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Suddenly, Poison Pills Are Relevant Again

Shareholder rights plans, so-called poison pills, have long drawn the ire of the institutional investor community and have lost favor with Corporate America. But a Delaware judge's recent decision to uphold Airgas's poison pill—followed by Air Products & Chemicals's prompt termination of its hostile bid—confirms that rights plans are still the most potent takeover defense available to targets of unsolicited bids.

The unsolicited offer by Air Products (APD) for Airgas (ARG) has been one of the longest-running hostile bids in recent memory. Seeking to bring its offer for Airgas to a resolution, Air Products asked the Delaware Chancery Court to invalidate Airgas's poison pill. Although the case centered on the facts in that corporate saga, the Feb. 15 decision by Chancellor William B. Chandler III to affirm Airgas's shareholder rights plan has broader implications at a time when unsolicited bids are again becoming a common tool for strategic buyers.

Unsolicited offers have picked up since the subprime mortgage crisis. To be sure, today's unsolicited bids are not triggering the hostile takeover fights of days gone by, which unalterably changed Corporate America. The nomenclature that developed around the bids of the 1970s and '80s justifiably evoked the imagery of pirates and raiders. The terminology remains the same, but the nature, tactics, and objectives of strategic buyers have little in common with those employed by the greenmailers and corporate bust-up artists of that era.

Potential takeover targets frequently used to find themselves defenseless until corporate lawyers crafted a broad range of effective defenses such as the poison pill, which was developed in 1982. Poison pills are designed to ward off unsolicited bids by severely diluting the position of any shareholder acquiring more than a specified proportion (typically 15 percent) of the target company's shares without the prior approval of the company's board. The board of the target company retains the power to redeem the pill if it decides to approve an offer, thereby encouraging hostile bidders to negotiate with the board. A target's board can usually implement a poison pill quickly, without a shareholder vote, knowing that it has been endorsed by the courts.

Rights Plans Have Grown Unpopular

A shareholder rights plan is not designed to prevent hostile takeovers. Rather it allows directors of a target the time necessary to evaluate alternatives in order to maximize value. The extra time simply provides directors with leverage. After several judicial rulings affirmed their validity, shareholder rights plans were quickly recognized as a legitimate and effective anti-takeover device. U.S. public companies adopted rights plans in increasing numbers during the late 1980s and throughout the '90s. In spite of—or maybe because of—their effectiveness, corporate governance watchdogs and activist institutional investors increasingly opposed rights plans in the years following the collapse of Enron and the adoption of Sarbanes-Oxley.

Because of that opposition, many companies have simply permitted their rights plans to expire (most have a 10-year term) and some terminated their rights plans. The number of U.S. companies with rights plans has declined from more than 2,200 in 2001 to a relatively small number today.

Given the recent upswing in merger activity, unsolicited bids will likely become more frequent. Even though most U.S. companies no longer have a shareholder rights plan in place, many are poised to pull them off the shelf at the first sign of a hostile bidder. After all, an unwelcome takeover offer will require the boards of directors of target companies to consider their options. And boards can typically implement poison pills without shareholder approval.

Threat: Rapid Shareholder Base Shift

Whatever position institutional shareholders may hold in a particular company before a bid is launched, their position—and the leverage that comes with it—increases once an unsolicited acquisition proposal becomes public. A target company's shares often move rapidly from its traditional, long-term shareholders into the hands of arbitrageurs, hedge funds, and other short-term holders seeking to profit on the spread between the offer price and the current trading price. From the perspective of these holders, the faster a deal is done, the greater their return on investment.

Faced with a rapidly changing shareholder base that is pushing for a quick deal, directors often come under intense pressure to negotiate or capitulate. Despite the pressure, the fundamental fiduciary duty of boards of directors means that they must act in the best interests of all shareholders. Target-company boards must ensure that despite the pressure resulting from a rapid change in shareholder base, the company does not get sold at less than full value. The proper use of takeover defenses, consistent with the board's exercise of its fiduciary duties, should successfully enable the board to reject an inadequate price or to negotiate a price that represents a full and fair value for the company.

While not every unsolicited proposal should be accepted simply because its offer price is at a premium to the target's pre-offer share price, neither should every unsolicited proposal be summarily rejected on the basis that the offer is "hostile." Every change-of-control proposal, solicited or unsolicited, requires a thorough evaluation by the board of directors, taking into account all appropriate considerations. Management and directors of a company on the receiving end of an unexpected takeover bid must become immediately—and thoroughly—engaged in the process in order to achieve a resolution that is in the best interests of the company and its shareholders. After all, "unexpected" does not always mean "negative." When opportunity knocks, sometimes it can be a nice surprise.

Aquila is a partner in the Mergers & Acquisitions Group of Sullivan & Cromwell LLP.

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