scott Sacane, a Connecticut money manager, inadvertently triggered both Esperion Therapeutics’s and Aksys Ltd.’s rights plans, claiming that there was “a breakdown of internal controls” at the stockholder’s capital management company. See Floyd Norris, Market Place; Investor Says He Bought Stock and Didn't Know It, The New York Times (July 30, 2003), available at: https://www.nytimes.com/2003/07/30/business/market-place-investor-says-he-bought-stock-and-didn-t-know-it.html.

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