Editor’s Note: A counter-response immediately follows this post.

In a recent post, Professor Jeffrey N. Gordon argued that the Delaware Supreme Court should upend over three decades of precedents and apply Blasius, rather than Unocal, to invalidate a corporate board’s adoption and implementation of a poison pill.[1]  I disagree.  Doing so is neither necessary, nor justified, to uphold the Chancery Court’s determination that a particularly aggressive poison pill, adopted by The Williams Companies in March 2020, was not a reasonable response to potential activist threats under Unocal.[2]  Gordon’s post also misinterprets some of the history and operation of the poison pill.  I argue that Unocal remains the appropriate legal standard of review for board adoption and implementation of shareholder rights plans.

Poison Pills and “Discrimination Against Shareholders”

First, Gordon states that in approving the poison pill in the Household case in 1985, the Delaware Supreme Court “permitted the discrimination against a shareholder that is the heart of a pill.”[3]  However, the original flip-over rights plan that Household adopted was not discriminatory, as it did not void the rights held by the shareholder who triggered those rights (the “Acquiring Person”).[4]  If the Household rights were triggered, all shareholders, including the Acquiring Person, would be able to exercise them.  The dilution that would arise in a flip-over following a merger after the rights were triggered would be dilution of the shareholders of the other party to the merger, as the holders of rights (including the Acquiring Person) would be able to acquire stock of the surviving company at a 50 percent discount.  The plaintiff in Household argued that the Delaware General Corporation Law (“DGCL”) did not authorize the issuance of a rights plan, that the board impermissibly usurped the stockholders’ rights to receive hostile tender offers through adoption of the rights plan, and that the board was unauthorized to restrict stockholders’ rights to conduct a proxy contest.  The plaintiff did not argue that the rights plan constituted invalid discrimination.  In Household, the Delaware Supreme Court cited its recent Unocal decision for the proposition that the business judgement rule should be applied to assess the validity of defensive measures adopted by the board, as long as those measures were reasonable in relation to the threat posed – regardless of whether the particular defensive measures were discriminatory (as in Unocal) or not (as in Household).[5]

Flip-over rights plans deterred hostile bidders seeking to acquire 100 percent of a target through a merger; the subsequent development of flip-in provisions accelerated the dilutive event to the acquisition of a specified ownership threshold, increasing the effectiveness of the poison pill against a broad range of takeover tactics.  To be effective, flip-in provisions needed to include discriminatory provisions against the Acquiring Person.  In a flip-in, an Acquiring Person’s rights are voided upon crossing the triggering threshold, but all other shareholders are able to exercise their rights (or, if the board exercises the exchange provision and issues one share of common stock for each outstanding right, the company effectively pays a 100 percent stock dividend to every shareholder except the Acquiring Person).  This discriminatory feature is fundamental to a flip-in: Without voiding the Acquiring Person’s rights, the triggering event would have the effect of only a highly discounted common stock rights offering (or a 100 percent stock dividend), without dilution to the Acquiring Person.

Providence & Worcester Co. v. Baker,[6]  which involved a challenge in 1977 to a charter provision providing for lesser voting rights for holders of shares over a specified threshold, established a precedent that would help to validate the discriminatory feature of flip-in provisions.  The plaintiff in Providence & Worcester contended that, under DGCL “151(a) it is mandatory that all shares of stock within the same class have uniform voting rights” – a requirement that it argued was violated by Providence & Worcester’s charter provision.  However, the Delaware Supreme Court agreed with the company that the charter restrictions “are limitations upon the voting rights of the stockholder, not variations in the voting powers of the stock per se.”[7]

A Michigan federal court in 1986 applied the principles from Providence & Worcester in upholding the validity of flip-in provisions, reasoning that “a rights plan does not discriminate among shares, but, rather, among shareholders, which is not forbidden.”[8]  In 2010, the Delaware Supreme Court in Selectica upheld a flip-in rights plan and the exercise by the board of the exchange provision that discriminated against the Acquiring Person.[9]

