Poison Pills: My, How They Have Grown

February 24th, 2011
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Contributed by: Michael R. Levin, The Activist Investor
Previously I discussed the different share ownership levels that trigger various disclosure and regulatory obligations, such as when investors need to file a Schedule 13D (namely, when they own over 5% of a company’s shares). Among the most notorious and confusing thresholds is the one that triggers a shareholders rights plan, aka a poison pill.

That discussion, along with some recent developments in poison pill artistry and Marty Lipton’s reminiscence about how he started them, got us thinking about poison pills generally. They have morphed, with the cooperation of the Delaware courts, into a beast far beyond what even Marty might have intended back in 1985, when he defended one of the original poison pills.

1. Back then, they sought to protect corporations from unwanted (by management, at least) hostile buyers.

2. These days, they serve to limit any objectionable (again, to management) investor from owning a meaningful stake in the company.

Note that the development of poison pills entails, to a degree, the history of Delaware litigation between investors and management. Below we cite some of the major such cases, so apologies in advance for a bit of arcane and obscure legalese as part of the exposition.

Basic Mechanics Haven’t Changed
Corporations started to adopt poison pills since the late 1970s. They allow a company to dilute the holdings of an objectionable investor. The details have evolved over time, but they all work in this way.

The most recent major poison pill litigation, Air Products v. Airgas, which the Delaware Court of Chancellery decided last week, reminds us why poison pills have their peculiar structure (the opinion provides a detailed, if somewhat dry, history of poison pills). Delaware corporate law, and that of many other states, allows corporate directors to screen merger proposals, but not tender offers. So, a poison pill allows directors to “screen” tender offers, as well.

Originally, to reject a “structurally coercive tender offer”
Mesa Petroleum, run by one of the original hostile raiders, T. Boone Pickens, went after Unocal in 1985. Mesa put together a clever offer that rewarded early subscribers to the tender offer in cash, and later subscribers in junk bonds. Of course, investors rushed to take the cash. In one of its famous early cases, Delaware allowed Unocal to use a poison pill to dilute Mesa’s stake. Rather than actually have that happen (only one pill has ever been triggered, more in a moment), Mesa went away.

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