Shareholder Rights Plans
Shareholder rights plans (or “poison pills”) are designed to force an acquirer to negotiate with the board due to the dilutive nature of the “poison pill” threat. While rights plans cannot make a company “takeover-proof” and can be defeated through a proxy contest to acquire board control, rights plans are the most effective device in response to abusive takeover tactics. Boards should carefully review their governance structures and available defensive measures to ensure they can protect the company’s stockholders from opportunistic acquisition and activist strategies.
Benefits of a rights plan include that it affords the board time and ability to control the process, provides the directors with increased leverage to negotiate a better deal on behalf of stockholders, and may give the board the ability to “just say no” to an unsolicited bid which it reasonably considers not to be in the best strategic or financial interests of the company and its stockholders. A rights plan can complement the board’s goal of deterring a potential acquirer from putting a company prematurely “in play,” accumulating stock ownership above a threshold percentage or completing a tender/exchange offer without paying fair value to all stockholders. In the event a board ultimately determines to engage with an activist or acquirer, a rights plan will not interfere with a negotiated deal.
NOL rights plans, which function in a manner similar to traditional shareholder rights plans but have a lower trigger threshold (typically 4.99 percent), are designed to protect net operating loss carry-forwards (NOLs) against the threat that changes in share ownership could limit a company’s ability to use its NOLs to reduce future taxable income. Section 382 of the Internal Revenue Code of 1986 and related Treasury regulations substantially limit a company’s ability to use its NOLs if the company experiences substantial ownership shifts by its five percent stockholders. These limitations can significantly impair the value of an NOL asset. This may be particularly relevant given the current pandemic and depressed trading prices, or for a company in financial distress, where the value of a company’s NOL asset might exceed its current market capitalization.
Historically, rights plans were a common component of anti-takeover defensive planning. Widespread adoption prior to 2000 dramatically changed the playing field for unsolicited takeovers, with thousands of companies adopting rights plans. In the absence of strong takeover defenses like a rights plan, potential acquirers were free to take offers directly to stockholders—potentially avoiding board efforts to obtain the best deal reasonably possible for its stockholders.
In more recent years, however, the opposition of proxy advisory firms such as Institutional Shareholder Services (ISS) and Glass Lewis has led to a much lower rights plan adoption rate by public companies. Under the pressure of institutional investors and proxy advisory firms, most companies have given up nearly all of the traditional and effective anti-takeover defenses (e.g., classified boards). Even if rights plans are considered, institutional investors and the proxy advisory firms look more favorably on plans that have a limited term, more watered-down provisions and are adopted only in response to a specific threat.
A typical rights plan might have an ownership threshold trigger of 20 percent for Schedule 13G passive investors but a lower trigger of 10-15 percent for all other investors, and a term of one to three years depending upon whether the plan is put up for stockholder approval. Despite the long-standing policy of ISS “withholding” its voting recommendation for board members who adopt a rights plan with a term of more than 12 months or renew any existing rights plan without stockholder approval, a significant majority of companies who adopted traditional rights plans (or amended or renewed an existing one) in recent years did not seek stockholder approval/ratification. More of those plans tend to be shorter in length and are often customized in response to a perceived or specific threat, a measure that can improve the likelihood of receiving institutional stockholder support for a plan adoption.
In recent years, companies have been increasingly doing the advance work necessary to have a rights plan prepared, reviewed by the board and placed “on the shelf,” ready to implement on short notice if and when confronted with potentially coercive or abusive takeover activity or other appropriate circumstances. Given the market volatility raised by the current coronavirus pandemic (and the activists reportedly circling the wagons around attractive targets trading at discounts), now could very well be just such a time.
Tailored to the Current Circumstances
It its April 8, 2020 policy guidance “Impacts of the COVID-19 Pandemic,” ISS reaffirmed its existing policy approach with respect to poison pills adopted in the face of genuine, short-term potential threat situations. ISS considers rights plans with a duration of one year or less adopted without stockholder approval on a case-by-case basis. Important factors they consider in formulating their recommendation include the board’s disclosed rationale for adopting a rights plan, the existence of any imminent threats, the company’s commitment to put any future renewal of the plan up for a stockholder vote, and the specific provisions of the pill such as the trigger thresholds, duration, inclusion of a “qualified offer” provision and a split threshold for passive investors.
Importantly, with its latest policy guidance, ISS appears to be providing much-needed flexibility to companies in view of the current market disruption and investor uncertainty caused by the coronavirus pandemic. The latest ISS policy guidance specifically states, “A severe stock price decline as a result of the COVID-19 pandemic is likely to be considered valid justification in most cases for adopting a pill of less than one year in duration.”
In light of this latest reaffirmation, proxy advisory firms are expected to continue to exercise pragmatism in applying their voting policies and voting recommendations, to the extent that COVID-19 continues to be a factor. Given the latest ISS guidance, which lessens the concern of an unwelcome “withhold” recommendation being levied against director nominees for adopting a short-term rights plan without stockholder approval, rights plans continue to be a powerful defensive tool worthy of consideration.
In order to provide the desired level of protection and acceptance, rights plan provisions (such as duration, trigger levels and any stockholder approval/ratification requirements) should be specifically tailored to a company’s circumstances. If a company elects to adopt a form of rights plan with provisions that would be acceptable to ISS or Glass Lewis, it should be noted that those provisions will reduce the effectiveness of the rights plan in a takeover contest, and so the directors should carefully weigh this decision. The press release and Form 8-K disclosing a plan adoption should identify the underlying conditions that led to the board’s adoption of the rights plan and emphasize the board’s intent to protect shareholder rights and prevent potentially abusive or coercive takeover activity, given the current volatile market conditions.
Adopting or placing a rights plan “on the shelf” will require consultation with legal, financial and investor relations personnel, as well as preparing the rights plan and accompanying materials, reviewing with the board the company’s current defensive measures and its fiduciary duties, and educating the board regarding the purposes, benefits and mechanics of a rights plan, as well as coordinating with a potential rights agent (usually the company’s transfer agent).
Conclusion – Be Prepared
Companies and their boards should look closely at their available anti-takeover defenses and consider whether a limited-duration shareholder rights plan could be an effective tool to counter potential or actual unwelcome hostile activity resulting from the near-term stock price declines.
We recommend that companies consider either readying materials to be placed “on the shelf,” or dusting off any existing “shelf” materials with eye towards potential near-term implementation, given the current business and market environment. A company’s board is in a far better position to act quickly to protect shareholder rights during the current coronavirus pandemic if it has a shareholder rights plan in its arsenal, either having already been adopted or “on the shelf” and ready to go.