Courts in several other states initially invalidated flip-in plans in the late 1980s based on this discriminatory feature, as they did not accept the distinction in Providence & Worcester between discrimination among shareholders and discrimination among shares.  For example, in Bank of New York Company, Inc. v. Irving Bank Corporation,[10] a New York state court enjoined a flip-in provision because of a statutory provision that “each share shall be equal to every other share of the same class.”[11]  The court held that the flip-in provision impermissibly discriminated among shareholders of the same class.[12]  By 1990, in every state in which a court had enjoined a flip-in provision under state law, the state’s corporate statutes were amended to  validate flip-in provisions.[13]

The Origins of the Pill

Second, Gordon identifies two critical elements that were “ingeniously combined” in the original poison pill: (1) the use of the DGCL provision authorizing boards to issue rights to purchase shares,[14] and then to describe the terms of “blank check” preferred stock,[15] and (2) “the just-inaugurated (in Unocal v. Mesa Petroleum) power of the board to adopt defensive measures that would discriminate against a shareholder who made an unwanted bid.”[16]

As to the first element, while I agree with Gordon that the board’s ability to issue rights was important to the pill, the critical related provision was not the board’s ability to prescribe the terms of blank-check preferred stock.  It is not necessary that a rights plan incorporate preferred stock; indeed, companies without authorized blank-check preferred stock have adopted poison pills that issue rights to acquire common stock.[17]

The substantial majority of rights plans are preferred stock rights agreements because the ability to create a “common-equivalent” security that is 1/100 (or 1/1000) of a preferred share means that the company need only have available and reserve for issuance a number of authorized but unissued preferred shares equal to 1/100 (or 1/1000) of the number of outstanding common shares at the time of adoption.  By contrast, if a company that does not have authorized preferred stock adopts a common share rights agreement, it typically reserves a number of shares of authorized but unissued common stock equal to the number of outstanding shares of common stock.  That significantly limits the ability of the company to issue common stock for stock splits, acquisitions, or other corporate purposes unless it obtains shareholder approval to increase its authorized common stock.

Further, the board’s ability to prescribe the terms of preferred stock is not a critical element of a rights plan because the threat of dilution from a poison pill derives not from the potential issuance of the preferred stock underlying the rights (which have an exercise price that is far out of the money at the time of adoption), but from the ability of rights-holders to acquire common stock of the acquirer (in a flip-over) or issuer (in a flip-in) at a substantial discount.

The other component of the first element that was truly critical was issuing rights that, in the event of a merger following a triggering acquisition, entitle the holders to purchase another corporation’s capital stock – to “flip over” – at a substantial discount.  This provision provided the “poison” in the flip-over poison pill, and was perhaps the most important – and most controversial – feature of the flip-over pill invented by Martin Lipton.  The flip-over drew from the analogy to customary anti-dilution clauses in convertible securities, which adjust the conversion right following mergers in which the common stock is exchanged for securities or other consideration. The Household court upheld the validity of this provision by analogizing it to customary corporate finance instruments.[18]

The second element of the rights plan that Gordon cited as ingenious (the application of the Unocal test) overlooks that the pill was invented, and then adopted by a number of companies, including Household International, before the Unocal case was decided.  Six years before Unocal, when courts were inconsistent in applying the business judgment rule to particular defensive tactics, Lipton wrote in his seminal article, “Takeover Bids in the Target’s Boardroom,” “Where the directors have made a reasonable good-faith decision to reject the takeover on one or more of the bases set forth above, the business judgment rule should apply equally to any and all defensive tactics.”[19]  The critical second element of the original poison pill was that the business judgment rule would be applied to the adoption of the rights plan, as Lipton anticipated in 1979 with respect to “any and all defensive tactics,” and as confirmed by the Household court, relying on the standard expressed in Unocal.  Furthermore, a critical element of the original rights plan was not “the ability to adopt defensive measures that would discriminate against a shareholder who made an unwanted bid,” as the flip-over rights plan was not discriminatory, as discussed above.

Legal Standard of Review for Anti-Activist Pills

Third, I believe Gordon’s discussion of judicial review of the “anti-activist pill” goes too far.  It fails to consider the 2014 case involving Third Point’s activist campaign against Sotheby’s,[20] and falls short in its argument that, after 36 years of applying Unocal to the adoption of poison pills, the Delaware courts should apply Blasius to “anti-activist pills.”

