The Curtain- Raiser on Poison Pills and Different Legal Traditions
Takeovers transferring control over a publicly traded company are common in the corporate environment. Most of them eventually happen on terms laid down by the target company’s board of directors. The reason behind the fact that successful hostile takeovers are not that common is due to the target company’s board having powerful tools on its side such as the poison pill defense.
It is important to note that in the following text we will deal with the poison pill strategy from the point of view of the U.S. legal tradition, from which this defense measure stems. As a concept contrary to the European one (to which our country belongs as well), in the United States the acquisition of a controlling package of shares requires the approval of the company’s board of directors. Hence, board members are enabled to undertake corporate defense strategies without obtaining special consent from shareholders.
Such a powerful defense measure from the American legal practice has not been applied in the same manner in many European countries due to differently treating and understanding its main effect. Here we can, for instance, highlight the EU Directive 2004/25/EC on takeover bids. In the Republic of Serbia, the relevant legal framework for the takeover of joint stock companies is provided by the law of the same name.
A Little Bit of Corporate History.
The invention of the poison pill strategy is credited to Martin Lipton, an attorney from the New York law firm Wachtell, Lipton, Rozen and Katz, in the 1980s amid a wave of hostile takeovers. Lipton got the idea during two hostile takeover battles, namely between General American Oil against a bid by the corporate raider T. Boone Pickens, and the El Paso company defending itself against a hostile takeover bid as well. The phrase that got its name from the practice of spies carrying a poison pill that they could swallow if captured by the enemy became a popular defense tactic, ending with approximately 60 percent of the ‘Fortune 500’ companies having a poison pill strategy set in place by the end of 1989.
After the late 80s, hostile takeovers decreased broadly in number. One reason refers to a board-friendly case law on hostile takeovers in the United States. Particularly, we are talking about the decisions of the Delaware courts in the Airgas case that upheld the continued vitality of the poison pill tactic as an appropriate defensive measure. Another reason is associated with antitrust law.
From 2020 hostile takeovers have been making a comeback. Historically, hostile takeovers walked hand in hand with market downturns such as the 2008 financial crisis and the Covid-19 pandemic due to causing severe dislocations in stock markets.
Poison Pill Strategy Explained.
The poison pill strategy can be defined as a defensive strategy associated with the finance world that allows existing shareholders to purchase newly issued shares in a company at a discount to the trading plan, making any possible buyout plan costly and ineffective for the party that wanted to execute a hostile takeover.
As the associated phrase suggests, swallowing the poison pill may be bad for shareholders, but its main purpose is to make it difficult for the hostile parties to buy new shares and acquire a bigger percent of stake in the target company.
Using the poison pill strategy doesn’t mean that a company doesn’t want to be acquired. Sometimes, such as in the Twitter case, using the poison pill tactic is done to obtain a higher valuation or improve the initial terms of acquisition.
The poison pill strategy encompasses a number of possible options:
Flip-in poison pill
This is the most popular and frequently used option. Namely, the flip-in poison pill allows all shareholders, excluding the hostile party, to buy additional shares at a reduced price. In this text we are mainly focused on the flip-in poison pill option.
Flip- over poison pill
The flip-over option is a bit more complicated since it allows shareholders of the target company to purchase shares of the acquiring company at a reduced price. However, this option can only come into play if the hostile takeover has already succeeded. Before a poison pill can take effect, it must be laid down in the company’s bylaws.
Shadow pill
The poison pill strategy doesn’t have to be included right away. Namely, a company doesn’t need to have a poison pill defense strategy set in place at the time the buyout offer arrives. Instead, it can be adopted after the offer. Attaining the right to adopt a poison pill, in line with the bargaining power hypothesis, strengthens the negotiating position of the target company’s board in relation to any potential bidder.
From Netflix to Twitter – Antidotes to Hostile Takeovers
In November 2012, the popular streaming service Netflix successfully adopted a poison pill strategy against a hostile takeover by Carl Icahn, a popular American investor. Namely, the poison pill swallowed by Netflix made it expensive for anyone to accumulate more shares if they acquired 10 percent of the company without the board’s prior approval. How come Netflix managed to be immediately successful? First of all, Netflix was prepared as its stakeholder rights plan was designed to fight off hostile takeovers since it contained a ‘poison pill plan’ stating that if any entity or individual tried to buy-out a substantial part of Netflix without the approval of its board, Netflix had the right to use a technical scheme to flood the market with new shares. An interesting fact about poison pills is that in recent years many companies added so-called ‘wolf pack’ provisions with a language intended to ensure that the strategy addresses the ownership interests of multiple stakeholders who, without expressly agreeing to act together, are still acting in concert.
Further, in 2018 the restaurant chain Papa John’s board adopted a poison pill strategy to fight off the company’s removed founder and largest shareholder from gaining control again. The board adopted a temporary strategy to sell its stock to shareholders for half of its market price in case anyone gained a 15 percent stake or if the ousted founder and his affiliates increased their stake over 30 percent. The poison pill strategy’s comeback can also be seen in the decision of the department store group Nordstrom that adopted such a strategy in its shareholder rights plan to prevent anyone from amassing 10 percent or more of its shares.
In 2022 we witnessed another hostile takeover example that was widely portrayed by the media. A day after Elon Musk offered to buy Twitter for $43 billion, the board adopted a limited duration shareholder rights plan, namely a poison pill strategy. The defensive measure included a provision that if any individual or entity obtains beneficial ownership of at least 15 percent of the company’s common stock without the approval of its board, other shareholders will be enabled to purchase additional shares at a significantly reduced price. The acquisition of Twitter by Musk was concluded later in October 2022, yet the Twitter example demonstrates that not every poison pill strategy is created to fight off a hostile takeover. Instead, the tactic may be triggered to improve the negotiation position or the terms of the acquisition by the target company.
Sources:
Journal Articles / Publications :
Chase de Kay Wilson (1984) Marty Lipton’s Poison Pill. 3 Int’l Fin. L. Rev. 10.
- L. Sunder (2014) The Controversial ‘Poison Pill’ Takeover Defense: How valid are the arguments in support of it? NMIMS Management Review Double Issue: Volume XXIII October November 2013 / University Day Special issue January 2014.
Martjin Cremers et al (2022) Poison Pills in the Shadow of Law. European Corporate Governance Institute – Finance Working Paper No. 595/2019.
Milena Jovanovic Zattila (2014) Poison Pills: A Defensive Measure against a Hostile Takeover or a Demonstration of Power of the Target Company. Zbornik radova Pravnog fakulteta u Nišu, No. 68.
Web Articles:
Adam Hayes (2022) Poison Pill Defense: How Companies Fight Off a Takeover Bid? Investopedia.
Amanda Holpuch (2022) What Is a ‘Poison Pill’ Defense?. The New York Times.
Eric Savitz (2012) Netflix Adopts Poison Pill. Forbes.
Legislation:
Directive 2004/25/EC on takeover bids (2004) OJ L 142.
Law on the Takeover of Joint Stock Companies (Official Gazette of the Republic of Serbia No. 108/2016).
Case Law:
Air Product & Chemicals Inc. v Airgas Inc. C.A. No. 5249-CC
