The Enduring Illegitimacy of the Poison Pill

Late last year, in Leonard Loventhal Account v. Hilton Hotels Corp., the Delaware Supreme Court relied on the doctrine of stare decisis to reaffirm the central holding of Moran v. Household International, Inc.,2 a 1985 decision that upheld the validity of the poison pill. While the court had reaffirmed and even extended the Moran holding on a few previous occasions,3 its specific and aggressive invocation of stare decisis in Leonard Loventhal Account can only be seen as a signal that the Delaware Supreme Court considers the legitimacy of the poison pill to be a settled matter. The poison pill is the ultimate defense against a hostile takeover.4 It can be IMAGE FORMULA5implemented quickly and easily.5 It has no immediate negative effect on the company.6 And, while in place, it is an absolute barrier to the consummation of a hostile takeover.7 The only way to counter a poison pill is to have it removed, which is easier said than done. From management's perspective, the poison pill is almost too good to be true. The poison pill operates in a fairly simple manner.8 A company's board of directors adopts a "Shareholder Rights Plan" pursuant to which a dividend of one "Right" is declared on each share of common stock. Each Right is attached to, and not tradable separately from, its corresponding share. Initially, the Rights are essentially meaningless. However, if certain specified events occur, such as the acquisition by a hostile bidder of more than a specified percentage of the company's shares, the poison pill is triggered. Once triggered, the Rights would detach from the shares and entitle all of the target company's shareholders, other than the hostile bidder, to acquire securities at a discount. The type of securities that may be acquired depends upon the type of Rights. "Flip-over" Rights allow the holders to purchase shares in the acquiring company under certain circumstances,9 "flip-in" Rights allow the holders to purchase shares of the target company,10 and "back-end" Rights entitle the holders to acquire debt securities or other assets. I These discriminatory rights would severely dilute the hostile bidder's interest in IMAGE FORMULA7the target company. To avoid this dilution, the bidder must refrain from exceeding the threshold ownership level that would trigger the poison pill. The poison pill derives its effectiveness from this deterrence value--the incumbent management can remain in power because the hostile bidder cannot afford to trigger the poison pill.12 There are only three known ways around the poison pill. The first is to negotiate a friendly transaction with the target company. This is possible because the Rights are redeemable by the target company's board of directors until the poison pill is triggered.13 If a friendly arrangement can be reached, the poison pill Rights can be redeemed and the takeover can continue. However, this is little more than a phantom option; if a friendly transaction were feasible, a hostile bid would not have been necessary.14 A second way around the poison pill is to persuade the courts that the target company's board of directors is breaching its fiduciary duties by refusing to redeem the poison pill Rights. If this can be done, the court may order the company to redeem the Rights and allow the takeover to continue. However, courts are not easily persuaded. The target company can often develop a plausible rationale for resisting the hostile takeover in the interests of its shareholders. Despite the obvious benefits to shareholders, who would prefer to sell their shares at an often substantial premium to market price, courts are hesitant to second-guess the business judgment of directors. 15 Thus, the courts tend to permit the target company's directors to resist hostile takeovers, by means of the poison pill or otherwise. The third way around the poison pill is to launch a proxy contest to remove the target company's board of directors and replace them with a more sympathetic group. …