Third Point involved a challenge to a rights plan that would be triggered by a 10 percent acquisition for stockholders who filed a Schedule 13D, but a 20 percent threshold for stockholders who filed a Schedule 13G.  Third Point, which owned 9.6 percent of Sotheby’s shares, sought a waiver from the 10 percent threshold to allow it to acquire up to 20 percent of Sotheby’s shares, and sued to enjoin the pill when Sotheby’s declined to grant the waiver during a proxy fight that Third Point was waging.  The court held that “it is settled law that the Board’s compliance with their fiduciary duties in adopting and refusing to amend or redeem the Rights Plan in this case must be assessed under Unocal.”[21]  While the court considered whether Blasius would be implicated within the Unocal framework in this case, it concluded that there was no Delaware case that had invoked Blasius to examine a rights plan.[22]  The court declined to grant an injunction against the pill, finding that the board reasonably concluded that Third Point’s actions constituted a threat of “creeping control,” that the 10 percent threshold was neither preclusive nor coercive, and that the adoption of the rights plan and the refusal to grant a waiver were proportionate responses to the threat under Unocal.[23]

The Chancery Court in The Williams Companies case similarly determined that it is “settled law” that Unocal was the appropriate standard to assess the board’s adoption of a poison pill and its refusal to redeem it.[24]  The court held that the company’s adoption of a pill with an unusually low 5 percent triggering threshold,[25] together with an overly broad “acting in concert” provision with limited exceptions, was not a proportionate response to the perceived threat, and enjoined the pill.  There was no need or precedent for the court to apply the “compelling justification” standard under Blasius to rights plans.

Indeed, as the late Chancellor William Allen, the Blasius author himself, has written, Blasius is not so much a standard of review as a response triggered by intentional disenfranchisement.[26]  By contrast, the Unocal two-prong test exposes whether the motives underlying a defensive measure are legitimate and whether the measure is reasonable.  Thus, the Chancery Court has properly applied Unocal to strike down actions that unreasonably intruded upon stockholder voting rights in some cases, while in others finding that voting schedule adjustments, poison pills, and other defensive actions were reasonable measures.[27]  When applied properly, as in The Williams Companies, the Unocal test addresses the concerns that Gordon seeks to use Blasius to remedy.

Like Gordon, I would not be surprised to see the Delaware Supreme Court agree with the Chancery Court’s analysis and holding.  Wachtell, Lipton, Rosen & Katz issued a memorandum shortly after the adoption of the 5 percent pill by The Williams Companies, stating that our firm generally did not recommend that companies adopt poison pills with thresholds below 10 percent except in limited circumstances such as companies with valuable tax assets that could be adversely affected by acquisitions of 5 percent of a company’s shares, which adopt an “NOL pill” at a 4.99 percent trigger.[28]  In upholding the NOL pill adopted by Selectica, the Delaware Supreme Court cautioned that “[t]he fact that the NOL Poison Pill was reasonable under the specific facts and circumstances of this case, should not be construed as generally approving the reasonableness of a 4.99% trigger in the Rights Plan of a corporation with or without NOLs.”[29]  This cautionary language regarding future pills with 5 percent triggers cited Unitrin’s framing of the Unocal test.[30]  I see no reason for the Delaware Supreme Court, in considering the appeal of an injunction against a 5 percent non-NOL pill in The Williams Companies, to change decades of rights plan jurisprudence to now apply Blasius, rather than Unocal, as the appropriate standard for considering rights plans.

ENDNOTES

[1] See Jeffrey N. Gordon, Corporate Vote Suppression:  The Anti-Activist Pill in The Williams Companies Stockholder Litigation, Colum. L. Sch. Blue Sky Blog (Aug. 19, 2021), https://clsbluesky.law.columbia.edu/2021/08/19/corporate-vote-suppression-the-anti-activist-pill-in-the-williams-companies-stockholder-litigation.

[2] See Williams Cos. Stockholder Litig., No. 2020-0707-KSJM, 2021 WL 754593, at *40 (Del. Ch. Feb. 26, 2021).

[3] See Gordon, supra note i, n.27; see also Moran v. Household Int’l, Inc., 500 A.2d 1346 (Del. 1985).

[4] See Household Int’l, Inc. & Harris Trust & Sav. Bank, Rights Agreement Dated as of August 14, 1984 (1984), https://www.law.upenn.edu/live/files/7385-a.

