In a tale of what is old is new again, the Delaware Court of Chancery reviewed the propriety of a poison pill — a bulwark of the 1980s takeover era — but in the context of shareholder activism against the backdrop of the COVID-19 pandemic. Vice Chancellor Kathaleen McCormick’s detailed review of the pertinent case law and fact-specific decision to permanently enjoin The Williams Companies, Inc.’s extraordinary 5% poison pill offers a number of lessons for directors considering the adoption or renewal of a similar device. The Williams Cos. S’holder Litig. (Del. Ch. Feb. 26, 2021).

In March 2020, as the COVID-19 pandemic was tightening its grip on the United States, the company implemented a stockholder rights plan, or poison pill, with what the Court called an “extreme, unprecedented collection of features”:

• a 5% trigger;
• a definition of “acquiring persons” that captured derivative interests like warrants and options;
• an “acting in concert,” or “wolfpack,” provision that expanded the plan’s trigger further to aggregate the parallel activities of stockholders; and
• an unusually limited “passive investor” exemption.

The company’s board of directors adopted the plan after two meetings in mid-March 2020 (having had a rights plan “on the shelf” and being last briefed on the plan in October 2019), but litigation revealed that most directors had not considered the plan’s features other than the 5% trigger and did not receive a draft of the plan before deciding to adopt it. Although poison pills were originally developed as a tool to help a board address a known threat of a takeover or rapid accumulation of shares, the Williams board acted preemptively (i.e., in the absence of a particular threat). The board was concerned that the company’s stock price decline due to the pandemic and oil price volatility might encourage shareholder activism or other attempts to opportunistically purchase substantial influence or even control.

While the Court noted that the board’s process was “less than perfect,” it was not the process that led the Court to enjoin the pill. To the contrary, the Court found that the board was composed largely of independent, outside directors who conducted a good faith and reasonable investigation under the circumstances. Rather, the Court determined that the pill’s terms and the circumstances in which it was deployed fell short of the board’s obligations under the Unocal line of cases. Unocal is a situationally-specific form of enhanced scrutiny, that requires a board to satisfy a two-prong test to defend the propriety of a defensive measure. First, the board must show it had reasonable grounds “to conclude a threat to the corporate enterprise existed.”  Second, the board must show that the defensive measure was “reasonable in relation to the threat posed.”

It is noteworthy that the Court applied the Unocal level of scrutiny to the adoption of the pill, rather than a decision of the board not to dismantle or redeem the pill, noting the entrenchment effect of any pill by its nature. Although it is true that since Moran v. Household International, Inc., Delaware courts have subjected stockholder challenges to pills to intermediate scrutiny under Unocal, the Williams pill was adopted on a “clear day” and not in response to a specific activist or hostile takeover threat.

The Court concluded for purposes of the first Unocal prong that the board was not acting in response to any specific threat but rather was acting “pre-emptively to interdict hypothetical future threats.” The evidence suggested the board’s concerns encompassed a desire to prevent activism while the company’s stock price was depressed; the parallel threat of short-termism prevailing or distracting management; and finally that the pill would act as an early warning device if any stockholder acquired 5% or more of the company’s stock. None of these passed muster; the first two were rejected because they were purely speculative and not cognizable threats. As for the third, the Court assumed for purposes of its analysis (but did not hold) that a pill could provide a company with early warning of an accumulation of stock. Here the parties focused on a hypothetical “lightning strike” attack, in which an insurgent rapidly and stealthily continues to accumulate a large stake after crossing the 5% threshold for Schedule 13D filings, but no public disclosure is made until the 10-day deadline under the applicable federal securities laws.

