The recent collapse in equity values resulting from the coronavirus crisis has made public companies more vulnerable to opportunistic acquisition and activist strategies.[1] As a result, companies should consider whether they have in place appropriate protections against attempts to acquire control of or influence over the company without board approval and without paying an appropriate price.

To buttress other defenses, a board may wish to consider a stockholder rights plan (commonly known as a “poison pill”) and to take the steps needed to have a plan “on the shelf” so that it can be implemented quickly when desired.

Purpose

A rights plan acts to significantly dilute a stockholder who has accumulated ownership or other specified rights with respect to more than a specified amount of the company’s stock, thus discouraging (though not necessarily preventing) the person from exceeding that amount without prior approval by the company’s board.

A rights plan is not intended to make a company “takeover proof.” Rather, it is intended to encourage an acquiror to negotiate with the board and to give the board time to consider and respond to approaches. A rights plan can also be used in other situations where stock accumulation may be problematic, such as protecting a company’s net operating losses from a “change in control” based on changes in the company’s 5% shareholders and in certain regulatory situations.

Generally, a board can implement a rights plan without a stockholder vote (assuming the company has sufficient authorized common or blank check preferred stock). When implementing a rights plan, and thereafter when determining whether or not to lift a rights plan to allow a potential acquiror to proceed or for other reasons, the board must comply with its fiduciary duties to act with care and in the best interests of the company and its stockholders. In particular, a board’s decision to keep a rights plan in place in the face of a potential acquisition or other threat will likely be subject to heightened scrutiny by courts. The board should consider the rights plan in the context of the specific concern being addressed and the company’s overall positioning, including the company’s other internal defenses (such as whether it has a classified board) and external factors (such as the company’s shareholder base).

Mechanics

Under a rights plan, a company issues to its stockholders rights to purchase from the company newly issued shares of company stock (usually a newly created series of preferred stock). The rights are not initially exercisable, and in any event are priced far above a practical exercise point. If someone acquires ownership or other specified rights above a specified threshold, the rights convert so that holders (other than the triggering acquiror) can purchase shares at 50% of the market price, up to the number of shares equal to the exercise price of the right divided by the discounted share price, thus diluting the acquiror’s holdings. The board can also exchange the rights for shares of stock, rather than requiring or allowing shareholders to exercise the rights.

The board maintains control by retaining the power to redeem or amend the rights before they become exercisable, so that the board can allow an approved acquisition or other activity to proceed.

Prevalence and Stockholder Concerns

It was once common for companies to adopt and maintain rights plans, with long terms, simply as a deterrent. However, various stockholder and related groups began to oppose rights plans and other defensive measures that they saw as shifting rights away from stockholders, although they also recognized that such measures at times may be in the company’s and the stockholders’ best interests.

For example, if a company adopts a rights plan without stockholder approval, the general policy of Institutional Shareholder Services (ISS) is to recommend that stockholders vote against or withhold votes on all directors (other than new nominees), although ISS will also consider votes on a case-by-case basis if the rights plan has a term of one year or less, depending on the disclosed rationale for the adoption and other factors (such as a commitment to put any renewal to a stockholder vote). If a company asks its stockholders to approve a rights plan, ISS’s general policy is to vote on a case-by-case basis, and that the plan should include, among other things, no lower than a 20% trigger level (except in the case of net operating loss plans), a term of no more than three years and a stockholder redemption feature for certain qualified offers.[2]

Many companies thus opt to take the steps needed to prepare a rights plan and then put the plan “on the shelf” until circumstances indicate that it is needed imminently. Plans actually implemented often have relatively short terms, often of one year or less, designed to allow a company to maneuver through a particular set of potential problems or threats.

Companies should note, though, that it is not always easy to spot a threat before it becomes a potential issue. SEC rules generally require an acquiror of 5% of a company’s stock to disclose its acquisition (on Schedule 13D), but the initial disclosure is not required until 10 days after that threshold is reached, allowing the acquiror to accumulate additional shares before making the disclosure, and various swaps and other potential exposures are not always required to be reported on Schedule 13D.

Key Plan-Specific Considerations

While rights plans tend to follow a similar pattern, a board should consider a number of items when designing a rights plan, so that the plan reflects the company’s specific situation and concerns, including:

• Trigger Threshold. Many rights plans provide for thresholds between 10% and 20%. Some provide bifurcated thresholds, with, for example, 20% accumulation allowed for “passive” investors and 10% allowed for others. The trigger can be tailored to the company’s objectives, for example, by using a 4.99% threshold where the plan is intended to protect the potential tax benefits of net operating losses. Rights plans provide exceptions (“grandfather clauses”) for shareholders who (whether or not known to the company) may be above the threshold at the time the plan is announced, typically restricting the grandfathered stockholder from further purchases.
• Exercise Price. Boards generally determine this price with the assistance of a financial advisor. Often it is a multiple of the company’s current stock price. The exercise price affects the amount of dilution an acquiror will suffer, as described above.
• Term. Many rights plans have a term of less than one year, reflecting, among other things, the policies of proxy advisory firms. However, boards can adopt longer terms when they believe appropriate. Some plans provide for extension upon shareholder approval or, conversely, termination if shareholders decline to approve.
• Shareholder Approval. Most rights plans do not provide for shareholder approval, though some companies seek shareholder approval, to appease shareholder concerns and for other reasons, particularly for plans with terms greater than one year.

[1] For more background, including the increase in unsolicited takeover proposals and shareholder activism after the 2008 financial crisis, see our client alert, “The Potential Impact of the Coronavirus (COVID-19) Pandemic on Hostile M&A and Shareholder Activism in the U.S.”

[2] ISS United States Proxy Voting Guidelines Benchmark Policy Recommendations, published Nov. 18, 2019.

[View source.]