[5] See Household, 500 A.2d at 1356.

[6] 378 A.2d 121 (Del. Sup. Ct. 1977).

[7] Id. at 123.

[8] Harv. Indus., Inc. v. Tyson, No. 86-CV-74639-DT, 1986 U.S. Dist. LEXIS 17258, at *3 (E.D. Mich. Nov. 25, 1986).

[9] See Versata Enters. v. Selectica, Inc., 5 A.3d 586 (Del. 2010).

[10] 142 Misc. 2d 145 (N.Y. Sup. Ct. 1988).

[11] Id. at 147.

[12] See also, e.g., Amalgamated Sugar Co. v. NL Indus., Inc., 644 F. Supp. 1229 (S.D.N.Y. 1986) (enjoining flip-in provisions as discriminatory).

[13] See Eric S. Robinson, John C. Coates IV & Mitchell S. Presser, State Takeover Statutes:  A Fifty State Survey (1989) (on file with the author); see also, e.g., N.Y. Bus. Corp. Law § 505(a)(2); N.J. Rev. Stat. § 14A:7-7.

[14] See Del. Gen. Corp. L. § 157(a).

[15] See Del. Gen. Corp. L. §§ 151(a), (g) (governing board authority to specify terms of a new class of stock).

[16] See Gordon, supra note i (footnote omitted).

[17] See, e.g., Quality Sys., Inc., Current Report (Form 8-K) (Dec. 5, 1996), Ex. 3 (summarizing rights to common stock under the newly-adopted shareholder rights plan).

[18] See Moran v. Household Int’l, Inc., 500 A.2d 1346, 1351 (Del. 1985).

[19] Martin Lipton, Takeover Bids in the Target’s Boardroom, 35 Bus. Law. 101, 124 (1979).

[20] See Third Point LLC v. Ruprecht, 2014 WL 1922029 (Del. Ch. 2014).

[21] Id. at *15.

[22] See id.

[23] See id. at *17.

[24] Williams Cos. Stockholder Litig., No. 2020-0707-KSJM, 2021 WL 754593, at *21 (Del. Ch. Feb. 26, 2021).

[25] The typical triggering threshold for rights plans is between 10 and 20 percent, other than companies with substantial net operating losses where a 5 percent trigger is necessary to serve its objective.

[26] See William T. Allen, Jack B. Jacobs & Leo E. Strine, Jr., Function Over Form:  A Reassessment of Standards of Review in Delaware Corporation Law, 56 Bus. Law. 1287, 1312 (2001).

[27] Compare, e.g., Williams, 2021 WL 754593 (applying Unocal to invalidate a poison pill), with, e.g., Yucaipa Am. All. Fund II, L.P. v. Riggio, 1 A.3d 310 (Del. Ch. 2010) (applying Unocal to uphold a poison pill as a reasonable and proportional response to a legitimate threat), and Mercier v. Inter-Tel (Del.), Inc., 929 A.2d 786 (Del. Ch. 2007) (applying Unocal to uphold the board’s delay of a stockholder vote in light of new material information that stockholders should consider).

[28] See David Katz & Sebastian V. Niles, Rights Plans (“Poison Pills”) in the COVID-19 Environment—“On the Shelf and Ready to Go”?, Harv. L. Sch. F. on Corp. Governance (Apr. 2, 2020), https://corpgov.law.harvard.edu/2020/04/02/rights-plans-poison-pills-in-the-Covid-19-environment-on-the-shelf-and-ready-to-go.

[29] Versata Enters. v. Selectica, Inc., 5 A.3d 586, 607 & n.52 (Del. 2010).

[30] See id.; see also Unitrin, Inc. v. Am. Gen. Corp., 651 A.2d 1361, 1378 (Del. 1995) (citing Moran v. Household Int’l, Inc., 500 A.2d 1346, 1355 (Del. 1985) and Revlon, Inc. v. MacAndrews & Forbes Holdings, Inc., 506 A.2d 173, 179 (Del. 1986)).

This post comes to us from Eric S. Robinson, of counsel at the law firm of Wachtell, Lipton, Rosen & Katz.  Courtney D. Hauck, a law clerk at the firm, assisted in preparing the post.