Securities Law Explainifier #A: POISON PILL

Today I'm starting a series of posts that explain legal concepts that I wish someone had explained to me when I was a law librarian. After the discussion, some research tips. Coming soon: indenture, underwriter, derivative and multi-jurisidictional disclosure. If there's something you want explainified, let me know. Enjoy?

POISON PILL ZERO

To give you an idea of how a poison pill works, I’ll tell you the story of the very first poison pill …Once upon a time, in the go-go 80’s, Brown-Forman, manufacturer of Jack Daniels, decided that its liquor cabinet would not be complete without Lenox Inc., stodgy manufacturer of presidential china. The president of BF approached Lenox about a merger on friendly terms. The Southern ruffians were rebuffed. So, on June 8, 1983, BF launched a hostile tender offer at $87 per share, a 60% premium over Lenox’s market price. The next day Lenox shares shot up to $86.50.

Lenox hired Wachtell Lipton partner Martin Lipton to oversee its takeover defense. Lipton gets credit for inventing the poison pill. On June fifteenth, Lenox activated its pill. The board rejected BF’s offer and issued a “special cumulative dividend” to Lenox shareholders. The cumulative dividend was in the form of the right to purchase shares (called a share purchase right). Now watch closely: in the event that BF and Lenox merged the share purchase right would entitle the holder to buy, at a steep discount, Class A shares of Brown-Forman. Class A shares were the only voting shares of BF and they were held only by the Brown family. After the merger, the former stockholders of Lenox would control BF! How, I hear you ask, could Lenox think this would work? Contract law: if BF acquired Lenox, BF would become successor-in-interest to Lenox’s contracts. So, BF would be responsible for Lenox’s contract responsibilities.

This is a flip-over. No one has yet had the courage to challenge this mechanism in court. In my opinion, “poison pill,” with its images of a spy taking cyanide to avoid capture, is a deceptive name. This thing is more like the Trojan horse. You may be taking us over, but surprise, we’re taking you over, too! It also brings to mind the atomic bomb – a weapon so frightening that the bidder has no choice but to negotiate. A poison pill can be adopted by the board without shareholder approval. Once the pill has been activated, only the board can turn it off. In fact, the whole edifice rests on the power of the board to use the pill without resort to the shareholders. Starting with Moran v. Household Insurance in 1985, courts have consistently found that the adoption of a pill is within the board’s power under the business judgment rule.

The present model for poison pills follows the Lenox blueprint: the target issues share purchase rights. An event (or trigger) activates the rights. The activated rights give target shareholders power to complete a lucrative transaction that injures the bidder. A share purchase right is like a coupon – it is an option contract that offers to sell something at a discount. The rights are created and governed by an agreement between the company and a third party called a shareholder rights agreement. The third party is called the rights agent. The rights agreement sets out the mechanics of the pill. When the rights are created, they are “attached” to the common shares and can’t be exercised, if the triggering event happens, they “detach.”

What causes the rights to activate? A typical plan works this way:

TRIGGER 1: If there is a tender offer for a set percentage of the company’s securities the rights agent distributes the rights. Existing shareholders, except the bidder, are issued rights. As initially issued, rights have unfavorable terms.

REDEMPTION: Between triggers is a period called the “redemption window:” typically a few days. During that time, rights may be redeemed by the board for very little, often a tenth of a cent on the dollar.

TRIGGER 2: Closing by the bidder of a share purchase transaction activates the rights. Activation changes the terms from very unfavorable to very favorable.

And what does your share purchase right give you the right to purchase?

Flip-in rights: give the holder the right to purchase discounted shares of the target. Flip-in is also used to describe the first trigger.
Flip-over rights: give the holder the right to buy discounted shares of the merged entity, or of the acquirer.

EDGAR SEARCH TIPS:

Adoption or amendment of a poison pill is an 8-K event. Item 601 of Regulation S-K requires that an in-force shareholder rights agreement be attached as exhibit 4 to every registration statement and form 10-K.

WESTLAW RESOURCES

Treatises:

Corporate Anti-Takeover Defense: The Poison Pill Device (SECPILL). A handbook for drafting rights agreements, by Joy Marlene Bryan. Contains brief discussion, definitions, and sample language.

Special Study for Corporate Counsel on Poison Pills (CCPPILLS). A West publication containing discussion of the law and sample documents – it is updated every year and has a drafter’s checklist.

BNA Corporate Practice Series 6-3: Responses to Takeover Bids (BNACPS-RTB). This publication contains an overview of the process of responding to a takeover bid including a discussion of defensive mechanisms - updated monthly.

Reports:

Poison Pill Reports database from SDC Platinum (POISONPILL). Contains reports summarizing every pill ever adopted starting with Lenox Inc - updated daily.

For those that need to know the ending: BF managed to acquire Lenox for more than $400 million. In 2005, BF sold most of Lenox to Department 56 for $190 million. Wachtell Lipton respresented BF.