On Feb. 26, 2021, the Delaware Court of Chancery ruled that the board of directors of The Williams Companies breached its fiduciary duties by adopting a stockholder rights plan, otherwise known as a poison pill, because the Williams plan was overbroad and not appropriately tailored to a specific threat of stockholder activism.
Key Takeaway: While poison pills remain a potent tool for public company boards to employ in order to ward off hostile takeovers, the Williams decision provides helpful guideposts for public company boards to consider when implementing a poison pill.
Background: Poison pills were first adopted in the early 1980s in response to the initial boom in hostile takeovers. They prevent an acquirer from taking a control position in a company without first coming to its board of directors by giving all of the company’s stockholders, other than the potential acquirer, the right to purchase the target company’s shares at a significantly discounted price. This right is triggered when the potential acquirer owns a certain percentage of the target company’s publicly traded shares or announces a plan to acquire a certain percentage of a company’s stock.
If a poison pill is triggered, the potential acquirer would be significantly diluted as a result of the issuance of the new shares to the company’s existing stockholders. Given that such dilution would make the potential acquirer’s acquisition of a control position in the target company financially impractical, poison pills are intended to deter these kinds of hostile takeovers and force the potential acquirer to negotiate with the target company’s board.
Few public companies actually have poison pills in place, given the opposition to them by stockholders generally and stockholder advisory firms, like Institutional Shareholder Services; however, many companies have poison pill plans “on the shelf” that their boards can quickly adopt in response to a particular threat of stockholder activism. Most poison pills are triggered by a stockholder activist attempting to acquire 10 percent, 15 percent or more of the target company’s public traded stock, although poison pill plans adopted to protect a company’s net operating losses rather than in response to a specific threat of stockholder activism often have ownership triggers of 5 percent.
Why Did Williams Adopt a Poison Pill? Williams is an energy company that operates natural gas assets, including pipelines and processing facilities. The onset of the COVID-19 pandemic led to a swift and steep decline in its stock price. A subsequent price dispute between Saudi Arabia and Russia resulted in a rapid drop in energy prices. By the middle of March 2020, Williams’ stock price, which had been trading at around $24 per share prior to 2020, was trading at $11. The board viewed this drop in Williams’ stock price as making the company particularly vulnerable to a hostile takeover and decided it was in the best interest of the company to adopt a poison pill.
Key Features of Williams’ Poison Pill: The Williams plan had four main components that the Chancery Court closely scrutinized.
- 5 percent ownership trigger. The Williams plan would be triggered whenever a potential acquirer owned 5 percent or more of the company’s stock or commenced a tender offer that would result in the potential acquirer owning 5 percent or more of its common stock.
- Expansive definition of “beneficial ownership.” The Williams plan incorporated a broad definition of “beneficial ownership,” which included ownership of securities such as warrants and options, in determining whether an acquiring person was over the 5 percent threshold triggering the poison pill.
- Broad “acting in concert” provision. The poison pill also included a broad acting-in-concert provision, also known as a “wolfpack provision,” allowing the board to aggregate the holdings of multiple stockholders in determining whether the 5 percent trigger had been met. Under the Williams plan, in order to conclude that stockholders were acting in concert, the board had to determine that such stockholders were acting together to change or influence control of Williams, that each such stockholder was conscious of the other stockholder’s conduct and that one additional factor supported a determination by the board that such stockholders were acting in concert. Such factors could include exchanging information, attending meetings, conducting discussions or making or soliciting invitations to act in concert or parallel. The Williams plan also included a “daisy chain” concept that allowed the board to consider a group of stockholders to be acting in concert with each other even if some of the members of that group were not directly acting in concert with other members of that group.
- Narrow “passive investor” exemption. The Williams plan carved out passive investors from the definition of “Acquiring Person” so the holdings of passive investors would not trigger the 5 percent threshold in the Williams plan. Specifically, the definition excluded any stockholder that acquires an equity position in Williams for the purpose of directing or causing the direction of the management and policies of the company. Under federal securities laws, a holder of 5 percent or more of a public company’s stock is required to report such holder’s ownership position on Schedule 13-D unless the stockholder is considered a passive investor and did not acquire its equity position in the target company for the purpose of or with the effect of changing or influencing the control of the company in question. Thus, under the Williams plan’s more narrow definition of passive investor, many investors that would typically be considered passive investors under federal securities laws would not be considered passive investors for purposes of the Williams plan.
The Court of Chancery’s Decision: Under Delaware law, board actions are typically subject to scrutiny under the business judgment rule. In the case of a dispute over a Delaware company’s adoption of a poison pill, however, the decision of the board to adopt such a plan will be subject to the heightened standard of review set forth in the Delaware Supreme Court’s 1985 decision Unocal Corp. v. Mesa Petroleum. Unocal requires that a board show the following to substantiate the use of a stockholder rights plan: (i) in adopting a stockholder rights plan, the board had reasonable grounds for concluding that a threat to the corporate enterprise existed; and (ii) any defensive measures taken were reasonable in relation to the threat posed.
The Court of Chancery found that the Williams plan failed to meet the first prong of Unocal because it was not adopted in response to a particular attempt at taking over Williams, but rather in response to concerns about stockholder activism generally. The court also found that the Williams plan failed to meet the second prong of Unocal in that it was not proportionate in response to the threat posed. In reaching this conclusion, the court noted that the Williams plan’s 5 percent trigger was substantially lower than triggers for most other poison pills, that its definition of beneficial ownership was overly broad and that its definition of passive investor was atypically narrow.
The court also focused in particular on the breadth of the Williams plan’s acting-in-concert provision, noting that “potentially benign stockholder communications ‘relating to changing or influencing the control of the company’” and “routine activities such as attending investor conferences and advocating for the same corporate action” could cause two stockholders to be considered acting in concert under the Williams plan. Taken together, these factors led the court to conclude that the Williams plan was invalid, holding that Williams “failed to show that this extreme, unprecedented collection of features bears a reasonable relationship to their stated corporate objective.”
Next Steps: Despite the Williams decision, poison pills remain a key defensive mechanism that public company boards can employ to deter hostile takeover attempts. The Williams decision emphasizes the importance that any stockholder rights plan put into place be done so in response to a particular, and not generalized, threat, and although the court focused on some of the extreme features of the Williams plan in its decision, such features will not necessarily make a stockholder rights plan invalid if they are proportionate and reasonable in response to a more specific threat posed to the company. Thus, when adopting stockholder rights’ plans, it is imperative that boards keep in mind the Unocal standard and ensure that such plans are drafted in response to cognizable threats and are appropriately tailored to address such threats.
Furthermore, if a board is concerned about a “lightning strike” (the rapid accumulation of its stock by an activist) because such activists are not required to disclose their position for up to 10 days thereafter under the federal disclosure regime, the board should consider adopting an advance-notice pill to fill that 10-day gap (by allowing the potential acquirer to cross the 5 percent threshold without triggering the pill if such potential acquirer gives notice of having done so within one or two days thereafter, for example), because the court in the Williams decision did not explicitly say such a poison pill would be invalid.