In turning to the second Unocal prong, the Court found that the pill was not reasonable in relation to the assumed threat (the “lightning strike”). For starters, the Court held that a 5% trigger for a “regular” poison pill (i.e., excluding tax NOL pills) was practically without precedent. The sole other company to adopt such a plan did so “in the face of a campaign launched by an activist who owned 7% of the company’s outstanding shares.” Each of the other 20 plans adopted in the three weeks following the company’s had a higher threshold. And the Court went on to note that the plan’s other features exceeded what would be necessary to foreclose the lightning-strike attack.

Another problematic term in this regard was the Williams pill’s aggregation of the holdings of stockholders “acting in concert” without an express agreement. Vice Chancellor McCormick was highly critical of the company’s wolfpack provision, characterizing it as the “primary offender” and “the most problematic aspect of the Plan” (more so than the 5% trigger). The wolfpack provision in the Williams rights plan applied to persons acting in concert or in parallel or towards a common goal “relating to changing or influencing the control of the Company” where “at least one additional factor supports a determination by the Board that such Persons intended to act in concert or in parallel, which additional factors may include exchanging information, attending meetings, conducting discussions, or making or soliciting invitations to act in concert or in parallel,” with certain exceptions. This broad definition of “acting in concert” exceeds reporting requirements pursuant to the federal securities laws (which require an agreement). It was then coupled with a “daisy chain” clause, which further expanded the provision’s reach by aggregating stockholders even if they were unknown to each other. The Court took issue with the provision’s language, arguing that the board could misuse its power and trigger the rights plan in response to routine and innocuous stockholder communications and activities (e.g., attending the same investor conferences or advocating for the same shareholder proposals or corporate actions). The Court also took issue with how the Williams pill attempted to restrict stockholder communications and nominate directors. Williams suggests that Delaware courts will scrutinize carefully wolfpack provisions that potentially discourage legitimate interaction among stockholders. If a company’s board determines that a wolfpack provision is necessary and proportionate in response to a threat the company faces, it should be sure that the provision is drafted clearly and narrowly to minimize litigation risk.

The Williams decision should not wholesale deter boards from deploying a poison pill with features that are reasonable and proportionate in response to a cognizable threat. However, directors considering a poison pill should be mindful of and discuss at least the following with their counsel:

• ensuring adequate deliberation and discussion of the plan and its specific features prior to approval — preferably, over multiple meetings and with the benefit of review of all pertinent documents;
• memorializing the specific, non-hypothetical threat(s) to which the board is reacting;
• considering how the plan’s features, including its trigger threshold, compare with judicial precedents and market practice; and
• discussing how the plan and each of its features is tailored to the identified threat(s) to build the record for any subsequent judicial review pursuant to

Additional, more general, takeaways from the Williams decision include:

• another reminder not to include in board agendas allotted periods of time for specific items — the Court specifically called out how much time the agenda provided for specific items and even compared the fact that one agenda assigned 40 minutes to the rights plan and 20 minutes to the discussion of whether to hold the annual meeting virtually;
• that it is better to err on the side of sending the board too many materials than too few materials — it is important that directors receive copies of the agreements they are being asked to approve and, where appropriate, summaries of the key terms of those agreements; the Williams opinion notes that the Williams board did not receive a copy of the rights plan before the board approved it and that most of the directors admitted that they had not read the plan’s key features until after the litigation began;
• that it may not be ideal for management to take the lead presenting to the board on highly specialized topics like rights plans — while the Court did not specifically criticize this, it did note that “aspects of the process were less than perfect” and that the CEO and GC delivered the rights plan presentation (although outside counsel and financial advisors were in attendance); notably, while the decision quotes the financial advisor, it does not mention that representatives of outside counsel even spoke during the meeting; and
• another reminder to exercise caution in emails and notes — the Court cites emails between the company and its counsel regarding the activism threat in advance of the pill adoption, and the opinion quotes the CFO’s notes.

This post comes to us from Sidley Austin LLP. It is based on the firm’s memorandum, “Back to the Future: New Lines Drawn for Poison Pills,” dated March 25, 2021 and available on Sidley Austin’s Enhanced Scrutiny blog here.